I was listening to a podcast featuring Michael Lewis (author of Flashboys and Moneyball), who mentioned a black swan scenario where the administration would threaten to selectively not pay its Treasury bond obligations to China. If this were to be, I understand it would undermine confidence in the global economic system, but I am unable to anticipate exactly what the concrete results would be.
the administration would threaten to selectively not pay its Treasury Bond obligations to China
What exactly would a default trigger?
Selective default would be ineffective and it could backfire.
It would be ineffective because, at any point in time, a treasury bond has the same value regardless of who holds it. If the USA disavows its obligations toward China, clearly the top holder of US Treasury securities, China might opt to get rid of its holdings. China's move would predictably disrupt the bonds market due to the arbitrage opportunities that will ensue.
Selective default would backfire in two ways. Most certainly, the Treasury would attract fewer funds in the next round(s) of US bonds because the market would be "flooded" with the bonds of which China is getting rid.
The other way in which it could backfire is that selective default against China will make other countries wary of they themselves becoming the target of a subsequent selective default. Since no creditor likes the prospect of its holdings being singled out for default, there is a realistic chance that each country would decide to dump its holdings as well, and lead to a domino effect. That reaction is likelier now with the increasing efforts to replace the US as the "official" currency for international settlements (such as in oil or currency markets).
It would lead to a collapse of the global trading system.
It's hard to believe that in such a scenario, China would continue to accept dollars for goods. This will lead to the renminbi becoming a major reserve currency, as countries will now be expected to pay for their goods in renminbi and also to receive renminbi for their commodities. This would end the petrodollar, and the use of dollars for settlement of commodity trades in general, as China is the largest buyer of commodities. US-China trade will probably drop to zero, and that will mean shortages, inflation and economic depression.
