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The US president Donald Trump has repeated said that China will pay for the tariffs he has or plans to impose on Chinese goods entering the US. Many commentators has said that tariffs are paid at time of import by the importer, and that those costs are simply passed onto the consumer.

What would be the consequences if, instead of adding a tariff cost to the item being imported, the US Government instead deducted the same amount from the US debt that the Chinese Government owns? This would make it literally true that the Chinese are now paying for the trade deficit, and it would automatically stop once the Chinese no longer own US debt.

Besides making lenders extremely wary of buying US debt, what could be the economic repercussions from such a decision?

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    $\begingroup$ I'm voting to close this question as off-topic because this is extremely unlikely to happen and invites speculation. $\endgroup$ – Giskard May 16 '19 at 16:47
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    $\begingroup$ My guess is that an immediate consequence would be the US government contracting a Chinese subcompany of Apple (or any other company with foreign cash reserves) to sell them \$10 trillion in exchange for \$11 trillion. The company gains \$ 1 trillion, and the US can write off $25\% \cdot \$ 10$ trillion in debt. $\endgroup$ – Giskard May 16 '19 at 16:49
  • $\begingroup$ Where is the correct place to ask questions seeking speculative answers? $\endgroup$ – TeckFudge May 16 '19 at 17:15
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the US Government instead deducted the same amount from the US debt that the Chinese Government owns

That would be equivalent to a partial sovereign default of the US: we don't like you, therefore our bonds you own are now worth less/crap.

More technically, it would be a repudiation of (some) sovereign debt:

Repudiation happens when the sovereign rejects its obligation to pay, which could happen before or after any payment is due. Governments typically avoid questioning the validity of their debts, or announcing their intention not to pay before missing a payment, since in practice, repudiation carries all the traumatic consequences of payment default [...]. Repudiation may go hand in hand with governments questioning the legitimacy of one or more obligations. The literature on “Odious Debt” includes a handful of examples (King 2016, Lienau 2014). In 2008, Ecuador claimed that two bonds issued by a previous government were illegitimate and pledged not to pay them. It launched a buyback offer the following year in the shadow of the illegitimacy claim, and ultimately secured nearly 2/3 debt relief with more than 90 percent of the creditors participating.

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Repudiation [...] is rare in modern times. Repudiations most often occur after a regime change, and examples of repudiations include those in the wake of communist revolutions—such as Russia in 1917, China in 1949, and Cuba in 1960; Rhodesia in 1965, after its unilateral declaration of independence from the United Kingdom; Zaire in 1979; Ghana in 1979 and 1982; and North Korea in 1976.

Repudiation can go hand-in-hand with the concept of “odious debt,” which posits that a government is not obligated to pay for those debts incurred by a previous government contrary to the interests of the public. Though, the concept has strong moral appeal, it is difficult to define odious debt in a sufficiently limited way to allow its practical application (Reinhart and Rogoff 2009). The doctrine has not gained traction with arbitrators, courts, or credit rating agencies (Gelpern 2007; Blair 2014) and, the earlier example of Ecuador aside, states tend not to assert it explicitly.

As for effects, that's harder to predict. China would probably accelerate its sales of US treasuries, since the US move you propose is not going to impact all their holdings at once. The sooner they would sell, the fewer losses they would incur over time from the proposed US tax-like measure. On the other hand, selling too much too soon would hurt them too by dropping the price too much.

Russia substantially reduced its holding of US treasuries in 2018, presumably just based on fears:

Between March and May, Russia's holdings of US Treasury bonds plummeted by $81 billion, representing 84% of its total US debt holdings. [...]

"One theory is that this was Russia's revenge for US sanctions," said [Jason ] Bush [an analyst at consulting firm Eurasia Group].

Another theory is that Moscow feared further US sanctions that could cause its holdings of US debt to be frozen or even seized.

The Russian side didn't acknowledge this explicitly, but their central baker said something like

Russia assesses "all the risks: financial economic and geopolitical."

Russia however held a lot fewer US treasuries, only around 1/12 of China's even at their peak holdings. So Russia could sell the bulk of theirs relatively quickly.

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  • $\begingroup$ This is exactly what I was trying to figure out. Repeated, partial sovereign default makes so much sense. Thank you! $\endgroup$ – TeckFudge May 16 '19 at 18:24
  • $\begingroup$ Russia sold US bonds in bulk between March and May 2018, not this year. $\endgroup$ – Giskard May 16 '19 at 22:39
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    $\begingroup$ @Giskard: for some definition of "recently" ;-) I've replaced it with the exact year... $\endgroup$ – Fizz May 16 '19 at 22:40
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Repeated, partial sovereign default makes so much sense.

It's important to understand regarding default that it's a one-time decision. Announcing default for the future is announcing in the present. If everybody know a bond is going to be paid 80 instead of 100 promised, it won't exchange as 100 in the market, that's why it's current value decreases.

And, economists generally don't consider sovereign default very lightly. By devaluating sovereign assets, the obligation market would crunch, and liquidity with it. In the same time, to counter the problem of lenders refusing to lend to a "bad student" (and lacking liquidity to do so anyway), the US would have to raise taxes or cut spending to compensate for deficit and/or borrow at high rates. Even for a small default

Consequences could be like a 2008 scenario : liquidity crisis, banks refusing to lend, company have harder time to access credit, lower growth, and ultimately consequences on employment and purchasing power, across all countries having invested directly or indirectly in US treasure. Moreover, the US would have screwed at a diplomatic level, opening itself for retaliation.

In comparison, it makes much more sense to simply raise taxes to address debt. The end result are the same, the taxpayers will get less, but this is much more controlled, and politically much easier to support.

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