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China has the ultimate weapon in trade war with US

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Commerce Secretary Wilbur Ross said something the other day that was either right on the mark or profoundly stupid.

Only time will tell which it is.

Ross said that China was “out of bullets” in the trade war that the Trump administration escalated this week by placing another $200 billion in tariffs — basically taxes — on Chinese goods entering the US.

What Ross meant was that, since China sends more of its goods to the US than we send to China, a tit-for-tat trade battle would ultimately be won by the US. We can tax more of their goods than they can of ours.

Put in Ross’ words, we can fire more tariff bullets at them than they can at us.

President Trump’s strategy isn’t a secret: Squeeze China until it is willing to negotiate a fairer deal that will reduce the $375 billion trade deficit that the US had with China last year and play fairer when it comes to intellectual property.

Bravo! How can you argue with the intent of that if you are an American?

If the US can alter the trade imbalance with China (and the other countries Trump is fighting with), it will mean more jobs for Americans, more business for our companies and another star on the report card of the Trump White House that already is acing — for the time being, at least — economics even if it is failing in the area of conduct.

But there’s a bigger issue here that I would be careless in ignoring.

If Ross is right on the bullets issue of the trade war, does that mean China will have to resort to using its financial missiles to combat what Trump is doing?

And by that I mean the $1.171 trillion in US securities that Beijing owned as of July.

What if the Chinese decided to sharply reduce their holdings in US debt? What if Beijing decided to launch a few financial missiles by either selling down their holdings of US Treasuries — or simply not buying any more? A little missile that could still do a lot of damage would be China simply threatening publicly to sell US debt, something that has been hinted at before.

That would certainly get Wall Street’s attention.

First, let me say that there is a school of thought that believes this will never happen. Why? Because by just threatening to sell US securities in a large amount — or by actually doing so — the Chinese would cause the value of US bonds to fall and interest rates to climb here and throughout the world.

And the Chinese, who hold so much of that US debt, would take heavy losses. Plus, the higher interest rates would make it harder for the Chinese to finance their own country’s deficit.

In other words, the optimists in this trade war say that the Chinese may have financial missiles — but that they can’t launch them at the US.

So what happens if today the Chinese decide to become irrational because they are out of bullets? What if they start selling loads of US government bonds?

If that happens, Washington will have to either a) severely cut back its spending so that we don’t need the money the Chinese are giving us through bond purchases or (b) find other buyers of our debt.

Since Washington never cuts spending, the second choice is probably the best option. But where can other customers be found?

Japan is the second-biggest buyer of US debt, but Tokyo owns only a little more than $1 trillion worth. And Japan’s economy isn’t in great shape, so it can’t afford to send more capital abroad.

The next-biggest US government-bond holder, if you can believe it, is Ireland with only $300 billion worth. OPEC nations are small-time investors in our bonds: Saudi Arabia has $167 billion, United Arab Emirates $60 billion and Kuwait $43 billion. So oil money from abroad isn’t going to do the trick.

And if the US is going to lure other countries to invest in our debt, the bonds will have to be made more attractive. That’s another way of saying that interest rates will have to rise.

You’ve already heard that the Federal Reserve is raising interest rates, but what might be needed to entice additional buyers is a course of a different color — a rate increase on top of the Fed-fueled increase.

But that will translate into higher costs for anyone who is borrowing money — from Uncle Sam, already running a nearly $1-trillion-a-year deficit, all the way down to your Aunt Tilly looking to buy a house.

To be sure, there’s another option — but it would be controversial.

The Fed could begin another quantitative easing program, which in the past has easily created new money to buy bonds. The intention when QE was done in the late aughts was to make interest rates extraordinarily low.

The next QE might be launched to make up for the lack of interest in US government bonds. QE, in this case, would be the same as Washington printing money so that it can again act as a shill buyer at Treasury bond auctions.

It would be a fraud and it would raise big questions about the health of the US currency and put our country in a poor light.

People laughed when Trump is alleged to have said that the solution to America’s financial problems is printing more money. If the Fed has to QE our way out of bond-market trouble, it’ll be as hilarious — and frightening — as what Trump is said to have proposed.

Which brings us back to my original question: Are the Chinese really out of bullets or is there just a lull in the fighting before the big guns come out?

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