Here’s what’s ‘more disturbing’ to Larry Fink about the future of US-China trade than anything else

FAN Editor

As CEO of the world’s largest asset management fund, BlackRock’s Larry Fink always has his eye on the long term. The trade war and ongoing negotiations between the world’s two largest economies is a looming danger, he says — but not for its immediate impact on markets or growth.

The threat the CEO says we are not talking about — but need to be — is the long-term impact of the U.S.-China trade war on U.S. Treasury bonds.

“What worries me about the conversation between the U.S. and China — China has a $1.3 trillion pool of U.S. Treasurys, they’ve been accumulating U.S. Treasurys because of the trade deficit,” Fink told CNBC’s Hadley Gamble in Sunday. “Now as China reduces its trade deficit with the U.S., the likelihood of them reducing their need for U.S. Treasurys is large.”

China is the biggest buyer of U.S. sovereign debt. In January, media reports revealed that officials in Beijing recommended the Chinese government lower — or even stop — its buying of U.S. debt. This is something market analysts have described as a major threat to markets, as Treasury financing needs climbed significantly in 2018 and are projected to continue rising more sharply than in recent years.

“So over the next few years — and this is something we are not talking about enough and we need to be talking about this — we should expect over the number of years ahead, less ownership of U.S. Treasurys as their deficits shrink.

“But that’s at the same time the U.S. deficit still seems to be growing at a trillion dollars,” Fink continued, “so it is long term a little more disturbing for me to see the implications of smaller Chinese purchases of debt with rising deficits.

“So the bigger question is: who’s going to be the substitute buyer to buy this?”

As the trade war kicked off in spring of last year, economists warned of China’s “trillion-dollar weapon”: They said the country could dump its massive holding of Treasurys as retaliation, which would wreak major havoc on international markets and spike U.S. borrowing costs.

China has steadily slashed its holdings of U.S. sovereign notes, bills and bonds for the last several months. It held $1.123 trillion in U.S. Treasurys in December of last year, down from $1.15 trillion in September and $1.184 trillion in the same month of 2017, according to U.S. Treasury Department data. America’s second-largest debt buyer is Japan, who’s also been cutting its holdings: It’s currently down to $1.042 trillion in Treasurys from $1.061 trillion in the same time frame.

Over the last several years, China has bought scores of treasury bonds partly because it has U.S. dollars it needs to spend. Just like any investor, China wants to put some of the greenbacks it’s made off its exports to the United States into safe investments, and there’s nothing perceived to be safer than U.S. bonds.

But demand for the U.S.’ bonds is set to wane, Fink warned.

“At the same time, the global bond indexes are now including more Chinese debt, and next year one of the big indexes is going to include up to 6 percent Chinese debt, which reduces U.S. demand by 2.6 percent of their debt,” he said.

“So all of these things are playing out. We’re going to see some winners, we’re going to see some losers — but long term, the U.S. Treasury bid is a loser in this. Now maybe the expansion of the U.S. economy by more purchases will offset some of that, so we’ll see how it all plays out.”

The U.S. federal budget deficit rose in fiscal 2018 to $799 billion, the highest level in six years as spending climbed, the Trump administration said in October. Already at a six-year high, the deficit could reach $1 trillion by the end of 2019, according to the Committee for a Responsible Federal Budget.

A taper in Chinese purchases would come as the Federal Reserve unwinds the massive balance sheet it amassed after the financial crisis. The Fed is also expected to raise rates several times this year.

U.S. and Chinese negotiators are currently holding trade talks in a bid to resolve a dispute between the countries over trade practices which has led both sides to impose punitive tariffs on each other’s imports. Both sides are aiming to reach a deal before a March 1 deadline imposed by U.S. President Donald Trump, who has threatened to impose further tariffs on Chinese goods.

Looking ahead, Fink reiterated his worry: “In years, I do believe this Treasury volume is going to be a big issue in the coming future. Or put it another way — the deficits in the U.S. could become a bigger issue.”

CNBC’s Fred Imbert and Bryan Borzykowski contributed to this report

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