Will the Chinese Drop American Debt? The Behavioral Perspective...

There has been a lot made out of the prospect that China will drop US treasuries, and even that the rest of the world will follow suit and take on some form of a new global currency. Let's look at it from a behavioral perspective.

China essentially has two choices: 1.) It could continue buying US treasuries, while running the risk that the debt will continue to fall in value, or 2.) Begin selling off its treasuries and adopt a new preferred form of reserves. Which decision makes the most financial sense? That would be option 1. If the second option were implemented, it would result in a massive loss of reserves for the Chinese. Their remaining treasuries would plummet and they would put themselves in a race with other treasury-holders to dump them the quickest.

Yet if they choose option 1, don't they still have to deal with the dollar slowly losing its value? Of course, but it's not like the Chinese don't have any say in the matter. This is the beauty of viewing this issue from a behavioral perspective. If you were the Chinese and you had decided to hold onto your US debt, yet you didn't like the American devaluing their own debt by printing money and spending excessively, what would you do? You would threaten to dump it. This is why we're seeing the Chinese and other foreign nations question the legitimacy of American debt and suggest a switch to something else. They know that the US can't run without the Chinese buying treasuries, so by threatening to sell off American debt, the Chinese are hoping to put a little fear in the back of the mind of the US government. As a result, the US is more likely to try to maintain the value of the dollar, and by extension the American debt held by the Chinese. It would be highly unlikely that the Chinese would actually follow through on this threat, and if they did it would probably occur a long way down the road. But for now, at least from the behavioral perspective, it is reasonable to believe that this threat is empty.