$2bn Power Play: China’s Saudi bond deal shifts global financial dynamics

Onome Amuge

A seemingly mundane financial transaction can sometimes ripple with geopolitical implications, as is the case with China’s recent $2 billion USD-denominated sovereign bond sale in Saudi Arabia.

This deal has set off a firestorm of speculation about its true meaning, particularly against the backdrop of a potential Trump administration return in the US, with  financial experts and geopolitical strategists alike trying to decode the real intention behind this transaction.

Entrepreneur Arnaud Bertrand, founder of UK-based online vacation rental marketplace Housetrip, recently discussed the buzz surrounding China’s issuance of $2 billion in USD-denominated sovereign bonds in Saudi Arabia.

At first, he remarked, this may appear to be a “relatively boring” transaction – a government selling bonds to investors, who then get paid back with interest. Nothing unusual there. But, Bertrand pointed out, when you dig a bit deeper, things get a little more intriguing.

Bertrand identified an interesting aspect to this seemingly routine bond issuance – the fact that the bonds were oversubscribed by almost 20 times, meaning that investors were clamouring to get a piece of China’s USD-denominated debt to the tune of $40+ billion, far surpassing the amount of bonds on offer.

This is a stark contrast to the typical oversubscription rate for US Treasury auctions, which range from 2x to 3x. This suggests that investors see something desirable in China’s dollar-denominated debt, which could have broader implications for the global financial market.

According to Bertrand, another captivating aspect of China’s USD-denominated sovereign bond issuance is the exceptionally low interest rate it secured. Specifically, China’s bonds were only 1-3 basis points (0.01-0.03%) higher than the US Treasury rates.

Essentially, China is now in the unique position of being able to borrow money in US dollars at virtually the same rate as the US government itself, a feat that no other country on earth has achieved.

“. That’s the case for no other country in the world. As a benchmark, countries with the highest credit ratings (AAA) typically pay at least 10-20 basis points over US Treasuries in the rare instances when they issue USD bonds,” Bertrand noted.

Bertrand, analysing the geopolitical and economic implications of China’s USD-denominated bond issuance, also pointed out the third peculiar aspect – the choice of venue. Traditionally, sovereign bonds are typically issued in major financial centers such as London, New York, or Hong Kong.

However, China’s decision to sell these bonds in Saudi Arabia was a departure from the norm. The choice of Saudi Arabia, and the Saudis’ agreement to this, is particularly significant given the country’s historical role in the global dollar system, commonly referred to as the “petrodollar” system.

“By issuing dollar bonds in Saudi Arabia that compete directly with US Treasuries, and getting essentially the same interest rate, China is demonstrating it can operate as an alternative manager of dollar liquidity right in the heart of the petrodollar system. For Saudi Arabia, which holds hundreds of billions in dollar reserves, this creates a new option for investing their dollars: they can invest it with the Chinese government instead of the US government.

Ok, that’s all interesting but still not the main reason why Chinese social media is abuzz. The reason why is because they postulate that this is trial round by China to demonstrate to the US that they can effectively use their own currency against them, with potentially dramatic consequences,” the entrepreneur and commentator on economics and geopolitics remarked.

Expanding on the potential implications of China’s move, Bertrand explained that China is effectively using the US dollar against the US, with potentially far-reaching consequences.

He argued that if China were to scale up the bond issuance from the current $2 billion to tens or even hundreds of billions, this would mean China would effectively be competing with the US Treasury in the global dollar market. Instead of countries like Saudi Arabia automatically recycling their dollars into US Treasury bonds, they could choose to invest in Chinese dollar bonds that pay the same rate.

Bertrand opined that if China were to successfully scale up their USD-denominated sovereign bond issuance, they would effectively create a parallel dollar system in which China, not the US, would control a significant portion of the flow of dollars in the global economy.

According to him, the US would continue to print the dollars, but China would increasingly determine where those dollars go, essentially redistributing global power and financial influence.

Uncovering yet another potential ramification, Bertrand noted that if China were to successfully establish itself as a major issuer of USD-denominated sovereign bonds, this could create immense financing difficulties for the US government.

If countries like Saudi Arabia start investing in Chinese dollar bonds instead of US Treasuries, each dollar going into these Chinese bonds represents a dollar that is not funding the US government’s massive deficits, he opined.

Bertrand observed that on the surface, China doesn’t seem to need any more US dollars. After all, with a trade surplus of $823.2 billion in 2023, rising to a projected $940 billion in 2024, the Asian powerhouse is “absolutely awash with dollars”.

As Bertrand points out, the Belt & Road Initiative (BRI),  a global infrastructure development strategy that aims to connect Asia, Africa, and Europe through land and maritime networks, isn’t just a fancy infrastructure project, but a strategic play by China to use its surplus dollars to gain a foothold in the global economy.

According to Bertrand,out of the 193 countries in the world, 152 are BRI countries, with a large percentage of them owing debts in US dollars to the US government or other Western lenders.  The entrepreneur pointed out that China could offer to help these countries clear their debt, in exchange for being repaid in their own currency, the yuan, or in strategic resources, or through other bilateral arrangements.

“This would create a triple win for China: they get rid of their excess dollars, they help their partner countries escape dollar dependency, and they deepen these countries’ economic integration with China instead of the US.

“For BRI countries, this is attractive because they can escape the trap of dollar-denominated debt (and the threat of US financial sanctions) and get likely better conditions with China, which will help their development.

“In effect this would China placing itself as an intermediary at the heart of the dollar system, where the dollars still eventually make their way back to the US – just through a path that builds Chinese rather than American influence and progressively undermines the US’s ability to finance itself (with all the consequences this has on inflation, etc.),” he explained further.

As Bertrand noted, the US might want to step in and stop China’s strategy, but they’re in a difficult position. Any direct intervention could further weaken the dominance of the dollar in global trade and finance.

The US could, theoretically, threaten sanctions against countries or institutions that buy Chinese dollar bonds. But that approach, he argued would show that the US isn’t afraid to use its power to influence the market, which could cause countries to start diversifying their assets, reducing the demand for dollars and weakening its position as the global reserve currency.

According to Bertrand,another option could be for the Federal Reserve to raise interest rates to boost the appeal of US Treasuries, but this would be self-defeating.

With the US government already struggling with massive deficits, an interest rate hike could potentially trigger a recession. And China,  getting similar rates as the US, could simply match any rate increase.

He also noted that the US could also go for the “nuclear option” of restricting China’s ability to clear dollar transactions but this would effectively immediately fragment the global financial system, undermining the dollar’s role as the global reserve currency, which is exactly what the US wants to avoid. And with China being the most important trading partner of the immense majority of the world’s countries, nothing is less sure that the U.S. would win at this game.

Bertrand noted that at this stage, the  $2 billion USD-denominated sovereign bonds in Saudi Arabia is most likely just a message by China to the upcoming Trump administration: “we can do this so maybe think very carefully about all the nasty things you have in mind for us…”

He concluded that the beauty of this move is how strategically elegant it is, as it costs China almost nothing to demonstrate. However, it forces the US to consider some very uncomfortable scenarios that could change the global financial landscape.