As the United States confronts an impending government shutdown amid an unwelcome outbreak of bond vigilantism, an unexpected remedy to global financial implosion might just lie in a murky corner of long forgotten financial history.
Dormant for decades, the Blind Spot understands the overlooked issue of defaulted Chinese imperial debt is quietly turning heads on the Hill and emerging as an unanticipated, yet plausible, approach to mitigating the fiscal impasse with much-needed bipartisan support.
Some are treating the idea as no more kooky than the much more frequently floated plan to mint a $1 trillion coin. Others see it as a far more viable
strategy. For the MAGA contingent, meanwhile, it might just represent Donald Trump’s best chance at a hail Mary pass out of his legal and felony troubles.
The story centres on the international treatment of debt originating from the Qing Dynasty and the Republic of China, disavowed by the People’s Republic of China yet still viewed as valid by certain scholars and politicians. Advocates contend this debt, adjusted for interest and underlying collateral, could be worth trillions in today’s dollars.
The bonds, which are gold-backed and bearer in nature, have sporadically captured the interest of policymakers and experts in sovereign default, but so far have failed to garner substantial political momentum. Throughout the years they’ve mostly peppered academic and theoretical discussions focused on imaginative ways out of the U.S. debt problem, going only as far as to inspire the formation of the American Bondholders Foundation to lobby for settlement.
That is, until today.
Andrew Hale, an economist at the right-wing Heritage Foundation, told TBS that, due to the financial pressures being faced by the West, he believes there is growing bipartisan support for any bill that might draw on the bonds to empower the U.S. Treasury’s standing on the international stage. “Kissinger himself didn’t factor it into negotiations because at the time China was considered too poor,” Hale told TBS. That, however, is no longer the case. And certain draft bills pertaining to the bonds are already circulating around Washington.
Hale set out the thrust of the argument to force China to recognise the defaulted debt in an op-ed for The Hill website on July 4.
“The United States pays interest on approximately $850 billion in debt held by the People’s Republic of China. China, however, is currently in default on its sovereign debt held by American bondholders,” he wrote. “Successive U.S. administrations have chosen to sidestep this fact, allowing business and trade with China to proceed as normal. Now that the relationship with China has soured and the People’s Republic of China has become the greatest adversarial threat to the U.S. and Western security, policymakers should revisit this appalling failure of justice.”
Following the article’s publication, Hale was flooded with enquiries from policymakers and bondholders worldwide.
“I was quite surprised by the bipartisan interest. It’s been overwhelming,” Hale told TBS.
Where there’s a debt there’s a way
In America’s current financially-strained scenario, finding a long-forgotten $1 trillion behind the proverbial Treasury couch is nothing to be sniffed at.
Yet, is the idea far-fetched? Not necessarily. According to Mitu Gulati, a sovereign default expert at Duke University, valid legal arguments exist for reviving the claims. He told the Financial Times in July, 2020, a legal argument could be made to revive some of the claims, not least because some of the old obligations include legal clauses that suggest new Chinese debt cannot be issued until old debt has been dealt with.
But the most promising factor by far is that UK Prime Minister Margaret Thatcher managed to negotiate a settlement of the sterling component of the debt back in 1987, as part of negotiations for Britain’s return of Hong Kong to China. The final deal saw £20 million worth of bonds settled in exchange for the promise of continued access to London capital markets for the former British-ruled island microstate.
This fact alone assures the default is, in the parlance of bond legalese, “selective”, says Hale, and provides an inroad for American bondholders to set out similar arguments.
“They [the Chinese] are very good in getting countries indebted to them for their Belt and Road infrastructure programmes. But at the same time very good at not forgiving debt when there’s a good cause to do so,” Hale said, explaining that politically now was the best time to act.
So how might it be done?
According to Prof Gulati, one way to push ahead is to get American holders of the Chinese debt to argue for a debt swap or “set off” against existing US Treasury debt.
Another option, according to Hale, is to pass a bill that forces American credit agencies to factor the historic Chinese debt into their credit opinions knocking their current A+ rating of the country down to selective default status. This, he notes, would have immediate capital market consequences and provide America with renewed leverage in any negotiations, not least because China’s own economy is still intricately intertwined with that of the West’s, and facing similar economic fragility.
In the right diplomatic context, however, there might be opportunities for China, too.
As it stands, international financial law treats sovereign debt as lifelong, even if a country experiences regime change. The problem with the Chinese debt, much like Russia’s debt, is that when the Chinese Communist Party (CCP) ascended to power in 1949 it rejected capitalism as a point of principle. Since the CCP didn’t care about the country’s standing on the international market, it dubbed the debt of both China’s Qing dynasty and the Republic of China as “odious”. The now-exiled government in Taiwan, meanwhile, rejected responsibility over it too because, having lost access to the underlying collateral and infrastructure that backed the bonds, it had no access to the related cashflows.
Creditor memory
But markets never forget. A refusal to pay off, even, historic bonds bears consequences as soon as a country needs access back to the international capital markets. Even Russia, said Hale, had to address its outstanding pre-Russian Revolution debt once the Soviet Union fell, as it sought to return properly to the capital markets.
The only reason these longstanding responsibilities were overlooked in the case of China was due to hopes the communist state would eventually become a respected and lawful member of the international trading community. Indeed, the country’s access to Western capital markets was conditional to becoming “more like us”.
“We allowed China to have its cake and eat it too, where they get to engage in all these international organisations, they get to engage in international trade, but … we don’t require them to abide by the rules and I think that’s a real problem,” Hale said.
By the mid-2010s, however, it became clear China was failing to live up to its side of the bargain — a fact famously seized upon by the Trump administration to justify and impose trade tariffs.
With tensions over Taiwan growing as China faces up to its own financial fragility as well as America’s, resolving this debt could be a pathway for international recognition of Taiwan as part of China’s territory. Any reunification would, after all, see the bond issuers reunited with the proceeds of the capital investments they enabled. This could allow China to put the idea of treating Taiwan under a One Country, Two Systems principle (previously applied to Hong Kong) on the table in exchange for a bond settlement— even if it eventually failed with Hong Kong itself.
But there is a caveat. For any formal negotiations to begin, the US government would have to acquire the bonds from private hands. And that’s where Donald Trump’s own potential leverage in the scenario might come in.
For the debt swap to meaningfully address the national debt, the US government must acquire these bonds at a significant discount to whatever the final settlement turns out to be.
But Tennessee-based Jonna Bianco, who heads the American Bondholders Foundation — which says it represents $1.6tn in claims of Chinese debt — is a diehard Trump loyalist and MAGA enthusiast.
That’s bad news for Democrats since she is unlikely to cut a favourable deal with anyone other than a MAGA representative. In the worst case scenario, she might even have the power to insist that Donald Trump alone represents the US in any formal negotiations with China.
The government’s counter move could be to impose a confiscation order on the bonds, or tax the capital gains to high heaven. But doing so risks undermining its own standing in negotiations, since China could then take the moral high ground with respect to the treatment and respect of private property rights.
Which is about where we must leave the plot for now.
But who knows, Trump’s recent consideration of a trip to Congress, where he may well pitch himself as a speaker candidate, could be the platform where this issue – intertwining legal, financial, and political threads – comes to life.
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