There are a flock of Chicken Littles, not all of them on the right, predicting that China will -- unless we follow their advice -- sell all their treasury bonds and reduce the US to bankruptcy. Now, any change beyond the resiliency of the market would be disastrous, but such change isn't going to happen. (One reason that it isn't is that, were China to dump its holdings of treasuries on the market, they would get only a fraction of what they paid for them.)
Let's consider, though, what the results would be for a much smaller change, China stops net buying of US treasuries, and no other country takes up the slack. (I say net borrowing because China holds millions of bonds which come due each month.)
Well, why is it necessary for the US Treasury to sell so many bonds?
The primary reason, as Lord Keynes taught us, is that in a closed economy, savings = investment. (By a closed economy, I mean one that has no foreign trade and investment. Most economies operate almost like that, and the Earth as a whole operates precisely like that.) This is sometimes taught as if it were some esoteric discovery, but it is the logical consequence of two other simple equations:
Production = consumption + investment. (Everything produced is either consumed -- including waste -- or invested in either inventory change or in plant and equipment.)
Claims on production = savings + consumption.
Now, whenever anything is produced, equal claims on production are produced along with it. Some of those claims go to workers, some to suppliers of materials, some in taxes, and the remainder to owners. Now since the dollar value of claims on production is the dollar value of production, and consumption is consumption, the remaining terms must be equal.
Now, at any level of economic activity, there is an intention to save and an intention (mostly of other people than those who intend to save) to invest. If the intentions to save total greater than the intentions to invest, the result is an increase in investment in inventory greater than was intended. The obvious response is to manufacture less. So, when the intention to save is greater than the intention at any level of economic activity to invest, then economic activity falls until it reaches a level at which the intention to save at that level equals the intention to invest at that level. That means a recession.
Now that is total savings, including government savings. So, when intended private savings exceeds intended private investment at a healthy level of the economy, the task of the government is to run negative savings (aka borrowing) until total savings matches total intended investment at a healthy level of economic activity. That's the reason we need to run a deficit these days.
The problem is that we are not only soaking up the excess savings of domestic private actors, we are soaking up the savings of foreign actors, including the PRC government. If those foreign actors declined to buy our bonds we could return to a healthy economic level rapidly and at with much less federal borrowing.
Now, I repeat. A precipitous change would lead to catastrophe. But a gradual change foreseen by the US government and a sensible response to that change would be in our best interests.
Of course, the Chinese government is not operating on their opinion of what would be in our best interests, but on their perception of their best interests -- a mixture of varied opinions within the government of what would be best for China, of what would be best for the Chinese government, and of what would be best for the individual politicians. (Just like here at home.)