China has run a small-scale test of the "nuclear option" in its trade war with the US by selling $20 billion of US government debt.

If China sold its $1.2 trillion in US Treasurys, it could raise America's borrowing costs, weaken the US dollar, and plunge global markets into chaos.

However, a fire sale would strengthen the yuan, making Chinese exports less attractive, and could spin the currency out of control.

Visit Markets Insider's homepage for more stories.

China has already run a small-scale test of the "nuclear option" in its trade war with the US. The Asian nation sold $20 billion worth of US Treasurys in March, possibly foreshadowing a total offloading of American government bonds that would plunge global markets into chaos.

China is the biggest foreign holder of US government debt, with more than $1.2 trillion in Treasurys or about 7% of the entire market. The latest sale represents its largest disposal in more than two years, according to the Financial Times. While the world's second-largest economy occasionally sells US Treasurys to replenish its reserves or support its currency, the yuan, those don't appear to be the reasons for the latest dumping.

The idea of a fire sale has been gaining traction. "Many Chinese scholars are discussing the possibility of dumping US Treasuries and how to do it specifically," Hu Xijin, the editor-in-chief of state-aligned Chinese tabloid Global Times, tweeted this month.

A wholesale disposal of US Treasurys by China would weaken the US dollar and hike America's borrowing costs, causing significant disruption to its economy. UBS recently predicted a sale would raise the 10-year yield on US Treasurys by 30 to 40 basis points, driving it as high as 2.754% based on its current yield.

However, yields could also fall if investors buy US Treasurys in anticipation of the Federal Reserve reacting to a worse global economic backdrop and delaying interest-rate hikes, argued Joe Weisenthal, Bloomberg's executive editor for daily news, in a daily markets email.

It's highly unlikely China will pull the trigger, though. There are few other markets that could absorb its massive reserves and offer as attractive a return as US Treasurys. As a major player in global trade, China also needs dollar reserves for its international dealings. Selling US Treasurys could also strengthen the yuan, making Chinese exports more expensive and harder to sell, and potentially spin the currency out of control.

The sale came shortly before the Trump administration accused Chinese officials of sabotaging a prospective trade deal and hiked tariffs to 25% on $200 billion worth of Chinese imports. The US is also preparing to expand tariffs to another $300 billion worth of Chinese goods, and has blacklisted the Chinese telecom giant Huawei. China has retaliated with higher tariffs on $60 billion of US imports starting in June.

President Xi Jinping and Vice Premier Liu He, the nation's top trade negotiator, visited a rare-earth magnet factory in eastern China this week. The highly publicized trip may have signaled their willingness to cut off America's supply of rare-earth materials, which are widely used in its manufacturing, technology, and defense industries.

Given the potentially devastating consequences for the global economy and the significant risk of backfiring, China is unlikely to hit the nuclear button and sell its US Treasurys. The more likely explanation is that China is sending a signal to Trump that he should watch his step.