There's a risk China may sell Treasurys, could cause 'real rout' in bonds: Yale's Stephen Roach

• We depend on China to fund our budget deficits, says Stephen Roach, former chair of Morgan Stanley Asia.
• If China reduce its buying at a time when the U.S. is increasing its supply of new Treasurys into the market that could lead to a real rout in the bond market, he says.
• "If they stop doing that where are we going to get the money from?"

As the trade conflict escalates between the United States and China, there's a risk China could look at selling some of its U.S. Treasurys, Yale economist Stephen Roach warned on Wednesday.

China is the largest holder of U.S. debt, holding $1.17 trillion in Treasury bonds.

"We depend on China to fund our budget deficits, which as you know are going to get bigger and bigger," the former chairman of Morgan Stanley Asia said on CNBC's "Power Lunch."

"If they just reduce their buying at a time when we are increasing our supply of new Treasurys into the market that could lead to a real rout in the bond market."

The Federal Reserve is in the process of unwinding its balance sheet, which includes Treasury bonds.

Roach said the problem is the U.S. does not save as a nation. The overall savings rate, which includes businesses, households and the government, adjusted for depreciation fell to 1.3 percent of the national income in the fourth quarter, he said.

"Lacking in saving and wanting to grow, we import surplus savings from aboard to square the circle," he said. "China loans us their surplus saving to help us square the circle. And so, if they stop doing that where are we going to get the money from?"

Earlier Wednesday, China announced additional tariffs on 106 U.S. products. The move came less than 24 hours after President Donald Trump unveiled a list of Chinese imports the administration plans to target as part of what the president deems unfair trade practices.

Treasury purchases have not been brought to the table, but some fear that could come to pass if tensions escalate.

So far, there have been mixed messages coming from China on the issue.

On Tuesday night, China's ambassador to the U.S., Cui Tiankai, responded to a question on Treasury bond purchases simply by saying that, "If the other side makes a wrong choice, we have no alternative but to fight back."

However, on Wednesday, China's vice finance minister, Zhu Guangyao, told CNBC's Eunice Yoon the government is not considering reducing its holdings anytime soon.

— CNBC's Natasha Turak contributed to this report.