Wednesday, August 08, 2007

China Threatens 'Nuclear Option' of Dollar Sales

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Two officials at leading Communist Party bodies have given interviews in recent days warning - for the first time - that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.
First, how stupid have we been in the US to have given this power to China? By spending more than we earn we have given the Chinese (and also the oil exporters of the world) the ability to tank our economy whenever they choose. All they have to do is sell their US bonds and take the money out of the US.

Second, how stupid is this Chinese threat? They are planning to do this because they don't want trade sanctions or a yuan revaluation. But, if they tank the dollar, the yuan will become stronger in relation and yet this is exactly the kind of yuan revaluation that the Chinese have been fighting. And if they tip the US economy into recession, this will lower demand for Chinese goods more than any trade sanction would.

The fact of the matter is that the Chinese and American economies are in a co-dependent relationship, and the Chinese can't pull off this threat without harming their economy as much as America's.

via The Telegraph


Audacious Epigone said...

China is being stupid, in that time is clearly on their side and risking direct confrontation is unnecessary if the goal is to increase influence in Asia and eventually the world.

But what makes you think the PRC won't simply move that investment money elsewhere?

The yuan would rise moderately against the dollar if the Chinese government decided to continue to let it be influenced to some extent by other currencies. But it is still chiefly tied to the dollar, with a slight premium--that would not change. The dollar's value is the greatest driver of the yuan's value. Consequently, a plummeting of the dollar cannot mean anything but a drop in the international valuation of the yuan, even if it gains somewhat against the dollar.

Other reasons the yuan will suffer:

- China's economy, especially its banking industry, is not nearly as sound as the US'. So if the PRC doesn't retain its dollar peg (although I think it would in any case), it is going to become more volatile, and that volatility will come with some cost premium.

- The US is China's leading export market. A weakening dollar will drastically cut into Chinese exports to the US, especially if that dollar drop is a result of this threatened nuclear option, in which case Congress will almost certainly react with major 'protectionist' measures directed at curbing Chinese exports. A Chinese slowdown will put downward pressure on the yuan.

The PRC does what it does because its population, already gaining materially in an astounding way, doesn't demand it do more. The average Chinaman is becoming wealthier, yet at the same time he is managing to delay consumption now for more consumption in the future, thanks to the PRC's policies. It's a strategy long-term in oritentation--nationally, the Chinese are living under their means. Americans are living beyond theirs'.

Fat Knowledge said...


See my comments on your blog post.

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