From the Telegraph
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.
OK -- this sounds like a really big threat. And it could be. Here is a chart of the US dollar index versus major currencies. The dollar has been dropping for the last 5 years or so and currently stands at a major point of support.
According to the Treasury Department, China holds $407 billion in US Treasury Debt. They are the second largest holder of US government debt. That means this threat is a big deal.
But it's not going to happen.
Here are a few takes on the statement.
From Bloomberg.
China's $1.33 trillion foreign- exchange reserves are becoming a political tool in trade negotiations with the U.S., said Simon Derrick, Bank of New York's chief currency strategist.
China, the largest holder of U.S. Treasuries after Japan with $407 billion, plans to invest in other securities as it sets up an agency to boost returns on its investments. The government should use reserves as a ``bargaining chip'' with foreign governments, Market News cited a government researcher as saying July 30.
``It is easy to believe that China's foreign-exchange reserves are becoming politicized,'' London-based Derrick wrote in a research note dated yesterday. Recent comments from Chinese researchers ``carry an underlying threat.''
I think this analysis is spot on. What we're hearing right now is standard political posturing. No one wants to be seen as bowing down to the US.
And over the last 6 years, China has become the major power player in Asia. In addition, China has quietly become a major diplomatic player in our own backyard. They have inked deals all across South America. In other words, China has become a major world player. And major world players don't want to crash the economy of a $9.7 trillion dollar consumer market.
However, even if they do --
Reports Wednesday suggested that Chinese officials have begun threatening a concerted series of foreign reserve sales to deliberately weaken the U.S. dollar and punish the U.S. Congress for its efforts to impose trade tariffs.
We should be so lucky.
Such sales would effectively accomplish what China's congressional critics want -- i.e. reduce U.S. imports -- while at the same time destroying part of the value of China's foreign exchange holdings.
Massive sales of U.S. treasuries would doubtless cause interest rates to rise and, combined with the already faltering U.S. housing market, probably push the U.S. economy into a recession we're probably overdue for.
Assuming the worst, this play would thrust the US into a recession. While this would be incredibly painful for a ton of people, it would also clear out the credit market garbage a whole lot faster. I know this sounds callous, but from my perspective if you know there's pain around the corner, deal with it head-on and get it over with.
Let's look at this from a purely political perspective. Crashing the dollar would send the US into a recession. First, the US is a huge export market. China needs us to keep buying all sorts of stuff they make.
In addition, think about the world wide political ramifications of a dollar dump by the Chinese. They have labored to become world players and have been pretty successful in that regard. Sending the US economy into a recession would kill all that goodwill and create a ton of animosity around the globe. The damage would also also be long-lasting -- as in it would probably last a generation or more. No one wants that, especially a country that is emerging as a dominant world player.
And it's this political calculus that leads me to believe this isn't going to happen. The Chinese have come a long way and they want to maintain their position on the world stage. What we're hearing right now is pure bluster for the public airwaves. Behind closed doors mt guess is all the players know exactly what this is -- a statement tailor-made for public consumption and nothing more.
Update [2007-8-9 8:22:8 by bonddad]:: Mannfrom Middletown posted a great observation from an exchange he had on the European Tribune:
Even if it's a fascist regime, the Chinese gov is not a monolith. The theatre is probably not just meant to placate the public pride but also more or less belligerent factions within the Chinese government, in particularl the PLA itself that Hu Jintao had to ally with to sit his own power.
That's the kind of theatre that can get out of hands very quickly.
This is an excellent point, and one that needs to be included in the analysis. My assumption is that all the players are rational political players. However, threats can get out of control as well. In other words, these statements could lead to unintended consequences.
Update [2007-8-9 9:45:45 by bonddad]:: Bonddad has stepped on a few toes. There are two other diaries on this. TaoNow wrote a really interest piece as did Gaspare. Tao isn't on this thread yet, but please keep an eye out so you can tip him. Here is a link to Gaspare's comment; please give him a recommend. Here's a link to his diary