There have been a couple of really good diaries on the current mess in the credit markets ("The credit crunch is here") and (Credit markets: "Don't panic", they beg). These diaries talk mostly about the US situation especially as it applies to real estate. However there is another looming threat...recent statements out of China!
In an article in today's Telegraph entitled China threatens 'nuclear option' of dollar sales It's not a long article so I would recommend that you read the entire thing. But here is a taste.
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.
What would happen if the Chinese started to dump dollars?
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.
There is even a reference to the Clinton campaign.
The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decisions being made in Beijing, Shanghai, or Tokyo".
She said foreign control over 44pc of the US national debt had left America acutely vulnerable.
Most have thought that China would never use this option because it would be one of the ones most hurt by a crash in the dollar (because it has so many and would not be able to get rid of too many before the crash happened).
However as Sun Tzu so aptly stated in the "Art of War", "the supreme height of skill is to win without fighting". In this case the mere threat of action, and maybe a small "hiccup" may be sufficient for the Chinese to get the results they desire (I just wish Bush would have read Sun Tzu before attacking Iraq).
If not, rest assured that China has been planning for the day when it may have to use the "option". It has been going around the world spending its US dollars buying up oil fields, coal mines, copper mines, you name it...anything with hard assets. It may also have built up enough of a hoard and enough of an internal economy that it could survive reasonably well the impact of US "reaction".
Of course it is in no-one's best interest to go nuclear, but the mere fact that China is threatening is BIG news.
Remember:
The last thing the US needs right now is a run on the dollar. It is at very important technical levels, which if breached could send the dollar plummeting, forcing up inflation and interest rates at a time when the economy can least afford it.
The FED today politely stepped aside from the market mess as it reiterated hat inflation was the big problem (not the economy). If they would have said the economy was the big problem the dollar would have been hit...They just could not go there today.
The best the Fed can hope for at the moment is a gradual dollar decline. That is why the Chinese action is so interesting. They have chosen a very interesting time to put the pressure on...knowing that the US dollar is very vulnerable right now.