China threatens ‘nuclear option’ of dollar sales

There’s an old saying that goes something like this:

“When you owe the bank $1,000,000, you have a major problem.

When you owe the bank $100,000,000, the bank has a major problem.”

Those of you familiar with the economic policy of the United States over the last few decades will recognize that in the saying listed above, the US is the ‘debtor’ and the rest of the world’s central banks are the ‘banks.’ Apparently, when the bank has several trillion dollars worth of everyone’s reserves, it’s not a wise idea to threaten said creditor with trade sanctions.

The common wisdom has been that China, who holds somewhere in the neighborhood of one trillion (yes, trillion) dollars worth of US bonds, is so dependent on the US market that they would be forced to buy and hold US dollars just to keep the consumer market in the States afloat. In order to keep the value of all their dollars up, China would be forced to not only keep buying dollars, but even buy them at a faster clip, while the US Treasury continued to more-or-less print dollars at will, thanks to the dollar/petrodollar’s unique role as the world’s reserve currency.

That may have been the case for a while, but perhaps not anymore.

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.

Oops.

There’s been talk of the US wanting China to remove the dollar peg from the yuan for several years now… the idea being that our trade deficit with China would somehow mysteriously correct itself if the yuan was allowed to rise to it’s market value. As mentioned above, the rhetoric has been turned up in recent months, with some legislators in DC talking about trade sanctions and the like if China fails to heed their wishes.

The Telegraph article I quoted from shows that our friends in Beijing know just how much clout they can exert over US financial policy, and it sounds like they have decided that they are willing to absorb the damage that would result from their dumping of US bonds, and that they’d come out better than we would.

The US dollar continues to maintain it’s strength due to other countries willingness to continue buying our debt, with China being one of if not the major buyer. If this game of brinksmanship continues to get more and more vitriolic, it could get really, really ugly.

 

HT: Cryptogon

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5 Responses to China threatens ‘nuclear option’ of dollar sales

  1. Daniel Partlow says:

    The Chinese are threatening to liquidate their U.S. Dollar Reserve holdings if the US pursues trade sanctions. It is suggested that this threat was made in response to Democratic calls for protectionism.

    While I am a Republican, and generally against protectionism, I do not believe that U.S. trade policy should be held hostage to such threats.

    But there is a way to emasculate this ‘nuclear option’.

    I have drafted the following bill in order to disuade foreign states from even contemplating engaging in such economic warfare. As a result, the Chinese would probably no longer participate in new US Treasury issues, but that is already happening.

    Here it is: The Partlow Don’t Tread On Me – Economic Freedom Act of 2007

    Whereas, Certain Foreign State’s Central Banks have made public their willingness to use offensive and aggressive use of U.S. Government Security selling in a potential ‘trade war’.

    Whereas, certain countries which have made such indications also hold a significant portions of U.S. Treasury Securities in circulation.

    Whereas such actions, without countervailing action by the U.S. Treasury, would certainly lead to unprecedented economic turmoil including one or all of the following:
    1) Immediate and dramatic depreciation in the value of the U.S. Dollar;
    2) Immediate and catastrophic rise in Interest Rates and Inflation-Expectations
    3) Subsequent and catastrophic loss of foreign investment
    4) Subsequent and catastrophic Increase in the rate of inflation
    5) Subsequent and catastrophic drops in asset values, including real estate, equity in U.S. corporations, bond-values.
    6) Subsequent and catastrophic decreases in production and employment.
    7) Subsequent and catastrophic hardships on the Citizens of the United States of America due to this externally induced and rampant stagflation.
    8. Beyond all this, under current legislation, the U.S. Treasury would still be obliged to make interest and principle payments, even on residual positions held by countries engaged in economic warfare against the Citizens of the United States of America.

    Whereas, U.S. Treasury Securities are backed by the ‘full faith and credit of the U.S. Government’

    Whereas, the U.S. Government is an organization chartered “Of, By, and For, the People” of the United States of America.

    Whereas, the Good Citizens of the United States of America are a free people, answering only to their Creator and their freely elected officials, and cannot be bound either financially or morally to obligations made to or held by countries engaged in economic warfare against the people of the United States of America.

    Whereas, Countervailing and Pre-emptive Measures may be taken to dissuade such action without in any way encumbering the value of U.S. securities for friendly trading partners.

    And in order to emasculate any Foreign State Contemplating Economic Warfare of what is popularly called ‘the nuclear option’:

    I. Be it resolved, that the U.S. Treasury shall make neither interest, nor principle payments on U.S. Treasury securities (member of Regulated Securities) held by, or recently in the possession of Foreign States involved in actions economic warfare against the Citizens of the United States of America. The otherwise due payments shall be diverted into the U.S. Federal Reserves for use in open market activities including the support of the U.S. Dollar, maintenance of healthy interest rates and levels of liquidity.

    II. Be it resolved, that the U.S. Treasury, Federal Reserve System, and any appropriate government agencies, will prevent similar interest, principle, fee, or derivative based payments by any U.S. Government Agency, and Government Sponsored Entities (member of Regulated Securities) to Entities of Foreign States Engaged in Economic Warfare against the Citizens of the United States of America. The otherwise due payments shall be diverted into the U.S. Treasury for the implementation of countervailing fiscal policies for the purposes of bolstering the U.S. economy.

    III. Be it resolved, that the U.S. Treasury, Federal Reserve System, and any appropriate government agencies, will prevent similar interest, principle, fee, or derivative based payments by any U.S. Registered or Domiciled Corporation (member of Regulated Securities) to Entities of Foreign States Engaged in Economic Warfare against the Citizens of the United States of America. The otherwise due payments shall be diverted into the U.S. Treasury for the implementation of countervailing fiscal policies to bolster the U.S. economy including income tax reductions and the promotion of strategic commercial activity. The exception shall be trade payments, made for the purpose of buying real goods.

    Definition 1. The definition of an Act of Economic Warfare shall include any net sales of U.S. Treasury Securities, U.S. Agency, or Government Sponsored Entities, or Corporate obligations over .5% per month or over 1.5% per annum – including via swap, short sale, repurchase arrangement, assignment, re-issuance, re-structure, pledge as collateral, use as a form of payment, trade an option agreement to sell or any other financial arrangement which purpose is to the transfer economic value of and hence devalue the Regulated Securities; but not including the natural maturity of said securities.

    Definition 2. The definition of an Entity of a Foreign State Engaged in Economic Warfare shall be any Foreign Central Bank; any Financial Institution domiciled in the foreign state or owned (either legally or beneficially, in part or in whole) by the Foreign Central Bank, or Federal, Regional, or Local Government; any Corporation or Economic Entity domiciled in the Foreign State or owned by (either legally or beneficially, in part or in whole) by the Foreign Central Bank or Federal, Regional, or Local Government; or Otherwise Neutral Fiscal Agent of any of the preceding.

    IV. The U.S. Treasury may, as a part of a negotiated end of economic hostilities with the Foreign State Engaged in Economic Warfare allow the resumption of accrual and payment of interest, principle, fee, or derivative based payments from the real calendar date of a signed and enforced treaty, however the interest, fees, principle and derivative based payments due during the period of hostilities from the date of actual occurrence until the real calendar date of a signed and enforced treaty, will be forfeit and unrecoverable.

    Definition 3. Date of Actual Occurrence: The date of the first sale of Regulated Securities in a year or month in which the Act of Economic Warfare was committed.

    Definition 4. Real Calendar Date of a Signed and Enforced Treaty: Date on which all Economic Warfare has desisted, value has been restored, and economic treaties have been reached and ratified by the U.S. Congress.

    Copyright © 2007 Daniel Partlow

  2. Bart says:

    Hi Daniel,

    Thanks for the comment. You obviously have put a lot of thought into it, and I appreciate you posting it here.

    A few questions:

    Were this law to be put into place, the restrictions on the sale of US securities listed in here would make foreign central banks and other overseas purchasers much less likely to buy them. Since we rely on these institutions to buy our debt, this would seem to be counter-productive.

    It is also safe to assume that *if* China is making these threats, they have already decided that they are willing to absorb whatever losses may occur from such an action. Wouldn’t that make a law such as yours moot?

    Thanks again for your comment.

  3. BT ga econ says:

    yea there is a couple of problems here, the idea of a play nice law sounds good but you really can’t do that unless you have a command and control economy like China. You know that little sentence on your dollar that says “this note is legal tender for all debts public, and private” essentially this bill adds a little clause on the end “( unless you piss us off and then we’re totally not going to honor this dollar ptthbitt)” not exactly a confidence builder. Besides a bill like this might imply that America should play fair too, and we wouldn’t want that.

    China totally owns us we’re just gonna have to deal with it. We’ve mortgaged our country to buy plastic crap from walmart.

  4. walter libby says:

    As I understand it, if China dumps dollars and Treasuries it results in a revaluation of its currency. Is that correct? Iwould appreciate an answer. Thanks

  5. Bart says:

    I’m no expert, but as I understand things, China stopped pegging the yuan to the US dollar in 2005… it now floats against a basket of international currencies. I think it is still suppressed, but there isn’t a direct tie to the greenback anymore.

    If China dumps dollars and Treasuries, they will take a major financial hit… the question is whether a time comes that China is mad enough at us to consider doing so, and if they feel that it is a hit they can stomach. If they are hurt but survive while the US economy is in ashes, they may decide it’s a risk they can take.

    It’s all speculation at this point… but assuming that the Chinese will willingly buy our debt forever is foolhardy. They’ve already cut back on buying new debt. We’re just praying they won’t start dumping what they have already accumulated.

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