While trade sanctions against China are being discussed on Capital Hill, the Chinese government has begun a concerted campaign of economic threats against the United States in a game called “Who will blink first?”
Several leading Chinese Communist officials have warned that Beijing may use its $1.33 trillion foreign reserves as a political weapon to counter Congressional plans for trade sanctions. Some have called this China’s “nuclear option” since dumping U.S. bonds could trigger a dollar crash at a moment when the currency is already breaking down through historic support levels.
Such a move could cause a spike in U.S. bond yields, hammer the already vulnerable housing market and perhaps tip the economy into recession. Therefore these threats cannot be taken lightly.
It is estimated that China holds over $900 billion in a mix of U.S. bonds, clearly the bulk of its foreign reserves. Xia Bin, chief at the Development Research Center, indicated that Beijing’s foreign reserves should be used to influence U.S. trade policy in what is an unambiguous threat. “Of course,” he added “China doesn’t want any undesirable phenomenon in the global financial order.”
He Fan, an official at the Chinese Academy of Social Science, said China has the power to set off a “dollar collapse if it chooses to do so.” He noted, “China has accumulated a large sum of U.S. dollars. Such a big sum, of which a considerable portion… contributes… to maintaining the position of the dollar as a reserve currency.”
Clearly China is unlikely to follow this scenario as long as the yuan’s exchange rate is stable against the dollar. Moreover, the U.S. has some leverage in this arrangement since a recession would diminish U.S. buying and importing power thereby adversely affecting Chinese markets.
But there is little doubt the Chinese intend to play the blackmail card and contend the U.S. is hostage to economic decisions made in Beijing. Having control of over 44 percent of the U.S. national debt undoubtedly leaves America acutely vulnerable.
The timing of these threats is particularly troubling. They come at a time when credit markets are already fearful of contagion from subprime mortgage troubles. That may explain why Secretary of Treasury Henry Paulson said any trade sanctions would undermine America’s authority to promote free trade and open markets.