"Prediction Validated - China and the Dollar" The National Interest

"Last year, in laying out various scenarios for how the United States might choose to confront Iran’s pursuit of a nuclear weapons program ("Contemplating the Ifs", The National Interest, Summer 2006), W. Patrick Lang and Larry C. Johnson noted that U.S. planners have to consider factors far beyond developments in the Persian Gulf.

One point they raised:

[China] hold[s] a substantial amount of U.S. debt. What happens if they decide to find some other currency to hold instead of the dollar? . . . Although the dollar traditionally has been the currency people seek during a crisis, the growing imbalance with China creates new dynamics that could convince the Chinese that holding dollars no longer made economic sense. Under such a scenario, dumping dollars on the international market would trigger an inflationary spiral in the United States.

The scenario of an inflationary spike triggered by China's dumping of dollars may strike some as fanciful. The point for U.S. planners and policymakers, though, is to recognize that war brings unintended consequences that go well beyond the tactical realities on the ground where the fighting occurs.

In other words, the United States needs to consider what happens if China uses its financial leverage to affect U.S. freedom of action.

The Daily Telegraph is now reporting:

A sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable. . . .

David Powell, an economist at IDEAglobal in New York, pointed the finger at Beijing as the main suspect in the sudden bond flight this summer.

In a client note entitled "Has China started to dump US Treasuries?", he said the sales appear to coincide with early moves by Beijing to launch its new $300bn sovereign wealth fund.

The scheme is part of the government's plan to diversify it $1,340bn reserves from bonds (mostly in the US) to a broader portfolio of investments and a better yield."  TNI

http://www.nationalinterest.org/Article.aspx?id=15458

Comments

[China hand]

Sorry about the confusion, Mr Howley. That obviously should've been directed at geos. And I do fully agree with you about economic warfare, although I'm not sure your '80's example to my mind qualifies. I perceive the fall of the Soviet Union as less related to U.S. policy than to an inevitable implosion from internal pressures -- I credit the invention of computers and telecommunications hardware much more than I do '80's era CIA policies.

@charly : I respectfully disagree; "Ordinary Business" is what takes place between neighbors who largely share an interest in the success or failure of their local community and are competing with each other within an agreed upon, ethical framework. Economic Warfare is an entirely different thing altogether, in much the same way a boxing match or a football game is different from a declaration of war.

I'd suggest a better example -- and one quite relevant to this discussion -- would be the years following the Opium Wars, where China was forced to eliminate state-sponsored anti-drug policies that were directly analagous to the U.S.'s current "War on Drugs". Britain wanted porcelain and tea, but couldn't find any products that interested the Chinese people enough to balance the trade; meanwhile, China was amassing a huge silver reserve while quite literally draining Britain's coffers. Opium was the solution, and in addition helped to destabilize Chinese government institutions through corruption and graft. A weakened central Chinese government in turn allowed Overseas Chinese even greater freedom to aid European businesses in the South Pacific, which in turn increased the graft and corruption in Mainland China. It was a debilitating cycle from which the Imperial Court never recovered.

It's a formula that has since been followed many times over, and is relevant to the current situation insofar as the balance of trade is today flowing in the opposite direction: from the U.S. to China. The U.S. is going to have just as hard a time squaring this circle as the Imperial Court once did, and - I would argue - for similar reasons (nothing nefarious; just human praxis). The difference is that this is the first century in a long line of centuries that Western governments have faced a serious non-European competitor.

mlaw: I don't really see any point to an undisclosed bourse. When considering such a significant institution, I think the key worry would be when interested parties might be able to back up their intent with both economic and military power.

Militarily that is still a few years off for China (I have heard numbers from Jane's Defense people of something like 10 years, give or take a few?), but not so far off that they aren't already taking action today. Economically, both India and China have already gone a long way towards laying a solid groundwork.

Let me also say I don't consider this a terrible threat to the U.S. per se; but if our current policies continue to be interpreted through what are essentially colonialist- and cold war frameworks then I am cetain there will be grave, pervasive tribulations within my own lifetime.

In short, I fully agree with Col. Lang: this "flat earth" thing of Friedman's is worse than a bunch of hot air.

[Duncan Kinder]

The 1956 Suez precedent, while real, is actually less ominous than another, the 1929 Wiemar Republic precedent

To make a long story short, in the late 1920's, the Wiemar Republic had been propped up by loans from the United States. After the 1929 stock market crash, the United States then became unable to continue propping up Wiemar. The rest, as they say, is history....

Quite obviously, this 1929 cessation of support resulted, not from any policy choice by the United States but simply because the 1929 economic panic overwhelmed it.

And this could happen to China too. One reason why the recent reports of lead paint in children's toys is so disturbing is that it is one of many indicators that the Chinese economy is more form than substance. Other indicators: the rampant pollution, the unrest in the countryside, the wage pressures ( yes, this is happening ), the unsound banking structure, the corruption.

The difference between the 1956 scenario and the 1929 scenario is that the 1956 scenario, for all the problems that it would indeed pose, nevertheless would be controllable.