Tuesday, August 07, 2007

China's Nuclear Option

This ties in nicely with the entry below about Congress and their protectionist legislation. Apparently, the Chinese don't feel the need to revalue their currency --and for good reason: they own almost $1 trillion worth of our Treasury Notes:

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.

Of course, there are consequences to China (and the rest of the world) if they use this option. The consequences for the US economy would be much more severe though. A crash of Argentina proportions could not be ruled out. The dollar would fall, interest rates would rise and god knows where stocks would stop. Our politicians are playing a dangerous game. The Federal Reserve also deserves to share the credit for getting us in this situation. Two bubbles in 10 years is not a record to be proud of.

It doesn't seem good economic policy or foreign policy to be so deep in debt to one country, but we're in the situation now; it needs to be addressed. How do we get out of this mess? We need to attract capital to the US economy and the Chinese have been happy to assist us up until now. If their capital is withdrawn, we will need to do something to entice new investments. If we don't offer higher returns on equity capital, the enticement post Chinese selling, will be higher interest rates. Congress needs to quit bloviating about the Chinese currency and get to work on a corporate tax cut. I'm not holding my breath.

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