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China’s “Nuclear Option”

In the past few days two Chinese officials have threatened to employ the “nuclear option” against the United States: selling dollars and U.S. Treasury obligations to retaliate against possible American legislation. Congress is now considering bills meant to counter Beijing’s tight control of the value of its currency, the renminbi. China possesses somewhere in the vicinity of $1.3 trillion of foreign exchange reserves. Analysts believe that the Chinese government holds about $900 billion in dollar assets.

“I personally believe we have so many foreign exchange reserves that we should be smarter in setting the issues,” said Xia Bin, one of the officials, at the end of July. “It should at least be a bargaining chip in talks.” This is the first time that a senior economic adviser to Beijing publicly has suggested using China’s reserves for political leverage. He Fan, the other official, wrote in the China Daily on Tuesday about Beijing’s causing “a mass depreciation” of the greenback.

We should thank Xia and He for revealing the thinking in the inner circles in Beijing. They provide a useful reminder that we need to pay down our debt and rebalance our economic relations with China. Yet let’s not panic and give into the bluster of China’s autocrats. Unfortunately for them, their holding of dollars is not much of a weapon. Imagine the worst-case scenario: Beijing tries to dump all of its dollars in one day. What would happen? The Chinese would have to buy something—say, for example, euros and yen. The values of those currencies would then shoot up through the ceiling. The Europeans and the Japanese, to stabilize their currencies, would then have to buy . . . dollars. In short, there would be a great circular flow of cash in the world’s currency and debt markets.

There would be turmoil in those markets, but it would not last long—two quarters at the most, perhaps even just a few weeks. And we would end up in just the same place that we are now, except that our friends, instead of our adversary, would be holding our debt. Global markets are deep and flexible and can handle just about anything.

Hillary Clinton once said we can’t argue with our Chinese bankers. I think we can.


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