CHINA’S NUCLEAR OPTION AGAINST THE DOLLAR

There are rumors, this is Washington, after all, that the Chinese government has initiated a 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. Iran has already done this, and Saudi Arabia has threatened to do this, although my source in the US State Department has told me that the Saudis have already begun swapping in their dollars for Euros.

Two officials at leading Communist Party bodies have given interviews in recent days warning that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress to redress the US-China trade imbalance.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels. It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.

Xia Bin, finance chief at the Development Research Centre (which has cabinet rank), kicked off what now appears to be government policy with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US. "Of course, China doesn't want any undesirable phenomenon in the global financial order," he added.

He Fan, a Chinese official, reportedly has suggested in bold terms that Beijing had the power to set off a dollar collapse if it choose to do so. "China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency. Russia, Switzerland, and several other countries have reduced the their dollar holdings.

The US Senate has drafted a bill backed by the Senate Finance Committee which calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.

The yuan has appreciated 9% against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9 billion in June.

Henry Paulson, the US Treasury Secretary, said any such sanctions would undermine American authority and "could trigger a global cycle of protectionist legislation." Paulson, a China expert from his days as head of Goldman Sachs, has opted for a softer form of diplomacy, but appeared to win few concessions from Beijing on a unscheduled trip to China last week aimed at calming the waters.

So I guess it's time to stop buying Chinese.