Friday, September 7, 2007

Toto, We're Not in Sichuan Anymore...

A report from the Daily Telegraph describes dark hints at from Chinese official in interviews that it may use its extensive holdings of dollar-denominated assets, such as Treasury Bonds as leverage against threats of increased tariffs on Chinese goods. The massive trade deficit between the U.S. and China has allowed it to amass over $900 billion of these assets. Nothing highlights both the types of strategic opportunities and threats that feature in today's global information-enabled economy than the game that China is attempting to play. It greatly fears increased import tariffs on its goods and by fingering the trigger of this particular gun, China is telegraphing to the world that it means business.The pain of such a course of action for the U.S. could be dramatic, including a greatly weakened dollar and massive hikes in interest rates. However, the extensively-interconnected global economy means that wielding power results in unanticipated (and often severe) consequences that would redound to China as well. First, an insolvent domestic credit system will need most of that $900 billion to set right. Declining rates of return, or the destruction of this wealth through trade war will throw millions of Chinese out of work (especially combined with a the loss of teh U.S. market) and undermine the stability of the country -- a perennial concern for the communist party there. Furthermore, the threat may be hollow in that thw world economy might not be large enough to accomodate a transfer of this size. Where would this money go, to the euro? the yen? the pound? the ruble?If advanced or rapidly developing economies do not fight because they have too much to lose then we do not have too much to worry about. The die is already cast as China will continue to hold U.S. Treasuries and the U.S. will allow the relatively free flow of Chinese imports. Both sides will find an amicable solution to trade and financial imbalance and neither will resort to the "nuclear option." If, however, conflict and war results from questions of honor, fear, and "face" -- in spite of the consequences -- then China's threat is far more consequential indeed. On which side of this calculus does history come down?***UPDATED August 9 13:58***It is not all that often that "unthinkable" courses of action by a foreign state are commented on by the President. It happened today, however as the Commander in Chief took note of Chinese threats to dump the dollar. In the president's words, it would be "foolhardy" to attempt to push down the dollar in retaliation for US pressure over Beijing's alleged currency manipulation.Bush said he had not seen the report that Beijing was hinting at such a move, in Britain's Daily "That would be foolhardy of them to do that."

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