It’s one thing for US officials to verbally display discontent toward Chinese foreign exchange policy; it’s quite another to actually give them an ultimatum by introducing a bill threatening to slap tariffs on any incoming goods from China if current Chinese FX policy is not reconsidered. According to reports, at least a dozen US Senators have agreed to co-sponsor a bill that would give China a 180-day time window to revalue their currency or face a 27.5% tariff on all incoming Chinese goods.
This bill, if ratified, would elicit a new wave of protectionism – something that has long worried Morgan’s Steve Roach. It would also compromise the delicate relationship where China subsidizes the US consumer through capital inflows (and thus through bond purchases) while US consumers purchase cheap Chinese goods.
The “leverage” factor also comes into play. China has the leverage – through the boatloads of Treasuries it holds – to soothe protectionism fears by dumping/limiting purchases of US bonds (thereby shutting up US policymakers fearful of a Chinese-induced US recession), or to possibly expedite certain geopolitical or militaristic agendas if aggravated. The use of large dollar holdings to push a political agenda or express displeasure over US policy is not without precedent.
Beyond the economic considerations that might motivate central bank dollar sales, one would think that the US Administration would be equally concerned about the potential for politically motivated such sales. As Barry Eichengreen, the noted economic historian, reminds us, it is not so long ago that General Charles De Gaulle used France’s large dollar holdings in the early 1970s to express displeasure about the US handling of the Vietnam War. By unloading France’s dollar holdings, he pulled the plug on the erstwhile Bretton Woods fixed exchange rate system, whose collapse shook global financial markets.
The question that now needs to be addressed is whether the foreign central banks’ massive dollar reserve holdings might not place the US in an untenably vulnerable economic position. Might for instance China not be tempted some day to unload its vast dollar holdings to express its displeasure over US policy concerning the Straits of Taiwan?
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