The Currency 'Nuclear Option' That Isn't

 |  Includes: CYB, UDN, UUP
by: Firat Ünlü

Whenever tensions over the value of the RMB rise the old chestnut of China dumping its Treasury holdings comes up. That concept has to be one of the most-widely misunderstood ones in today’s world. The value of the Chinese holdings rests on the promise of the US government to meet its obligation and pay both principle and interest. Some argue that the US could handle a sudden influx of Treasuries in a manner which would not cripple it too much economically, say via the Fed monetizing but at the same time sterilizing the purchase.

The point is that even if this co-called ‘nuclear option’ were to have an adverse effect on the US economy there is a simple measure the US could take: declare those bonds null and void.

The question of whether or not the US could get away with it rests on the legitimacy of any such action. If a sudden ‘dump’ of Chinese holdings were to have serious negative consequences the US could justifiably claim that this was a case of natural security and an act of economic warfare. Thus any action of the Chinese side would be rendered meaningless instantly as the value of those bonds would be zero either way.

Other foreign investors could be reassured by adding e.g. 1.5%, to the principal of their bonds (since debt has substantially fallen) and would have nothing to fear as responsible actors.

Nonetheless this does not mean that the US can safely start introducing protectionist measures. The Sino-US trade relationship cannot be allowed to deteriorate as the whole relationship rests fundamentally on this one pillar, after all the US government would love to see nothing more than overthrow of the Chinese Communist Party. Without that strong bond values and strategic objectives which differ hugely would come to into the open and we'd be close to another Cold War.

Disclosure: No position.