The Magazine

The Dollar's New Best Friend

Beijing warms up to the greenback--because it has to.

Jun 29, 2009, Vol. 14, No. 39 • By GORDON G. CHANG
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The central government does occasionally sell Treasuries, but such dispositions are small and always followed by more purchases. Americans are concerned that the Chinese will one day change their mind and dump our debt, thereby throwing our economy--and the global financial system--into turmoil. Beijing, from time to time, hints that is what it could do. For instance, in the middle of 2007, two Chinese officials threatened to employ the "nuclear option" against the United States: sell dollars and U.S. Treasury obligations. "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 pair. "It should at least be a bargaining chip in talks." This is the first time that a senior economic adviser in Beijing publicly suggested using China's reserves for political leverage. He Fan, the other official, wrote in the official China Daily about Beijing causing "a mass depreciation" of the greenback.

We should thank Xia and He for revealing the thinking in the inner circles in Beijing and for providing a reminder that we need to pay down our debt and rebalance our economic relations with China. But their remarks, in reality, were not much of a threat. What would happen in the worst case scenario if the Chinese central government decided to dump U.S. Treasuries? Beijing would have to buy something with the proceeds of its sales. As a practical matter, it would have to buy debt denominated in pounds, euros, and yen. The values of those currencies would then skyrocket. London, Brussels, and Tokyo would then have to try to depress the values of their currencies, which means they would 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 beyond the time the Chinese ended their dollar dump. And we would end up in just the same place that we are now, except that our friends, instead of a potential adversary, would be holding our debt. Global markets are still deep and flexible and can handle just about anything. The fact that Beijing has not employed its so-called nuclear weapon is an indication that the Chinese know it is not, as a practical matter, usable.

And the Chinese realize something else. They have been, over the last two decades, the biggest beneficiary of the dollar-based international financial system that Washington maintains. If the dollar were dethroned, there would be turmoil in global markets. That would, in all probability, lead to a reduction in global commerce. And should Beijing get its wish and the renminbi become the world's reserve currency, its value would surely appreciate, thereby choking off China's export economy. A recent estimate says the renminbi is undervalued by about 40 percent against the dollar.

Hillary Clinton once said we can't "get tough" with our Chinese bankers. She's wrong. We can.

Gordon G. Chang is the author of The Coming Collapse of China.