No Comment — August 8, 2007, 7:55 am

Rumblings of a Trade War

If the United States were a “normal” country, its profligate spending habits and the staggering debt it has amassed—habits of the current “war president” who reversed the prudent spending habits and surpluses racked up under his predecessor—would have immediate consequences for its currency, the dollar. They would produce a quick devaluation of the dollar against other currencies in the world.

But the Bush Administration is insulated against this phenomenon. Why? Because the dollar is not just the currency of the United States; it is, in a very real way, the currency of the world. It is used as the basis for global transactions in petroleum, for instance. And it is hoarded by consumers around the world. More C-notes ($100 bills) are in circulation outside of the United States than within it, and most of these notes are not actually in circulation–in China and Japan, for example, investors have vast holdings in U.S. treasury instruments. All of this has “suspended the rules.” But what if that situation were to change?

American assumptions that the current benefits gained by the reification of U.S. currency will coast along indefinitely are extremely foolish. In fact, they constitute a major vulnerability for the country—and a vulnerability of which very few Americans are conscious.

But today there are distant rumblings that suggest the American dollar, and the American economy, may be in for a hard landing. While U.S. media has ignored the story, a low-level trade war between America and China has commenced. And it could have very broad consequences. Today’s London Telegraph discusses the issues:

The Chinese government has begun a concerted 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.

Two officials at leading Communist Party bodies have given interviews in recent days warning – for the first time – that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

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.

Meanwhile, in Russia, the Kremlin has long been looking at plans to move away from dollar denominated petroleum transactions, using the Euro as a replacement.

Americans have been living through an economic bubble for many years now. Is it about to pop? The odds look increasingly strong.

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