China owns tons of US Treasuries. They need to diversify their portfolio, and will soon begin selling some of these treasuries. They have also been accused (rightfully so) of manipulating their currency to keep the Yuan at falsely low levels. What this does to help China is to keep their exports at artificially low levels. This also helps US consumers afford their goods, but makes it difficult for American manufactures to compete.
Hank Paulson – the former Secretary of Treasury – was instrumental in fostering good relations with China. The hope was that Hank could help persuade China to free-float the Yuan. Although that didn’t happen, China did allow it to fluctuate a little higher heading into the Olympics. Now we have a new Treasury Secretary, Timothy Geithner, who has already expressed to senators his views that China is manipulating their currency.
So, what is the game of chicken? The game of chicken is that China gets irritated enough to dump all their US treasuries at once, immediately hurting the value of the US dollar. Some economists believe this could be a severe blow to our economy; others believe that as China sells, other countries will buy. Either way, selling all the treasuries at once would undoubtedly also hurt China’s ability to export to the US. The goal is to get China to free-float the Yuan, something that would ultimately be in China’s best interest, without irritating them enough to sell off all the treasuries in one fell-swoop.
Within the last two weeks, this game of chicken has escalated rapidly. Last week, the Premier of China for the first time publically criticized our debt holdings, and the Chinese are now vocal that they are concerned. "We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets. To speak truthfully, I do indeed have some worries," and he wants the US to "keep their promise and guarantee the safety of Chinese assets."
This was followed up immediately by the Fed’s statement this week that it is purchasing mortgage-related securities and government bonds, thereby pushing down the yields on the treasuries and slightly devaluing our currency. Obviously the Chinese were not happy with what transpired, and this morning China called for the creation of a new currency to replace the dollar as the world's standard. Russia made a similar proposal earlier this month, and OPEC publically discussed this last fall. Only time will tell if the Greenback will lose its throne or not, but the escalating "cold cash" war with China will continue into the foreseeable future. Although these are my thoughts, Clark’s Thoughts, they are also the thoughts of our entire Allocation Team.
