China Sells Dollars, U.S. Charges Currency Manipulation

China’s unloading of $34 billion in U.S. bonds earlier this month, caught market watchers a bit by surprise. When I first wrote about the sell-off, I questioned whether the move was motivated by risk concerns over the U.S. economy, or simply a “shot across the bow” in retribution to recent events interpreted as deliberate attempts to embarrass China on the international stage.

[mserve id=”Central_Bank_PBOC.jpeg” align=”left” width=”250″ caption=”People’s Bank of China ” alt=”Peoples Bank of China PBOC Central” title=”People’s Bank of China”]

The two countries have a long history of schoolyard taunting with the latest incident coming courtesy of Washington’s recent agreement to supply $6.4 billion in high-tech weaponry to Taiwan. Naturally, this was immediately denounced by Chinese officials who continue to treat Taiwan as a “break-away province” ever since Taiwan declared its independence after the 1949 civil war. Not to be content with this public tweaking of the Imperial nose however, the U.S. followed up a few weeks later with the “Dali Lama” incident, where President Obama’s receiving of the Dali Lama – the exiled spiritual leader of Tibet – was seen as a further insult to Chinese nationalism.

Yesterday, the fiery rhetoric between the two countries continued unabated with a Chinese official admonishing the US and insisting that the Obama administration “undo the damage” caused by these perceived transgressions. Meanwhile, President Obama is facing increased pressure at home to address what is widely-considered to be currency manipulation on China’s part. U.S. Senators – both Republican and Democrats – have accused China of artificially deflating its currency to ensure its exports remain competitive and by extension, increasing America’s trade deficit with China.

“One of the main causes of the public’s discontent is that they feel China doesn’t treat us fairly, and that no one is doing anything about it,” said Democratic Senator Charles Schumer when asked about the trade deficit with China. “This may importune the administration to act, but if they don’t, there’s a strong move in Congress to do so.”

So, where does this lead us? Is it likely that China will continue to sell U.S. debt and simply stop buying U.S. securities into its massive foreign reserves? Will the U.S. risk a trade war by imposing tariffs to punish China’s exporters?

Politics aside, it is hard to imagine anything so drastic. Both sides will continue to grumble and make veiled threats, but the truth is, both countries need each other more than they care to admit. The U.S. must continue to borrow in order to meet its operational expenses, while China needs a relatively healthy U.S. to continue to buy its products. In fact, now that the Euro is struggling to deal with solvency issues in Greece – and potentially, several other countries as well – China has no choice but to invest in the dollar as the euro looks more suspect with each passing day.

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