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China talks tough to hide a weak hand

China is apparently threatening to dump their massive holding of US dollars if Congress gets too aggressive with trade tariffs:

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.

The unfortunate thing is that China and the US have a unhealthy codependent relationship. The US is addicted to the cheap money the Chinese have been providing, which allows interest rates to stay low and keep the economy moving. And China is dependent on the US to soak up all the crap they produce so they can keep their people working and avoid social unrest. It's a situation that can't go on forever, and perhaps the cracks are finally beginning to show.

But economic crises are caused not by changing economic conditions, but by the rate of change of those conditions. Markets generally adapt to change very well, but too much too fast will cause enormous disruptions that unpredictable effects. Both the tariffs proposed by the US and the dumping of dollars by the Chinese will rebound to their own countries and cause a lot of economic devastation.

The fact that the two countries are still making threats to each other in public tells me they're still a long way from cooperating in disentangling themselves from this mess they're in. Personally, I think it's far too late to do anything anyway, especially with the debt crisis growing in the US. It's likely the rhetoric will get more heated as the two nations seek to blame each other for the inevitable pain as they break free of their codependency the hard way.


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