One of the most frequent questions I get from readers is about China’s willingness to dump US Treasuries. Won’t such an action result in mutually-assured destruction?

Yes, if China aggressively dumps US assets the US dollar will drop (since China owns a significant portion of outstanding US Treasuries), thus devaluing the remaining US assets held by China. But that’s the right answer to the wrong question. The more appropriate question is this: regardless of the consequences, does China’s capability to dump US assets give it a strategic advantage over the United States?

The answer is a resounding ‘yes’. Luckily, we have a fairly recent example from which to draw a precedent.

Anyone that doubts the strategic influence China’s ownership of US Treasuries has on US foreign and domestic policy must look at the Suez Canal crisis of the 1950s.

I’m summarizing here, but after Egypt nationalized the canal in 1954 Britain and France were deeply concerned and sent troops to Egypt to take back the canal. The Americans weren’t informed in advance and were furious that their allies would threaten to destabilize the middle east without consultation. At the time, the US was a major holder of UK sovereign debt.

The textbooks tell you that US, USSR and UN pressure caused Britain to withdraw from Egypt. But various sources go deeper and describe a conversation between the US president and UK prime minister, during which the US president threatened to dump UK assets. Skeptics at the time said the US president was bluffing, as this action would be mutually destructive. However, the UK prime minister caved. Why? Two reasons: 1) When someone holds a gun to your head you do what they say, even if they risk prison…the person holding the gun knows this; 2) The mutually-assured destruction surely would have ruined the UK economy but may have only impacted the value of US foreign reserve assets. Moreover, if the US dumped UK bonds the pound sterling would have possibly plummeted raising the cost of energy and food imports, potentially crippling UK transportation and industry and starving the domestic population. During this crisis, Britain’s financial dependence on foreign bond holders clearly shifted the balance of power and Britain’s ability to act in its own interests.

Making things worse, during the crisis Saudi Arabia started an oil embargo against Britain and France, and western nations – under the influence of the US – refused to fill the gap until Britain and France retreated. Again, Britain’s dependence on foreign energy provided countries with control over oil supplies a significant advantage.

With the financial and energy threat growing stronger by the day, Britain caved to foreign demands and announced a cease fire. Many mark this moment as the official end of the British Empire.

Politicians in the UK surely debated whether or not the US president was bluffing, and many argued that by dumping UK bonds the US administration would shoot itself in the foot. However, the downside risk to the UK economy was simply too great to call the bluff and UK politicians retreated.

Many look at Chinese ownership of US debt today and point to a similar (or worse) crisis down the road. What they fail to realize is that US policy is already being influenced by the Chinese. According to documents released by Wikileaks, during the financial crisis of 2008 the US administration received numerous concerned calls by Chinese officials who implied that China would second-guess its ownership of US assets if the US Treasury didn’t effectively nationalize Fannie and Freddie. The US Treasury complied.

If one were to draw parallels to the British experience of the 1950s, one might say this point marked the end of the American empire.

Check out the Wikileaks cables on this issue:

http://www.planbeconomics.com/2011/02/17/america-you-now-report-to-china/

Frankly, we won’t know how this turns out for another 50 years, but as foreign ownership of US sovereign debt rises risks to US hegemony continue to grow.

In the meantime, here’s a documentary on the Suez Crisis: