The widely-circulated "nuclear" theory suggests China would dump US treasuries in a trade war with the US. That theory never made any sense. Such a move would tend to strengthen the yuan, making Chinese exports more expensive. Thus, it would be precisely what the US would want.

The Real Nuclear Option

The real nuclear option would be a devaluation of the yuan, making Chinese goods less expensive to the US.

Reportedly, China is Studying Devaluation.

China is evaluating the potential impact of a gradual yuan depreciation, people familiar with the matter said, as the country’s leaders weigh their options in a trade spat with U.S. President Donald Trump that has roiled financial markets worldwide.

Senior Chinese officials are studying a two-pronged analysis of the yuan that was prepared by the government, the people said. One part looks at the effect of using the currency as a tool in trade negotiations with the U.S., while a second part examines what would happen if China devalues the yuan to offset the impact of any trade deal that curbs exports.

While a weaker yuan could help President Xi Jinping shore up China’s export industries in the event of widespread tariffs in the U.S., a devaluation comes with plenty of risks. It would encourage Trump to follow through on his threat to brand China a currency manipulator, make it more difficult for Chinese companies to service their mountain of offshore debt, and undermine recent efforts by the government to move toward a more market-oriented exchange rate system.

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It would also expose China to the risk of heightened financial-market volatility, something authorities have worked hard to avoid in recent years. When China unexpectedly devalued the yuan by about 2 percent in August 2015, the move fueled capital outflows and sent shock-waves through global markets.

Nuclear Option Risks

Clearly, there are risks of devaluation. But China can mitigate much of those risks with a controlled, slow devaluation instead of multi-percent move as we saw in 2015.

Brad Sester echoes sentiment I expressed previously regarding the alleged "nuclear" dumping option.

Five days ago, I stated "It's highly unlikely China would dump US treasuries in a trade war. Yet, the talk surfaces all the time."

For further discussion, please see Understanding the Trade "Nuclear" Threat, China Dumping Treasuries.

It's amusing how ass backward the "nuclear" proponents were. A devaluation, not dumping treasuries, is the real nuclear option.

Mike "Mish" Shedlock

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