Is This The End For The U.S. Dollar?

China, the biggest foreign creditor of the United States, owns a truckload of our government bonds. Over the past several weeks, it’s been selling some of those bonds to prop up their currency, the yuan. This is supposed to signal the end of the dollar. As the Chinese put our bonds out for the bid, interest rates are going to shoot higher, driving down the value of the greenback and making imports unaffordable. At least, that’s what dollar haters have expected for years.

There’s only one problem. It’s not happening. And in our view, it won’t happen in the near future.

China’s actions have everything to do with their problems, and nothing to do with the valuation of the dollar or their assessment of U.S. policy moves. Besides, when it comes to U.S. Treasury bonds, we’ve got an ace in the hole, even if we don’t like it very much.

In the early 2000s, the Federal Reserve devalued the U.S. dollar by holding interest rates exceptionally low. Since the Chinese yuan is pegged to the dollar, Chinese goods became ever cheaper in currency terms on the world market.

They sold a lot of stuff, so their exporters were flush with foreign currency. They traded their dollars, euros, and yen for yuan, which the Chinese government had to print to satisfy demand. The process led to inflation in China from all the newly-printed currency, and a rapid buildup of foreign reserves in their central bank.

After cries of currency manipulation and a lot of inflation at home, the Chinese allowed their currency to strengthen a bit. The pegged rate moved down from just over 8 yuan per dollar to about 6 yuan per dollar over the course of a couple of years. On a daily basis, the government allows the yuan to trade 2% above or below the pegged rate. To keep the yuan within the band, the Chinese government uses some of its foreign currency to buy or sell yuan as needed.

This all works great until economic trends change.