Dr. Susmit Kumar, Ph.D.

President Trump has started a trade war between US and China. Prior to him, no US administration even talked about it because top policymakers have known for a long time that the US cannot win a trade war with China. Mr. Trump thinks that he is a genius who does not need any advice. If Mr. Trump escalates the trade war with China to a level of do or die, China may take extreme step of destroying the US dollar and the US economy by dumping its massive US investments, although it would have severe damage to the Chinese economy also. China would make its currency Yuan as the global currency, replacing the US dollar. It would put the death knell to the US economy as the country would face several decades of massive economic depression (please see my paper: Part IV – US Bogus Market-Driven Economy and RBI’s Functional Autonomy).

In March 2009, the Pentagon for the first time held a series of economic war games exercises. In each and every scenario, the US lost to China consistently. The soldiers were Wall Street traders and executives, economists, and academics – all were Americans. Wall Street bankers were flown in from Manhattan to a bunker at the Applied Physics Laboratory in Maryland for the two-day event. They were assembled in the Warfare Analysis Laboratory, surrounded by uniformed officers of the highest levels in the Pentagon, facing a dizzying array of screens normally used to simulate nuclear world war. Only this time the weapons were stocks, bonds, and currencies. The group was split into five teams: America, Russia, China, Pacific Rim, and a "grey team", representing shady outfits such as terrorist organizations. They were sent into "bunker rooms" and told to use financial or economic tools - currency, debt, stocks, gold - to bring their enemies to their knees. Everything was conducted via computer, and they could be as devious and ruthless as they liked. At the end of that Pentagon session, the 80-odd players returned from their bunkers and assessed the damage. China won, without so much as reaching for a gun (“Pentagon prepares for economic warfare,” Helen Rumbelow, The Australian, August 20, 2011; “China’s giant economic sway,” Eric J. Weiner, Los Angeles Times, October 6, 2010.)

The reason for the 2009 Pentagon economic warfare exercises was the fear of dumping of Chinese US holdings at the onset of the 2008 Great Recession. Before the 2008 housing bubble collapse, China and Japan had as much as $400 billion and $74.5 billion investments, respectively, in Fannie Mae and Freddie Mac when these two agencies were bailed out by the US government. As US officials were deciding in August 2008 whether to take over Fannie Mae and Freddie Mac, the US Treasury Department held informal talks with officials from the People’s Bank of China (China’s central bank). The Chinese representatives told them they expected the US government to “do whatever is necessary to protect the investments” (Japan China Locked in by Investments, Blaine Harden and Ariana Eunjung Cha, “Japan, China Locked In by Investments,” Washington Post, September 20, 2008).

At the onset of the 2008 Great Recession in US, Russian President Putin contacted the Chinese to dump their US holdings to severely damage the US economy. Russia had only $400 billion in US investment whereas China had $1.8 trillion in US investment at that time. Hence China might have lost a lot as compared to Russia had the US dollar and US economy gone down drastically due to their actions. That’s why China did not heed to Russian advice. In a BBC interview, Hank Paulson, the then US Treasury Secretary, described the incident (Russia 'planned Wall Street bear raid', Robert Peston, BBC, 17 March, 2014):

"When Fannie Mae and Freddie Mac started to become unglued, and you know there were $5.4tn of securities relating to Fannie and Freddie, $1.7tn outside of the US. The Chinese were the biggest external investor holding Fannie and Freddie securities, so the Chinese were very, very concerned."

Or to put it another way, the Chinese government owned $1.7tn of mortgage-backed bonds issued by Fannie Mae and Freddie Mac, and it was deeply concerned it would incur huge losses on these bonds.

Mr Paulson: "I was talking to them [Chinese ministers and officials] regularly because I didn't want them to dump the securities on the market and precipitate a bigger crisis.

"And so when I went to Congress and asked for these emergency powers [to stabilise Fannie and Freddie], and I was getting the living daylights beaten out of me by our Congress publicly, I needed to call the Chinese regularly to explain to the Central Bank, 'listen this is our political system, this is political theatre, we will get this done'. And I didn't have quite that much certainty myself but I sure did everything I could to reassure them."

In other words, China had lent so much to the US that Mr Paulson needed to do his best to persuade the Chinese government and central bank that China's investment in all this US debt would not be impaired.

"Here I'm not going to name the senior person, but I was meeting with someone… This person told me that the Chinese had received a message from the Russians which was, 'Hey let's join together and sell Fannie and Freddie securities on the market.' The Chinese weren't going to do that but again, it just, it just drove home to me how vulnerable I felt until we had put Fannie and Freddie into conservatorship [the rescue plan for them, that was eventually put in place]."

For me this is pretty jaw-dropping stuff - the Chinese told Hank Paulson that the Russians were suggesting a joint pact with China to drive down the price of the debt of Fannie and Freddie, and maximize the turmoil on Wall Street - presumably with a view to maximizing the cost of the rescue for Washington and further damaging its financial health.

Paulson says this guerrilla skirmish in markets by the Russians and Chinese didn't happen.

But this kind of intelligence from China on Russian desire and willingness to embarrass the US in a financial sense may help to explain - in a small way - why President Obama shows little desire to understand Crimea as seen by Mr Putin.

If Mr. Trump escalates the trade war with China, the US might witness its own “Suez Fiasco” that caused the United Kingdom and France to lose their superpower status. Describing the stranglehold of China over the US economy, Richard Haass, President of Council of Foreign Relations, a premier US think-tank, said (“Don't be distracted by Greece: Americans must also face financial facts,” Justin Webb, The Telegraph (UK), June 25, 2011.)

Essentially the U.S. took advantage of Britain’s Sterling problem to exercise economic leverage over the British government, and that led to a hasty retreat in the 1956 Suez War (despite defeating the primitive Egyptian army on all the fronts, the invading forces had to withdraw). So one can imagine a situation nowadays, where, say, there is a crisis over Taiwan between the U.S. and China—which holds a significant number of dollars—and one can imagine the Chinese might be prepared to threaten the dollar, make some comments to weaken it unless the U.S. backs off some of its support of Taiwan.