A Mexican Standoff

Or, more appropriately, a Chinese American standoff. Here, in a nutshell is the situation:

1. The Chinese are nervous about holding large dollar denominated foreign reserves, but are also nervous about allowing their currency to appreciate. The only way to keep the currency to appreciate is to buy dollar denominated assets in sufficient amounts to keep that from happening.

2. The Americans want the Chinese to allow the Chinese currency to appreciate, but need the Chinese to continue buying U.S. government securities to finance the American deficits (fiscal and trade). If the Chinese were to stop increasing, much less begin liquidating, their dollar holdings there would be a serious problem.

So, the Chinese cannot achieve their currency objective without continuing to finance the American deficit. The Americans may lecture on currency manipulation (lecturers fallen silent recently) but urgently need the Chinese purchasing presence.

What makes this situation unusual, from an American perspective, is that the outcome is dependent more on how the Chinese assess the situation than on any American initiative.

The United States is in the unfamiliar position of responding to the policies of others, rather than framing an initiating its own. This is Un-American, and a situation ripe for miscalculation.