At the end of last week, the warning came. The Chinese officially warned Hank Paulson et al. that they better get their act together on Fannie and Freddie. The Chinese own a ton of GSE paper and they would be hopping mad to see their investments lose value.
The implicit threat is that the Chinese will cut the dollar loose if Fannie and Freddie fail. If the dollar falls precipitously against China’s currency, then all bets are off regarding the future course of the U.S. economy and inflation. That said, it remains to be seen whether the Chinese would make good on their threat as it would cause problems for the China and its export market as well.
In the end, the comments highlight how excessive pending by the U.S. has led to the relative weakness in geopolitics. But, so it is when one depends on the kindness of foreign governments.
“If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,” Yu said in e-mailed answers to questions yesterday. “If it is not the end of the world, it is the end of the current international financial system.”
–Yu Yongding, former adviser to China’s Central Bank