It's an empty threat. The Chinese have been gamed, just like the...

It's an empty threat. The Chinese have been gamed, just like the US investment banks gamed the world's savers.

What currency is going to replace the USD? This crisis has exposed how terribly weak a fiat-based system is, but especially how susceptible the all of the non-reserve currencies are. They have all been smashed - none are safe.

The Chinese were conned into buying what, to them, have become illiquid assets. There is no market for the amount of US Treasury bonds which the Chinese own. Therefore, they are unsaleable. The Yanks have snookered them. It's finally starting to dawn on the Chinese leadership. They're p***ed, but what can they do? They've started buying up stakes in overseas resource companies, but it's really a drop in the ocean, compared with the money they have "invested".

They're like a hedge fund investor, and the manager announces a "temporary" freeze on redemptions. Annoyed? Hell, yeah! But read the fine print, buddy!

So, the Chinese threaten to not buy anymore US treasury bonds? Who cares? All that means is that Helicopter Ben and Timmay get to do what they've been wanting to do (but haven't found a good reason, yet): pring mo' money!

The last thing the Yanks want at the moment is a strong dollar! It makes their imports more expensive, it reduces the rate of inflation...who needs a strong dollar? Well, only the holders of USD reserves.

Do you think a strong dollar was in Gentle Ben's How-To-Avoid-A-Depression plan? No way! Read the helicopter speech and you'll see that. What nobody counted on, was the extremes to which globalization and interconnectedness had gone.

In previous recessions, there were regions which weren't so badly affected. This time, however, every country in the modern world drank the Kool-Aid. As reserve currency, the USD is seen to be the last thing standing. So, who needs China?

Well, here's the thing: Big Barack has a Big Spending program lined up this year. At the outset, it seems like everyone (apart from China's) interests are served by this big Treasury issuance: nobody, not even China, has enough savings to fund such extravagance, so Heli Ben will need to print money. This will reduce the value of the dollar, thereby assisting the US's ever-shrinking band of exporters. It's always easier to print money, rather than market your product (US debt, in this case), so everything will seem beautiful for a while.

Cue in, equities rally - the worst is over; we're in a sweet spot; whew! dodged that one, didn't we?

This is where I believe we are right now.

The Northern Hemisphere countries, I believe, will have a summer of tentative "relief". People will just start to think that it isn't really all that bad....then Autumn will come.

In the second half of 2009, I think inflation will smack people, hard. The moment the equities rally starts to take hold, the USD will start to drop again. When the dollar is dropping, zero interest rates on Treasuries won't sell you too many Treasuries! Printing money to pay for new ones doesn't help the dollar, either. This has major snowball potential.

If the world's reserve currency goes into a death spiral and loses, say, 25% of its value in a few months, there is every chance that the world will experience 25% inflation over the following year or so (and China will experience a 25% reduction in their reserves).

Now, all of this is pure speculation. Things may play out differently. I haven't tried to extrapolate this scenario any further, because it's all speculative. It's just trying to say that I view what's happening as highly unstable. If events get to the point that I raise above, it will be like the bloke standing up in the dinghy, who starts to lose his balance, overcorrects, etc....you see it and you know that it's only a matter of time before he capsizes, however it's impossible to predict which side he will fall out.

JMO