> With China threatening to dump some of its treasury
> holdings (if the US continues to talk about human
> rights issues, or barriers against certain Chinese
> products),it seems more likely that rates will
> increase, in order to attract new foreign lenders.
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Could be.
However, China has been gradually diversifying out of the dollar for some time now, as have other Asian, Middle Eastern, and European central banks, but not nearly in such volume or at such a pace as to sent interest rates soaring and choke off US and global growth.
As exporters, they have to buy dollars in order to maintain a favourable exchange rate against it, and they've accumulated large stashes of USD reserves as a result - about $700 billion in China's case - which are vulnerable to dollar depreciation. In fact, the USD has already lost nearly a third of its value over the past five years against a basket of the world's major currencies (mostly the euro) so it isn't as if we are at the beginning of the devaluation process or that it has been provoking any great alarm.
All of the central banks want to see a slow and orderly rebalancing of currencies in order to encourage debt-strapped US consumers to pull back and Chinese and other savers to consume more. US Treasury officials haven't made a secret of the fact that they would welcome China spending somewhat less of its foreign earnings on Treasuries and more on boosting purchasing power at home to absorb more US exports.
Naturally, there is always the danger of sudden collapse if investors abruptly lose confidence in the dollar for any reason. Maybe it will be triggered by a US crash precipitated by the unwinding of the housing bubble, but while foreign investors are worried about possible hidden exposure of their own banks and funds to the seized-up MBS market, they haven't as yet shown any signs of abandoning the the dollar. On the contrary, during the latest round of jitters, they seem up to now to have moved more strongly into Treasuries in a "flight to quality".