The velvet gloves are off. Escalating tension over a simmering US-China trade war is threatening to spill out of control.

Chinese think tanks and academics have boasted about the capability of sinking the US Dollar by selling the huge reserves that they have accumulated. With most of this reserve invested in US treasuries, the threat to the Dollar supremacy is very real.

The Dollar sale threat does not come at an opportune time, as the American subprime mortgage market is facing teething problems.

As Globalization marches to lift millions out of poverty, growing apprehension about America turning protectionist could trigger a global trade war as more nations adopt protectionist laws.

American lawmakers are to contemplate, an autumn legislation that could impose trade restriction on Chinese imports so as to protect the American economy from being held hostage to economic decisions taken in Beijing or Tokyo.

Referring to the Chinese threat about a Dollar sale, Simon Derrick, a currency strategist with Bank of New York Mellon said ‘the words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the subprime troubles’.

Imposing sanctions against China or hindering free trade, in order to force a revaluation of the Yuan could prove counter productive for the growing economic might of China may force it to sell US bonds to protect the Yuan. An appreciating Yuan would mean selling of US dollars, which would further dip its value and could threaten the Dollar’s status as a ‘reserve currency’.

While the Russians and Swiss have reduced their dollar holdings, the rising Asian economies as well as the oil rich nations still bank on the stability of the dollar. Fallout of the US-China trade war could mean erosion of value for most of the dollar rich countries. Adding to the woes of US Dollar supremacy is the rise of Euro.

Not just a huge trade deficit against China, the US dollar is under pressure against most currencies around the globe, be it the Japanese Yen, the Euro, the Canadian Dollar or even the Russian Ruble that was considered worthless a decade ago.

America is at one of its most crucial moments in history.

The Iraq war gone wrong has eroded moral creditability of a nation leading the way, its high spending consumers are feeling the pinch from rising gas prices and higher mortgage interest rates and outsourcing has relocated manufacturing to China and services to India and other countries.

With the heat of the 2008 election campaign getting to the prospective nominees, especially the democrats, the call for protectionism is getting shriller.

A weakening dollar could kick start domestic manufacturing but any erosion of the US economy could tip it into recession.

And a recession of the US economy would mean an economic winter for many poor nations.

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