I wrote yesterday about the recent Chinese veiled threat to dump its dollar holdings if the U.S. raises tariffs in hopes of coercing them to let the Yuan rise against the dollar. Today I had the opportunity to pick the brain of an expert on the topic, Brad Setser, Chief Economist at RGE Monitor and former acting director of the Office of International Monetary and Financial Policy at the U.S. Treasury.

My first question to him was, is this a credible threat? Setser didn't believe so, because it would represent a huge shift in China policy. The Chinese government, he explained, has shown a consistent bias toward supporting the country's exports, even at the cost of holding onto dollars as their value drops against other world currency. In fact, China continues to bolster its dollar holdings, adding $350-400 billion this year alone.

Setser went on to explain that, in his opinion, the Yuan was currently undervalued against the dollar by approximately 30%. If such an imbalance were abruptly corrected it would dramatically disrupt their export market.

He went on to say that China is in effect swallowing huge losses by holding dollars in order to support their exports, but the current regime has not indicated any likelihood to change that position.

However, he cautions, tensions between the two countries are growing, as the Chinese government takes umbrage at the growing movement in the U.S. to address the trade imbalance with legislation.

My take from this discussion: a change in the status quo is not in the offing, but the trade discussions in Congress are being watched carefully by the Chinese government. In the political season we are entering, pro-tariff campaign rhetoric could bring about more threats of reprisal.