Add one more pill to the daily Oxycodone consumption by the Chair Central Planner. In what is about to become the latest headache for Bernanke, popular Chinese economist Lu Zhengwei, a senior economist at China's Industrial Bank Co., has advised that China should promptly sell its GSE holdings on concerns that continued "blank check" writing by Congress to the GSEs will be "almost impossible" as well as fears that as soon as QE2 ends, the entire US bond complex will see a major sell off. In other words welcome to the world of game theory defection: he who sells first, loses the least.

From Dow Jones:

A popular Chinese economist on Thursday said China should be aware of risks in its holdings of debt issued by U.S. government-controlled mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC), and suggested that China sell the securities soon.



The report by Lu Zhengwei, a senior economist at China's Industrial Bank Co., doesn't represent the views of China's leadership, but it does highlight persistent concerns about the security of Fannie Mae and Freddie Mac securities among Chinese civilians and some influential thinkers.



Lu's warning comes just ahead of a report from the Obama administration, which could come as soon as Friday, that will outline options to gradually phase-out the two companies, reducing the government's footprint in the U.S. mortgage industry.



Although an outright default is unlikely, Lu said that the end of the Federal Reserve's program of quantitative easing could cause the price of the securities to fall. He suggested China sell its Fannie and Freddie holdings before the U.S.'s quantitative easing ends in June.

If China were to sell its GSE debt how big would be the damage? Pretty big: $500 billion worth of big.

Lu estimated in the report that "Chinese organizations" hold around $500 billion of debt backed by the two companies. In a telephone interview with Dow Jones Newswires, Lu said "Chinese organizations" was a reference to holdings by the Chinese government in their foreign exchange reserves. Lu said he based this estimate on Chinese media reports, as the Chinese government has never confirmed the size of its holdings in the two agencies.



According to the U.S Treasury's report on foreign holdings of U.S. securities, China held $454 billion of long-term U.S. agency debt as of June 30, 2009. That includes $358 billion of "asset backed securities???backed primarily by home mortgages," and $96 billion of other long-term agency debt.



The bulk of those holdings are likely in Fannie and Freddie bonds and securities, though it also includes debt from other U.S. government agencies such as the Government National Mortgage Association.

And as all those who follow the shady dealing of the "Direct Bidders" and the UK-based buyers, the number is likely far, far greater:

The U.S. Treasury data may understate the true extent of China's holdings, as they don't include purchases made through special units based in Hong Kong and in other locations outside China.

As Zero Hedge has been reporting with every single TIC report, China has continued to sell its agency debt, as well as lowering its US Treasury holdings.

According to separate figures from the U.S. Treasury, China has been steadily selling its holdings of agency securities since mid-2008. It sold a net $24.67 billion worth of agency securities it 2009, and $27.35 billion in the first 11 months of 2010, according to the data.

So if China decides to not only not buy any incremental debt issued by the US, but to fully commit to selling, this virtually guarantees QE3, as the only way to find a buyer for the debt will be to prime the Fed's printer. Which in turn will activate the timer fuse on the 21st century's first Wiemar Republic recreation. And to think of just how much of a coward Tim Geithner was forced to appear last week when he announced that China is not a currency manipulator: it will be so very fitting for the country to add insult to injury and literally take a bond dump on Geithner's front lawn.

h/t Papa