While some countries have already reduced their U.S. dollar-based currency reserves, a similar decision by the Chinese government would be bad news for the greenback. That threat will likely hover over the market in 2007, and the U.S. government is doing what it can to prevent it.The biggest threat to the dollar — and to U.S. prosperity — is the chance the Chinese government will dump its roughly $700 billion in dollar-denominated reserves, as it has hinted it will. The sum of $700 billion is only fairly large in the forex universe, but the psychological effect of such action would be huge. It would reverberate throughout the financial world, inducing others to diversify reserves into euros, the British pound, the low-yielding Japanese yen, and even zero-yielding gold.

Reserve diversification has already become a big deal. The Bank for International Settlements recently reported the dollar has slipped from 67 percent of the world’s reserves to 65 percent.