What Leverage Does Chinese Ownership of US Assets Give Them?

I agree with Stephen Walt’s overall point that part of what we’re seeing on Barack Obama’s Asia trip is that the Bush administration’s squandering of American national power has increased China’s status vis-a-vis the United States. That said, there’s a particular thread in his comments that you hear a lot and that I don’t really understand:

No president is going to be able to lay down the law on human rights, exchange rates, or sanctions on Iran when China owns over a trillion dollars in U.S. assets, when the U.S. economy is on life support, and when the American military Is mired in two losing wars. Until we get our house in order over here, nobody should expect China to be especially responsive to our wishes or expect its leaders to view the “American model” as especially appealing.

My question is, in the specific case of the US-China currency dispute what leverage does Chinese ownership of US assets give them? If we annoy them too much about our desire to see their currency appreciate, they might sell their dollar-denominated assets thus . . . causing their currency to appreciate? It doesn’t add up. China isn’t buying that stuff as a favor to us that they can then revoke. They’re buying it as an integral element of their exchange rate policy.

The real question about this is whether American officials really want them to stop. They say they do. But while dollar depreciation would be good for the American labor market, and good for the long-term balance of the world economy, it could make the deficit situation more urgent.