2021 Economic Armageddon with China on the Horizon

U.S. government officials should make avoiding a trade war — or worse — with China a higher priority than trying to avert a short-term retrenchment in the economy next year, said hedge-fund legend Paul Tudor Jones in a provocative missive to investors this month.

"Authorities on both sides of the Pacific now appear more concerned with avoiding a potential double-dip in 2011, than Armageddon in 2021," wrote Jones, whose personal worth totals $3 billion, according to Forbes, after three decades navigating his hedge fund through the commodity, equity and currency markets.

While Jones clearly plays down in the letter actual "combat" as a likely outcome, he is not the first investor to raise the specter of serious consequences to arise over the long term if the financial imbalances caused by the Renminbi-peg to the dollar are allowed to continue.

China setting its currency artificially low worked well for both parties for a while. The U.S. got cheap goods and cheap labor and China got to transform from an agricultural based economy into an industrial one. With the money from selling to the U.S. population, China bought Treasuries, further funding an American credit boom that temporarily raised the quality of life here and turned many manufacturing jobs into higher-paying service positions.

But with unemployment at double digits and China’s economy maturing into an industrial powerhouse with an emerging middle class that has domestic demand of its own, this once peaceful relationship is coming to a head.

For the health of both nations, China needs to do a "two-year bilateral 30 percent revaluation of the Chinese Renminbi against the dollar," said Jones, adding that the move should be followed by other trading partners such as Brazil and Russia. This would be a much more effective move than the additional quantitative easing the Federal Reserve is about to embark on, because it would create more manufacturing jobs on U.S. soil, reduce inflation and head off – instead of cause — a bubble in the very bonds that China owns.

"I am very concerned about the long-term implications of the currency peg," said Tim Seymour, who manages an international hedge fund and founded Emergingmoney.com. "Mutually-assured economic destruction, or worse, is where we are headed because China and the U.S. are still the most dominant economies in the world."

Right now it’s in China’s best interest to support its tremendous amount of dollar assets, but that won’t always be the case, said Seymour, who is also a ‘Fast Money’ trader. "Once they diversify away from U.S. assets, they will have zero interest in propping up the current account and budget deficit here," he said.

China has let its currency appreciate somewhat this year to avoid being labeled a "manipulator" by the U.S. Treasury. Last weekend, the G20 group of finance ministers, including Treasury Secretary Tim Geithner, said they would work to contain the mounting deficits among developed countries, but many policy makers here are pushing for the Treasury to do more.

Some disagree with Jones that a China revaluation holds the key to our continued prosperity. "A 30 percent appreciation over a short period of time would be a destabilizing factor," said Marc Chandler, Global Head of Currency Strategy for Brown Brothers Harriman. "Those jobs would likely not come here, but to other emerging market countries."

For now, misdirected as it may be, Jones is putting his money behind beneficiaries of the liquidity and inflation he believes will arise from the Fed buying assets "over $1 Trillion." The manager recommends a portfolio of emerging market consumer stocks, gold, copper, grains and 10-year notes.

But our bigger priority should be holding China accountable for not allowing its currency to appreciate more and eventually free float, he said.

"The U.S. has already been in a trade war for nearly two decades and it is the only time in this nation’s history it surrendered without ever firing a shot," said Jones, who used war metaphors throughout the note. "The United States lost six million jobs, indebted itself to China by $1.4 trillion, and received in return a host of consumer goods, many of which now reside in landfills across the country."

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John Melloy is the Executive Producer of Fast Money. Before joining CNBC, he was an editor for Bloomberg News, overseeing the U.S. Stock Market coverage team