China is really in a pickle here if the US continues to do what it is with the currency. Since they hold so much US debt, not only would unloading a substantial amount hurt the rest of their US debt, but even not buying further bonds to a certain extent could hurt their currently held debt. It depends how far they are willing to go before they decide cutting the losses might just be the best option.
The Fed of course has been and will probably continue picking up the slack. It should be noted however that a substantial amount of the devaluation is actually not fiscally driven by the administration (although a lot definitely is), but instead by the Fed itself through easy money- QE1 drove the Fed balance sheet to about ~$2 trillion (which was more than double it was previously I'm pretty sure- I forget the exact amount right now) and now they are talking about QE2 which will likely be $100 billion additions to the balance sheet per month for at least 5-6 months.
Of course the market and investors will take advantage- US yield changes recently certainly show it- no surprise there though.
For those of us who don't believe in inflating a currency to "stimulate" the economy, it seems to be a waiting game at this point as you said. For those like Krugman who believe this will work (and will almost certainly dig themselves into deeper and deeper holes every time a new round of QE or government spending fails) it is about sticking to their failing ideology either because they really believe the nonsense or worse, because they don't want to seem stupid by admitting they were wrong and their life's work was based on fraudulent ideas.
