We're already past the point where half of the coins are in circulation. But think about the bold bit of your quote. You are suggesting they could kill bitcoins by giving to bitcoin owners the market value in fiat.
That is not killing it, that is embracing it. They would need to buy many bitcoins, I don't know what your definition of slowly is, but you are suggesting they would provide continuous demand for BTC. By the time they dump them, the markets will gratefully eat them and ask for more.
I think the point is that a government actor could most easily destabilize the BTC market this way, and in doing so, make it too risky to use.
A billion dollar market is a tenth of a rounding error to a large government, and if this was carried out in the name of "national security," the costs would be irrelevant (and classified) anyway. They wouldn't care that they enrich a few thousand people in order to shut down a way for evil-doers to finance their operations.
This is an interesting idea to play with, but IMO, highly unlikely. I think they are more likely to apply the necessary pressure to the weak points in the system in order to track and monitor the movement of large sums.
It's true that 1 billion cap is tiny, but to buy enough coins to really control the market in a "definitive" way you need to spend A LOT more than its seems, supply is very limited, and for this kind of attack you really want to expose as many people as possible to your stunt - traders are not afraid of volatility, if you want people to run away from BTC you need to really skyrocket it to the moon to then crush it to the closest to 0 as possible. That wont cost hundreds of millions, that will cost billions ATM, and every year that passes this kind of attack gets more and more expensive.
And then, do not forget that
Satoshi never moved a single coin. He controls
at least 1M BTC. He's holding to be able to neutralize any deep-pockets attacker
(tinfoil hat mode off)
Someone dumped what, $6 million and left the markets looking like Hurricane Katrina just hit. People are still on the sidelines waiting for the next dump. $6m is nothing as it relates to governments. Bitcoin, IMO, is not ready for a massive attack, with some serious $100+ million. Not saying I have the battle plan perfectly mapped out, but just these Sunday dumps is enough to highlight that the potential is real. This is absolutely an exploitable weakness. Maybe Bitcoin could survive, maybe it wouldn't. As was said, it would be entertaining as hell. 
