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The Foreign Policy of China's Reserves and the Trade Bubble

Posted by: Michael Mandel on March 15

This is a follow-up post to “The Simple Guide….,” involving a deeper look at China. I’m going to use Brad Setser’s post from Saturday, entitled China has more to worry about than its Treasury holdings. Brad writes:

Remember, that Treasuries account for only about half of China’s US portfolio. China likely has about $750 billion Treasuries. But it also has around $500 billion of Agencies. It could have about $150 billion of US corporate bonds. It probably has invested in a range of money market funds, not just reserve primary. And China had about $100 billion in US stocks in the middle of 2008 — though those stocks are now worth substantially less.

Wen’s comments, at least to me, seemed to echo the comments that a host of anonymous Chinese officials made to the Wall Street Journal in January. Their main concern? That the US government wouldn’t backstop bonds that China thought had the implicit backing of the US government. China wouldn’t mind at all if the US provided a full faith and credit guarantee to the Agencies — or to any other financial institution that China had lent money to — even if this meant a larger US government debt stock

Remember that a good chunk of those “corporate bonds” are likely to be bank bonds. The implication is that China doesn’t want to take a loss if a bank is nationalized or goes bankrupt. Isn’t that a surprise?

Brad then goes on to say:

No one forced China’s government to hold a $1.95 trillion reserve portfolio — a total that rises to over $2300 billion if the PBoC’s $184 billion in other foreign assets, the CIC’s foreign portfolio and the State banks foreign portfolio is added to the total. China’s huge foreign portfolio is function of China’s own decision not to allow its currency to appreciate even as China’s current account surplus soared and private money poured into China.

China long viewed its massive reserves with pride, as a symbol of China’s strength. But they are also a burden. In some sense, China is only now waking up to the costs of holding far more reserves than in really needs. China is likely to take losses on China’s reserves — as it in effect overpaid for foreign assets to hold its currency down. If it invests its portfolio unwisely, it may also take additional losses. That in some sense is the bill for using the exchange rate to support China’s exports; it is a cost that China’s taxpayers will have to pick up. I have long argued that the benefits (rapid export growth, lots of investment in the export sector) associated with China’s exchange rate policy were front-loaded while the costs (export dependence, losses on China’s reserves) were back-loaded. The bill for subsidizing China’s exports during the boom is just now coming due.

The housing bubble was a product of the credit bubble, and the credit bubble was a product of the trade bubble. Chickens are coming home to roost, and the only good way to get out is by collective global action.

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Reader Comments


March 15, 2009 08:37 PM

What evidence is there that trade growth was a bubble, ie irrational and unsustainable? I'd argue that trade simply grew as it should have, the problems only came about with how the resulting credit was unwisely dumped into housing, by dumb financiers and investors who provided no oversight for them. As for collective global action, considering how the US and Chinese govts enabled this disaster by pushing Fannie/Freddie into subprime and holding the Chinese currency down, respectively, perhaps collective action should come from private actors and not from govts? The govts can fix their own problems, like Fannie/Freddie and the giant Chinese reserves.


March 15, 2009 10:50 PM

You would have thought that China would have learned from Japan.Through their protectionist trade policies,Japan and now China,are denying their citizens a higher standard of living than they could have with more open trade.They could import much of their food,especially,Japan,much cheaper than they can grow it themselves,but refuse to do so,because they want to protect their farmers.Meanwhile they pile up huge current account surpluses,which will ultimately lose value,as their currencies will appreciate.


March 16, 2009 01:42 AM

"The housing bubble was a product of the credit bubble, and the credit bubble was a product of the trade bubble."
Therefore, the preventive solution for the credit bubble is that China to have stopped buying T-bill and American bond and other American equity long time ago. Right now, China need to stop buying any more T-Bill, bond and American equity to fix this credit bubble mess or even start selling its T-bill and bond to fix this mess ASAP! Less credit is the solution for this credit bubble problem since excessive credit was the source of this problem!


March 16, 2009 03:00 AM

Dear Mike!
I have just recently found your blog and devote an amount of time to catch up with the posts. I find them very insightful and inspiring.
I have a question, though. In previous posts in which you compare recent crisis to the one of the Great Depression you compare years 1929-1939 to 1999-2009. Why? Didn’t the crisis start at 1929 in previous times and start at 2007-2008 recent years? If you compared 1919-1929 to 1999-2009 it would make more sense to me (though the periods can hardly be compared due to the different characteristics of the two periods – restructuring after war, etc.). Could you help mi in this? Thanks in advance!


March 16, 2009 03:37 AM

There is something wrong with this blog that always return a fail or time out that it give one the impression that one has failed to post the news.


March 16, 2009 06:57 AM

China's trouble is equally big as that of the US. It cannot solve it without making concessions at the global round table.


March 16, 2009 01:15 PM

yes, and sorry about that


March 16, 2009 04:13 PM

Here is the deal : Mr Wen, we, the US goverment, will backstop bonds not issued by us and for which we don't morally bear responsibility. This "protection" though is very likely to increase our debt. To do this for you, your country will continue financing our debt at very favorable rates until the economy returns back to normal.
Seems that China is caught in a vicious circle that it may find difficult to escape from unless it is ready to accept losses.
AIG was a free cookie for the Europeans. China should not be given one. It bears the greatest responsibility for what is happening, Europe is also its victim.


March 16, 2009 05:57 PM

Where the blame belongs is a pretty philosophical question. The world was in a big mercantile game of chicken. Who's supposed to turn first? The American consumer? Multi-national corporations? Investment banks? Jobs-hungry national governments? Take your pick: the short term and long-term incentives were completely opposed.

The way responsibility is nominally proportioned, the blame for the financial crisis starts at the borrowers and propagates through the banks to the creditors, and then through investment and consumer credit. We're scared to see those set of dominoes fall, so then it boils down to: where are we once the accounting clouds have cleared, what stable equilibrium do we want to go to, and how can we get there? I think a "reset" is appropriate, but what do we reset to?

Allocation of production and capital clearly support yesterday's trade flows, which are not sustainable. So we either establish a new world "order" or let the dominoes fall and the dead hand clean up the wreckage. My preference is that public actors, private actors, whatever, the folks that can influence cash and production, need to get in a room and get behind a vision.


March 16, 2009 08:34 PM

I think I'll stick with my original idea, that allowing the current financial disaster to develop may have been the only possible way to force China to decouple its economy, without appearing to be protectionist. If China had tried harder to grow a large middle class and lift more from poverty, instead of eagerly exploiting us and others, then they could have become the rich marketplace that U.S. business hungers to exploit! My recent personal research lends nothing new, but it does make me a little less vindictive toward China. ['less' added per next comment]

U.S. business annual sales revenue has been in the neighborhood of $30 trillion, but consumers consume only $6 to 10 trillion and exports are only about $1 trillion. Profits are normally $1-3 trillion, so business spends about $27 trillion to win at most $11 trillion in sales and make $3 trillion in profit.

Business expenses include payroll of $6 trillion, benefits of about $2-3 trillion, and goods for resale of about $2 trillion. This adds up to about $10 trillion. How did they spend the other $17 trillion, and where did they get the other $19 trillion in revenue? Business bought and sold it from each other. Where did they get the money? Presumably from bonds and banks and equity markets.

The sheer magnitude of these numbers puts China's role in a new light for me, making it seem almost trivial. As individuals, we feel the pain of the jobs they took, but for less than $1 trillion in loans to really be significant would tend to suggest precariousness of the economy we've built. The whole exercise has significantly shifted my understanding of how great a role the credit markets play for us, and frankly does not do a lot for my confidence.


March 16, 2009 09:09 PM

Excuse me, I meant to say I'm feeling a little LESS vindictive toward China. They were foolish like many of the rest of us, and they need to learn something by losing something, like the rest of us, but maybe what looks like a haircut to us would look brutal to them. I just hope all can figure out what the lesson is.

I've been getting a broken link when I submit a comment, so I hope my initial re-submit is not republished.


March 17, 2009 10:22 AM


Good post! Thanks for digging up those numbers.


March 17, 2009 02:06 PM


Thanks, I found it striking, yet the odd thing is that these numbers represent relationships that I've known for years but just never pitted against one another in quite this way. I tried to find something I might have overlooked but it's all in there or is peanuts in comparison -- consumer debt, spending from savings, unrepatrioted foreign earnings, government spending, etc. I don't have the figures regarding corporate cash hoarding, but it is mostly reported in billions, not trillions.

You commented on my post about demand constraint, and I should have said that yes, I agree with your take. The whole subject, though, left me feeling that there is something more required to really get my arms around this economy, which led to this commentary here.


March 17, 2009 02:46 PM


I'm too lazy/busy to do real follow-up most of the time on what is essentially just a curiosity for me, but I'm always grateful when other people do. :)
How did you say you classified unrepatriated foreign earnings? There are quite a few "information economy" exports that would awfully hard to classify.


March 17, 2009 04:37 PM


You might say that I found foreign earnings to be noise level.

Here are trade numbers that show 2007 services exports at $500 billion and services imports at $380 billion (a lot of it is travel):

Here is investment and income abroad. Income for all industries is $350 billion, services only $8 billion:

It wasn't clear whether the resultant foreign earnings were repatriated, but the profits would be a few billion so it is noise level.

I, too, was anticipating higher numbers. It's humbling.


March 17, 2009 05:23 PM


Either that, or the figures are under-reported and wrong abroad. After all, the US government's information abroad is likely to be worse than locally.
But if foreign earnings+exports really are in the 10-15% range of U.S. earning, the globalization story that's being sold today (by corporations) is wrong: the US market is still where where all the money is. Again, unless we're just really non-competitive globally so far: which would mean the globalization story is still off, but in a different way.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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