In These New Times

Reuters on Friday quoted China’s Prime Minister Wen Jiabao: “I want to say that at this time, when some European countries are suffering sovereign debt crises, China has always held out a helping hand.”

Clearly, it’s a major development that Chinese deep pockets have come to the eurozone’s aid. There are reasons for China’s policymakers to see it in their country’s best interest to purchase European debt. At the top of the list, euro weakness provided an opportunity to diversify some of its $2.45 trillion – and counting – of international reserves. The markets have been focused on European structural debt issues. But perhaps the Chinese, from a longer-term strategic point of view, see European investment as more favorable than accumulating additional US debt.

Doug Noland

Asia Times

20th July, 2010

According to the Federal Reserve’s Z.1 “flow of funds” data, Rest of World (ROW) holdings of US financial assetsended the 1980s at about US$1.9 trillion and closed the nineties at $5.6 trillion. By the end of 2009, ROW holdings had ballooned to $15.3 trillion. During the past decade, the world’s holdings of our financial assets surged to 108% of US GDP from 60%.

Gigantic and unending US current account deficits were the major force behind the extraordinary foreign accumulation of our (largely debt) securities. This implies structural deficiencies in both the credit system and real economy. It would also be quite unusual for such a fundamental backdrop to support a strong currency.

To better gauge the soundness of the dollar, one must attempt some necessarily subjective assessment of underlying US financial and economic structures. Over the past 20 years, total system credit rose from $12.830 trillion to $52.328 trillion – or from a historically very high 234% of GDP to an unprecedented 367%. The important question then becomes, did this historic increase in debt correspond with an expansion of production/wealth-producing investment? Does our economy have the wherewithal to pay back our foreign creditors? When will it matter in the marketplace?

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