China and US deficits

It is estimated that more than two-thirds of the Chinese Central Bank’s $1.95 trillion in foreign exchange reserves are believed to be in American securities, with the rest in assets denominated in euros, yen and other currencies. Some other estimates puts its holdings of the US debt papers at $1.7 trillion. But recent trends indicate that these purchases, which have for so long financed the massive US current account deficits, besides contributing to keeping the US Dollar strong, may be waning.



Brad Setser, though, feels that instead of declining, the accumulation of foreign holdings may have stabilized.



It is now well acknowledged that the macroeconomic imbalances generated over the past two decades in the world economy, by way of the currency manipulation by Central Banks, "savings glut" and exports generated foreign exchange reserves of emerging economies and the consumption driven imports surge in the US fuelled by the "wealth effect" unleashed by successive asset bubbles, has been a major contributor to the ongoing economic crisis.

After the crisis broke out, the spectacularly swift de-leveraging of their positions in emerging economies by the Wall Street firms and the flight to the relative safety and liquidity of US dollar denominated assets by private investors across the world have had the effect of shoring up the beleaguered dollar, sustaining the huge US current account deficits, and keeping interest rates low.