The People's Bank fo China continues to amass huge levels of foreign currency reserves with little attention paid. Those reserves totaled $2.4 trillion as of December 2009, which is larger than the GDP of Italy, the world's 7th largest economy. China's reserves are growing at about $400 billion per year, roughly adding Norway's economy to their reserve surplus every year.



These reserves are generated from structural imbalances in the world economy, with China running huge trade surpluses which are exacerbated by China's currency peg. To keep the currency within a narrow range, China is forced to buy foreign currency that comes into the country. The Yuan it spends to buy foreign cash is added to the funds sloshing around China's banking system. In addition, the foreign currency that the Bank of China holds is then reinvested, mostly in low yielding investments like US Treasury Bonds. In fact, China is the largest holder of US Treasuries. The Yuan flowing around the banking system is causing some to wonder about inflation and asset bubbles. Some market participants are taking notice of bank loan growth and Urban real estate markets. Chinese officials have taken steps recently to slow loan growth and to potentially slow inflationary pressures. We've seen the market respond with the Hang Seng Index falling over 11% over the last month.

Source: Bloomberg
China's huge arsenal of reserves is increasingly troublesome. William Pesek of Bloomberg has called it a "massive and growing pyramid scheme." China is essentially trapped in its current arrangement; as it buys more US Treasuries, it becomes harder to sell them without causing huge capital losses.

China has been an economic hot spot over the past few years. Even as the global economy grew weaker last year, the country remained on track and kept backward momentum to a minimum. Now that a global recovery is in the offing, keep an eye on China’s ETFs.

While the world economy shrank 0.8% last year, China’s economy grew 8.7% in 2009 and 10.7% in the the fourth quarter alone. As China’s economy continues to grow and strengthen, there are benefits in store for the rest of us, reports Tony Sagami for Uncommon Wisdom.

Back on December 11th, I sent an alert to subscribers on the downside risks to the euro, concluding:

The bond markets are already reflecting a two-tier Europe as spreads have soared for Spain, Ireland Greece and Portugal (and to a lesser extent Italy) compared to German Bunds and 'core' Europe. If we get another debt crisis leg, in 2010 or 2011 one policy option will be to allow those countries to devalue within the EMU framework and return to an ERM style system where a new 'Euro-Lite' pegs to the core Euro in a trading band. It would be messy and a last resort, but has been quietly discussed in German policy circles. I'd put the probability at 20-25%, which certainly isn't yet reflected in the euro/dollar exchange rate but will be in 2010; I'd expect to see the euro slide to as low as 1.20 at some point in the next 6-12 mths on such fears.