More than a trillion dollar Chinese foreign exchange reserve – what does it say for economy, bond and stock market?
Marla Guthrie
Oct. 17, 2006

China and India are gathering foreign reserves through Foreign Direct Deposits and in case of China trade surplus and favorable balance of payments. The foreign exchange reserve of China soon will top $1 trillion. At the same time China is very concerned about facing the reality – it has to pay its due as a newly achieved status – a rich country.

A trillion or more foreign exchange reserve for country that still believes it is poor is dangerous. Most of these foreign exchange reserves are invested in US short-term treasury. China controls its inflation through investing in US debt instruments. It is known as Chinese sterilization effects.

But what happens to the mentality that China is poor? Anyone who believes he or she is poor is very skeptical about his or her money. A little jolt in the security of the investment will create panic in Chinese minds. Indians are also similar. China and India like to keep their money in gold. But in order to control inflation, China invests heavily in US bond markets.

Things are no different when all are quiet and normal market behavior is maintained. Things can change abruptly if US economy enters a recession; there is even a slight manifestation that the Chinese investments are at risk. The scary minds in Chinese central Bank will run fast in case of a slight fiscal problem.

The abrupt withdrawal of all the money in the tune of trillions of dollars – a real run is what can happen. The bond market can collapse. The yields all on a sudden can shoot up to 10% or higher. The stocks will crash instantaneously. The financial meltdown will occur in the trillion dollar meltdown that will be unstoppable.

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