ABSTRACT
Over the last decade, external wealth holdings of emerging economies have grown in a mirror image of the overall distribution of global wealth. China, in particular, has seen a dramatic increase in foreign reserves (Lane and Milesi-Ferretti, 2007; Eichengreen, 2009). A good part of this investment is in the form of international portfolio capital, with China being a prominent investor in US treasuries (Shen and Ng, 2008; Song, 2008). By September 2008, China had become the largest holder of US treasury securities, with a position of US$894.8 billion. At the same time, the US trade deficit with China reached US$51.53 billion (Figure 2.1), a reflection of excessive American consumption. The peculiar partnership of American excess consumption and Chinese financial extravaganza raises the question of how long this situation can be sustained. Concerns have been raised in international research about the potential consequences if there is sudden stop to China's holdings of US treasuries (Dobbs et al., 2010). Within China itself, doubts have arisen among an increasingly vocal audience, challenging the wisdom of this investment policy.
