Chinese Depression: Will Its Massive Foreign Reserve Hoard Save the Country's Economy?

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As the United States and Europe deal with economic contraction resulting from excessive credit expansion that many believe has lead to another Great Depression, China’s future remains hazy. Some argue that China has replaced the US as the global engine of growth because of increased internal consumption, export capacity and massive reserves. And for these reasons, China will avoid the same fate as the US and Europe.

Not everyone is convinced, however.

Trend Forecaster Gerald Celente believes that the depression is global and a contraction across the entire planet cannot be avoided, and that includes China. Economist Harry Dent holds a similar view, recently saying that, “China will see their bubble collapse strongly when the U.S.-led stimulus program fails due to rising defaults and foreclosures later in 2010, at the same time that the world is looking for China to pull it out of this global downturn.”

Michael Pettis, of China Financial Markets, says that the conditions in China are eerily similar to conditions in the United States right before the 1930’s Great Depression and Japan’s depression which started in the 1990’s and continues even today. According to Pettis, there are a multitude of reasons why China’s massive $2 trillion plus in reserve may not save them from an economic collapse:

Twice before in history a country has, under similar circumstances, run up foreign reserves of the same magnitude.

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The first time occurred in the late 1920s when, after a decade of record-beating trade and capital account surpluses, the United States had accumulated what John Maynard Keynes worriedly described as “all the bullion in the world”. At the time, total reserves accumulated by the US were more than 5-6% of global GDP. My back-of-the-envelope calculations suggest that this was probably the greatest hoard of central bank reserves ever accumulated as a share of global GDP, but please check before you accept this claim.

The second time occurred in the late 1980s, when it was Japan’s turn to combine huge trade surpluses, along with more moderate surpluses on the capital account, to accumulate a stockpile of foreign reserves only a little less than the equivalent of 5-6% of global GDP. By the late 1980s, Japan’s accumulation of reserves drew the sort of same breathless description – much of it incorrect, of course – that China’s does today.

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February 10, 2010