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The China Investment Challenge

NEW YORK – China now sits atop $2.4 trillion in foreign-exchange reserves, the largest stockpile of any country in the world (Japan stands in second place with $1 trillion). But this bounty comes with one big headache: where should Chinese Communist Party officials park all that money?

International bankers estimate that roughly two-thirds of Chinese reserves have been invested in dollar assets. In other words, China owns a huge chunk of America’s ballooning debt. Chinese reserves invested in these conservative financial instruments are relatively safe, but they yield little return. They have, however, helped support China’s economy by allowing Americans to run up consumer debt by buying more Chinese goods than they rightfully need.

A moment of truth is looming for both sides of this co-dependent, and ultimately dysfunctional, economic relationship. First, there are limits to how many trillions of dollars China can, and should, put into US Treasury bills. After all, should the dollar depreciate, China does not want to have too many eggs in the US basket. Investors should diversify their risk, and so must China.

But with so much capital, the options are limited. Until the euro weakened recently, Chinese bankers had been buying more euro-denominated assets, no doubt recognizing that, despite the frailty of the eurozone economy, Chinese exporters also need European consumers to keep buying their goods. But the reality is that neither the euro nor the yen is capable of soaking up China’s growing foreign-exchange reserves.