Stress Cracks Appear In Economy

According to an article entitled "Japan Urges China to Manage Reserves Responsibly," Japan is asking China to be very careful as they look at currency reserves and the large concentration of dollars in those reserves. Why would Japan, a country that is not all that friendly with China, care how their currency reserves are handled? Well, it's like this. The two countries are currently holding in the neighborhood of $2 trillion dollars of currency reserves in foreign assets. A majority of those reserves are in U.S. dollars.

So what happens if China begins to rebalance their currency reserves in attempt to lighten up their holdings of U.S. dollars? The obvious result would be a drop in the value of the dollar. If Japan is left holding the bag (of dollars) it would result in huge loses. It might also start a stampede for the door by other countries and the fragile house of cards, or dollars, would come tumbling down.

Now, to be sure, it is not in China's best interest to cause a collapse in the value of the dollar. After all, the U.S. consumer is the buyer of first choice for all of the bangles and baubles that China is cranking out right now. A collapse of the dollar would in turn cause a collapse of China's export economy. That would not be a pretty sight.

All of this points to a real problem that the U.S. is facing. We have financed our economy with debt and most of that debt has been purchased by foreign investors. When, not if, these foreign investors stop buying our debt, the fun will really start. For all of the posturing by the Fed, our economic future is now in the hands of foreign countries and that is not a very comforting position to be in.