25% of China's GDP invested in US Bonds

Fantastic post by Brad Setser about how much Chinese money is invested in US bonds (both treasuries, and Fannie Mae/Freddie Mac paper). The Chinese central bank has been taking money from Chinese taxpayers and giving it to Americans so they can 1) build houses, and 2) buy Chinese goods. They now want the US Government to take money from US taxpayers and give it to the Chinese central bank by honoring Fannie and Freddie's debt obligations. Chinese taxpayers have no say over what happens to their money. US taxpayers do (kind of).

In some sense, it is remarkable that the system for channeling the emerging world’s savings into the US housing market - a system that relied on governments every step of the way, whether the state banks in China, that took in RMB deposits from Chinese savers and lent those funds to China’s central bank which then bought dollars and dollar-denominated Agency bonds, or the Agencies ability to use their implicit guarantee to turn US mortgages into a fairly liquid reserve assets — hasn’t broken down after the “subprime” crisis. The expectation that the US government would stand behind the Agencies is a big reason why.

That allowed the US government to turn to the Agencies to backstop the mortgage market once the “private” market for securitized mortgages dried up, as emerging market governments continued to buy huge quantities of Agencies.

And it now seems that this game will break down on the US end before it breaks on the emerging market end. The Agencies will run out of equity before central banks lose their willingness to buy Agency paper.

In general, I've been impressed by how China's been governed over the past 10 years or so -- they've made smart decisions and genuinely become wealthier and more productive. But I wonder how they will feel if they have to take a 5% haircut on their bonds and take a 1% loss to their GDP on top of their dramatic currency losses to date.