The United States is rapidly approaching its legal debt limit of just over $12 trillion. As of September 2009, U.S. debt stood at $11.9 trillion. As these charts indicate, Congress has raised the limit four times in the past three years, as the need for financing has risen. Some hope that the limit will encourage fiscal responsibility. Others fear that this exercise raises the risk of a technical default, as nearly occurred in 1995, which would disrupt markets and potentially impose severe costs on a struggling economy.

Bartlett: Why Congress Must Now Abolish Its Debt Limit
NYT: Treasury Expects Debt Limit Will Be Hit in Dec.
FT: U.S. Government Debt
Economist: America’s Public Debt

Over the last decade, Asia has developed into a major manufacturing base for the developed world. This relationship has provided mutual benefits: the West has received cheap goods while the East has developed its production capacity more quickly. China, to a significant extent, has been the assembler nation, importing raw materials and intermediate products from the rest of Asia and exporting finished products to the West. This relationship is illustrated in the chart above, which plots China’s imports from Asia and its exports to the U.S. and Europe since January 2000. Recently, however, this relationship has weakened slightly — China is providing more demand for Asian exports than the West is providing for Chinese exports. An important question is whether the strong Asian recovery can continue without a robust recovery in Western demand for Chinese goods.

Economist: Special Report on China and America
Expert Brief: Why China May Stumble
CFR Meeting: The U.S. Chinese Economic Relationship
Jung-a, Anderlini: China Demand Drives Growth for South Korea

The greatest challenge of European monetary union is devising a single monetary policy for a large grouping of countries facing divergent economic conditions. As these charts show, this challenge has been thrust to the fore since 2008, as eurozone employment conditions have diverged dramatically across member countries. Whereas the effectiveness of independent monetary policy as a tool for managing employment in smaller open economies is much debated among economists, the political challenge facing the European Central Bank in having to justify its policy decisions under current conditions is clear.

Economist: Special Report on the Euro Area
CFR Meeting: The Euro at 10

Near zero T-bill yields throughout 2009 is keeping U.S. debt service low even though the amount of outstanding debt continues to rise. A forecast increase in U.S. interest rates, along with growth in the amount of debt, will lift interest expenses sharply over the next ten years. In fact, as this chart shows, interest payments are projected to surpass defense spending by 2017. According to the Bureau of Economic Analysis, which collects data back to 1929, interest payments have never surpassed defense spending.

FT: U.S. Government Debt
Economist: America’s Public Debt

China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet the chart shows that over the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar.

CGS Chart Book: Foreign Exchange Reserves in the BRICs (Updated 10/09)
Wolf: The Rumors of the Dollar’s Death Are Much Exaggerated
Evans-Pritchard: China Calls Time on Dollar Hegemony
Bloomberg: Hu Says Currency-Reserve Nations Must Be Aware of Global Role
Guha: Down But Not Out

This chart shows who financed the massive amounts of debt that the U.S. government issued in the first half of 2009. The total net issuance of treasuries and agencies is shown on the left, and economic sectors are ordered from left to right by the size of their total purchases. Given the federal backing of the GSEs – government sponsored entities such as Freddie Mac and Fannie Mae – it is best to look at the sum of treasuries and agencies rather than treasury issuance alone. Through the first two quarters of 2009, issuance has been financed primarily by official buyers. Official buyers often have motivations other than profit. The Federal Reserve is buying debt as a part of its quantitative easing program, while some foreign central banks are accumulating debt as a function of their currency policy. The Federal Reserve plans to slow and then stop its purchases by the end of the first quarter of 2010. This raises the question of who will replace this source of demand, and at what price.

Wolf: Finding a Route To Recovery and Reform Gets Tough Now
Hughes: Short View: Treasury Market
Coote: On The Money

This chart shows the U.S. federal gross debt issuance, the sum of debt refinancing and fiscal deficits, as a percentage of GDP. The U.S. Treasury must issue debt to finance expenditures in excess of receipts as well as to pay off debts that are due. Although it is often assumed that debtholders will recycle their capital into new debt, they have no obligation to do so. Concerns about the level of federal debt and the size of future deficits may make creditors reconsider their investment choices. If many creditors opt out of the U.S. treasury market as their bonds mature, the U.S. Treasury may have a difficult time finding buyers for the unprecedented level of issuance. This would create a complicated trade-off for the Federal Reserve between higher interest rates, which may smother a budding recovery, and monetizing the debt, which may stoke inflation and pose a serious risk to the dollar.

Taylor: Exploding Debt Threatens America
Krugman: Till Debt Does Its Part

This chart shows China’s overweight or underweight observed external investment position since 2000 in a given sector relative to that sector’s share of world market capitalization. A positive number indicates that China is overweight in a given sector; a negative number indicates that China is underweight. As the chart below shows, China is most overweight in materials and energy. This reflects a desire for stable economic growth, which, in the Chinese government’s view, requires a secure source of inputs. As other sectors in China develop, along with the managerial skills required to integrate international acquisitions, China’s aggregate portfolio allocation will likely even out.

Economist: Sino-Trojan Horse
Shearer: The China Paradox
BBC: China Invests in Canada Oil Sands

In a typical post-war recession, recovery would be well under way after twenty-one months. This time around, all that has emerged is limited optimism over ‘green shoots.’ Although conditions in financial markets have improved (e.g., the spread between AAA corporate debt and treasuries has narrowed by over 150 basis points since November 2008), the labor market has continued to deteriorate. The chart below indicates that the increase in unemployment since this recession began is worse than all post World War II recessionary spikes in unemployment.

CGS: Economic Cycle
Economist: Green-Shoots Index
Altman: Why This Will Not Be a Normal Cyclical Recovery
Roubini: Green Shoots or Yellow Weeds?
Krugman: Green Shoots and Glimmers

The Federal Reserve responded aggressively to the economic crisis with unconventional monetary policy measures. These measures have vastly expanded the size of the Fed’s balance sheet, leading to concerns over future inflation. Chairman Ben Bernanke has argued that the Fed has the tools to fight any uptick in inflation; for example paying interest on reserves. But it is not only the size of the Fed’s balance sheet that has changed; its composition has changed as well. As the chart above illustrates, the Fed is now holding riskier assets, such as mortgage backed securities, that may prove difficult to unwind in a timely fashion.

Krugman: The Big Inflation Scare
Meltzer: Inflation Nation
Bernanke: Semiannual Monetary Policy Report to Congress
Economist: Inflation Is Bad, But Deflation Is Worse