US-China Financial Interdependence

• In the 1990s, there was minimal financial interdependence between the US and China, as China wasn't running significant current account surpluses or accumulating substantial reserves.
• This changed after China joined the WTO, leading to a large expansion in China's trade and trade surplus, partly due to an undervalued exchange rate, particularly after the dollar depreciated in 2003 and China followed suit.
• China experienced a large positive shock from WTO entry, coupled with a 10% real effective exchange rate depreciation, leading to substantial trade surpluses. These surpluses were recycled into China's reserves, primarily invested in US financial assets, initially thought to be mostly Treasuries.