China's 'QT' is the real global economic threat

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Red flags for China's economy: Expert

Investors have been agonizing over how big a threat China poses to the global economy, but they may be looking in the wrong place.

China's stock market has tumbled following stratospheric gains that peaked in June, while economic data indicate that the nation is likely to fall short of its 7 percent growth expectation.

What matters more than either metric, though, is China's plan for retooling its economy, from one focused on industrial and housing growth atop piles of debt to consumer-based gains in consumption and investments in the stock market.

How they go about achieving that strategy, in part by reducing the amount of foreign debt purchases, is what could have more impact than anything else.

"There is a strong case to be made that it is neither the selloff in Chinese stocks nor weakness in the currency that matters the most," George Saravelos, forex strategist at Deutsche Bank, said in a note to clients. "Instead, it is what is happening to China's FX reserves and what this means for global liquidity."

In 2003, China began a "reserve accumulation" program that amounted to the equivalent of $4 trillion, which exceeds even the $3.7 trillion or so in a similar quantitative easing program the Federal Reserve initiated in 2008 and ended in October 2014.

During China's massive QE run, it increased its U.S. Treasury holdings by a factor of 10—from $120.7 billion in 2003 to $1.27 trillion in June 2015, according to the latest U.S. Treasury data. All that buying pushed it past Japan in the global lead for holders of American debt, while keeping U.S. yields low and producing, except for the financial crisis, a flat yield curve.