A few hundred yards from the Nam Dae Mun market -- a vast jumble of alleys where sunglasses, underwear and jade stones are on sale alongside giant mushrooms and dried octopus -- stands a stately, Renaissance-style building. There can be found an answer to the question: Who are the foreigners to whom the United States owes trillions of dollars in debt?
The building houses South Korea's central bank, the Bank of Korea, the country's equivalent of the Federal Reserve. The Bank of Korea is the final destination for many of the dollars earned by Korean exporters such as HJC Helmets, the No. 1 supplier to the U.S. motorcycle-helmet market. As a result, it has become one of the United States' biggest creditors.
The Bank of Korea's reserves of foreign exchange have roughly doubled in the past 31/2 years, to $207 billion -- a staggeringly large sum for a country of 48 million people but not a uniquely Korean phenomenon. The Bank of Japan holds reserves of $823 billion; the People's Bank of China holds $769 billion; Taiwan's central bank holds $252 billion. The vast bulk of those reserves are invested in U.S. Treasury bonds and other U.S. securities, such as bonds issued by the mortgage finance company Fannie Mae.
Tracing the dollars that change hands when an American consumer buys an HJC helmet reveals how these U.S. debts accumulate. Some of the money from a helmet purchase goes to Americans, of course -- to the retailer and to distributors, among others. But of the dollars that go to HJC, here is what happens:
To pay its employees and suppliers in Korea, HJC converts nearly all of the dollars it earns into Korean won. That means the dollars go first to the company's commercial bank, the Industrial Bank of Korea, which handles similar transactions for thousands of customers. Although Korean commercial banks such as the Industrial Bank keep a fair amount of dollars on hand for people who need the currency on a daily basis -- importers of U.S. goods, for example -- usually they have surplus dollars because their customers have earned so many overseas. The Bank of Korea steps in to buy those dollars, in what it calls "smoothing operations," when necessary to avoid sharp swings in the won's exchange rate.
Thus, hundreds of billions of dollars end up at the Bank of Korea and other Asian central banks. This process poses an awkward problem for those economists and policymakers, including Bush administration officials, who contend that foreign investors buy large amounts of U.S. securities because they have deep faith in U.S. economic fundamentals.
It is true that many foreign holders of dollars are private investors -- such as insurance companies or pension funds -- seeking the highest and most secure returns. But in 2003 and 2004 in particular, the largest foreign purchasers of dollars were Asian central banks such as the Bank of Korea, which wanted to keep their currencies from rising too fast so their manufacturers could continue to export.
The official at the Bank of Korea responsible for managing the reserves is Assistant Governor Rhee Yeung-kyun, a man who chooses his words carefully -- understandably so, as a comment by another Korean central bank official earlier this year sent the dollar tumbling for a few hours on global markets.
In an interview, Rhee noted that central banks do not have the same motives as profit-obsessed money managers. So their large holdings of dollars, he suggested, should help ease the fear that a mass sell-off of U.S. bonds by foreign investors could send interest rates soaring and choke economic growth.
"We do not have any plan to change the portion of dollars or any other currencies in our reserves," Rhee said. Although he acknowledged that the reserves are "a public asset" that should be managed prudently, "I also believe the reserves should not be managed in a way that would . . . upset the stability of the markets," he said.
But some experts see grounds for alarm. Even if central banks do not dump their holdings of U.S. bonds, they could slow their purchases enough to cause financial distress in the United States.
"While central banks care less than private investors about the return on their investments, they're not completely clueless," said economist Nouriel Roubini of New York University. "At some point, they have to consider the severe losses they could suffer" from a big decline in the dollar. China provides a striking example; if its currency rose 20 percent against the dollar, the nation's central bank would lose well over $100 billion on its holdings of U.S. securities.
And then there are the political implications of central banks such as China's or Russia's holding so many U.S. securities. "The ability to send a 'sell' order that roils markets may not give China a veto over U.S. foreign policy, but it surely does increase the cost of any U.S. policy that China opposes," Roubini wrote recently with his colleague Brad Setser in the journal Foreign Affairs.
There is no precedent for a country the size of the United States becoming so indebted to foreigners by running trade deficits as large as today's, said Sebastian Edwards, an economics professor at the University of California at Los Angeles, who recently produced a study of past cases from around the world.
The closest episode was the period from 1987 to 1991, which began with record U.S. trade deficits. During those years, the dollar lost about 30 percent of its value, interest rates rose substantially, "and at the tail end of it, we had a recession," said Edwards. Although the trade deficit could not be blamed for all of those untoward events, it played a part by causing markets to drive down the dollar, which in turn raised inflation worries that helped lift interest rates.
"And now the deficit is twice as large," Edwards noted. "We should be concerned. This cannot go on forever."