Oct 22 0200

Silver lining of US recession- more balanced trade

This post was originally published on March 17, 2008. It is being re-published today to support a recent lesson in IB Economics.

FT.com / World – Surplus countries told to encourage demand

Is it strange at all that in a time of rising unemployment, increasing uncertainty, rising prices and falling wages, consumers are being told to spend spend spend? This is the paradox of capitalistic markets in which macroeconomic health depend on continued spending, either in the form of consumption, investment, government spending or the sale of exports to foreigners. It is this last type of spending that has begun to slow for many of the world’s developing economies, those historically dependent on strong demand from consumers abroad for their output.

The “coupling” of the economies of several developing countries to that of the United States refers to the dependence on strong consumption by Americans of their exports for domestic macroeconomic health. This symbiotic relationship, while it has contributed to a long period of high growth rates in many Asian economies, threatens to drag growth rates in several developing economies downward as Americans’ spending on imports declines.

China, one of those countries heavily dependent on export-driven growth, is now facing the prospect of a more balanced current account, which measures the difference between a countries income from exports and its expenditure on imports. Since the early ’90s, China has experienced consistent surpluses in its current account, and this will continue for the foreseeable future. Today, with falling demand for its exports from the US, China faces a new challenge:

Unwinding imbalances required domestic demand growth to slow in deficit countries but also to accelerate in countries with big surpluses from exports – such as China and oil-producing states.
It was, therefore, helpful that China planned to spend more on infrastructure, encourage household spending and allow more flexibility than previously in the exchange rate, he said.

“If the slowdown is not to dominate, we need to see a shift in relative prices to rebalance demand – that is a gradual real exchange rate depreciation of deficit countries against surplus ones,” he said.

In IB Economics, we are in the middle of our unit on international trade, in which we study exchange rate determination and the effects of an depreciation of a nation’s currency on its balance of trade. In this case, a weaker dollar will change “relative prices” by making Chinese imports more expensive to American consumers. Likewise, American goods will become cheaper to Chinese consumers, encouraging Chinese to buy more American products and fewer domestic ones.

The combined threat of falling exports and the change in relative prices that results in falling domestic demand will shift trade between the US and China towards a greater balance. According to NYT Economics columnist Paul Krugman, this rebalancing between the US and its trading partners may be just what’s needed to soften America’s economic decline.

Discussion Questions:

  1. How do falling incomes in the US affect the balance of trade between the US and China?
  2. How does the change in trade flows affect the value of currencies in foreign exchange markets assuming exchange rates are “floating”?
  3. Why would a weaker dollar help accelerate the recovery of the US economy? Is a weak dollar in the interest of China? Why or why not?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

35 responses so far

35 Responses to “Silver lining of US recession- more balanced trade”

  1. Alex Goldmanon 17 Mar 2008 at 8:53 pm

    Not only will this "rebalancing between the US and its trading partners" help soften America’s economic decline, but may also benefit China to some extent. Yes, China will be experiencing a slight blow to the economy, but we've seen plenty of articles speculating on how China may "suffocate on its growth." With that in mind, this sort of rebalancing could be quite beneficial towards China.

  2. TimChuon 17 Mar 2008 at 9:03 pm

    Interesting that China might be the one buying goods from the US in the future. Perhaps this is the first step in the fall of the United States? Sure they may be the number one country right now, but signs point that perhaps China might be rising to take it's place. I find the whole thing quite interesting. I agree with Alex's statement that this recession will indeed benefit both countries.

  3. howard linon 17 Mar 2008 at 10:05 pm

    Yes i think this rebalancing between the US and its trading partner, China would help america slowdown its ecnomic decline or perhaps even start inclining again. But it got me thinking that perhaps China's economy will start to decline too in the near future as companies move out to counties with cheaper labor? (since it has already been driven up by cooperations)

  4. Nicole Wongon 17 Mar 2008 at 11:05 pm

    It seems strange that the U.S. and China are "switching roles" in a sense. I wonder, though, if the U.S. has a large enough labour force and resources to take on the role of China as an exporter. I also wondered what would happen to the Chinese economy if this were to happen. Would the economy continue its unparalleled expansion because of its more expensive imports? The Chinese economy has already grown so rapidly that further growth seems almost unimaginable.

  5. kevinyehon 17 Mar 2008 at 11:26 pm

    I don't really see how having the US export more makes China become a more dominant country. Perhaps it becomes more consumer driven, while the US imports less. There is a more favorable balance of trade for both nations, and everyone's happy. ok so some american ppl will get less cheap chinese goods but in the long run it doesnt really matter taht much

  6. Jessica Ngon 18 Mar 2008 at 12:18 am

    We see products everywhere with labels of "Made in China" and it's pretty cool to see the potential for China to be the importer instead of the constant exporter. With a weaker U.S. dollar, China will be able to buy more goods from the U.S. while the rising RMB is going to act as part of the net export effect that slows down China's growth. This might actually be helpful considering that China is in such rapid inflation. this might help slow it down a little, before China ends its expansionary phase into recession.

  7. Jack Loon 18 Mar 2008 at 12:24 am

    Hmm…how interesting. My dad mentioned this situation to me just a few days ago. China's GDP will definetly slow down as it imports more US goods and exports less of its own goods. However, this may not be a bad thing for China. Many economists have warned that Chian is growing TOO FAST for its own good. China's inflation rate are also about to go skyrocketing.

  8. Margaret Liuon 18 Mar 2008 at 9:49 am

    This rebalancing would probably seem ideal to china as well, since it's already trying to dampen its booming economy by increasing the reserve ratio.

  9. Jo Loon 18 Mar 2008 at 5:16 pm

    Since China is trying to prevent an overheating of the economy, this rebalancing will help it. As US imports decline, exports will rise as a result because with the greenback lower in value than before, foreigners will want more US products. This will help China because the country will probably spend a little more on imports, thus h elping to prevent the overheating.

  10. Christina Huon 18 Mar 2008 at 5:56 pm

    I think this act is aptly named- rebalancing. I think it's quite apparent that China does depend too much on U.S. exports, and is growing at a hyp, and, like Jack mentioned, perhaps too fast for its own good. A recession in the US, a decrease in the demand for Chinese exports, will force China to become more independent and to rely on its own consumers to keep the economy growing. This will also slow down what looks like demand-pull inflation.

  11. Michael Dailyon 18 Mar 2008 at 6:33 pm

    Yeah, this re-balancing act seems rather interesting. I mean countless American products are "made in China." But now for the Chinese they should be seeing a lot more American products. So I guess their is some what of a benefit for America with the declining value of the dollar. It seems weird that Chinese stuff will be worth nearly the same as American stuff, but if the dollar continues to get lower it may actually get pretty close. So maybe America isn't in the best of situations for the economy currently, but at least they may help some aspects of the global economy, like China's.

  12. Howard Jingon 18 Mar 2008 at 8:29 pm

    As everyone is saying, although having less foreign imports will hurt China in the short run, being forced to focus on its domestic population will only help China in the long run.

  13. calebon 18 Mar 2008 at 9:18 pm

    I agree that this will improve both countries in the long run, but I don't for a second believe that America will be replaced anytime soon. China's present growth should not lead us to assume that China's anywhere near the United States.

  14. Mondon 18 Mar 2008 at 9:34 pm

    I agree with what is being said. This is a good thing because it teaches China to be less dependent on other countries. Thus, creating a more stable economy in China.

  15. Trevor Sunon 18 Mar 2008 at 11:06 pm

    I agree with mond in that China should become more independent. However, I don't think this change will come about quickly. Plus stopping exports to other countries is good either.

  16. Cassy Changon 19 Mar 2008 at 12:03 am

    It is a positive effect on global economy, since more american export counters, if only minimally, the recession in the us, while at the same time slows China's inflation rate.

  17. julie.linon 19 Mar 2008 at 12:23 am

    this will help china to stabilize china's economy in the long run, as everyones saying, and i think that china will become more independent of other countries and more purchases on imports.

  18. Jessicaon 19 Mar 2008 at 12:40 am

    Wow I never thought about this. I guess it's good that China and the US are slowly balancing out. If the US dollar continues to fall, will the two countries eventually reverse their roles? Wow. Wouldn't it be really strange to have America exporting all goods and China buying everything? Everything would be "made in america" instead of "made in china." Haha. Oh well. I highly doubt this will happen anytime soon, if ever.

  19. Kai Lin Fuon 20 Mar 2008 at 9:07 pm

    This is will definitely have a positive step. It;s just like what Julie said, China will be more independent. This change may be just what society needs. It will help slow down and balance out China's rapid growth in economy

  20. Tarynon 02 Apr 2008 at 10:02 am

    I find it amazing how the American economy has the ability to "fix itself". As the dollar value decreases, American goods will become less expensive to people in foreign countries and thus there will be a greater demand for the dollar which will increase the GDP in America and possibly help to not only balance trade in areas such as China but also to help America get out of its recession. I don't believe that this can totally fix the" recession" but I believe it can help pull the lowering economy back up a bit.

  21. Jeff Yeon 10 Apr 2008 at 9:04 pm

    Going with previous responses, i agree that this will benefit China as a world power. Not only might it pull the U.S. economy out of recession, but it would also help balance China's growth. Thus this would help out just about everybody.

  22. Dana Y.on 13 Apr 2008 at 5:32 am

    Many economists have speculated whether U.S. recession will bring "coupling" or "decoupling" changes in Chinese economy. Now that a few months have passed, the effects of plumetting Chinese stocks are becoming visible day by day. These patterns reveal that, although many have thought that "BRIC" countries would not be as severely affected by the U.S. recession, it has had great effect on the Chinese economy. Thus, I believe it is premature to say that China's status as the rising economic superpower will guarantee a balance between Chinese and US. economy.

  23. Liviaon 08 Dec 2008 at 8:26 pm

    Between countries like the US and China there clearly is not balanced trade. The exports from China to the US are by far larger than the exports from the US to China. However as the article says, if the US goes into a recession, thereby decreasing the relative price levels, thus depreciating the dollar, the Chinese imports will appear more expensive for the American consumer and therefore they will demand less Chinese imports. This was proven, as the article stated, that the American demand for Chinese imports has decreased a little and if this recession continues and if the dollar continues to depreciate, then the amount of imports from China to the US should become balanced with the amount of exports from the US to China.

    However, lately I was reading an article on Italian consumer and consumers in general from Europe that because they have been demanding so many American imports, therefore so many dollars, in terms of the euro, the dollar has appreciated a little. It would be interesting to know that if with an appreciating dollar in terms of euro, would the demand for Chinese imports then change?

  24. lianyuon 26 Oct 2009 at 4:03 pm

    Chinese imports seem more expensive for Americans, thus they will demand less Chinese imports. At the same time, US will be more balanced with its exports and imports, with US dollars depreciate. Increased AD in US will help accelerate the recovery of the US economy. AD in China will decrease as there is less export to US. It is not good at present, but might be good for China to look for another way of increasing AD.

  25. LEE JIHYEon 26 Oct 2009 at 4:03 pm

    I believe that countries like a China and US are not easy to balanced each other. When US income falls, people who living in US feels that the currency in China is high. It means that who living in US have to buy China's product in high rate. Therefore, they might not easily trade with other countires such as China, Korea, Japan and India. However, as the value of the US dollar, falls as the income of the US falls, China will import more goods from US. Hence, China might face to other problems. This is because, if they are not able to sell their goods to US, their import from US will increase and exports to US will decrease. Once, the exchange rates are floating as i mentioned above, China import more from US and export less to US which it might lead to slow economic growth in China. If they want to make a balance, the value of China Yuan has to falls down to rise their exports. This is because, it is better to have lesser difference in interest rates.

  26. Charlie Carrickon 26 Oct 2009 at 8:59 pm

    1) As the incomes in the US decrease, there is a lower percentage of that money that is available for expenditure. This means that more of the income is being spent on basic necessities. Demand for imports from China decrease and therefore the balance of trade in both nations will decrease.

    2) If there is a decrease in demand for imports, then the value of the US dollar will depreciate compared with foreign markets. China's decrease in exports means that their currency will appreciate compared with those of other nations.

    3) A weaker dollar in the US would help it to recover, because if the demand for imports is decreasing, it means that the citizens are going to have to purchase from domestic producers. This will in general help the US to inflate, because a higher demand for domestic goods will increase incomes of those employees and maintaining the balance of incomes vs expenditure. A weak dollar is good for the Chinese economy as well because with all these products being produced, but not sold overseas, they are then sold in local markets. This is good for China as it now has more consumer expenditure within its own nation and can increase factors such as employment and prevent the economy from expanding in the rate that it has been doing so for many years.

  27. D. Takaokaon 27 Oct 2009 at 12:22 am

    1. As US enters recession, its dollar depreciates and therefore make Chinese imports more expensive for US, resulting in fall in demand for Chinese products. Effect of this on the balance of trade between the US and China is that since US imports from China decrease, it would balance with the amount of export from US to China.

    2. In the floating exchange rates, decrease in imports of Chinese products will depreciate US dollars, however on the other hand, Chinese currency will appreciates.

    3. Weak dollar will help recovery of US economy because as American products become cheaper for Chinese people, they would import more US products, and since US imports falls due to more expensive Chinese products, there will be more export receipt than the import payments, which will result in increase in net export. Increase in net export will increase aggregate demand and thus leads to increase in GDP. This may not benefit China much, as their surplus gained from trade falls, due to decrease in export. However, they could sell the amount of export that couldn't be sold to US to their citizens, and therefore increase consumption spending.

  28. Theresaon 27 Oct 2009 at 1:57 am

    China is dependent on exonomic growth driven by its exports to the US and others. As incomes in the US fall there is not only less consumption in the US but also less import. The balance of tread between the US and China, which was dominated by US imports, will move more towards equality as less is importet.

    As stated in the commentary “relative prices will change” if the dollar is weaker. Chinese imports will be made more exponsive to american consumers, which again decreases imports and hurts the chinese economy. On the other hand american goods will seem cheaper to Chinese consumers who will import more and spend more and them. This will benefit the US economy.

  29. Rocio Perezon 27 Oct 2009 at 6:33 am

    With lower incomes people demand less domestic goods as well as foreign goods, thus less is exported from China and the US's balance of trade between the US and China levels out.

    I don't think a weak dollar would be in China's interest because as the dollar now buys less than it did before when it was stronger, the US will have to spend less on Chinese exports especially during a recession. This might be beneficial for America's budget deficit, even if it is only slight difference.

  30. christianoon 27 Oct 2009 at 5:05 pm

    The trade between China and the US is characterized by China's current account surplus (revenue from exports exceeds money spend on imports) and America's financial account surplus (Chinese ownership of American assets increases more quickly than American ownership of Chinese assets). Falling incomes in the US, however, cause Chinese exports to decrease which would move the US towards a more balanced current account. This, however, would also mean that the US would move slightly towards a financial account deficit since the Chinese do not have as much money available to buy American assets.

  31. Marenon 28 Oct 2009 at 1:51 am

    Falling incomes in the US would lead to less consumption of goods that were imported from China. The US has a current account deficit, because they are importing more than they are exporting, but with less imported from China the current account deficit could be reduced.

    When the dollar is weak the exports of the US increase because it is now cheaper for foreign countries to buy US goods and this helps the US economy. But a weak dollar is not in the interest of China because the goods they want to export to the US are too expensive for US citizens and thus they consume less which can cause unemployment in China and a fall in GDP.

  32. Laura Perezon 28 Oct 2009 at 5:04 am

    1. How do falling incomes in the US affect the balance of trade between the US and China?

    Falling incomes mean less imports and therefore lower demand for Chinese goods. If incomes are low, demand in the country will be low and prices will go down. Lower prices will make American good attractive to China increasing exports in the country. This will create a more balanced trade between China and America in that China will not have such a huge surplus and America will not have such a large deficit from spending so much on Chinese products.

    2. How does the change in trade flows affect the value of currencies in foreign exchange markets assuming exchange rates are “floating”?

    A change in trade will depreciate the US dollar making imports more expensive. Exports will be more attractive, though because the US dollar is low.

    3. Why would a weaker dollar help accelerate the recovery of the US economy? Is a weak dollar in the interest of China? Why or why not?

    A weaker dollar will encourage exports because US products will be cheaper to foreign nations since the value of their currency is now worth more than it used to be against the US dollar. It is not in the interest of China because that means they will be exporting less. Even though prices are cheaper in the US, they are not so interested in these products because they are able to produce much of what they need for lower costs in their own country.

  33. Bastien Vogton 02 Nov 2009 at 4:12 am

    Although it is in the interest of a nation to have balanced trade with other countries, this cannot be said between the US and China. This is because the exports from China to the US create a trade surplus for China. In the case of a recession the price level in the US would decrease, as the article states, which would cause a depreciation of the USD. This would mean that Chinese products would seem more expensive to US consumers thus harming the Chinese economy, because there would be less demand for Chinese goods. If there are no improvements in the US economy then the USD will depreciate decreasing imports from China to the US, in the long run this could mean a trade balance between the US and China as the demand for Chinese goods will decrease and Chinas demand for Us goods may increase.

  34. Colinon 19 Apr 2010 at 6:11 pm

    1. How do falling incomes in the US affect the balance of trade between the US and China? The fall of incomes affect the trade between the US and China, due to the fact that the US goods and services are cheaper, which will make the Chinese buy those products. Which will balances the trade because it’s usually the US who demand Chinese products, with these cheaper goods the Chinese demand them which will end up with them buying US products not only US buying Chinese products.

    2. How does the change in trade flows affect the value of currencies in foreign exchange markets assuming exchange rates are “floating”? A recession in the US will keep a balance between trading of the two countries.

    3. Why would a weaker dollar help accelerate the recovery of the US economy? Is a weak dollar in the interest of China? Why or why not? Because people will buy more US products which are reduce demand for Chinese goods so it is a bad thing for the Chinese economy but good for the American economy

  35. Axelon 19 Apr 2010 at 6:14 pm

    The Fall of income affect the trade Between the US and China because the US products are now cheaper compared to the Chinese, and now the Chinese can now buy more foreign products. This balances the trade between them because initially it was mostly only Americans demanding Chinese goods.

    Assuming "floating" exchange rates with all countries, the value of the american dollar has depreciated increasing its demand for its products. now more countries demand the american products instead of the Chinese. this balances out the Chinese and American trade imbalance.

    A weaker dollar could increase demand for American products which would accelerate how fast the Americans recover. this is bad for china because they specialize in cheap exports and now when the Americans have cheaper prices then China will struggle because people demand less Chinese goods and more American.