A nation’s balance of payments measures all the transactions between the residents of that nation and the residents of foreign nations, including the flow of money for the purchase of goods and services (measured in the current account) and the flow of financial or real assets (measured in the financial or capital account). The sale of exports counts as a positive in the current account, while the purchase of imports counts as a negative. In this way, a nation can have either a positive balance on its current account (a trade surplus) or a negative balance (a trade deficit).

The US has for decades run persistent deficits in its current account. As the world’s largest importer, Americans’ appetite for foreign goods has been unrivaled in the global economy. Of course, this is not to say that the US has not been a large exporter as well. In fact, the US is also one of the largest exporting nations, along with China, Germany and Japan, in the world. However, the total expenditures by Americans on imports has exceeded the country’s income from the sale of exports year after year, resulting in a net deficit in its current account.

So the news that rising incomes in China have fueled a boom in US export sales should come as a relief to US politicians and more importantly, firms in the American export industry:

Last year, American exports to China soared 32 percent to a record $91.9 billion.

A study by a trade group called the U.S.- China Business Council says China is now the world’s fastest-growing destination for American exports.

While United States exports to the rest of the world have grown 55 percent over the past decade, American exports to China have jumped 468 percent.

Most of those exports have come from California, Washington and Texas, which have shipped huge quantities of microchips, computer components and aircraft. But states that produce grain, chemicals and transportation equipment have also benefited.

China, which last year surpassed Japan to become the world’s second largest economy (measured by total output), is soon expected to become the world’s second largest importer as well:

And while much of what China imports is used to make goods that are then re-exported, like the Apple iPhone, Mr. Brasher says a growing share of what China imports from the United States, including cotton and grain as well as aircraft and automobiles, is staying in China.

“You know all those BMW X5 S.U.V.’s that are in China? They’re being imported from the U.S.,” Mr. Brasher said in a telephone interview Thursday. “They’re being made by a BMW factory in South Carolina.”

All this must be good news for the US, right? Growing exports to China must mean a smaller current account deficit, greater net exports and thus stronger aggregate demand, more employment and greater output in the United States. However, this may not be the case. While exports to China grow, the US economy’s recovery has led to a boost in the demand for imports from China as well. So, ironically, even as exports have grown 468 percent in the last decade, the US has still managed to maintain a stunningly large trade deficit with China: 

Last year, China’s trade surplus with the United States was between $180 billion or $250 billion, according to various calculations.

Still, the combination of a weakening American dollar and China’s growing economic clout is likely to bode well for American exports. With China short of water and arable land, exports of crops to China jumped to $13.8 billion last year.

Study the graph below and answer the questions that follow.

Discussion Questions:

1. What is the primary determinant of demand for exports that has lead to the growth over the last decade seen in the graph above?
2. What types of goods has China primarily imported from the US in the past? As incomes in China rise, how will the composition of its imports from the US likely change?
3. How is it possible that the US current account deficit remains as large as it does (as much as $250 billion) despite the growth in exports to China?
4. The value of China’s currency, the RMB, is closely managed by the Chinese Central Bank to maintain a low exchange rate against the US dollar. How does maintaining a low value of its currency exacerbate the imbalance of trade between China and the US? How would allowing greater flexibility in the RMB’s value help reduce the large imbalance of trade between the two countries?
5. If the US spent $250 billion more on Chinese goods than China did on US goods in 2010, where did that $250 billion end up? What does China do with the money the US spends on its goods that it does not spend on US goods? Define the financial account and explain the relationship between a nation’s current account balance and its financial account balance.

1. Why does Hayek’s “classical” aggregate supply curve always lead to an equilibrium level of national output equal to the full-employment level of
   

   real GDP?

2. The vertical AS curve above is sometimes referred to as the “flexible-wage and flexible-price” model of the macroeconomy. Why must wages and prices be perfectly flexible for this model to be an accurate representation of a nation’s economy.
3. Hayek was an advocate for free markets, he felt that government intervention in a nation’s economy would only interfere and disrupt the efficient allocation of resources. How does the model above reflect his belief that governments cannot improve a nation’s level of output beyond what the free market is able to achieve?
4. Do you believe that the classical model of aggregate supply is representative of the real world? Why or why not? What evidence is there from recent history that the model is or is not accurate?

Figure 2: The Keynesian AD/AS model

1. Based on the model above, which level of aggregate demand corresponds with the macroeconomic goals of “full-employment and stable
   

   prices”?

2. Changes in which factors could cause aggregate demand to shift from AD2 to AD3? If AD falls to AD3, what happens to the price level in the economy? What happens to the level of output of goods and services? What happens to employment and unemployment?
3. Sometimes the Keynesian AS model is known as the “sticky-wage and sticky-price model”. How does the model reflect the idea that wages are downwardly inflexible, in other words, will not fall even if demand for goods and services fall? For what reasons might wages in an economy be downwardly inflexible (in other words, not fall even as total demand in the economy falls)?
4. How realistic is the Keynsian model of aggregate supply in the real world?
   1. Can you point to any evidence from the last few years that it might be correct (in other words, that a fall in AD will lead to decrease in national output?) Find data on the GDP’s of two Western European countries from 2008 and 2009 to support your findings.
   2. Can you point to any evidence from the last few years that the model might be flawed (in other words, that a fall in AD actually does lead to a fall in the price level)? Find data on inflation in the same two Western European countries to examine whether or not wages and prices are completely inflexible downwards as the model suggests.

1. How does the above model represent a compromise between Keynes’ and Hayek’s view of aggregate supply?
2. Why are there two aggregate supply curves? What is the difference between the two?
3. What happens in the SHORT-RUN when AD falls from AD2 to AD3 to the price level and output? What will happen in the long-run? In macroeconomics, the short-run is known as the “fixed-wage period” and the long-run the “flexible-wage period”. The main factor that can shift the SRAS curve is the level of wages in the economy (in other words, a change in wages will shift the SRAS). How does this help explain the adjustment from the short-run equilibrium and the long-run equilibrium following a fall in AD?
4. What happens in the SHORT-RUN when AD increases from AD2 to AD1? What will happen in the long-run? How does the long-run flexibility of wages explain why output always seems to return to its full employment level of output in the long-run?
5. What does the model above indicate about the possible need for government intervention to help an economy achieve its macroeconomic goals of full-employment and price level stability in the short-run?