Nov 07 2011

Excuse me, China… could you lend us another billion? Understanding the imbalance of trade between China and the United States

The $1.4 Trillion Question – James Fallows – the Atlantic

American consumers are a curious bunch. Up until 2007, the average savings rate in the United States fell as low as 1%, and during brief period was actually negative. What does negative savings actually mean? It means that Americans consume more than they actually produce.On the micro level, the only way to consume beyond ones income is to borrow from someone else to pay for the additional consumption. In other words, savings must be negative for one to consume beyond his or her income. The US is a nation of borrowers, but from whom do we borrow? China, for one…

China is a nation of “savers”, where national savings averages 50% of income. What exactly does this mean? Well, just the opposite what negative savings means; rather than consuming more than it produces, the Chinese consume only about half of what it produces. Here’s how James Fallows, a Shanghai-based journalist, explains the China/US dilemma:

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.
What happens to the rest of China’s output? Naturally, it’s shipped overseas for Americans and others in the West to consume. The irony is that the consumption of China’s products has been kept affordable and cheap thanks to the actions the Chinese government has taken to suppress the value of the RMB, thus keeping its products cheap and attractive to American consumers.

When the dollar is strong, the following (good) things happen: the price of food, fuel, imports, manufactured goods, and just about everything else (vacations in Europe!) goes down. The value of the stock market, real estate, and just about all other American assets goes up. Interest rates go down—for mortgage loans, credit-card debt, and commercial borrowing. Tax rates can be lower, since foreign lenders hold down the cost of financing the national debt. The only problem is that American-made goods become more expensive for foreigners, so the country’s exports are hurt.

When the dollar is weak, the following (bad) things happen: the price of food, fuel, imports, and so on (no more vacations in Europe) goes up. The value of the stock market, real estate, and just about all other American assets goes down. Interest rates are higher. Tax rates can be higher, to cover the increased cost of financing the national debt. The only benefit is that American-made goods become cheaper for foreigners, which helps create new jobs and can raise the value of export-oriented American firms (winemakers in California, producers of medical devices in New England).

Clearly, a strong dollar is good for America in many ways. The dollar’s strength in the last decade can be credited partially to the Chinese, who have been buying dollar denominated assets in record numbers over the last seven years.

By 1996, China amassed its first $100 billion in foreign assets, mainly held in U.S. dollars. (China considers these holdings a state secret, so all numbers come from analyses by outside experts.) By 2001, that sum doubled to about $200 billion… Since then, it has increased more than sixfold, by well over a trillion dollars, and China’s foreign reserves are now the largest in the world.

China’s purchase of American assets keeps demand for dollars on foreign exchange markets strong, thus the value of the dollar high relative to other currencies, allowing American firms and consumers the benefits of a strong dollars described above.
A nation’s balance of payments consists of the current account, which measures the difference between a country’s expenditures on imports and its income from exports (In 2008 China had a $232 billion current account surplus with the US, meaning the US bought more Chinese goods than China bought of American goods), and the capital account, which measures the difference between the inflows of foreign money for the purchase of real and financial assets at home and the outflows of currency for the purchase of foreign assets abroad. In the financial account, China maintains a deficit (meaning China holds more American financial and real assets than America does of China’s), to off-set its current account surplus.The two accounts together, by definition, balance out… usually. Any deficit in the China’s capital account that does not cover the surplus in its current account can be held as foreign exchange reserves by the People’s Bank of China. The PBOC, however, prefers not to hold excess dollars in reserve, as the dollar’s value is continually eroded by inflation and depreciation; therefore it invests the hundreds of billions of excess dollars it receives from Americans’ purchase of Chinese goods back into the American economy, buying up American assets, with the aim of earning interest on these assets that exceed the inflation rates.

The “assets” the Chinese are using their large influx of dollars to buy are primarily US government bonds. The government issues these bonds to finance its budget deficits, and the Chinese are happy to buy these bonds for a couple of reasons: They are secure investments, meaning that unless the US government collapses, the interest on US bonds is guaranteed income for China. That’s one reason; but the primary reason is that the purchase of these bonds puts US dollars that were originally spent by American consumers on Chinese imports right back into the hands of American consumers (via government spending or tax rebates), so they can continue buying more Chinese imports.

The Chinese demand for dollar denominated financial assets, including government bonds, corporate stocks and bonds, and real assets like real estate, factories, buildings and so on, has resulted in a long period of a strong dollar. If the Chinese ever decided to stem the flow of dollars into American assets, the dollar’s value would plummet to record lows, leading to high inflation and eventually a balancing of America’s enormous current account deficit with China and the rest of the world.

However, a falling dollar is the last thing China wants to see happen, for two reasons: One, it would make Chinese imports more expensive thus less attractive to American households, thus harming Chinese manufacturers and slowing growth in China. Two, US dollars are an asset to China. Its $1.4 billion of US debt would evaporate if the dollar took a major plunge. To China, this would represent a loss of national wealth; in effect all that “savings” that makes China so unique would disappear as the dollar dived relative to the RMB. For these reasons, it seems likely that China will continue to be a willing buyer of America’s debt, thus the financier of Americans’ insanely high consumptive lifestyle.

Discussion Questions:
  1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
  2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
  3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
  4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? 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

153 responses so far

153 Responses to “Excuse me, China… could you lend us another billion? Understanding the imbalance of trade between China and the United States”

  1. djohnon 23 Nov 2011 at 6:33 pm

    1.Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    From the article China is a country that is opposite to what America does. In China the country produces more than it consumes whereas in American the country consumes more than it produces. If China does dump their dollar holdings in America then the value of the American dollar will weaken. When the American dollar weakens the price of food, fuel, imports and many more products will get affected as the price will rise. Whereas for stock markets, real estate and other American assets the price will go down. Citizens of America will be greatly hit but on the other hand the citizens of China will gain a profit as their new currency will be stronger which means that the price of food, fuel and imports will be low and for personal assets the price will be higher.

    2.Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    If China dumps its dollar in America it will affect the imports as from the article it will be more expensive to American households therefore making it less attractive and it will lead to affecting Chinese manufacturers and will slow the growth rate in China. Also if China dumps its dollar then its exchange rate value will increase causing exchanging of currency to decrease as it is expensive. This would lead to a loss of national wealth to China as the $1.4billion US debt will ‘evaporate’. US is an asset to China so for this reason China is more towards the unlikely side to dump its dollars.

    3.How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    China is issuing bonds; it means they want to eradicate their deficit. Since they want to reduce the prices of their importing products American households will get imported goods at a cheaper price as Chinese products are made to attract Americans. Lifestyle commodity prices will come down. From this arrangement the only way that they will suffer is the risk of the dollar value in the international affairs will become weak.
    4.Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    In my opinion no it cannot continue to finance its budget deficits through the continued sale of debt to foreigners forever because foreigners are aware of the plight. Foreigners are going to come to the point where they do not want to exchange money at that specific rate. The more debt the US comes to, the harder it is for them to pay the debt. Foreigners will soon become part of US assets if the US continues sales of debt to foreigners.

  2. Mehmet M Sumaon 24 Nov 2011 at 9:33 pm

    1. Depreciation of the dollar would be seen. This would be the end of the highly consuming life-style of America because of the expensive imports.
    2.The USA is a principal consumer for Chinese products. The expensive imports would not be attractive to the US consumers. It would harm the economic growth of China. Besides, US dollar is an asset for China. China wouldn't want to reduce the value of its asset.
    3. They benefit from the cheap imports, as China supports a strong dollar. However, the strong currency makes US goods expensive and harder to export. They are becoming less competitive. This is likely to cause structural unemployment.
    4. The deficit would become so large that China will question its part in the US economy. Besides, the US would not want to let China have the greater sovereignty in the US economy.

  3. abredeeon 04 Dec 2011 at 9:35 pm

    so , do you think the practice of america is sustainable or unsustainable? Otherwise i agree.

  4. Alexander Wallaron 28 Nov 2011 at 8:39 am

    1.Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    Since China is a major customer for American currency, if China were to dump their dollar holdings, the demand for the dollar would decrease substantially. If there is a sudden decrease in demand, the supply will be higher than the demand in the short run. This means that the dollar will be worth less than it was before and there will be a large rate of inflation. This high rate of inflation will decrease the purchasing power of the dollar and therefore make imports more expensive. Since the United States’ economy is firmly built off of imports and thus it has a current account deficit, the total price of goods will increase and thus make everything more expensive. This decreases the consumer surplus and causes a loss in consumer welfare. There are two plusses to this situation though. If the dollar loses value, American exports are going to look more appealing in the international market. This decreases the current account deficit but also decreases the capital account surplus. The other plus that comes from the inflation is increased employment in the short run. Unemployed consumers see that goods are becoming more expensive and therefore try to become employed in order to afford their wants and needs.

    2.Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    The United States is one of China’s biggest trading partners. If China were to get rid of the American currency, there would be devaluation in the dollar because of decreased demand as explained before. This decreases the purchasing power of the United States, and thus the United States would import less from China because goods from China are going to cost more to the American consumers. This hurts the Chinese economy and therefore keeping the American currency is an incentive for economic prosperity in China. Also if China was to drop the American assets, goods produced in the United States would look more profitable on the world market and thus China would have produced a rivaling competitor in the international market – something that China wants to avoid.

    3.How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    American households benefit from China’s financing of the government’s budget by having extremely cheap goods at their disposal. When China buys out American debt and purchases American currency, the purchasing power of the dollar increases. This means that the dollar is able to purchase goods from all over the world and it gives the consumer a variety of choices. Also, the market open to a consumer using the dollar is substantially larger than those using weaker currencies because importing goods do not appear to be as expensive. This means that the international market for the American consumer is very competitive. This leads to even lower prices and a higher quality of the good. American consumer can also suffer through this process because of their dependency on Chinese production. The problem is with China is that people see China’s production power and production ranking to be ever growing and sustainable. This is not entirely true. Since China has bought up the American debt, Americans are at risk of a Chinese economic meltdown or recession. America’s economy, because of how dependent it is on China, will suffer every single Chinese economic problem.

    4.Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    I do not think that American can continue to finance its budget deficits through the continued sale of debt to foreigners because of interest rates. As the American debt increases, so does the interest rate. When countries buy American assets, they are in essence lending America money to decrease its debt. This money needs to be paid back along with a certain percentage of interest. This means that America will have to pay back lending countries more than the amount of America’s debt. This is simply unsustainable.

  5. Alexander Wallaron 28 Nov 2011 at 8:44 am

    @ Mehmet
    For your answer to question 4:
    China enjoys having the United States in debt and enjoys even more owning the debt. Having China purchase our debt artificially increases the demand for American currency and therefore increases the dollar's purchasing power. This combined with the weak Chinese currency and cheap Chinese goods gives China an edge against competitors in the international market competing for America's imports

  6. abredeeon 04 Dec 2011 at 9:33 pm

    I think that the US could continue this cycle for a few more years, but it couldn't happen for too much longer. Pretty soon the deficit will become so big that investors will begin to question if they will get a return on their money. This will break investor confidence in the US government and economy, and will eventually cause the destruction of the country as a whole. As soon as the US starts to pay off their debts though, they will begin to look good in the eyes of investors, and will allow them to continue for a long time. The only problem is, that requires a drastic change in US ideals, and a move towards saving vs. spending. This will be hard for the US public, but needs to be done if they want to survive.

  7. abredeeon 04 Dec 2011 at 9:34 pm

    1.Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    Since China is a major customer for American currency, if China dumps their dollar holdings, the demand for the dollar would decrease immensely. The supply will then be higher than the demand in the short run. Thus, the dollar will be worth less than it was before, which will result in inflation. The high rate of inflation will decrease the purchasing power of the dollar and therefore make imports more expensive. This will make many goods in the US more expensive. This decrease consumer surplus and thus overall welfare. However, this also has the advantages that the depreciated dollar will make US exports relatively cheaper and thus decrease current account deficit.

    2.Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    The United States is one of China’s biggest trading partners. If China gets rid of the American currency, there would be depreciation in the dollar because of decreased demand as explained before. Thus the United states would import less Chinese products and this would damage the Chinese economy. Also, as stated previously, Us exports will increase and thus these may rival Chinese exports.

    3.How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    American households benefit from China’s financing of the government’s budget by having extremely cheap goods at their disposal. Chinas supply of goods increases consumer surplus and decreases prices for American households. Consumers have acces to a greater variety and quality of goods.

    4.Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    I think that the US could continue this cycle for a few more years, but it couldn't happen for too much longer. Pretty soon the deficit will become so big that investors will begin to question if they will get a return on their money. This will break investor confidence in the US government and economy, and will eventually cause the destruction of the country as a whole. As soon as the US starts to pay off their debts though, they will begin to look good in the eyes of investors, and will allow them to continue for a long time. The only problem is, that requires a drastic change in US ideals, and a move towards saving vs. spending. This will be hard for the US public, but needs to be done if they want to survive.

  8. Jackson Moteon 07 Dec 2011 at 2:56 pm

    1. If China decided to change its foreign reserves to another currency, the value of the US dollar would drop significantly and most likely further the economic downturn that the United States is currently experiencing. Last week, President Barack Obama was quoted saying that "This is the worst economic downturn since the Great Depression". If China takes this action, the United States will be in real trouble of imports and exports

    2. It is very unlikely that China will take this action because China's main exports are to the US and this action could put this trade in jeopardy. The status quo will benefit China as well as the US because neither country wants to take action against the other because of economic repercussion. At the moment, the United States depends on China for cheap labor and ease of importation whereas China depends on the US to continue this international with the country. The American household benefits from this financing because it consolidates the debt which the US currently owns to China. However in the long term, this financing will hurt the United States because they will have to pay more back than was lent to them.

    3. America cannot continue to finance these budget deficits because eventually the amount owed would not be repayable. This will send the US economy to levels lower than the Great Depression.

  9. Jackson Moteon 07 Dec 2011 at 3:05 pm

    @Nabil

    Rergardless of whether the exports would increase from the US, this would not account for the major loss of importations to the US.

  10. selin tatlicanon 13 Dec 2011 at 1:47 pm

    1)Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    In this case USA economy would effect from this in a bad way, there would be a dumping in their dollar holdings. And the value of dollar would decrease. Because of that in American economy the inflation rate increases. This case may increase the price levels of Chinese products so that there will be less demand.

    2)Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    China is unlikely to do that because in this case USA will not be the only one who is in danger. Also China is the one who is going to effect from this in a bad way. Because the more US dollars lose value, the less Chinese products are produced. This will decrease the China’s exports.

    3)How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    According to the relation between the money and the price, when the value of dollar gets higher, the prices will go down. When the prices are less, the consumer starts to consume more and spend money. So that American consumers benefit from China’s financing of the government’s budget deficit.

    4)Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    I think America cannot continue to finance its budget deficits because when deficit increases too much, America will have problems to pay all of them. So that it is dangerous for American economy.

  11. Will Overhauseron 23 Dec 2011 at 7:23 pm

    In #3, what ways do the Americans suffer form the arrangement?

  12. Will Overhauseron 23 Dec 2011 at 7:21 pm

    1.Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    The value of the dollar would become very low, resulting in high US inflation, since there would be a huge amount of dollars on the market and not enough demand to meet the supply.
    2.Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    Since their currency would suddenly be less valuable, US consumers would not buy nearly as many imports from China because they would be so much more expensive. Also, China would lose all the money they had invested in the value of the dollar.
    3.How do American households benefit from China’s financing of the government’s budget deficits? In what way do they suffer from this arrangement?
    They benefit by continuing to have a strong currency that has many benefits in of itself. They suffer from the uncertainty that comes along with someone else having control over your government and economy.
    4.Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    No, eventually the balance will become so unstable that something will have to change.

  13. […] Excuse me, China… could you lend us another billion? Understanding the imbalance of trade between … […]

  14. jessicakennyon 16 Nov 2012 at 9:06 pm

    1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    The value of the USD would drop dramatically because the US is in a huge trade deficit, which would, under “normal circumstances”, pressure the exchange rate to lower, since there is low demand for American goods. However, with China investing so much money in American assets, the demand for the USD remains artificially high, which keeps the value of the dollar high.
    2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    It’s unlikely because the Chinese are “savers” by nature, so they sell more than they spend. Thus, it is beneficial for them to maintain a low RMB so that Chinese exports stay relatively cheap and desirable for foreign consumers. The only way for China to accomplish this is by buying a lot of American bonds, in order to maintain the supply of the USD low on the foreign exchange market, so that its value remains relatively high and the RMB’s value remains relatively low. Since the US benefits from a high dollar, this status quo benefits both nations. If China stopped this practice, the high demand for Chinese goods (which comes largely from Americans) would cause the RMB’s exchange rate to rise, making Chinese exports less attractive.
    3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    They benefit because their culture of consumerism is sustained, since they can buy more than they produce because China injects money into the US’s circular flow, which can then be used by banks to loan to American households for their purchases of cars, homes, etc. If China did not finance the budget deficit, there would be no money for Banks to loan to American citizens. Households suffer from this arrangement because the lack of pressure for domestic production, causes unemployment and inflation, since even though many Americans don’t have jobs, consumption doesn’t decrease since China still finances it, so inflationary pressures aren’t abated.
    4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    No, the 2008 credit crash is an example that eventually, if money is simply loaned heedlessly to consumers who do not have stable jobs and cannot pay for it, eventually the whole scheme will implode. For one thing, China expects to receive its investments back with interest – and the only way for the US government to fulfill this obligation is using tax money, which will only be available if Americans are employed and industries are producing.

  15. jessicakennyon 16 Nov 2012 at 9:28 pm

    @Will Overhauser

    In response to #1, I agree that the value of the USD would drop and there might be high inflation in the US, but not because the supply of dollars on the foreign exchange market is too high, but because a low exchange would make imports more expensive, causing higher domestic consumption, which might cause inflation because of the increased demand for a limited amount of American goods. In response to #2, I agree that China would not want to lose its investments in American bonds, but China is not as concerned with losing the US as customers to their products once Americans can’t afford imports when the dollar’s exchange rate is low, as much as they are concerned with maintaining their own exports cheap for the entire world.

  16. jzhengon 18 Nov 2012 at 1:51 pm

    1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    If China decides to change its foreign reserves to another currency, the Chinese currency demand of the US dollar will drop dramatically, which represents a huge drop in the value of the US dollar.

    2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    If the value of the US dollar falls, it is very likely that US demand of Chinese exports will fall, and will therefore also raise the value of the Chinese RMB. While the US demand drops, Chinese employment rate would also fall. In addition, Chinese foreign reserves of US dollar would lose its worth.

    3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    American households benefit, as they are able to continue demanding from the variety of choices of imports from Chinese cheap exports. However, as most US demand goes to the Chinese exports, there is a relatively low aggregate demand in the US economy, thus the productivity and employment rate is low.

    4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    No. If America continues running a deficit in exports while gaining profit in the capital accound, American income would naturally come to an end, as most income would go to the Chinese economy even if China invests their reserves back into the American economy.

  17. aaxler2on 19 Nov 2012 at 9:31 pm

    Abraham Axler

    • Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    o The value of the dollar would likely rapidly decline. This assumes that no other country is willing take buy US bonds in the quantity China has enabling the US to keep consumption high.
    • Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    o China benefits from a strong dollar in that US the largest importer of Chinese goods. America is so fond of Chinese goods because the exchange rate is such that they are relatively inexpensive to American consumers. Furthermore, the US bonds that China buys allows the US to spend beyond its means, often through the purchase of Chinese products. Not only do the Chinese get a guaranteed return on their investment through the interest rate on US bonds, they get a portion of money back immediately through exporting to the US. The US benefits by the availability and affordability of Chinese produced goods.
    • How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    o American households benefit from the funds gained through the sale of US bonds to China that are spent on government programs like free-preschool or “ cash for clunkers.” Additionally, they benefit from the cheaply produced Chinese goods like clothing, and electronic accessories. American households might suffer, because China’s financing is boosting the value of the dollar. If the dollar were weaker American produced goods would be more competitive in the world market. If demanded increased for American made products American producers would likely hire Americans, thus benefiting American households.
    • Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    o At certain point the sale of debt to foreigners becomes like Ponzi Scheme. The basis of a Ponzi scheme is that the investment from the new investors in the spurious business is use to pay the old investors. This becomes like a pyramid where there are eventually no new investors to pay the old investors and the base collapses taking down the whole scheme with it. As the fiscal cliff looms, it appears America is getting close to this point. The world market is far too volatile to be a reliable source of debt buyers. The Eurozone crisis is evidence that no country, or economic conglomerate is so stable that it can be counted on to buy US debt forever.

  18. rthornton2on 20 Nov 2012 at 3:27 pm

    Discussion Questions:

    1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    If the Chinese dumped their dollar holdings, the supply of the dollar would increase greatly and the value of the dollar would plummet.

    2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    It is very unlikely that China will dump their dollar holdings due to their trade relationship with the US. If the value of the dollar plummeted, Chinese exports would become more expensive, thus decreasing the demand for Chinese exports. The strong value of the dollar allows for Chinese exports to be cheap, therefore, the demand for Chinese exports remains high.

    3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    American households benefit from China’s financing of the government’s budget deficits because the value of the dollar remains high. A high value of the US dollar results in cheaper exports from China. With cheaper goods available, the domestic consumers benefit. Domestic producers suffer the consequences for this as the value of the dollar remains high, making their exports become more expensive. Following this, the demand for American exports would decrease. There is also more competition for goods sold in the US as Chinese goods are cheaper, thus more appealing. American producers suffer loss of demand from China’s financing of the government’s budget deficits.

    4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    I do not think that America can continue to finance its budget deficits through the continued sale of debt to foreigners forever. The debt owed by America will continue to rise to a point where it is unlikely that they can pay off their debt.

  19. Anair2on 20 Nov 2012 at 3:58 pm

    1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    The article above clearly explains that due to the fact that China purchases the American Assets, the demand for dollars on the foreign exchange market is maintained and thus the value of the US dollar is relatively high relative to that of other currencies however if these purchasing was halted then the value of the dollar would drop immensely as a result.

    2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    It is very unlikely that China will do this and that if this were to take place it would mean that the Chinese products exported to China would not be as effective to the American consumer as the price would increase in relation and therefore damaging the Chinese manufacturers and affecting the nation’s economic growth. Essentially by doing this they are harming their own economy, which is not really, the typical approach by any economy, as the savings would drop greatly. Therefore this status quo helps stabilize and maintain the demand for their exports, which is a major component of their economy.

    3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    The American Households (consumers) benefit from the fact that with China’s financing of the government’s deficits in that the US dollar rises in its value as a currency and thus the government can spend on more with the same amount of money. Therefore consumer spending in the US will increase however this will only apply to foreign goods and thus Americans will be less willing to buy domestically produced goods and thus they will suffer from much higher rates of unemployment as the firms they work for will go bankrupt. Lastly this arrangement will mean that the US is in some ways controlled by China in that the deficit depends upon China’s decisions.

    4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    The title of this article really summarize the situation ‘excuse me China could In my opinion it is very unlikely that America could continue with this in that it will only make things far worse and the deficits are not going to get any better. However when looking at America as a nation, it is definitely trying to reduce costs and the government is doing a good job of this. The fact is that if this were to continue it would mean that one nation would bring a halt it simply cannot continue as China may in fact desire a great deal of American goods and thus that will be quite difficult to get and maintain as their money lies in the government bonds. Therefore as this situation is prolonged it will only increase the issues with what may happen to the Economy in the US. Currently the US is dependent on the investments made by other nation but the fact is that other nations won’t finance another forever, economies are unpredictable and at any point in time problems may arise.

  20. seun2on 20 Nov 2012 at 4:19 pm

    1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    If the dollar holdings were dumped by the Chinese, the value of the currency will decrease greatly as there is a large supply of dollars in the foreign market.

    2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    It is very unlikely that China will dump their dollar holdings for many reasons. First, if the value of the dollar plummets and inflation occurs, the $1.4 billion of US debt would evaporate, leading to a decrease of national wealth. Next, it would make Chinese imports more expensive thus less attractive to American households, thus harming Chinese manufacturers and slowing growth in China

    3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    China’s financing of the government’s budget deficits is like a double edged sword. American households benefit from the financing because it helps the US maintain a strong dollar currency. A strong Dollar will allow the US to bring in exports from China cheaply, allowing a lower price level for many products. This will benefit the domestic consumers as they can get more cheap, accessible products. However, it will harm the domestic producers as this may lead to less opportunities in exports, as it make the exports more expensive. Thus we can’t make a certain judgement as it contains two potentially contrasting results.

    4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    I do not think that the United States can continue this budget deficit forever because this unbalanced budget balance will implode if the deficit gets larger and larger. This process is simply delaying the collapse because the process is so unnatural. Like the 2008 Economic Collapse due to Prime mortgage, or the 1928 crisis due to speculation, it can be seen that some unnatural systems are unsustainable and will someday fall.

  21. Anair2on 20 Nov 2012 at 4:34 pm

    @ Behiye
    Overall you had some very concise responses to the question. As for the first question I would not necessarily say that the imports would be more expensive in that they cost the same however relative to the US currency they may seem costlier than previously. You took a very interesting approach to question 2 as you took the approach that America may benefit however although this is true they will be running so much debt that problems will still arise. As for question 4 I definitely agree the US cannot prolong this too much.

  22. seun2on 20 Nov 2012 at 4:37 pm

    #Jessica Kenny
    Hey, I think for response#2, it is not just a difference in the nature of consumption, but also because of economic reasons. Saving by nature is one thing, but they do not release it because it makes Chinese trade less competitive. However, for #4, I think bringing in tax is a good solution to the problem. This will probably lead to higher tax rates, but in order to reduce the budget deficit, ,I think it is necessary.

  23. sybellevon 20 Nov 2012 at 11:16 pm

    • Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    The value of the US dollar would plummet to record lows. This would happen because the supply of US dollars would dramatically increase if China decided to change its foreign reserves to another currency. Additionally, as the Chinese demand for American currency would dramatically decline, the overall demand for the dollar would decline and result in depreciation.

    • Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    It is unlikely that China would do this for two main reasons. Firstly, China holds about $1 trillion in American debt currently (Bloomberg) and would run the risk of losing national wealth if the value of the dollar depreciated. Secondly, if the value of the dollar decreased dramatically, Chinese goods would become more expensive for American consumers. Demand for Chinese goods would fall in America, and this would be detrimental to Chinese manufacturers and the overall economy.

    • How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    American households are able to spend more as a result of China’s financing of the US government’s budget deficits; China’s purchases of American bonds keep the value of the dollar high and the price of imports cheap in America. Inadvertently, Americans suffer from this arrangement because the demand for US domestic products is relatively low compared to the demand for Chinese imports; this contributes to rising unemployment and greater dependency on China.

    • Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    I do not think it is possible for American to continue to finance its budget deficits through the continued sale of debt to foreigners forever. I believe that at some point, the American debt will be so high that Americans will want to take action. Additionally, as Americans become more dependent on China, relations between the two countries become increasingly strained. Eventually, if there is a major policy disagreement between the two countries, there could be far reaching economic consequences.

  24. sybellevon 20 Nov 2012 at 11:27 pm

    @seun2 :

    I agree with your response to the last question, and I liked your use of specific examples from history of unsustainable economic practices. I also thought your observation that American households suffer from the financing arrangement with China was on point.

    Though America is moving away from being a manufacturing nation, as more and more companies outsource their production, it seems quite obvious that the relationship with China is a central cause to rising unemployment rates in the United States. At some point, Americans that would normally be employed in manufacturing will have to adapt, and find a new career that is sustainable in the dynamic American economy, or reforms will have to be put into place so that more production can take place cost-effectively in the United States.

    However, another way that American households inadvertently suffer is that the more they buy into Chinese products, the more interconnected they become with China. We cannot have Wal-Mart and all the manufacturing jobs, too; it comes down to one or the other. Since economics is based on efficiency and self-interest, the majority of the time, people will choose a cheaper price instead of a boycott of a Chinese good for long term benefit. Because of this, it is hard to see an end to the interdependent and somewhat convoluted American relationship with China.

  25. Stefan Josephon 21 Nov 2012 at 2:37 am

    • Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?

    This would simply create the reverse effect of buying the American assets. As China buys the assets with no intention of selling, the demand for the American dollar is kept high and supply low. This is done to keep the dollar strong in relation to the RMB. The dumping of these assets would basically flood the market with an excess supply of US dollars and there would be a severe depreciation of the USD.

    • Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?

    China’s main goal is to keep American demand high for Chinese exports and to do so, they need to keep their currency weak and the USD strong to make it less expensive to American consumers. By depreciating the dollar, there would be less demand for Chinese exports as they will become more expensive shifting the demand.

    • How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?

    The buying of American government bonds will simply place US dollars back into the American economy and will allow American consumers to continue spending on Chinese exports due to tax rebates/government spending. However, this will simply place the American’s into more debt as it encourages their consumptive lifestyle and China will basically be able to determine the fate of the USD.

    • Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

    Allowing foreigners to finance America’s budget deficits will not lead to a long term solution if their consumption patterns don’t change. The American’s receive foreign aid and simply throw it back at them by consuming foreign goods which will fuel their deficit in BofP leading to increased national debt.

  26. Stefan Josephon 21 Nov 2012 at 2:47 am

    @Anair2

    Hey Arjun, I like your response to the fourth question. I am wondering why Yr 2 Economics students are able to determine that foreign funding of America’s budget deficit will not lead to positive impacts, but America doesn’t? However, do you think China will ever stop funding their top consumer in the near future?

  27. jzhengon 21 Nov 2012 at 6:31 pm

    @ rthornton2

    In question 2, I believe that China is also unlikely to do so because the reserves of US dollar obtained from the positive balance of payment will lose its worth, therefore the wealth of China will be hugely affected.
    In question 3, the Americans will also becomes indebted if they are spending more than they earn.

  28. zphuaon 21 Nov 2012 at 10:31 pm

    • Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
    If China wants to change its foreign reserves to another currency, they sell the large amounts of US assets they have for a foreign currency. This causes the supply of USD in increase by a great extent considering the huge amounts of foreign reserves China hold. This will cause a great drop in the value of USD, and hence US would have to spend much more money on imports, increasing the cost of production and hence causing serious inflation.
    • Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
    It is very unlikely that China will dump all of its reserves. This is because China would then lose a lot of income from American exports, since China goods will become more unattractive to them. This will cause a decrease in China’s employment rate. Also, this will also be a lost of national wealth, as if the USD depreciates all of its national reserve would “evaporate”. The US would also not want those high inflation rates, hence both countries go well together.
    • How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
    With a strong value of currency the price of a lot of things go down. The value of their assets go down. Interest rates will also go down, so that people would borrow more money. Tax rates could also be lower, since national debt is held by foreign lenders. They have a higher standard of living.
    However, they also suffer because of the decreased export, and might lead to a lower employment rate. Also, debts are debts, they have to be repaid. One day when China wants the US to pay back, the US would be in a state that they have to drop their live style of the higher standard of living that they previously had, and that would cause drastic changes to their lives.
    • Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?
    I think that no, America won’t be able to live on foreign financed debt forever. This is because as they get more and more deficit, they would gradually get to a point where they have nothing left, and so no interest to repay other countries. When that time comes America would be in great trouble because they will have to find money to continue financing the lives of all Americans, and also there is no way they could cover that big financial hole in a short period of time.

  29. zphuaon 21 Nov 2012 at 10:38 pm

    @sybelle,
    Thanks for bringing up in question 1 that not only supply would increase, but also demand will decrease. However, I would like to add that one benefit of the American households is that they get to have a high standard of living. For your last question, I agree with you, but I am curious about when would the US think it is actually time to take action? Because that deficit gets greater by the day, and it is really tricky that China puts the money right back to US for them to continuing spending, creating even bigger deficit.

  30. eztrader tradingon 15 Jun 2016 at 10:24 am

    eztrader trading

    Excuse me, China… could you lend us another billion? Understanding the imbalance of trade between China and the United States | Economics in Plain English

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