Listen to the podcast, watch the video lesson, and respond to the discussion questions that follow.
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Discussion Questions:
Why does the Chinese Central Bank possess over $3 trillion of foreign exchange reserves?
What does the Chinese Central Bank do with the vast majority of the money it earns from the sale of its exports that it does NOT spend on US goods? Why not keep this money in cash?
Why does the Chinese Central Bank manage the value of its currency, the RMB? Why not let the exchange rate be determined by the free market?
As the RMB is slowly strengthened against the dollar, who are the winners and losers? What impact should a stronger RMB have on the balance of trade between China and the US?
I have two interesting stories on Apple and the iPad to reflect on today.
First, ABC’s Nightline recently became the first Western journalists actually welcomed into an Apple assembly plant in China. The show recently aired a 15 minute feature on working conditions inside Apple’s Foxconn factory in Shenzhen, China last week. Watch the video and then scroll down for what may be some additional surprising news about Apple’s operations in China.
Next, the story that has gone unreported lately is a University of California study titled “Capturing Value in Global Networks: Apple’s iPad and iPhone”. The study’s most interesting finding, in my opinion, is the tiny percentage of the total value of Apple’s iPhone and iPad that actually goes to the Chinese manufacturers of the products. The charts below, from the study, show how the value is divided among the various groups involved it their production and sales:
The chart shows a geographical breakdown of the retail price of an iPad. The main rewards go to American shareholders and workers. Apple’s profit amounts to about 30% of the sales price. Product design, software development and marketing are based in America. Add in the profits and wages of American suppliers, and distribution and retail costs, and America retains about half the total value of an iPad sold there. The next biggest gainers are South Korean firms like Samsung and LG, which provide the display and memory chips, whose profits account for 7% of an iPad’s value. The main financial benefit to China is wages paid to workers for assembling the product and for manufacturing some inputs—equivalent to only 2% of the retail price.
A student today asked why Apple doesn’t produce its products in the United States, where an economic downturn has left 14 million American out of work for the last three or four years. If iPads and iPhones were just made in America, jobs could be created, households would have more income to spend on Apples products, and both the country and the economy would benefit.
The data in the UC study indicates that in fact, more than half the value of an iPad or iPhone does end up in the hands of Americans. But Apple could never achieve the low costs and high profits that it does by assembling its products in the US. After watching the Nightline video above, it should be clear that the type of production involved in Apple factories’ is very low-skilled and labor-intensive. Using American labor, with its unions, minimum wages and 40 hour work weeks, would require Apple to employ such large numbers of workers and raise the company’s variable cost to such a level that the firm’s profits would be reduced significantly and its sales would fall dramatically. Apple would lose out to foreign producers of smart phones and tablet computers, such as LG, Samsung, Sony and others, which would continue assembling their goods with Chinese labor.
Ultimately, any gain to the low-skilled American workers (presuming Apple could even find enough to do the work of the 400,000 Chinese employed in the production of Apple products in China), would be offset by a loss of profits enjoyed by the millions of Americans who hold shares in Apple Computer and the thousands of American who are employed engineering and designing its products, as the firm’s sales would slip in the face of lower-cost competitors.
So this student’s question identifies an interesting paradox: America, with its large pool of unemployed workers, will never be attractive as a place to produce labor-intensive products such as phones and tablet computers, due to the vast wage differential between the US and China. And even if one firm did decide to produce its products in America, the gains to low-skilled workers who may find minimum wage work in the new assembly plants would be off-set by losses to the firms’ shareholders and the high-skilled workers whose jobs would be lost as sales decline due to the lower prices offered by lower-cost competitors.
The lesson here is two-fold: First, Apple and other American technology companies should continue using Chinese labor to assemble their products, and second, America is better off for it: lower costs mean cheaper products and higher sales, thus greater employment in the high-skilled sectors of the US economy, and more profits and returns on the investments of shareholders in American corporations. Americans are richer and enjoy a higher standard of living thanks to the millions of Chinese working in factories assembling the goods we consume.
Keep in mind, this analysis did not even consider the effect on the Chinese economy and the millions of Chinese workers (whose lives are much harder than the typical American) should companies like Apple shut down their Chinese manufacturing plants. That’s a whole other blog post!
Related Unit: IB Economics Unit 4.7 – Balance of Payments (Unit 3.3 in the new IB Economics syllabus)
Topic: The Marshall Lerner Condition and the J-Curve
Learning Goals/Objectives:
For students to understand that the levels of price elasticity of demand for a country’s imports and exports determines whether a depreciation or devaluation of the country’s currency will move the nation’s balance of payments towards a surplus or a deficit.
For students to understand the impact of time on the effect of a depreciation or devaluation of a nation’s currency on its balance of payments in the current account.
For students to evaluate the argument that a country will always benefit from a weaker currency.
Test of prior knowledge:
Define ‘price elasticity of demand’ and explain how it is measured.
With the use of examples, explain why some products have low price elasticity while others have a high elasticity. With the use of examples, explain why the price elasticity of demand for some goods changes over time
Explain how the depreciation of a country’s exchange rate might affect its current account balance. IS THIS ALWAYS THE CASE?
How might the PED for exports and imports influence the balance on the current account following a change in the value of a nation’s currency?
Process:
Each student should research the forex market for his or her home country in the United States. If you are American, research the forex market for the dollar in Europe.
Using Yahoo Finance, research exchange rate data from the two countries two years ago up to today.
Use Yahoo’s software to create two a line graph plotting the value of your currency in terms of dollars. For your initial graph, show the exchange rates over a two year period. For example:
The exchange rate of Japanese Yen in the United States over the last two years:
Next create a Google Doc (shared with your teacher) of your answers to the following questions. Include in the presentation the graph of the exchange rates created in the step above.
Questions to answer in your Google Doc:
Create a graph of your currency’s exchange rate in the US over the last two years. Take a screen shot and save it to your computer as an image. Insert the chart into your Google Doc. Write a one paragraph description of the changes in your country’s exchange rate over the last two years. (2 marks)
Focus on two specific time periods from during the last two years: One in which your currency appreciated noticeably and one in which it depreciated noticeably. These could be periods of just a couple of days or longer periods of weeks or more. (4 marks)
In Yahoo Finance, narrow the range of dates shown on your chart to the distinct period in which your currency strengthened and another period during which it weakened. Take a screen shot of the new graphs you’ve created, save them to your computer and upload them into the Google Doc.
Under each new chart, describe what is happening to the value of your currency in the two periods identified.
Beneath your two new graphs, explain TWO factors that may have caused the currency to change in value. (2 marks)
Given the changes to the exchange rate you identified above, what would you predict would happen to your country’s current account balance over the two periods identified? Explain. (4 marks)
For both the period of appreciation and the period of depreciation you identified above, explain the impact of the change in exchange rates on the following (4 marks)
a firm that imports its raw materials from the other country
a firm that exports its finished products to the other country
consumers who buy imports from the other country
a firm that produces good for the domestic market and competes with firms from the other country
Why does the price elasticity of demand for imports and exports increase over time following a change in a country’s exchange rate? (2 marks)
Why will a depreciating currency worsen a country’s current account balance in the short-run? Assuming the currency remains weak, how would the current account balance change over time. (2 marks)
Draw a J-Curve showing the likely change in your nation’s current account balance following the period of depreciation of its currency shown in your chart above and explain its shape, referring to your country’s currency. (2 marks)
Some applaud the dollar’s fall because they believe it makes U.S. exports less expensive and that higher demand will cut the trade deficit. The downside of a low-value dollar is that it makes all the imports we consume more expensive, including raw material and parts used by U.S. businesses, and makes it costlier for U.S. dollar holders to travel or invest outside the U.S. A continued drop in the dollar’s value could destabilize the international economy, leading to a worldwide recession.
Why might the weaker dollar worsen the US trade deficit? Under what conditions would the weaker dollar improve America’s trade deficit? (2 marks)
Some argue our large trade deficit (or current account deficit) is responsible for the fall in the dollar’s value. They have it backward. It is the flow of foreign investment dollars (the capital account) into the U.S. economy that drives the trade deficit.
How does a large financial (capital) account surplus allow the United States to maintain a large current account deficit? (2 marks)
The world now is actually on a two-currency standard — the dollar and the euro. China in effect has fixed its currency to the dollar for the last two decades, and the Japanese central bank only allows the yen to fluctuate within a limited range against the dollar.
How do exchange rate controls by China and Japan reduce the likelihood that a weaker dollar will improve the United States’ current account balance? (2 marks)
So long as the U.S. continues to offer a higher return on capital than its foreign competitors, both foreign banks’ and private investors’ demand for dollars grow, and the current account deficit can be sustained.
If investments in the United States began earning lower returns relative to investments in other countries’ financial and capital markets, what would ultimately happen to the US balance of payments in its current and financial accounts? Explain (2 marks)
Total 30 marks – You have two class periods to work on this assignment. It will be graded as a “coursework” grade and counted towards your semester 1 report. To earn full marks, it must be completed by the end of the second class period.
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:
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?
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?
How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
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 table below shows the trade balances for the nations from which my year two IB Economics student come. They are ranked in order from the country whose trade deficit makes up the largest percentage of its GDP (Zimbabwe) to the country whose trade surplus makes up the largest percentage of its GDP (Germany). The blue bars represent the value of the deficit or surplus of each nation. As can be seen, Zimbabwe’s trade deficit is very small in dollar terms, but since its economy is also very small this deficit makes up a large percentage of its total GDP. Click on the image to visit an interactive version of the chart on which you can study the data more closely. Then answer the questions that follow. Discussion Questions:
Identify and define the four components of an nation’s current account balance.
According to the data, which three countries are the most import dependent? Which three countries are the most export dependent? Which country has the most balance trade in goods and services? Which has the most imbalanced trade?
If your country is one of deficit countries above, answer the following two questions:
Assuming its currencies’ exchange rates is floating, explain how persistent current account deficits will affect a country’s exchange rate over time?
Summarize and explain the likely effects of a current account deficit on the following: a) the financial account balance, b) domestic interest rates, and c) national debt.
If your country is one of the surplus countries above, answer the following two questions:
Assuming its currencies’ exchange rates is floating, explain how persistent current account surpluses will affect a country’s exchange rate over time?
Summarize and explain the likely effects of a current account surplus on the following: a) domestic savings rates, b) the financial account balance.
What are the various methods a country can take to reduce a current account deficit? What is the benefit of having a balanced current account as opposed to a large deficit or surplus?
How did a barren rock in the middle of the North Atlantic Ocean become one of the richest countries in the world, where the average citizen earns $40,000 per year?
Iceland’s prosperity is a perfect example of how a country that participates in international trade based on the principal of comparative advantage can produce the goods for which it has a relatively low opportunity cost, export them to the rest of the world, and become rich. Listen to the podcast below, then complete the activity that follows.
Look up your home country from the drop down menu.
Click on the “Economy” section and read the introduction to your nation’s economy.
Look through the economy section and find information on your nation’s exports, then answer the questions that follow.
Questions:
What is the value of your home country’s exports (in dollars)?
What are the main exports from your country to the rest of the world?
Calculate the percentage of your nation’s GDP is represented by exports (divide the dollar value of exports by the dollar value of GDP, and multiply by 100).
What types of goods does your country export? Are they land-intensive? Labor-intensive? Capital-intensive? Discuss why your country exports what it does to the rest of the world.
What does your country import? What is the dollar value of your country’s imports? What is the percentage of your country’s GDP made up of imports?
What is greater, the value of imports or the value of exports in your country? What does this mean for your nation’s “circular flow” of income?
Referring to the principal of comparative advantage, discuss the composition of your nation’s exports and imports. What types of goods or services do you think your nation has a comparative advantage in? How can you tell?
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.
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:
What is the primary determinant of demand for exports that has lead to the growth over the last decade seen in the graph above?
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?
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?
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?
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.
Should President Obama consider writing a thank you note to Chinese leaders for artificially manipulating the Chinese Yuan in the foreign currency markets?
For many years now, Chinese authorities have artificially intervened in the foreign currency market by buying up U.S. dollars spent on Chinese products and, in turn, investing those same U.S. dollars in U.S. Treasury Securities (ie, bonds and notes). For those that are not familiar with the foreign currency market, Chinese authorities buy the same U.S. Dollars provided by the U.S. to purchase Chinese products and, thus, leave or supply Chinese Yuan to the currency traders resulting in a decrease in the price of the now more plentiful Yuan and an increase in the price of the now more scarce dollar. The Chinese authorities intervene in the foreign currency market for the sole purpose of depreciating (weakening) the Yuan relative to the U.S. Dollar, thereby helping Chinese exporters to become more price competitive in global markets. It is estimated by many economists, that the Yuan may be overvalued versus the U.S. dollar by approximately 30% due to this foreign currency intervention by China.
So while it is true that this action taken by Chinese authorities clearly depreciates the Yuan and appreciates the Dollar, thus, unfairly harming U.S. exporters; it is also hitting the “sweet spot” by sending those same U.S. dollars back to the U.S. Government to fund the record federal deficit spending expecting to total $1.3T in 2011 and providing American citizens with reduced prices on imports via the stronger dollar! More specifically, this currency intervention by Chinese authorities provides needed loanable funds back to the U.S. Government lowering borrowing costs or interest rates during this important U.S. economic recovery time. It also appears that US leaders are sending mixed messages to China as just last year, Secretary of State Hillary Clinton visited Beijing to encourage Chinese leaders to continue to purchase U.S. Government securities. This seems at odds with US officials cry for China to stop intervening in the foreign currency markets because by doing so needed federal deficit funding would dry up from the Chinese, forcing the US to borrow elsewhere and raise interest rates to entice that lending.
In summary, perhaps in the short term the United States should consider not pressuring China, as Treasury Secretary Tim Geihtner, Obama and the media have done regularly. Perhaps US officials should lay low, at least for awhile, and start pressuring the Chinese again in about three or four years, after the Government’s budget no longer calls for such large spending deficits.
Review Questions
What specifically are Chinese leaders doing to keep the Yuan weak against the U.S. dollar?
Why are Chinese leaders intervening in the foreign currency market?
Which parties, both American and Chinese, are helped and hurt by this intervention?
What would happen, other things equal to U.S. interest rates if Chinese authorities immediately stopped intervening in the currency market? Why?
What would be the immediate impact on the U.S. poor and working class if the Chinese immediately stopped intervening in the currency market?
What policy position would you take as President of the United States on this issue?
“The Americans get the toys, the Chinese get the Treasuries and we get screwed.” Thus a European Union official once characterised the pattern of Beijing accumulating US assets by selling renminbis for dollars, while nothing stood in the way of a rapid and destabilising appreciation of the euro.
In a world of freely floating exchange rates trade imbalances between countries would ultimately be reduced and eliminated. At least, that’s the belief of those advocating a floating exchange rate between East Asian currencies and the United States.
Here’s how it is supposed to work:
Cheap labor and cheap imports from China following China’s joining the world economy 30 years ago led to a rapid increase in demand for Chinese manufactured goods in the US, creating growth, jobs, and rising national income for China.
A trade imbalance emerges between the US and China as US spending on imports increases more rapidly than America’s sale of exports. If the Chinese currency were allowed to float freely on foreign exchange markets, however, this imbalance would be temporary, because…
The US current account deficit means, literally, that Americans are supplying more of their dollars in the foreign exchange market, while demanding more Chinese RMB. The forces of supply and demand would naturally lead to an appreciation of the RMB and a depreciation of the dollar.
The weaker dollar resulting from the trade deficit with China would eventually make Chinese goods less attractive to Americans. Despite their lower costs of production, the weak dollar makes imported Chinese goods more expensive and less appealing to the American consumer.
The strong RMB, on the other hand, makes American produced goods and services cheaper to Chinese consumers, who begin to import more from the US at the same time that Americans demand fewer of China’s products.
Through free-floating exchange rates, a current account imbalance is eventually reduced and eliminated as exchange rates adjust to the flows of goods and services between trading partners.
A graphical version of this story is told here:
This, of course, is precisely what has NOT happened, thanks to China’s strict management of the value of the RMB. In order to keep its currency weak, Beijing directly intervenes in foreign exchange markets, “by selling renmenbi for dollars” to accumulate American assets. As seen in the next graph, such interference has the effect of keeping the dollar strong against the RMB.
As any IB student knows, the Balance of Payments between two countries includes not only the trade in goods and services, but also the flow of real and financial assets, such as government securities, stocks, real estate, factories, and so on, between the countries. China has actively promoted a policy of acquiring such American assets, which keeps demand for dollars strong in China, and supply of RMB high in America, without creating any jobs in manufacturing or services for Americans. China has financed America’s current account deficit by assuring it maintains a capital account surplus!
Put more simply, China has exported goods and services to America, while America has exported ownership of its real and financial assets to China. This is a major area of concern for US policy makers, who would like to see a more balanced current account between the two countries, since it is the export of goods and services that creates jobs for American workers, not the sale of bonds, stocks and real estate.
Discussion Questions:
Why does Europe care about China’s fixed exchange rate with the US dollar?
Do you believe that American demand for Chinese goods would actually decline if the RMB were allowed to appreciate against the dollar? Why or why not?
Besides American workers and firms, who else suffers from a weak Chinese currency? How could China actually benefit from allowing the RMB to strengthen against the dollar?
How does China maintain the RMB’s peg against the dollar without buying large quantities of US exports?
