If Country A enacts export trade policies that result in a surging current account surplus, then Country B must see its current account deficit surge by the same amount.
Cumulatively, between 1993 and 2004 US real GDP grew by 46 percent, while gross domestic purchases rose by 53 percent. The difference is the US trade deficit–which is financed by promises of future payment known as debt. China sends goods and services to the US and accepts dollars and promises of US dollars (debt) in exchange. Because the amounts are so huge there is no way for the Chinese to “exchange” trillions of dollars into other currencies. They are stuck with dollars.
As of March 2009 China has accumulated $2000 B in excess dollar reserves. Seeking to gain a return on these dollars much of it is invested in US Treasury bonds (i.e., debt). Net effect? The goods and services come to the US but the dollars used to pay for them return to the US too (recycled into the US economy as US Treasury bond indebtedness). In other words, China sells us goods and services, then loans us our purchase monies back, trusting the US Treasury to invest it wisely in the US economy on their behalf.
Asia’s expanding export of goods and services to the US tends to displace corresponding sectors in the US economy and create unemployment in the US. As a result, over the last 10 years, the Federal Reserve has faced a difficult choice between rising unemployment and rising indebtedness, either:
– Attempt to limit US unemployment by permitting the US money supply to expand, thereby increasing consumer demand for goods and services, satisfied by both increasing domestic production and imports from China, increasing trade deficits, which are recycled back to the US as investments in US Treasury bonds, thus increasing indebtedness; or
– Attempt to limit US indebtedness by permitting a rise in US unemployment, which reduces money supply in the US economy, causing US consumption to decline, limiting domestic production and imports from China, leading to smaller trade deficits, thus resulting in less debt to China.
For the last several years the US Federal Reserve has chosen to cut interest rates, to expand the economy, and to mitigate unemployment. Allowing US unemployment to rise was seen as politically impossible. The Fed’s attempts to keep the US economy strong, led to excess demand for tradable goods and services, which partially appears as increasing trade and current account deficits, which are recycled back into US Treasury bonds, increasing US indebtedness. Neither China nor the US could have done it without the cooperation of the other–like it or not, China and the US are partners locked together in this global financial crisis. (Hat tip to: Michael Pettis.)
China’s trade data is tracking the US trade quite so closely.
The overall story from the trade data is still quite grim and the trade data doesn’t suggest that China’s economy is in robust health. (Source.)