Renminbi at the Heart of Trade Imbalances

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Global Trade, Macroeconomics

A clearly written and eloquent explanation of global trade imbalances and potential solutions was made in the Financial Times newspaper this week. The article addresses the two major imbalances in the world, the US and China, because as the article puts it — all other imbalances pale in significance. Global leaders have agreed reducing America’s US $500 billion current account deficit and China’s US $350 billion current account surplus is a priority and some progress has been made.

The decline in the dollar has stimulated exports of US goods and restricted imports trimming the deficit somewhat, although the US government continues to borrow so heavily on the global debt market, the deficit will never be closed. The administration has to agree to a budget that will steer towards balance in the years ahead, just as households and companies have to increase savings and retained earnings respectively.

China too has made some progress in stimulating domestic demand and trying to move the economy away from exports. Real consumer spending has jumped 15 percent in the past year, outpacing the almost double-digit rise in gross domestic product. Domestic demand has been boosted by massive government investment in infrastructure and low-cost housing. However, the real problem, as we have written before, is the Renminbi’s peg to the US dollar. When the dollar falls, so does the RMB, making Chinese exports still cheaper in Europe and Japan, boosting the country’s exports and making imports even more expensive, exacerbating the surplus.

We do, however, take issue with the article’s definition of current account surpluses and deficits as follows “a current account surplus is the difference between a nation’s savings and investment.” Not because it is intrinsically wrong (we suspect it is chosen because it conveniently suits the purpose of the article, which is primarily focused on the two countries’ respective savings rates), but more because most people would prefer to see the definition as the current account is the sum of the Balance of Trade simply put, exports minus imports of goods and services. You can further deduct or add overseas aid and debt payments to get a more accurate figure, but the simpler definition is usually enough. And that we feel hits the nut of the problem. Yes, the US is not saving enough, and yes, China is saving too much, but if US consumers (both public and corporate) were to buy American manufactured goods rather than imports, the balance of payment would improve even if savings did not. Likewise, if the Chinese purchased more imported products, encouraged by a stronger exchange rate that made imports cheaper, then their balance of payments would become more balanced. A weaker dollar and a stronger Renminbi would rapidly reverse the dangerous trend of massive deficit and massive surplus, not without some pain, we admit – mostly on the part of China. But in the long run, it would be to both countries’ benefit to have more balanced economies not skewed by unrealistic exchange rates.

–Stuart Burns

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