China’s Foreign Trade Position

Michael Spence, a Nobel laureate in economics, has a good article in today’s Wall Street Journal.  Some of his key points:

• China’s total trade surplus isn’t very large, though it runs a large surplus with the U.S.  China runs a deficit on energy and raw materials, so it’s in surplus with respect to some countries, deficit with respect to others.
• China’s large growth of financial reserves is only partially driven by its trade surplus.  The remainder comes from an excess of domestic savings over investment.  In essence, instead of using all of their savings to buy equipment, they use a portion of it to buy U.S. treasury bonds.
• The U.S. has a mirror-image imbalance: we want to have capital investment (equipment, buildings, software) in excess of our domestic savings.  This is the mirror image of our trade deficit.  (Spence doesn’t say this, but the equality between our trade deficit and our capital inflow is forced on us by accountants who insist that both sides of the ledger have to add up.  Why can’t they loosen up a bit?)
• "The graceful way out of this is gradual: an increase in U.S. savings relative to investment, a reduction in savings relative to investment in China and Japan, a probable further lowering of the market-determined value of the dollar in the short and medium term. As part of the process, it would be useful if we stopped pretending or alleging that China’s exchange-rate policies are the root cause of our trade deficit."