China's role in global rebalancing

Arthur Kroeber, managing editor of the China Economic Quarterly, provides an excellent perspective on China's role in the global balance of payments in an article in the Financial Times.

China's accumulation of reserves does not result from classic mercantilism... China held on to its US-dollar peg when the dollar was strong and rising, in 1998-2001, precisely the opposite of the mercantilist prescription. China's import growth has outstripped export growth every year but one since 1998, by an average of five percentage points. Between 1998 and 2003, China's total trade volume zoomed from 34 per cent to over 60 per cent of GDP. Yet during the same period, the trade surplus shrank, from 4.6 per cent to less than 2 per cent of GDP.

[S]ince the end of 2001, [China] has added over US$300bn to its foreign-currency holdings. But this has little to do with trade. Reserve accumulation results mainly from speculative short-term capital inflows... Chinese policy makers know that such inflows are highly volatile... So they are rightly sceptical of the notion that they should change their long-run currency regime simply in response to short-term capital movements.

Next, is it really true that China bears chief responsibility for the proposed adjustment?

According to economist Jonathan Anderson at UBS Securities, the US current account deficit will reach US$600bn this year. Against this, Japan, South Korea and Taiwan -- the three big mercantilist economies of East Asia -- will post a combined surplus of around US$230bn. Singapore and Malaysia, combined, will add another US$45bn. China, meanwhile, is heading for a surplus of around US$40bn.

These figures suggest that...China should be a significant but by no means the chief player. Indeed, one could more plausibly argue that the lead should be taken by Japan, which is a much bigger and more mature economy than China, and a bigger contributor both to the pile-up of foreign US dollar holdings and to exchange-rate distortions.

Japan could do far more than China to address the global financial imbalance, by opening its markets and stimulating domestic demand... The surplus savings of [Japan and continental Europe] are the result of economic policies deliberately designed to favour domestic producers and suppress domestic consumption. If those policies were dismantled, global imbalances would vanish, and sustainably so.

However, while it is true that China's role in the US current account deficit may have been exaggerated, it's also worthwhile to point out what Brad Setser has argued: "that booming China should be running a current account deficit of $50 billion (financed by FDI inflows) right now, not a current account surplus of $50 billion".

Seen in that light, even the relatively small surplus may be reflecting a significant imbalance in global flows.