One of the excerpts we used to introduce this chapter touched on the effects of the crisis on exports from China. We now broaden our discussion to include those effects as well. Looking back at ***Figure 4.19 "A Decrease in Demand for Labor", recall that part of household spending goes toward the purchase of goods and services produced in other countries. A significant fraction of imports to the United States come from China. China also sells goods and services to Japan, Europe, and most of the world.
When demand from these economies slumps, as it did in 2008, exports from China also decrease. Since exports are a part of overall spending, this leads firms in China to cut back their production and employment. Thus the Chinese economy was also slowed down by the effects of the financial crisis.
The reduced demand for imports has another effect. Because the demand for foreign currency is partly motivated by the desire to buy goods from that country, a decrease in the import of Chinese goods to the United States and other countries leads to a decrease in demand for the Chinese yuan. There is a leftward shift in the demand for that currency and thus a lower price in dollars. (As with all comparative static exercises, this assumes that nothing else is changing to offset these effects on the demand for the yuan.)
The current account balance is (roughly speaking) the difference between the value of exports and imports of goods and services. A country has a current account surplus if the value of exports of goods and services exceeds the value of its imports. A country has a current account deficit if the value of imports of goods and services exceeds the value of its exports. Looking at the United States and China, one sees very different behavior for the current account. [***This discussion draws on data from the International Monetary Fund. See Stephan
Danninger and Florence Jaumotte, “Divergence of Current Account Balances across Emerging Economies,” World Economic Outlook, Chapter 6, accessed June 28,
2011,http://www.imf.org/external/pubs/ft/weo/2008/02/pdf/c6.pdf. ***] In recent years, the United States has run a current account deficit of nearly 5 percent of its gross domestic product (GDP). China, in contrast, has run a current account surplus of about 6.1 percent of its GDP since 2002.
The reduced demand for imports from China has an effect on the current account balance of China. We would expect to see a reduction in the current account surplus of China due to the reduction in economic activity of its trading partners.
You might also wonder how the persistent deficits of the United States are paid for. When a country runs a current account deficit, it is borrowing from other countries. This is just like a household that pays for consumption above its income by means of borrowing. The rules of national income accounting tell us that the flows in and out of each sector must always be in balance. If we look at the flows in and out of the foreign sector we see that
borrowing from abroad = imports − exports
or
lending to abroad = exports − imports.
Net exports (sometimes called the trade surplus) equal exports minus imports. So lending to other countries equals net exports. The circular flow of income tells us something powerful: whenever we import more than we export, we must, on net, be borrowing from abroad. On reflection, this is not so surprising. Other countries are giving us more goods and services than we are giving to them. This is not done out of generosity; they do so because they expect to be repaid at some point in the future. If we export more than we import, then this flow goes in the other direction, and we are lending to abroad.
Both China and the United States trade with many other countries, so this pattern of trade holds true bilaterally (that is, between them) as well. China has run systematic current account surpluses with the United States, meaning that China is lending to the United States. Those loans take many forms, with commentators highlighting Chinese purchases of US government debt. US Secretary of State Hilary Clinton alluded to this connection between the two economies during a visit to China in early 2009.
US Secretary of State Hillary Clinton yesterday urged China to keep buying US debt as
she wrapped up her first overseas trip, during which she agreed to work closely with Beijing on the financial crisis.
[…]
By continuing to support American Treasury instruments the Chinese are recognizing our interconnection… [***“Keep Buying US Treasury Bills, Clinton Urges China,” Taipai Times, February 23, 2009, accessed June 28, 2011,http://www.taipeitimes.com/News/front/print/2009/02/23/2003436802.*** ]
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