The recent global economic crisis has raised questions regarding the extent to which the continued existence of global economic imbalances has contributed to economic crises in the world. With sufficient evidence now available to link such global economic imbalances with the economic crises of modern times, the pressure is turning to those nations that have imbalances themselves to act to avert a return of a crisis of the magnitude just witnessed. This is as direct follow-up to the evidence that for as long as certain nations continue to sustain huge deficits and surpluses in the current accounts as is the case with the US and China, global economic imbalances will never cease. Therefore, it is the responsibility of every nation in the world to ensure that it has very minimal imbalances in its current account so that global economic imbalances can be minimized with the result that global economic crises would become a thing of the past.
Organizations like the World Trade organization ought to also be more proactive in seeing to it that member countries adhere to practices that promote fair trade and limit economic imbalances. To achieve this, therefore, it is important that different countries are reviewed to ascertain their current account situation and so establish whether or not they need to make changes to conform to WTO requirements. For this reason, this research is devoted to the critical evaluation of the economies of China and the US. The aim is to appraise their economic situation and so gain insight into their role in the global economic imbalances. This is done through a discussion of trade patterns of the US and China, arguments related to exchange rates, foreign investment; and other forms of capital flows. Also discussed are the growth rates of the GDP of both countries and their economic policies in the past and the present. The overall aim is to ascertain how the policy changes have impacted the global economy.
The state of the world economy is greatly affected by the relative actions of the leading economies to an extent that every economic move they make has an effect on the other nations (Edwards 2005b). Being in a position where a nation is regarded as among the leading economic powerhouses globally, therefore, calls for deliberate efforts on the part of such nations to put in place mechanisms that allow them to act only in ways that do not harm or negatively affect the other smaller economies in the world. Usually, the level of control that an individual nation has over the economy of the world is a direct function of its size as an independent economy as measured by the various economic indicators such as purchasing power parity (PPP) and the level of output as measured by the gross domestic product (GDP) (Adams & Park 2009). The greater a country’s GDP the more likely that that country will have a lot of impact on global economic activities whenever it undertakes its own economic activities. It is on this basis that leading world economies ought to be in a position to use their dominant positions in a way that does not hamper the economic performance of the world and of other smaller economies. Instead, they need to adopt economic policies that are at best favorable and that enhance fairness and growth in the economy of the world.
For a long time now, the United States of America and China have remained dominant economic powers in the world. The two nations are not only the current first and second largest economies in the world but also the leading markets globally. As far as nominal GDP is concerned, the US economy still ranks as the largest globally, and according to 2009 estimates, it stood at about 14.3 trillion US dollars. As far as purchasing power parity is concerned, the country is still ranked the first globally. As far as production is concerned, the country registers among the highest production in the world, with its per capita GDP ranked the sixth highest in the world in 2009 at 46,381 US dollars (Morrison 2009).
Fig. 1: Quarterly growth in GDP for the US (2006-2010). Source: US Bureau of Analysis
Table 1 (below): The variations in China’s GDP, exchange rate per US dollar, inflation index, and per capita income. Source: US Bureau of Analysis
Per Capita Income
(as % of USA)
China has recently managed to dislodge Japan from the position of second largest national economy in the world (Park 2007). Currently, the Chinese economy is at least three times smaller the size of the US economy as far as nominal GDP is concerned. Nominal GDP stood at 4.99 trillion US dollars in 2009, while its purchasing power parity at the same time was 8.77 trillion US dollars. As the world’s fastest growing economy, China, like the US, is expected to greatly increase its dominant position in the world economy and be a great player in matters of global economics. It is on the basis of this dominance of the world economy by these two nations that this thesis seeks to critically evaluate their role in creating economic imbalances in the global economy. This largely stems from the fact that dominance of any nature over the entire economy or a section of it has its own negative effects. First of all, actions taken by one such player usually have far-reaching effects on other nations in the economy much in a similar manner as when a large corporation in a market that has other numerous smaller firms exert a dominant effect over them (William 2005a). Where the two leading economies have tendencies to work together as opposed to against each other, the negative effects tend to be minimized than when unilateralism is the key approach taken.
The world economy is very volatile and wrong moves by any one leading economy can cause serious negative effects to it (Mussa 2004). Working together, therefore, ought to be greatly enhanced. That aside, it is critical that the key players are able to show leadership so that all other players get to benefit. The state of the word economy calls for concerted efforts to be able to make this mutual benefits accrue to every player. As recently shown by the global economic crisis, it is not the efforts of any one state, regardless the size of its economy, that can restore the global economic order to normalcy and keep it there but the working together of every nation. The leading economic powers in the world, such as China, the US, and the EU ought to play an even greater role. Otherwise, more challenging crises are bound to emerge with direr consequences (Plück & Mann 2005a). The need for a global economic balance cannot be overemphasized. Through trade and aids to trade as well as other commercial activities, nations ought to work together so that there is a balance for the benefit of all players. Putting in place measures that benefit one country at the expense of others constitutes unfair competitive policy practices and ought to be discouraged.
Similarly, the need for reforming national approaches to the whole issue of trade, particularly international trade, to make it more accommodative of other players is critical (Park 2008). This is not only so because of the rapid rate at which globalization is taking its toll on the world but also as a result of the need for world economies, particularly the major ones, to work together towards the creation of balances in the world economy through use of favorable trade policies and encouragement of foreign direct investments. Free trade is one of the ways through which any nation can ensure that it contributes towards the ensuring that the world economy is at a state where it creates balance – allowing all players to benefit. As such, restriction of all forms to trade, including trade barriers and discouragement to foreign direct investments are unpopular measures that ought to be discouraged.
Of particular concern, however, have been the global economic imbalances that have tended to have one side of the world either producing too much than it can consume or never having the capacity to effectively make use of what it has produced (Wong & Adams 2002). On the other hand, other parts of the world have tended to be historical consumers so much so that they hardly ever get enough to satisfy the needs of their hungry, consumption-conscious populations. This has resulted in a situation where instead of there being a balance between production and consumption in a region or even nation, such a balance has not been able to be attained. Instead, in a desperate attempt to make up for what one side lacks and yet so much desires, unpopular patterns of trading have been emerging. For any economy to be sound and balanced there has to be a fairly close link between what is produced and what is consumed. Naturally, demand can outstrip supply and that is fine but it ought not to be by a very wide margin that has the capacity to cause problems. Similarly, there can be an oversupply in an economy to an extent that it becomes difficult for the domestic market to make use of all that is available for consumption. Again, this ought not to be allowed to go overboard because it almost always creates other economic challenges that are inherent in global economic imbalances.
While it is not right to point fingers at any specific nations that are fond of adopting such policies as do create such imbalances in the world economy, it is clear that China and the United States of America are two countries that lead the pack on either side of this global economic imbalance (Wong & Clyde 2006). On the one side is the Chinese government with its historical overproduction such that it can never come close to getting its domestic consumption to consume nearly half of its production (ADB. Various years). Little wonder, then, that it has such a high gross domestic product (GDP) which is essentially a measure of the level of output from a given economy. On the other extreme end is the United States of America that has a tendency to consume more than it can produce. The result has been that it has sought to almost always import to meet domestic demand. While other countries are also involved in the creation of these global economic imbalances, their roles are less significant compared to China and USA (Plück & Mann 2005b). They have, therefore, tended to form a kind of trade pattern where exports from China find their way into the over-consuming US in a measure to manage to maintain their economies. This thriving on such unpopular trade policies, however, stands to affect the entire economy of the world particularly considering that German and Japan, the other leading economies in the world, are also deeply entrenched in these global economic imbalances. With the world economy virtually held by these four nations, such imbalances pose great danger – the greatest of all being that of causing yet another global economic crisis. But China and the US are by far more significant role players in the global economic imbalances (Anonymous).
The Aims and Objectives of the Research
It is worth noting here that the current global economic crisis is still affecting many nations in a negative way even though some like China and the US have been officially declared by the international monetary fund (IMF) to be out of the crisis. That aside, the effects that the crisis has had on many nations around the world are too many and very dire to an extent no nation can afford to go through a similar crisis all over again. As it stands, though, the world is headed back into a similar economic crisis if not a worse one. This is for as long as nations like the US and China continue to create a huge economic imbalance and bring about a state of being where there is a lot of reliance by either side on imports and exports from the other side. As it stands today, neither of the two nations can sustain itself economically without the other, a position that has exposed and continues to expose the world to more economic woes resulting from spending patterns that are too risky even if they are very necessary. The huge trade deficits and the subsequent current account deficits of the US mean that the country is too reliant on foreign goods. China, too, is heavily reliant on foreign trade to make use of its too many domestically produced commodities. It is important, therefore, that these two countries are assessed critically with a view to establishing their relative reliability on either foreign imports or exports. This will in turn help in the formulation of appropriate policy frameworks that can be adopted to help them reduce this overreliance.
It is also the objective of this research to ensure that causes of global economic imbalances are indentified and possibly addressed by a series of measures and policy frameworks that can be made available. Global economic imbalances are responsible for the greatest global economic crises ever witnessed in the modern world. With China’s economy growing at a rapid rate of 10% per annum, it is projected that unless it can adopt some reform measures to its current approaches to trade and general fiscal and monetary policies, then it is destined for a further creation of imbalances in the global economy at a time when a balance is being sought (Park & Shin 2009). This research seeks to come up with measures that can be applied to reverse the trend where the two nations are failing to put in place any deliberate fiscal and monetary policies to address their current balance of trade problems and instead are leaving politicians to decide the future of trade, fiscal, and monetary issues and policies. Understanding the effects that such global economic imbalances are bound to have on the world economy and even on the economies of these two nations can ago a long way in forcing them to adopt counter measures to reduce those effects.
This research seeks to delve deep into the economics of trade, fiscal, and monetary policy to uncover the goings-on there with a view to determining the measures that can work to address them. Then there is an attempt to prove that the crisis pertaining to the US current account deficit is not at all the result of the acts by China’s exchange rate policy. Instead, it is largely as a result of China’s measures to stimulate economic activities such as ensuring favorable interest rates prevail in the economy, incentives to expand its balance sheets, as well as forces of liberalization. Finally, the research explores the issues of foreign exchange rates, particularly how they affect this global economic imbalance. This is largely because there has been a war between China and the US regarding the exchange rates between the two countries’ currencies. For the US, Chinese imports have been very cheap in the US and has resulted in its population naturally getting inclined to consume them more than US goods.
However, the Chinese, who until recently regulated the value of their currency, maintain that the price of its goods in the US result not from currency exchange manipulation but from the ability for its government to subsidize local producers (Robert & Gordon 1983). As such, this research explores the sense in these arguments and counter-arguments so as to come up with a recommendation for future adoption. As it stands, the two countries are just trapped in a vicious circle of dependence, none exactly being able to extricate itself from it in spite of international concerns. The last objective of the research is to review the work of international organizations like the World Trade Organization (WTO), the World Bank, and the IMF in seeking to restore the much-desired world economic order.
According to Adams & Park (2009), the issue of global economic imbalances is not an entirely new one. In fact it has been around for so long a time, only coming out more forcefully in times when crises emerge and nations make a mad rush for solutions. It is during this rush for urgent solutions that issues regarding global economic imbalances come to the fore and for once get close to being discussed with the seriousness that they deserve. In the past, though, the group of eight leading industrialized nations (G-8) has almost had the issue in its agenda but political interests have hindered it from being discussed exhaustively. With the current global economic crisis having had an unprecedented effect on nations around the world, their economic position in the world notwithstanding, a lot more attention is being given to the existing global economic imbalances. Every nation seeks to be among those that have sources of solutions for the crisis, including providing sufficient shields against a similar crisis in the future. But first the focus in on freeing those trapped by the debilitating effects of the crisis (Bailey & Soyoung 2009). To do this, economic stimulus packages have been handed out generously by governments in spite of the outcry from enraged tax payers. Still, struggling businesses and economies continue to be supported as fear is rife that such struggling nations as the PIGS (Portugal, Italy, Greece, and Spain) in Europe have the potential of dragging the entire region back into the crisis.
However, long-term measures are also being sought, and a focus has been on, among other issues, the causal or perceived causal agents for such crises. Altariba & Heredia (2008) believe global economic imbalances particularly as exhibited by China and the US have been underscored as leading causes. For once, therefore, this issue stands to be addressed with the due diligence that it deserves. The problem that is yet to be exhibited again just as has happened before is that the same forces that opposed the previous moves are bound to oppose them this time around. This leaves not too few questions lingering on minds of many economists regarding what measures ought to be used to deal with the crises of modern times. They reiterate that while all relevant international organizations agree, or seem to agree, that global economic imbalances are instrumental in causing global economic crises. What they cannot come to agree on is whether or not to face the problem and address it once and for all or to pretend it is not that severe and ignore it, preferring instead to seek for more contingency measures that deal with the symptoms only visible presently. This division is largely political than it is an economic one because political meddling has ensured the goodwill required to address the problem is never made available. Instead, every player seems more concerned with ensuring only the current needs are met, postponing that main problem of addressing the root causes of the problem to a future date – a date that might as well never come by.
Mann (1999) argues that what is even disgusting, almost funny, is that both the G-8 and G-7 are well aware of this problem but they cannot afford to speak out loud about it. They are glossing over it, assuming it will just go away. In the meantime, the US continues to accumulate trade deficits, borrowing to sustain its population that consumes too much – far more than it can produce locally. Now the G-8 is usually quick to point out the sources of problems for any of their members and they have shown some concern about the huge trade deficit between China and the US (Baily & Lawrence 2006). Its leading economists know pretty well that what is needed to address this is a radical change in policy from the current one where there is a lot of focus on microeconomics and monetary policies to one that boldly puts in place a macroeconomic approach. Guillaume & Francoise (2004) believes China ought to do the same, although the Chinese are in a fairly better off external economic position compared to the Americans. What is shocking economic experts is the rate at which the gap between imports and exports for the US has been widening in the run-up to the global economic crisis. This has been happening in spite of the low value of the US dollar against most leading currencies like the Japanese yen, the euro, and the sterling pound. Even the Chinese currency was highly priced over the US dollar during this time.
For the last ten years, there has also tended to be similar trends in many other countries or regions around the world – East Asia, EU, and the US. The EU is led by Germany where overproduction has left many wondering how much longer the country is going to rely on export revenue to manage its domestic economy. In China, as per the thoughts of Kujis (2005), the gap between exports and imports might not be as large but its level of production far exceeds its consumption rate. Like Germany, it has to continuously seek to export the surplus. The US, a leading global economy and one that virtually affects all of the world economy, is tethering on the brink of collapse from an accumulation of huge foreign debt due to its continued overreliance on imports (Roubini & Setser 2004). The country cannot just manage to produce enough, forcing it to have huge current account deficits. In view of this, it remains the concern to the world why the US cannot seek for another policy mechanism to address its surging foreign debt. It is believed, though, that its desire to retain its protectionist policies is greatly to account for this state of affairs. Even though the fiscal and monetary policy makers may be willing to make radical policy changes, the political elite in the country have been very unforgiving. It all boils down to the link between economic policies and political pressure in determining the fiscal and economic decisions of the world (Roubini & Setser 2004).
Global Economic Imbalance and the Global Economic Crisis
Truman (2005) notes that the Bretton Woods institutions alongside other leading international organizations have been working around the clock to come up with solutions for the growing problem of a dwindling world economy and one that is dominated by a few players whose balance of trade is far from desirable. The desire by WTO, IMF and the World Bank regarding the issue has been that there are measures put in place to deal with these global economic imbalances because they have been cited as being instrumental in causing the current global economic crisis (Dooley, Folkerts-Landau & Garber 2003). What remain unclear has always been how this exactly happened and which country is to bear the greatest blame. However, the fingers being pointed at both the US and China have sufficed to indicate that they were responsible for a significant portion of the blame regarding the global economic crisis. The analysis of the current global economic situation as far as its causes has found mainly the US as a major culprit. Analysts have cited the financial crisis that eventually resulted into the economic hardships as having roots in the US’s finical sector (Dooley, Folkerts-Landau & Garber 2004). When the banks there realized that they had issued out so many unsecured loans and that the rate of defaulting on the loans was increasing, fear gripped the sector. Lending stopped not just because there was nothing to lend per se but also because it was numerically and logically impossible to lend under those circumstances. According to Roubini & Setser (2004), the fear was too significant to be effectively contained within the sector and it rapidly spread to other sectors. There were no loans for businesses and this caused many of them to literally come to a standstill. Economic activities stalled as businesses failed to finance their operations. To try and reduce on mounting costs, firms drastically reduced their workforce and the result was rampant unemployment.
Roubini & Setser say that with more defaulting on the loans, banks stood their ground and even government stimulus packages alone could not get them to lend. Fiscal and monetary policies were hurriedly changed and incepted to save both face and economy. The Federal Reserve introduced short-term emergency measures to deal with the issue, but the result was that it was going to be hard to address it fully without the country having to borrow. In fact the crisis led to an even more pronounced deficit in the country’s current account. It had to borrow widely from abroad to finance its recovery programs (Edwards 2002). An issue of concern came when Lehman Brothers led the pack for the collapse of banks and other firms. It was more than anyone had anticipated, and the fear in the sector reached an all-time high. Unable to stand on the sides and watch more economically significant businesses going under, the government defied public outcry and pumped trillions of dollars into the economy as stimulus package to buoy up struggling firms. Beneficiaries may have managed to get back on their feet again as evidenced by General Motors and Chrysler but the questions remained how sustainable these measures were. To this day, it is still a race against time to see if the US will reform its policies to rid the world of its susceptibility to global economic crises occasioned by actions by one country.
According to James et al. (2008), this evidence alone has not been enough to prove that actions by the US to rely on foreign products are to blame for the global economic crisis. Economists have been quick to offer a direct road that depicts how this came about. As a nation that seems happy to spend what is produced elsewhere – or rather one that eats more than it produces – the US has had to make available products needed by its people from wherever. That notwithstanding, the period of time in the history of the world when global economic imbalances grew at alarming rates has coincided with a time of relatively higher rates of prosperity in the US. This time, covering the last ten years, saw a rapid rise in the economy of the US particularly as its domestic productivity seemed to be increasing steadily. A housing boom was the most visible way of the manner in which the economy was improving (Setser 2008). Contrary to other countries, however, the US kept widening its current account deficit gap, bringing it to within limits of about 6% of GDP in 2006 (Edwards 2005a).
As the housing market thrived and it was approaching its climax, banks that were eager to cash in on a spending public sought for funds from all sources and invested in government bonds (Edwards 2005a). The mistake was that so many banks managed to issue loans without any need for serious vetting of beneficiaries. Subprime mortgages were issued generously – this was a spending public and it was not their problem where the goods they wanted came from. It was a housing boom and every one needed another extra home. Both the public and the banks were making a quick profit, the former getting houses rather easily and without having to offer a lot of security while the latter benefitting from the huge returns anticipated from the many sales and the high interest rates (Edwards 2005a). But it was short-lived this. In the period of time running up to the year 2007, the housing boom did burst and marked the start of problems for the country. This happened as the unsecured mortgages failed to be repaid by many beneficiaries. Even the oversight authorities charged with regulating the financial sector must have slept comfortably during the housing boom to an extent they failed to do their work. The result was the crises not in the US economy alone by extension that of the entire world. As it is, therefore, the global economic crisis traces its origin to the economic imbalances in the world, particularly in the US and China.
Sustainability of the US Current Account
For many scholars, it has been difficult to understand why the US will not reform its micro economy and macro economy to make it more representative of what other nations find more appealing. The country cannot accept any manipulation but it holds that its huge current account deficits, at least compared to its capital account, is not the result of its own policies but that of policies made elsewhere – particularly by China. In the wake of a rapidly expanding Asian economy coupled by the emergence of China and India as world economic powers, the US has been insistent that measures put in place by China towards controlling its economic performance hinder its ability to reduce its current account deficits (Dooley, Folkerts-Landau & Garber 2004). That notwithstanding, it has been constantly the worry and anxiety of other nations particularly the G8 and G7 regarding the sustainability of the US and world economies given the state in the US. Many arguments and counter-arguments have followed. There have been those who argue that for as long as the US can maintain its current account deficit to a minimal level – minimal in this respect refers to any value between 1% and 6% of its GDP – then it can as well manage to do this indefinitely without harming the global economy.
As Mann (2005) puts it, these arguments have one main supporting argument. This is that there are many countries out there – some of them with small enough economies, seeking to lay hold of US assets at all costs. Such nations are ready to do whatever it takes to export to the US. In fact the policies in such countries are geared towards enhancing production to meet the growing global demands. And there is no nation in the world that desires imports than the USA. For this reason, it has been argued that the US ought to continue maintaining a deficit in its current account so that these other nations can manage to rise to the level they desire. Think of a world where there is no market for produces produced at enormous costs? Consider a case where every country or region served to produce only what it needs or only as much as it needs to consume. What would happen? It will be a disaster, just to mention one. Nations require to have not only favorable balance of payments with other countries but also to be able to exceed it if possible. As Adam Smith would put it, economics entails satisfying unlimited wants using limited resources. If a country lacks capacity to produce just as the US, then production can be done by another country and the products exported to the US.
Trade also thrives on there being global economic imbalances. According to Knoop (2004), every country cannot satisfy its own people exactly and in all ways. If it was so, trade would lose its value. In fact the World Trade Organization has the mandate, among other duties, to promote fair trade among countries. To do this, it has to partly encourage countries to purchase some of what they need and is not locally available. Finally, the forces of globalization have had and will continue having an indelible effect on world economies. Freer trading is the norm, especially with foreign direct investments and outsourcing increasingly becoming advanced. In the 21st century, therefore, the US’s huge current account deficit ought to be made even wider so it can trade with other nations. On its part, the US has reiterated its commitment to deal with foreign debt, and has pointed out that all countries need to allow a floating currency system where economic indicators alone can determine the direction of the currency. It has also been noted that the US is rather reveling in the recent indication that its foreign assets as opposed to the domestic ones are highly valued. This has been reason for the country to consider itself capable of dealing with its foreign debts while still relying on foreign imports.
On a general note, there have been a lot of commentary on the huge current account deficit of the country but surprisingly very little literature is available regarding how this can be made sustainable over the long-term. In fact the available commentary on the sustainability of the country’s economy given this deficit has tended to be left to media critics only. As Bernanke (2005) has it, one major point upon which some form of agreement has tended to be reached is that for as long as oil prices will keep rising and other countries that have a higher output level like Russia continue to seek to sell the oil at elevated prices, then the sustainability of the US’s current account deficit will be untenable, at least in the near future. This is because oil has been one of the chief commodities that the US imports in bulk and one for which it solely relies to drive its materialistic culture. In fact every American wants to change cars as frequently as possible. Given this trend, the dependence of the country on oil will in effect be a determinant factor as to whether or not it will be able to sustain its huge deficit (Mann 1999).
Fig. 2: Graph showing variation of the US current account between 2002 and 2010. Source: US Bureau of Analysis
During the global financial crisis when the demand for goods in the country drastically fell, the country managed for the first time in many years to reduce its foreign debt to a level acceptable by the international community. Plück & Mann (2005) indicate that what concerns many is that crises of similar magnitude will not always be there and even if they were to persist their effects would be direr than those brought about by the country’ being habitually in a state of borrowing abroad. During the crisis, the reduction in foreign debt resulted directly from the reduced domestic demand as well as the greatly diminished capacity of other nations to operate optimally. Actually, the few businesses that managed to remain in operation during the global economic crisis were operating under excess capacity, having failed to make use of all their ability due to limited finances. This included the leading OPEC countries which, by extension, faced slumps in their sale of oil and were forced to cut back output and reduce prices (Dooley, Folkerts-Landau & Garber 2004).
Americans had other issues to deal with to think of new cars and jets. For once, they contended themselves with what they had, and even sought to dispose of some assets to manage to live through the economic hard times. The oil exporters might have suffered but this was a moment for the US to breath. So, in view of this, the US can only successfully manage to sustain a current account deficit long enough if oil prices can go down or remain stable for a fairly long period of time. The chances of this happening, particularly in the wake of a recovering global economy, are as slim as they can get. Otherwise, the country will have to engage in macroeconomic reforms where it seeks to increase its exports.
The view of Morrison (2009) is that the issue of the Chinese currency has only added more trouble to the US’s trouble-ridden internal trade system. That China is constantly manipulating its renminbi (RMB) is not the issue here. Instead the critical issue is what the fact that the renminbi is highly undervalued in relation to the dollar means for China’s exports to the USA. For a fact, China is well too aware that it relies on trade with the US to get its surplus production sold off. It is also well aware of the US’s protectionist approaches to trade that makes it hard for countries to sell there. Subsidies particularly have been used by the US to hinder and discourage cheap imports from finding their way into the country. With this knowledge, China has only one tool to use if its goods are to remain cheap and marketable in the US – the use of foreign exchange (Knoop 2004). With a devalued renminbi – whether by deliberate mechanisms or automatically – the country’s exports to the US will remain fairly cheap – cheaper than even what is produced locally there. So the US will not actually manage to sustain its indebtedness for long for as long as China cannot develop a market large enough to reduce the balance of payment surplus it is experiencing currently. Less reliable on oil, China is in a better position to sustain its surplus in the current account (Mann 2004).
Shang-Jin (2000) believes that another possible way of enhancing sustainability of the US’s current account deficit is to push China to do something towards ensuring that the RMB is not as devalued as it is. Now it is important to consider possible outcomes of this. If indeed this happens, the RMB will appreciate in value and for a time the current account deficit of the US will reduce. However, this doe not end there. A reduced value of the RB will signal a renewed demand for oil by the Chinese (Kujis 2005). Their imports of oil will suddenly fall in value and the demand for oil globally will automatically rise. Risen demand for oil will in turn get OPEC member states working around the clock to cash in on the increased demand by suddenly increasing prices. It will sooner or later result in a more negative situation for the US because it thrives on reduced oil prices. Heavily reliant on oil, the US cannot at all manage to control its expenditure on the product even in the direst of times as has been witnessed during that global economic crisis. Not even when the country is considering off-shore drilling of oil to meet domestic demand. The fact remains that oil will form a major import to the country for many years to come. So, an increase in value of the RMB will only reduce the US’s current account deficit woes for a limited time before ushering in even harder times. It is like a vicious cycle.
Sustainability of such a deficit is by all means difficult and measures ought to be taken to address it, says Bergsten (2005). What ought to be closely monitored now by the US is the fact that with the economy recovering and foreign trade normalizing, its current account deficit is starting to widen again. According to the Census Bureau statistics released early this year, the US, as of December 2009, had exports of $142.7 billion and imports of $182.9 billion. This resulted in a deficit of $40.2 billion, which is a significant rise from the deficit of $36.4 billion registered a month earlier in November. The exports for December accounted for $4.6 billion compared to November’s exports that brought into the country $138.1 billion. Imports for the month of December were $8.4 billion more than those of November which stood at $174.5 billion (James et al. 2008).
Fig. 3: US Trade deficits. Source: US Bureau of Analysis
The Chinese Role in Creating a Global Economic Imbalance
According to William (2010), China has been known to be in a position almost exactly opposite to that of the United States of America as far as foreign debt is concerned. For the country, it has had a historical tendency to overproduce and then rely on others to consume. This trend is largely because of the country’s huge reliance on its key sectors of industry and agriculture which have been accounting for as much as 70% of the total jobs in the country. Therefore, China has a huge balance of trade surplus, relying on the US and other trade partners for much-needed foreign currency. China’s current account surplus is to be blamed for playing a great role in the current economic imbalance in the world. However, unlike the US, China has fewer problems and is actually seeking to exert more control over the US as it grows further to become a force to reckon in international trade (Yin-Wong, Menzie & Eiji 2003). Today, China exports a lot to the US more than any other country. It thus holds so much US currency which it has used to invest in US securities (Shang-Jin 2000). The use of its dominant position in the world economy to its advantage has caused global economic imbalances in many ways. First, the country is now capable of influencing the interest rates of the US and by extension the world because the US has an economy that affects and influences the world economy.
Mussa (2004) notes that China, by virtue of its advantageous position as leading exporter to the US, has trillions of US dollars in its own treasury. When it invests in US assets at its own pleasure, interest rates are driven down and the result is the flow of capital assets to China from the US. This keeps the deficit in the US current account at a level that is high enough to be controlled by any other means. While its industrial sector has not advanced to a level necessary to meet the world quality standards, the country relies on it to meet local demand and exports abroad. The relationship that China and other East Asia neighbors have as far as the economic might is concerned has also been increasingly creating an imbalance in the world economic order. Specifically, Japan, the third largest economy in the world, and South Korea have contributed to make the region a major source of exports to other world nations. This is because Japan has a surplus in its current account just like China, relying on its exports to get going.
Wong & Adams (2002) say the combined effect of Japan and China also make East Asia an economy that can and will actually determine the direction of the world economy in the near future. Like China, Japan and South Korea have massive US dollar reserves at their disposal from their many exports to the US; raising fears that the dollar might not be any longer the ideal standard for currency conversion as it is less valuable in East Asia. As far a political relations are concerned, these leading surplus countries in East Asia do have frosty political relations (IMF 2006c). This has made the effects of their economic ability to be rather less severe. Were the three to work together, the economic balance of the world would forever be tipped in favor of that region. As it stands now, their continued operating as foes has helped to keep the imbalance of the global economy within manageable limits (Mann 2005).
Production: 2.8344 trillion kWh (2006)
Consumption: 2.8248 trillion kWh (2006)
Exports: 11.19 billion kWh (2005)
Imports: 5.011 billion kWh (2005)
Electricity – production by source:
Thermal power – 77.8% (68.7% from coal) (2006)
Hydro: 20.7% (2006)
Others: 0.4% (2006)
Nuclear: 1.1% (2006)
Production: 3.631 million barrels per day (2005)
Consumption: 6.534 million barrels per day (2005) and expected 9.3 million barrels per day in 2030
Exports: 443,300 barrels per day (2005)
Imports: 3.181 million barrels per day (2005)
Net imports: 2.74 million barrels per day (2005)
Proved reserves: 16.3 billion barrels (as at January 2006)
Production: 47.88 billion m3 (2005)
Consumption: 44.93 billion m3 (2005)
Exports: 2.944 billion m3 (2005)
Imports: 0 m3 (2005)
Proved reserves: 1.448 trillion m3 (as at January 2006)
Table 2: The exports and imports of China from various sectors of its economy at different times. Source: The World Bank
In view of the grim report as indicated by the table above, there needs to be a rebalancing of balance of payments and of trade particularly between the two nations – China and the US. Unless this is done, Park (2007) believes a disaster is looming and its effects could be more than can be projected. The issue will not be about who hurts the most of the two but rather the general effects on the entire world economy. Evidently, according to him, the current global economic crisis’s impacts on national economies cannot be underestimated. No nation is ready for a similar crisis, let alone a repeat of the same. The concern is that leading economies are also the leading causes of the imbalances (IMF 2006b). There has to be an intervention. China’s manipulative policies ought to be brought under check. It is about time the WTO reformed itself and played its role more effectively now than ever before. It ought to move away from being a mere passive player in trade relations to a more proactive one so that it can determine economic policies that nations ought not to use and which ones not to. With politics largely influencing relations between China and the US, it is far from over that the Chinese RMB will ever appreciate in value to levels that the US desires. WTO ought to move in and put in place a standard for the country’s currency to avoid worsening the global economic imbalance.
The US also ought to minimize its protection of key sectors from competition and allow freer trade to persist, according to Bailey & Soyoung (2009). They add that it has to reform its macroeconomic policy as well so that a lot more emphasis is placed on enhancing domestic production and reducing overreliance on foreign goods. Institutional reforms offer the greatest chance of ever turning the situation around for the better. It is important that the two countries review their policies towards exports and imports. A beginning point could be a cut in US imports from China and the wider ASEAN region (IMF 2006a). Once this is done, a panic of some kind will grip the entire region and without being pushed by anyone, least of them WTO, each of these nations will run to formulate and subsequently implement macroeconomic policies necessary to cope with the situation as it will be then. This is because China is only able to rely on exports to the US because the US has proven to be an indefinite, uncompromising, and reliable buyer or importer. If there is a policy change in the US such as a macro policy toward increasing domestic output, then the Chinese government will swiftly respond by putting in place fiscal policies to deal with the new challenge. Without any pushing, there will be a way through which the level of production in China will be made to balance, at least in economic terms, the level of consumption.
Bergsten (2007) believes one critical issue to address before this can be possible are concerns about job losses for the many Chinese laborers who rely on factory work to earn a daily living and who would be left without jobs if there is a reduction in export processing. Similar measures ought to be applied for the US to ensure that whatever was imported is produced locally. This might entail diversifying the economy and investing in local production. It will also entail a move to create jobs by building industries and refineries to extract crude oil. It will entail investing in alternative sources of energy like nuclear and wind power, and in the process reducing dependence on foreign imports. This is difficult to do in the short-term but can work over and extended period of time. The goodwill is what is lacking now on both sides, especially the US which views such investments as too costly to implement. What also needs to be a starting point is having political goodwill that can possibly allow both China and the US to work together towards addressing each other’s concerns. They need to adopt a more friendly approach towards each other now that they are key determinants of the direction that the world economy takes.
Having had a thorough and critical review of the literature, a number of key issues come to the fore which needs to be addressed. First, there is the issue of foreign direct investments and its role in affecting trade balance between the two nations. Then there is macroeconomic reform and specifically change in fiscal policy. Such and other issues ought to be ascertained clearly; and an in-depth understanding of their effects on the balance of trade between China and the US attained. To do this, a set of critical research questions ought to be used to for guiding the study. Similarly, appropriate hypotheses ought to be formulated to guide the study. For this research, the following research questions ought to be addressed:
To what extent and in which specific ways does China and the US contribute to the global economic imbalances?
What is the way forward in addressing the global economic imbalances?
In line with these research questions as derived from the issues raised in the literature earlier reviewed, the following two hypotheses were used to guide the research:
Both China and the US play a major role in the creation and sustenance of the global economic imbalance.
The best way forward in addressing the global economic imbalances is by having China and the US implement macroeconomic policies aimed at changing their current account surpluses and deficits respectively.
Understanding the aims of any research is critically important in achieving the intended purpose of offering information and understanding regarding a given subject matter or critical issue. That is why every research, regardless of what its approach is, has to seek to achieve certain objectives. With these objectives under consideration, an appropriate research design can be adopted and subsequently correct and reliable research methods applied. For this particular research, the overall objectives are summarized as follows:
To review the contribution that China and the United States of America make towards the global economic imbalances.
To critically appraise the policy frameworks, including the microeconomic and macroeconomic policies, that each of these countries has been using in an effort to sustain its economy.
To recommend appropriate fiscal policy changes, particularly as it pertains to macroeconomic reforms, which stand a higher chance of reversing the current balance of payments positions in which the two nations find themselves.
To critically analyze the reasons why the US continues to have a huge and growing current account deficit while China maintains a huge surplus in its current account.
To review the imports, exports, and foreign direct investment (FDI) issues as they apply to the two countries.
To discuss the trade patterns of the US and China; present arguments related to exchange rates and foreign investment, and other form of capital flows.
Analyze the growth rate of the GDP of both countries; their policies, and the effects these policies have changed in the recent times.
The Research Design
In order to achieve the objectives of the research, the research adopted a mixed approach where both qualitative and quantitative methods of research methods were used. This was done so that the results obtained would have both a qualitative and quantitative bearing for ease of interpretation.
The value of empirical information – information that has statistical evidence and can be fully relied upon without the need for verification – to a research of this nature cannot be overemphasized. Empirical information makes the data collected authentic and the information derived reliable. To collect such information, it was important that details about actual trade and economic issues involving China and USA be included in the data. Details offer insights into issues that otherwise hardly ever get to the fore or into the public limelight. For instance, information regarding China’s refusal to adopt a floating currency system and its fears about becoming more open to foreign direct investments could not be found in literature but only through close and in-depth analysis of the relevant sources of the information that were used. Information of this nature is best attained through the use of a qualitative research method which seeks to delve deeper in the details surrounding a given issue of research. A lot of “insider” information was needed to be able to complete this research effectively and come up with other findings. Of particular interest was the policy-making processes of both countries, which are usually events shrouded in secrecy and what gets out is just the final dossier ready for implementation.
It is necessary to have an insight into the real process, how it is affected by politics, and the command level and process that lead to the production of the final policy paper. Qualitative research allowed for such kind of data to be mined. The views of the public and their response to policies on trade, foreign direct investment, exchange rate system, and other economic decisions were also very necessary ingredients for this research. In a country like the US where the voice of the people is the driver of policy, it is very important to have an understanding of the feelings the people have towards a policy and even the government behind that policy. Almost always all unpopular public policies will be met with widespread condemnation if they are lucky enough to get through Congress. Therefore, where the public supports a policy the government will be willing to have that policy under operation even when it is hurting other nations in the world economy. There was particular need to understand why the US cannot adopt a macro-fiscal policy to limit its reliance on foreign imports and so reduce its foreign debt. Such information is widely available in literature but details came only from the use of a qualitative research approach. In China, the government does most of the decision-making and the people have little say in the day-to-day running of the country. However, it was also necessary to hear the views of the people regarding the economic policies of their nation, particularly as it applies to trade with other nations and foreign direct investment.
Qualitative research alone, however, could not be effective in availing the statistical data needed for purposes of comparison between the US and China. This research needed a lot of data mining and the use of the data to determine the relative balances there are in issues like trade, foreign direct investment, growth in GDP, and the value of imports and exports during the same period of time. While qualitative data offers the flexibility to vary research tools and instruments so that information deemed right and necessary can be extracted, quantitative research focuses a lot on getting the numerical values of such data. Most information regarding trade and investment, unlike those regarding policy frameworks, is best documented in the form of tabulated accounts which require quantitative research to extract.
Therefore, quantitative research allowed for collection of statistics on imports and exports for each country, their values, the amount of foreign currency that each country holds, and the proportion of this foreign currency that has been invested in treasury securities. A combination of the two research approaches made it possible to gather data on issues like foreign direct investment and then go ahead and analyze how foreign direct investment impacts economic parameters like growth, savings, balance of trade, investments, and the difference between investments and savings (current account). Using these two forms of research helped shed light on the effects that FDI has had on China and the US as nations with large populations, and how protectionist policies by the US have resulted in its continued sustenance of a huge current account deficit.
The Research Method
The widely applied and main research method for this research was the use of primary and secondary sources of data. Primary sources consulted included speeches by key policy makers in both China and USA, past interviews gathered and recorded in the form of books and other documents, and testimonials from people who have had a chance to work within the policy-making circles in both countries. Secondary data was gathered from books, journal articles, electronic sources of various kinds, and several other sources. Both primary and secondary data was reviewed critically to come up with the relevant information for completing the research question and achieving the objectives of the research. From such secondary and primary sources, it was possible to analyze the policies, strategies, and austerity measures that both China and the US have been employing to manage their economies. Scrutinizing the various sources allowed for comparison of detailed information and data about exchange rate patterns, the use of different exchange rate systems, the criticisms of some of these systems, and a general global reaction to them. From the literature, it was also possible to make informed decisions regarding which aspects of a nation’s micro and macro policies hinder or favor its continued operation with either a trade surplus or deficit.
Of particular interest was information regarding the role the economic status of the two countries play towards enhancing the global economic imbalance and how this was likely to change in the future. Secondary and primary sources of data, unlike interviews, were easy to access; and comparing the data therein was fast enough than could have happened for questionnaires. It was easy to find a host of relevant information all from one source, information that could not be offered even by five economists combined. However, finding data on latest trends in the economic circles, particularly involving issues of the policy reforms of less than a year ago, was difficult. It called for additional resources to be consulted.
Apart from secondary and primary data sources, this research used direct interviews to determine the issues that drive policy in China and the USA. Interviewed were economists in China and the US who have insights into the functioning of the both the domestic and global economy and who knew what effects different policies had on the economic performance of a country. The benefits that interviews offered to the research included an ability to have first hand information from experts in the area, and the rare opportunity to understand what sometimes happens behind the closed-door boardrooms where economic policies are formulated and their implementation strategies rolled out. The interviews also served as control experiments for the research – working to assess the authenticity of the information gathered from primary and secondary sources. The only major limitation of these direct interviews was that finding people who were close enough to the policy-making processes was difficult. Those who agreed to give interviews did so on condition of anonymity because they feared reprisals from their governments. Usually, such information is held as state secret and releasing it can be offensive. As such, the interviews were not only expensive to carry out but also posed issues of ethics. The most invaluable information derived from interviews was the direct answers provided for the research questions – whether or not the two countries were playing roles in the global economic imbalance, and what could be done to change this state of affairs for the benefit of the entire world.
There was no limit to the amount and type of literature consulted. The aim was to find as much information on the research problem as possible and so any book, journal, speech, and other documents on the subject were consulted from different sources. For the direct interviews, however, the research limited itself to a maximum of five economists and political figures in either country owing to the secrecy that surrounds some of such information and the difficulties in getting people of such caliber agreeing to respond to the questions of the nature necessary to for this research. Eventually, only eight people were interviewed – five on the US side and three from China. For ethical purposes, their locations and other details were not disclosed. All there was about them is that they were close enough, either currently or in the past, to the policy-making organs in their respective countries, and all had vast knowledge on the research problem. They were accessed at different times and their interviews recorded. The process of interviewing these people came after the main literature had been consulted; and this explains why interviews only served as sources of additional information to check what had already been gathered from the primary and secondary sources. Owing to this, it can be asserted here that the sample of interviewees, though small, represented the views of both sides of the players critical for the research. Besides, interviews were not the main source of information and the small sample size had no significant effect on the outcome.
RESULTS, FINDINGS, EVALUATION AND ANALYSIS
It was established that both China and the US are great contributors to global economic imbalances. This contribution, however, is in different ways and applies to different levels. From the handling of currency exchanges by China to seeking to protect domestic firms by the US, different measures have been applied by the two countries and the measures affect the global economic balance in different ways but with some overall effect – contributing to the existing global imbalance. In order to have a clearer understanding of the findings of the research, it is important for different economic indicators are discussed with respect to each country. These issues are foreign direct investment, exports and imports, currency regulation system, general capital flows, gross domestic product, and fiscal policy. These are discussed especially in the context of the last ten years.
Net Capital Flow
The flow of capital from and into countries can take on different forms, but the most common one is through direct foreign investments, investment in portfolio equities, and investment in portfolio debt. All these forms of investment have been implemented differently by the two countries. For China, its foreign direct investments to other countries has been growing over the years, only slowing down in the 2008-2009 period due to the global economic crisis. Other forms of investment have also expanded greatly (Takatoshi & Krueger 2000). The rise in the net FDI inflows into the country during the last ten years has been largely attributed to the country’s softening of its stance regarding foreign investments, becoming more politically friendly with former political foes like the US. It was also found that the admission of China into the WTO in 2001 marked a turning point in its FDI inflows. By 2003, the country was the leading FDI destination in the world, overtaking the USA. The country’s fast growing population has also served to further direct FDI there as it has become a large market. Its recent overtaking of Japan to become the second largest global economy after the US has also increased capital investments there (Truman & Bergsten 2007). In the real sense, the FDI that was utilized reached an all-time high of US$92.4 billion in 2008. This was without financial investment. However, flow of FDI fell steadily during the first half of 2009, although it soon after started on an upward trend again.
Table 3: Non-Financial Foreign Direct Investment (FDI) Inflows, 2000-09
Number of projects
Utilized FDI ($ billion)
US direct investment
Number of projects
Utilized FDI ($ billion)
US share of utilized investment (%)
Source: PRC Ministry of Commerce (MOFCOM); PRC National Bureau of Statistics (NBS), China Statistical Yearbook 2009
The sources of non-financial FDI TO China have been led by Hong Kong, followed by Taiwan, Japan, Singapore, USA, UK, Germany, Macao, and Canada in that order. This clearly shows that the country has tended to allow in FDI from Asian countries than from Western ones. China has lately diversified its investments from the developed world to the developing nations of Africa and Asia where a lot of investment is being done in the energy sector, industry, and even agriculture (Truman 2005). Similarly, the Chinese government has been gradually allowing foreign direct investment from countries like the US, and to date the US is the leading foreign investor in China. China’s investments in the US have been faced with obstacles such as regulation from the government, while America has complained of failure by China to follow internationally ratified procedures in its investment approaches. Between themselves, China and the US have huge deficits of capital flows (Williams & Bergsten 2004). As per 2008 estimates, China had a disproportionate advantage, investing more in the US than it had allowed the US to invest in China. Notable among China’s policies is the failure to adhere to commitments it made to the world trade organization regarding trade, and the industrial policies it has adopted. These Chinese industrial policies are more or less in the form of subsidies that have encouraged local firms to get more benefits at the expense of foreign ones. This has resulted in China having a large surplus in its current account (Weimer 2008).
Fig. 4: Decline in FDI. Source: Ministry of Commerce of the People’s Republic of China
For the US, foreign direct investments have also been growing rapidly (U.S. Department of State 2008). This is largely attributed to the fact that the US has been having a huge current account deficit and has been relying on imported goods to meet its ever-growing demand for consumer goods. Foreign firms employ a significantly large number of US citizens, and among the leading foreign investors are Japan and China. In 2008 alone, there was an estimated $325.3 billion in FDI which was able to find its way into the country. The US understands that FDI is not only a leading source of employment but also a way that has been helping it reduce its current account deficit. Increasing FDI increases total investments as well total savings for the country, and the result is a significant reduction in its foreign debt. The reaction towards FDI is varied. Some in the US view it as an opportunity by foreigners to take over US businesses and so expose the country to dependence (U.S. Department of State 2008). Others, however, have held that FDI is the only way through which the country will be able to deal with the negative effects stemming from its trade imbalances with the outside would, especially China. Because of this, there has been a fairly significant level of regulation to ownership of businesses.
As it stands now, no foreign firm or investor may own more than a quarter of the shares of a domestic firm (U.S. Department of State 2008). In spite of fierce opposition from countries from the EU and Asia, this policy still stands and has been blamed for causing global economic imbalances through the continued maintaining of huge external debts by the US. During the year 2000, foreign direct investments peaked, but drastically fell over the following four years. There was a rebound in 2005 but with a lesser magnitude compared to the 2000 record. The trend had been, nonetheless, a rebounding except for the 2008-2010 period when fears about the recession affected investor confidence negatively and slowed investment. This explains partly why there was little growth in GDP and savings over that period of time (U.S. Department of State 2008).
$ 42.18 billion
$ 5.13 billion
+ $ 37.04 billion
$ 122.72 billion
$ 40.79 billion
+ $ 81.93 billion
$ 206.27 billion
$ 329.23 billion
– $ 122.96 billion
$ 950.47 billion
$ 907.34 billion
+ $ 43.13 billion
$ 1,629.05 billion
$ 1,421.31 billion
+ $ 207.74 billion
$ 2,950.69 billion
$ 2,703.81 billion
+ $ 246.88 billion
Table 4: The net FDI for the US from 1969 to 2007 showing ten-year changes. Source: US Bureau of Economic Analysis (BEA)
Trade had been a reliable and almost indispensable tool that both China and the US have been using. For China, its trade partners are many, but what is unique about it is that it has historically been a surplus country (CIA 2010). China has habitually relied on exports to fund its economic activities, giving it a very large surplus in its current account. This is because production in China far exceeds consumption. China also imports a significant quantity of goods from abroad, particularly from the US (Chinn & Ito 2005). The excessive production of goods and services by China has been the main cause of a regional global economic imbalance, given that the entire South East Asia region is becoming an economic power in the world and most of the countries there have surpluses in their current accounts as well. The leading import sources for the US are China which accounts for 15.4%; Canada accounting for 11.6%; Mexico at 9.1%; Japan accounting for 4.9%; and Germany accounting for 3.7%. This is according to 2009 statistics (CIA 2010). The total value of imports into the US in 2009 was $1.558 trillion. The country’s main imports were agricultural products which accounted for 4.9% of all imports; industrial supplies accounted for 32.9% of which crude oil took 8.2%); and capital goods like computers, electric power machines, telecommunications equipment, office machinery, and auto parts which accounted for 30.4%. The other import goods were consumer goods that took a massive 31.8%. These included things like toys, mobile phones, and cosmetics. As regards exports, $1.057 trillion worth of exports was sold in 2009 (CIA 2010). These included the country’s leading products like agricultural goods which accounted for 9.2%; industrial supplies, particularly chemicals which accounted for 26.8%; capital goods like aircraft, auto parts, and telecommunications equipment accounted for 49.0%; and consumer goods, mainly cars and medicines, accounted for 15.0%. These exports were destined for Canada (13.2%); Mexico (8.3%); China (4.3%); and Japan (3.3%). The US works closely with international organizations like NAFTA, OECD, G-8, G-20, and WTO (CIA 2010).
China works together with WTO, APEC, and G-20. It exported $1.2 trillion worth of goods in 2009, which mainly consisted of optical equipment, electrical appliances and machinery; apparel and textiles; iron and steel; and medical equipment. China mainly exports to the US (17.7%), Hong Kong (13.3%), Japan (8.1%), South Korea (5.2%), and Germany (4.1%). During the same period of time (2009), the country imported goods worth $1.01 trillion and was the second largest importer after the US (CIA 2010). The country imports oil, mineral fuels, electrical machines, medical equipment, optical equipment, metal ores, organic chemicals, and plastics from Japan (13.3%), South Korea (9.9%), Taiwan (9.2%), the US (7.2%), and Germany (4.9%). As can be seen, both China and the US export to those countries from which thy import. This means that they are better placed to reduce any trade deficits existing between them if they can adopt different fiscal policies aimed at achieving long-term reforms in their economies (CIA 2010).
The Currency Exchange Debate
Because of the large quantity of goods that China sells outside particularly to the US, the country holds a lot of foreign currency reserves and is able to manipulate the economic performance of countries that are markets for its exports like the US (Bergsten 2007). China currently holds US dollar reserves in excess of one trillion, and this is excluding the amount held in terms of US treasury securities. Using these securities, China can influence interest rates and affect the direction of flow of investments (Eichengreen 2004). In fact the US invests a lot in China largely because of the effects of the huge debt it has with China. The fact that China does not use a floating currency exchange system has been an added advantage to it as far as trade with the US is concerned because it has been easy to make its exports very cheap in the US by keeping the RMB at a lesser value than the US dollar. In fact this issue has been a source of constant feuding between the two countries, some politicians urging the Obama administration to take decisive action against China regarding the issue (Cooper 2005).
Recently, though, China has stopped this practice and it remains to be seen whether the huge trade deficit between the two countries will move towards any real balance (William 2010). What experts believe is the going to happen is that as China becomes more economically developed and as it gradually begins to implement the requirements and commitments it made prior to being admitted into the WTO, it is going to experience more trade deficits as has been the experience of many other countries. It is highly unlike that the simple change in the value of the RMB will bring an end to the Sino-US trade deficits. Although the US exports a lot of its products abroad, its exports have remained far fewer than its imports. This has created a large deficit in its balance of payments, keeping the country in foreign debt almost indefinitely. There are alternatives to getting out of this but the country seems not be ready for them. For instance, if foreign direct investments can be allowed to increase, domestic growth can be higher and with it an increase in domestic production (William 2005b). This can significantly offset the huge demand for goods and services that is currently being exhibited in the country.
A focus ought to be placed on the diversification of the domestic economy to produce enough for its population and reduce overdependence on imports (IMF 2005). For the US, a leading commodity of import is oil. The country is heavily reliant on the commodity that it cannot possibly do without it. However, oil prices in the global market have never been stable or low. Instead, they keep increasing and this makes the country’s foreign debt even greater. On its side, China does not depend on oil as much as the US. The challenge present now is that if China devalues its currency, then although its exports will become expensive, its imports, including oil, will become cheaper. The result is that more Chinese will resort to importation of oil and sooner rather than later the prices of oil on the international market will soar. This will affect US purchases, taking it back to a level of indebtedness where it was before. This is an indication that pressing China into adopting a floating currency system might not at all be a remedy for US’s indebtedness.
In the year 2009, there were issues regarding the US resorting to the use of rather unpopular ways to help ease its deficits and to drive China to adopt a more proactive step towards dealing with its fixed currency policy (Bergsten & Williamson 2004). It was reported that the US was printing more currency so as to achieve this purpose. As expected, China responded angrily, threatening to break bilateral relations with the US. The effects of printing more money to China would be a loss in value of the large US dollar reserves that it holds. In a quick rejoinder, China said it was not going to have any of that; and if the worst came to the worst it would get rid of the dollar reserves and opt for other currencies (Bergsten 2009b. It also speculated that it would consider buying gold instead, which is less susceptible to fluctuation. The concern was, however, that gold prices would be affected and the markets would be affected. China also pointed out that such measures would only serve the intended purpose – reducing the value of the dollar – in the short run. After a year or two, the effect would be a drastically fall in the dollar and possible inflation in the US. The row raised new concerns about the new role that China is now playing in the determination of prices of gold on the international markets. This never changed China’s stance, though (Bergsten 2009a).
Gross Domestic Product and Growth
With the exception of the 2008 and2009 financial periods when both China and the US experienced negative growths, there has been a steady growth in the economies of the two countries (Bergsten 2007b). China has been growing at a comparatively faster rate than the US, and is projected to grow even more. The two are not only the current first and second largest economies in the world respectively but also the leading destination for exports from different regions of the world. They are critical markets to each other as well as to the rest of the world. Regarding nominal GDP, the US economy still ranks as the largest globally, with 2009 estimates putting the value at about 14.3 trillion US dollars. As far as purchasing power parity is concerned, the US is ranked the first globally. As far as production is concerned, the country registers among the highest production in the world, with its per capita GDP ranking as the sixth highest in the world in 2009 at 46,381 US dollars (Guillaume & Francoise 2004).
Fig. 5: the wealth of the US compared to other regions. Source: US Bureau of Analysis
China has just recently managed to dislodge Japan from the position of second largest national economy in the world and is doing pretty well in terms of economic growth. Currently, the Chinese economy is at least three times smaller than the size of the US economy as far as nominal GDP is concerned. Still, it is projected to grow even further and in disproportionate measures compared to the economy of the US. Nominal GDP for China stood at 4.99 trillion US dollars in 2009, while its purchasing power parity (PPP) at the same time was 8.77 trillion US dollars. Here is a summary of the economic position of the US and China:
GDP (Nominal) $14.266 trillion (2009)
GDP (PPP) $14.266 trillion (2009)
GDP growth -2.4% (2009)
GDP per capita (Nominal) $46,442 (2009)
GDP by Sector
Inflation (CPI) 2.2% (May 09-10)
Public debt $13.2 trillion (July 2010 88% of GDP
Revenues $2.106 trillion (2009)
Expenses $3.515 trillion (2009)
Economic aid (ODA) $19 billion, 0.2% of GDP (2004)
Table 5 (Above): Economic Statistics for the USA. Source: CIA World Fact Book
Table 6: (Below): Economic Statistics for China. Source: CIA World Fact Book
GDP (Nominal) $4.99 trillion (2009)
GDP (PPP) $8.77 trillion (2009)
GDP growth 9.1% (2009)
GDP per capita (Nominal) $3,677 (2009)
GDP by sector
Inflation (CPI) 3.3% (July 2010)
Public debt 18.2% of GDP (107th; 2009)
Revenues $972.3 billion (2009)
Expenses $1.137 trillion; (2009)
Economic aid (recipient): $1.12 per capita (2008)
Credit rating $5.555 trillion (4th; 2008)
Foreign reserves $2,447.1 billion (1st; Mar 2010)
As the world’s fastest growing economy, China, like the US, is expected to greatly increase its dominant position in the world economy and be a great player in matters of global economics (Bergsten 2005). It is on the basis of this dominance of the world economy by these two nations that this thesis seeks to critically evaluate their role in creating economic imbalances in the global economy. Its economic growth is driven by the increasing expansion of the public sector and the liberalization of businesses in the country. As the state allows for more private sector ownership, economic growth has been enhanced. Industrial growth and the rapid population growth have made the potential for economic growth of China to remain higher than the US. With reliable and cheap labor – a critical factor of production – China is still bound to grow and economists project that this growth will be associated with a gradual increase in its current account deficit. Although currently having a large surplus, the country is going to reduce the surplus as it implements commitments it made to the WTO.
Changes in Trade Policies
Both the US and China have had had rather difficult policies that have been changing over time. On the part of China, its approach to trade with foreign countries, especially those outside the ASEAN region, has been rather restrictive (Eichengreen 2006). Just like the communist government has been less willing to work together with other governments, trade in China has been very restrictive (Bernanke 2005). To date, restrictions are still in place regarding foreign direct investment although as the country grows economically and realizes the need to collaborate more with other nations, it is becoming more open and welcoming to foreign investors. China uses industrial policies to give its firms an advantage over any other foreign firms that have operations there. This has often caused a lot of concern from the US, the country’s leading trade partner. Through the use of incentives and subsidies, Chinese industries are well able to operate at minimal costs and produce cheaper goods which have undue advantage over other goods in the market.
Then there has the issue of intellectual property rights. China has adopted a policy of being less protective of intellectual property rights. It is almost common practice in China to copy or use other people’s intellectual property without intervention by the government. This issue has from time to time put China and the US at loggerheads, with the latter insisting that it will only continue trading with the former if it will do more to protect intellectual property rights. China has been using licensed intellectual property to develop and market its own goods in an attempt to find markets for its many goods. But of more concern is the refusal by the country to adopt a floating currency system – a fact that has been cited as giving its imports unfair advantage abroad where they are lowly priced. This, according to the US, is the major reason why China continues to hold a lot of US treasury securities (Bivens 2004).
However, only recently has the Chinese government shown signs of moving away from this policy and instead adopt a system used in the region to determine current exchange rates. The general trend in China, however, has been a gradual liberalization as state control passes on to the private sector (Bordo 2003). With its admission into the WTO, China is supposed to implement certain measures. It is expected that that over time it will be able to trade freely with other nations and remove all barriers to trade and investment. China needs to respect intellectual property and put in place measures to protect them. This is especially where foreign firms are concerned. Unless this is done, there is a risk that it will experience a reduction in FDI and its exports abroad might face reduced demand in protest against its anti-business and unfair trade policies (Feenstra & Hanson 2001).
On its part, the US follows a capitalist approach to trading and is fairly open to other capitalist investors. However, just like China, it restricts foreign direct investments to levels that are so low that it has been criticized several times (Feenstra et al. 1999). Apart from insisting on overly high quality standards for imports, it only allows foreign ownership of up to a maximum of 25% of the shares in any given enterprise. This has made many nations and international organizations to accuse it of deliberatively seeking to protect its firms while seeking to invest in other countries’ firms. There have also been talks towards having the country lift such restrictions, with a lot of pressure coming from the EU. However, more changes are needed. There is need for freer trading and an increase in foreign direct investments in order to help the country’s huge trade deficit. Growth is also needed, and this can also be attained through an increase in foreign direct investment. To this end, the US ought to endeavor to invite foreign investors to invest there, including in key sectors like transport and energy (Bergsten & Subramanian 2009).
Summary/Overview of the Research Findings
From the issues discussed, several important ones can be pointed out as the most significant of the findings and from which conclusions can be drawn and appropriate actions executed based thereof. Here is an overview of these findings:
Global economic imbalances are brought about when there is failure by nations or regional blocs to achieve a balance between output and consumption; and either produce more than they can consume in which case there is a surplus in their current account; or they produce far less than they need to satisfy the needs of their people, resulting in deficits in their current accounts.
China and the US are each on the extreme ends of this global economic imbalance, the latter being highly indebted and running huge deficits in its current account while the former having a huge surplus in its current account. Therefore, while China relies on exports for its economic growth, the US depends on imports in order to meet the needs of its population.
China and the US are the world’s first and second largest economies as measured by both nominal GDP and purchasing power parity (PPP). However, the growth in the GDP of China is by far faster than that of the US, a trend that is expected to assist the country in becoming less dependent on exports. Its population growth rate is also comparatively higher than the US’s.
Both China and the US need to carry out macroeconomic reforms, particularly fiscal policies, in order to reduce their reliance on exports and imports, respectively. This can be achieved by having the US encouraging more FDI and diversifying its economy to enhance production, while China seeking to produce based on the domestic needs.
In their trade patterns, the US imports a lot of oil and consumer goods while China imports machinery and mineral fuels. The US exports agricultural products in bulk, while China exports industrial equipment.
The exchange rate systems used currently by the China and the US are a fixed and floating systems respectively. The failure by China to use a floating currency system has been blamed by the US as the cause of its huge foreign debt.
As far as net capital flows are concerned, China recently overtook the US as the leading destination for FDI. The US also receives a lot of FDI but this is restricted by the country’s protectionist policies.
In the past, both countries have been using economic policies that have discouraged free trade. Over time, though, they have been reforming these policies. China has been adopting commitments it made when it joined the WTO in 2001, including allowing more foreign direct investments; while the US has been lifting restrictions to ownership of its assets by foreigners. However, both countries ought to do more to change their policies toward trade and foreign investments if they are to reduce their imbalances in trade and reduce global economic imbalances as well.
Chinese exports in the US are cheaper owing to its highly undervalued RMB. This has made it to hold a large quantity of US dollar reserves as well as US treasury securities. As such, China has become a major player in the economics of the world, determining the prices of essential goods like oil and gold. Petro dollars are of the world are likely to go into the hands of China in event the US devalues its currency as a measure to cut its foreign debt.
Both deficits and surpluses in the current accounts of the two nations have served to create global imbalances in the economy. These global economic imbalances have been responsible for negative economic outcomes in the world, more recently the 2008/2009 global economic crisis.
Global economic imbalances are brought about when different nations fail to balance their production and consumption levels such that either they produce more than they can consume and have to rely on exports to reduce their surpluses; or they consume more than they can produce, resorting to importing to bridge the deficits. This state of affairs is especially aggravated when different nations in one region have such imbalances. The resulting current account deficits and surpluses have been ascertained as being instrumental in the creation of global imbalances in the economy. The Role of China and the United States of America in the global economic imbalances is big as can be determined from the way in which the economies of the two countries are operated. Both China and the US have unbalanced economies, the former exporting more than it imports while the latter importing more than it exports. This has created a situation where their balance of trade and so balance of payments are unbalanced. Normally, it is important for countries to keep such imbalances within small margins of their gross domestic product, especially where there is a deficit in the current account. Allowing the deficit in current accounts to exceed certain threshold values will make a country to forever be indebted due to reliance on imports to sustain its economy.
The US finds itself in such a position where it produces less than it consumes. It has had to rely on imports, especially from its leading import partner – China. The results have been devastating for the country, having always to be cautious about how it deals with countries like China that now hold so much of its currency. The increasingly risky economic position that the US finds itself in and its dependence on countries like China has greatly compromised its ability as a world power, having to tread carefully in matters where China is involved. On the part of China, it has continuously produced more than its own domestic market can consume and so relies on exports to sustain it fast-growing economy. China has emerged as one of the leading global economic powers, and is expected that it can help tip the balance of trade between it and the US. As a surplus country, China has contributed to global economic imbalances particularly from the fact that the South East Asian region is largely a surplus region. And while China might be reveling in success, it needs to adjust to world economic standards by ensuring that its economy does not depend so much on exports.
Similarly, the US ought to reduce dependence on imports to reduce its huge foreign debt. This need for both countries to deal with their massive trade imbalances comes from their big role in global economic imbalances which have adverse effects on the economy of the world. In order to deal with the negative effects that arise from such global imbalances in the economy, contributors to the imbalances ought to put in place measures to change their state of the economy. So, the US and China, as the top two global economic powers, ought to change. Changes can come in various ways for each country but a common approach is macroeconomic reform. These reforms ought to focus particularly on fiscal policy so that the domestic economies are made to produce what is needed and no more. This is the only solution that will be sustainable for both countries. As measures towards achieving this, China ought to adopt a floating currency system to make its exports cheaper abroad, while the US ought to stop printing more currency to influence currency value. Both countries also ought to be less restrictive to trade and foreign investment. These measures will surely go a long way in reducing the trade imbalances between the two countries, further easing the imbalances in the global economy.
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