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Imbalances in China and U.S. Capital Flows

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  • Tatom, John

Abstract

China’s major imbalances include trade and capital account surpluses and a large annual build-up of international reserves. China has a capital account surplus reinforcing the accumulation of foreign exchange reserves, mainly U.S. dollar-denominated assets. Usually, a sustainable fixed or floating exchange rate system requires that a country with a large current account surplus run a capital account deficit. The U.S. is widely criticized for having a comparable trade deficit that mirrors, to a large extent, China’s surplus and for its dependence on large capital inflows including from China. There is political pressure for protectionism and for China to implement wasteful economic policies to reduce the surplus. Negative consequences of China’s imbalances include the build-up of large, low-return foreign exchange, leading to rapid growth in money and credit and to a sharp acceleration in inflation. Moreover, efforts to offset money growth and inflation have deepened inefficiencies in the financial system, which China had hoped to remedy by its efforts to recapitalize and list its banks’ equities on stock exchanges. China could eliminate these imbalances by policies that would reduce growth. One solution is to lift restrictions on capital outflows, allowing households and business to diversify their wealth holdings and realize higher returns and/or less volatility in their income and wealth. This would transform future asset growth to holdings of higher return, lower risk assets abroad and also would eliminate pressures on the People’s Bank of China, allowing for more rapid deregulation of banks, slower money and credit growth and lower inflation. The U.S. is already adjusting to these imbalances as the current account deficit began to decline in 2005 and the dollar has fallen dramatically. Unfortunately, such adverse developments are coming from political pressures to raise taxes, especially on capital resources income, and from protectionist policies, both of which are slowing growth in the U.S.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 11706.

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Date of creation: Sep 2008
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Handle: RePEc:pra:mprapa:11706

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Keywords: Capital account imbalance; capital controls and banking inefficiencies; capital outflows and financial development; exchange rate management; banking regulation;

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  1. Kevin Cowan & Jose De Gregorio, 2005. "International Borrowing, Capital Controls and the Exchange Rate: Lessons from Chile," Working Papers Central Bank of Chile 322, Central Bank of Chile.
  2. Francisco A. Gallego & Leonardo Hernandez & Klaus Schmidt-Hebbel, 2000. "Capital Controls in Chile: Effective? Efficient?," Econometric Society World Congress 2000 Contributed Papers 0330, Econometric Society.
  3. Yin-Wong Cheung & Menzie D. Chinn & Eiji Fujii, 2008. "Pitfalls in Measuring Exchange Rate Misalignment: The Yuan and Other Currencies," NBER Working Papers 14168, National Bureau of Economic Research, Inc.
  4. Tatom, John, 2007. "China currency dispute: is a rise in the yuan inevitable, necessary or desirable?," MPRA Paper 5366, University Library of Munich, Germany.
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