China’s current-account surplus is the largest in the world. With a trade surplus of US$190 billion and the income from its nearly US$3 trillion portfolio of foreign assets, China’s external surplus stands at US$316 billion, or 6.1 percent of annual GDP.
Since the current-account surplus is denominated in foreign currencies, China must use these funds to invest abroad, primarily by purchasing government bonds issued by the US and European countries. As a result, interest rates in those countries are lower than they would otherwise be.
That may be about to change. The policies China will adopt as part of its new five-year plan will shrink its trade and current-account surpluses. It is possible that, before the end of the decade, China’s current-account surplus will move into deficit, as it imports more than it exports and spends foreign-investment income on imports rather than on foreign securities. If that happens, China will no longer be a net buyer of US and other foreign bonds, putting upward pressure on interest rates in those countries.
This scenario is quite likely. After all, the policies that China will implement in the next few years target the country’s enormous saving rate — the cause of its large current-account surplus.
In any country, the current-account balance is the difference between national saving and national investment in plant and equipment, housing and inventories. This key fact is a fundamental national-income accounting identity, so any country that reduces its saving without cutting its investment will see its current-account surplus decline.
China’s national saving rate is now about 45 percent of its GDP, the highest in the world. However, looking ahead, the new five-year plan will cause the saving rate to decline, as Beijing seeks to boost consumer spending and therefore the standard of living of the average Chinese.
The plan calls for a shift to higher real wages so household income will rise as a share of GDP. Moreover, state-owned enterprises will be required to pay out a larger portion of their earnings as dividends, while the government will increase spending on consumption services such as healthcare and education.
These policies are motivated by domestic considerations, as the Chinese government seeks to raise living standards more rapidly than the moderating growth rate of GDP. Their net effect will be to raise consumption as a share of GDP and to reduce the national saving rate. And with that lower saving rate will come a smaller current-account surplus.
Since China’s current-account surplus is now 6 percent of its GDP, if the saving rate declines to less than 39 percent the surplus will become a deficit.
This outlook for the current-account balance does not depend on what happens to the Chinese yuan’s exchange rate against other currencies. The saving-investment imbalance is fundamental and it alone determines a country’s external position.
However, the fall in domestic saving is likely to cause Beijing to allow the yuan to appreciate more rapidly. Higher domestic consumer spending would otherwise create inflationary pressures. Allowing the currency to appreciate will help to offset those pressures and restrain price growth.
A stronger yuan would reduce the import bill while making Chinese goods more expensive for foreign buyers and foreign goods more attractive for Chinese. This would cause a shift from exports to production for the domestic market, shrinking the trade surplus and curbing inflation.
The US is eager for China to reduce its surplus and allow its currency to appreciate more rapidly. However a lower surplus and a stronger yuan imply a day when China is no longer a net buyer of US government bonds.
Martin Feldstein was chairman of former US president Ronald Reagan’s Council of Economic Advisers and is currently a professor of economics at Harvard University.
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