August 06, 2011
The NYT told readers that:
“Beijing has few options other than to continue to purchase United States Treasury bonds, Chinese officials are clearly concerned that China’s substantial holdings of American debt, worth at least $1.1 trillion, is being devalued.”
Both parts of this statement are wrong. Beijing has the option to stop buying dollars from its exporters. The reason that the government accumulates dollars and other foreign currencies is that it buys the currency from the companies who are exporting to the United States and other countries.
It has the option not to buy the currency. This would force the exporters to sell their dollars in international currency markets which would lower the value of the dollar. The lower valued dollar would help to correct the trade imbalance between the United States and the rest of the world. This is the adjustment process that is supposed to take place in a system of flexible exchange rates.
The second part of the statement, that “Chinese officials are clearly concerned that China’s substantial holdings of American debt … is being devalued,” is almost certainly wrong because Chinese officials should know with absolute certainty that it will be devalued. The only plausible route through which the trade deficit in the United States will be brought into balance is through a large reduction in the value of the dollar. Everyone who has taken an intro econ class knows this, so presumably China’s top economic officials understand this fact. They presumably have made the judgement that maintaining their export market in the United States is worth the expected loss on their dollar holdings.
Finally, as a matter of accounting identities, the existence of the large U.S. trade deficit means that it will be a net international borrower. In other words, the headline of this article that “China Tells U.S. It Must ‘Cure Addiction to Debt'” is absurd. China’s decision to prop up the dollar against the yuan is the main cause of the trade deficit that makes the U.S. a net borrower. In other words, it is China’s own actions that lead to the U.S. borrowing that it is complaining about.
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