Essay: Cross-Country Capital Flows and Currency

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[. . .] 2011.]

Quick growth does not come without its stretch marks, which are evident in the inflation of 4.4%. It is noteworthy that it is roughly equal to twice the inflation rate in the U.S. Chinese policy to tackle the growing inflation has been to raise interest rates, reducing export and offering tax incentives. [footnoteRef:12]Weaker Yuan has had its fallouts on reduced Chinese household income and diverting investment away from industries that serve the Chinese Consumer[footnoteRef:13]. [12: McMahon, Chris. "Forex, Trade and Politics." Futures Sept. 2007: 58+. ] [13: "IMF Chief Says Chinese Yuan Still Too Low," Manila Bulletin 29 June 2010: NA, Questia, Web, 18 Mar. 2011.]

This obviously has a negative effect on U.S. economy with huge trade deficits. There is an alternative where U.S. does not force the interest rates down, instead the unwinding strategy would drive down the U.S. export value, and consequently eradicate the trade deficit at the cost of competitors. It must be noted that exporting economies prefer a cheaper currency relative to dollar, since back home it is more value for that dollar.

7. Financial Crisis impacts on Sino-American Relationship

As the Chinese Economy grows, it has also become co dependent on U.S. economy. The relationship between these has financial implications for global trade and finance markets. China following the example of Japan manipulated the value of its currency by investing into U.S. Treasury securities, driving up the value of USD.

The systematic revaluation of Yuan though limited trade in 2005, had since been put to stop after the 2008 financial crisis. U.S. Congress argues that trade deficit with China is due to Chinese goods being cheaper and in no way the reason of higher quality preferable to American goods. In Beijing a dollar worth of goods are more than a dollar worth of goods back in New York, therefore U.S. manufactures cannot compete with low priced goods. Hence more and more workforce is being laid off.

In fact Rep. Mark Schauer (D-MI) from Detroit has cited report from Economic Policy Institute, which illustrated a loss of 2.4 million U.S. jobs due to the ride deficit between the two countries[footnoteRef:14]. [14: Jacob Barron, "Jobs, Exports and the Yuan: Pressure Builds on China for Currency Reform," Business Credit May 2010, Questia, Web, 18 Mar. 2011.]

Not all academics agree with the strategy of controlling trade surpluses by manipulating exchange rates. Swedish economist Gustav Cassel suggested that, "on average, exchange rates should line up so that country A's currency has the same purchasing power over a representative basket of goods and services as that of country B." [footnoteRef:15] [15: Ronald I. Mckinnon, "Solidifying a New G2: China and the United States Should Stabilize the Yuan/dollar Relationship," The International Economy Wntr 2009,Questia,]

There is a modification to this theory necessary since countries with lower wages will have lower prices (such as tailored clothing) than high wage countries. Therefore dollar will have more purchasing power in China.

China with its high national savings culture and U.S. consumer culture, they are both to be blamed for the global financial crisis. As Chinese run windfall trade surpluses it has no option but to invest the in U.S. securities.[footnoteRef:16] The United States is more than happy to finance its budget deficits and expensive stimulus bailouts with issuing those securities. [16: "China's Trade Surplus Tops All of 2006," Manila Bulletin 15 Oct. 2007: NA, Questia, Web, 16 Mar. 2011.]

China's reserves stood at around $1.9 trillion last year and the country's strong trade surplus promises of further swelling up of reserves. Yu Yongding, former member of China Central Bank board criticizes purchases of U.S. bonds by China and has advised to diversify away from dollar into euro and yen[footnoteRef:17]. With the U.S. budget deficit comprising of 10% of its GDP and treasuries demand lower than supply, China's decision to sell may be catastrophic. [17: Gordon Platt, "Obama's Economic Stimulus Plan Gives Dollar Strong Start to 2009 on Hopes Us Will Recover First," Global Finance Feb. 2009, Questia, Web, 20 Mar. 2011.]

Foreign exchange commentators downplay the possibility of China divesting out of dollars, effectively causing the dollar to fail, as it will invariably be a mutual destruction of both economies.

Like all relationships, one party sees itself as giving more than receiving, which creates a tension between them. It rears its ugly head when protectionism clauses are inserted in the Stimulus Bills, such "Buy American"[footnoteRef:18]. It will invariably negatively impact Chinese exports. This symbiotic relationship will be poisoned further it seems. [18: Eswar S. Prasad, "Effects of the Financial Crisis on the U.S.-China Economic Relationship," The Cato Journal 29.2 (2009), Questia, Web, 16 Mar. 2011.]

The China-U.S. standoff has become a political issue in Washington and Beijing, as theories suggest that "discrete" appreciation in renminbi will not necessarily affect the trade differences between the two countries. An appreciation of renminbi may just signal private capital as China being a high cost destination, effectively increasing net saving and surplus.

Monetary Policy

A question remains whether recession has subsided and economic recovery has started, but it can be best answered by actions of Treasury complex and its interest rates outlooks. Financial crisis of 2008-2009 saw rates frozen at near zero. Now in 2010, interest rates changes will likely affect dollar valuations, economy and eventually the unemployment rate.

Before the interest rates are hiked, credit facilities offered to financial institutes to enable them to weather the crisis will be withdrawn. [footnoteRef:19] [19: Christine Birkner, "Interest Rate Policy: under Pressure," Futures Jan. 2010,Questia, Web, 18 Mar. 2011.]

China has huge influence over the interest rate fluctuation, being the largest holder of U.S. treasuries up until now. Some say that china's hunger for U.S. bonds is the major cause of interest rate policy of keeping it as low as possible. This is interpreted as a counter move from the Federal Reserve, concerned about Chinese financial clout on U.S. bond market.

At the same time, being the largest creditor to the U.S. And its fiscal structure, China is probably concerned about the viability of American economy. In fact China along with Russia and Brazil are the most vocal opponents of a reserve currency and would like to see the global economy move away from dollar and its reliance on it. Regardless of this, China continues to buy more and more dollar debt. Chinese investment in commodities has helped currencies such as Australian and Canadian to hike up against USD. China has the most to gain or lose from the movement in the value of U.S. dollar.

The Federal Reserve has claimed repeatedly that interest rates will be low in the foreseeable future. It is weighing down heavily on dollar exchange rates which will reduce to Chinese trade deficit and drive up employment rates.

The Congressional Budget Office has estimated budget deficit for 2009 to be as high as $1.18 trillion. Andrew Wilson a senior analyst at interactive Brokers predicts that "big deficit will make the cost of borrowing increase which could turn the economy into a gutter"[footnoteRef:20]. Dollar has been weakening largely to the uninhibited spending by the Obama administration, which most analyst believe is the right course of action in the current economic conditions. Healthcare bill alone will cost $1 trillion, which the govt. will pay of course with printing more currency and borrowing more and raise taxes, all resulting in a weaker dollar. [20: Christine Birkner, "Currency Outlook: Risk and Recovery," Futures Sept. 2009, Questia, Web, 20 Mar. 2011.]

Interest rates are also linked with inflation, which is a cause of concerns to all policy makers in the Capitol Hill. Higher rates will hurt the already dwindling economy, yet prolonged low interest rates will invariably result in inflation to be seen in next 3-5 years[footnoteRef:21]. All analysts agree on the likely outcome of a surge in sell off of treasury market as interest rates increase. [21: Christine Birkner, "Interest Rate Policy: under Pressure," Futures Jan. 2010, Questia, Web, 20 Mar. 2011.]

Equity markets have gained the most from the lower interest rates as trading flourishes when the dollar is weak. Stocks are being priced far better than the bonds. Any upward movement in rates will be interpreted as a sign and balance will shift away from equity.

The recovery has been slow; we have all heard that too many times already. Part of the blame must be shared by Obama's confused economic policies which send mixed signals to the financial market. Industry has taken rather personally the bashing Obama administration served immediately after the credit crunch, which plunged the economy in deep recession.

8. Recession's and Its Affect

If one were to analyze Chinese ascent to globally dominant exporter, one may make a few forecasts on how the financial crisis may impact China's economic fabric. The 8-10% growth of the turn of the 21st century has slowed a little down to 7-8% in 20093. Still China has the population and its demands to fuel its growth as the domestic consumer's purchasing power rises. From… [END OF PREVIEW]

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Cross-Country Capital Flows and Currency.  (2011, March 17).  Retrieved July 22, 2019, from

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