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Does China have enough dollars?

Summary:
Tyler Cowen linked to an interesting article on China’s financial situation: The government’s dramatic about-face from encouraging aggressive overseas acquisitions to cracking down on risky lending and overseas transfers underscores worries over the risk that the nation could run short of enough US dollars to make the interest and principal payments on its mounting debt at a time when the current account balance is coming under pressure. . . On the surface, China should be the last country to worry about a US dollar shortage given that its US.1 trillion worth of foreign exchange reserves is the largest help by any nation. But analysts believe China’s reserves may be insufficient to pay for its massive imports and debt payments in response to a worse-case scenario caused by

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Tyler Cowen linked to an interesting article on China’s financial situation:

The government’s dramatic about-face from encouraging aggressive overseas acquisitions to cracking down on risky lending and overseas transfers underscores worries over the risk that the nation could run short of enough US dollars to make the interest and principal payments on its mounting debt at a time when the current account balance is coming under pressure..

On the surface, China should be the last country to worry about a US dollar shortage given that its US$3.1 trillion worth of foreign exchange reserves is the largest help by any nation.

But analysts believe China’s reserves may be insufficient to pay for its massive imports and debt payments in response to a worse-case scenario caused by the ongoing trade war with the United States, particularly since many of its assets cannot readily be turned into cash to help the central bank to save a crashing financial system or sharp devaluation of the yuan’s exchange rate.

I don’t feel qualified to discuss the details of the article, but the overall thesis seems plausible.  Rather, I’d like to discuss two implications of this claim, which might not be obvious:

1. Previous accusations of Chinese currency manipulation were probably unfounded.

2. Contra Trump, monetary stimulus by the Fed would make it harder for the US to win the trade war.

The accusation that China engaged in currency manipulation during the 2000s and early 2010s (not recently–no one except Navarro believes they are doing it today) is based on the premise that China’s forex reserve accumulation was “excessive”.  If it was not excessive, if they don’t have enough reserves, then the entire currency manipulation claim collapses.

If the Fed engages in an expansionary policy that injects lots of dollars into the global economy, reflating nominal incomes, then debts become easier to service.  This helps the US somewhat, but probably helps China a lot.  It might make it easier for China to ride out the trade war without negotiating.  Trump should be careful what he wishes for.

Or perhaps Trump is playing 6 dimensional chess.  He knows that constantly berating the Fed will make them even more determined to look “independent”.  And he knows that global dollar deflation will put extreme stress on China’s finances.  Yeah, that must be what’s going on.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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