Friday, December 26, 2008

Chinese reserves and US savings

The story goes like this ... Attracted by the cheap Chinese imports, which in turn keeps US inflation down, US consumers throw caution to the winds and go on a consumption binge. Chinese trade surplus soars and the forex reserves build up spectacularly. Preferring the safety and liquidity of the US Treasury assets, the People's Bank of China channels the reserves into these assets (China owns $1 of every $10 of America’s public debt). The easy money keeps US interest rates down. This, coupled with the wealth effect from the real estate bubble (itself magnified by the inflows from China and other emerging economies), makes the American consumers borrow even more. Household savings trip into negative territory. The figures below captures the same sequence of events graphically

The populist rhetoric amongst the American conservatives now blames the Chinese for maintaining the renminbi under-valued and thereby keeping the American economy drugged on an unsustainable, high testosterone growth. This is something akin to blaming the drug peddler for my addiction or the prostitute for my licentiousness!

(HT: Chinese Pockets Filled as Americans’ Emptied)

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