Feng Lu: The Mirror Image of External Imbalance between China and US Economy

 date:2008-8-20 9:42:00 source:BiMBA         

The Mirror Image of External Imbalance between China and US Economy

----Understanding the Characteristics of Recent Growth and Current Adjustment of Chinese Economy

Feng LU

Professor, CCER at Peking University

Since the beginning of this century, both China and the United States have experienced extraordinary external imbalances. The external imbalance in China is huge current account surplus, and that in the United States is huge current account deficit. This forms a mirror relationship.

There are two explanations on the imbalance of the U.S. economy. Some economists believe the imbalance is sustainable. The well-developed economic system and financial system make the U.S. competent to absorb excessive foreign savings. Other economists, however, indicate that if current account deficit is too large (say 5% of the GDP), it will be unsustainable and cause dollar devaluation, inflation, surging interest rate and recession. The subprime crisis is more or less related to the external imbalance and stands up for the unsustainable view. 

There are also two explanations on the surplus of China. Someone attributes the surplus to the high saving rate in China. However, high saving rate does not necessarily lead to high surplus. In fact, there will be no surplus if high saving happens together with high investment, no matter whether it is active investment or passive investment.

The author stresses that RMB exchange rate is a key factor in explaining China's external imbalance. The productivity catch-up of China requires currency appreciation and flexible exchange rate regime, otherwise many problems will emerge. Rising inflation rate and tightening policies have indicated that the imbalance of China is unsustainable and being corrected.  

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