Page 678 - The Principle of Economics

696 PART ELEVEN THE MACROECONOMICS OF OPEN ECONOMIES
IN THE NEWS
How the Chinese Help American Home Buyers
THIS ARTICLE DESCRIBES HOW CAPITAL IS flowing from China into the United States. Can you predict what would happen to the U.S. economy if these capital flows stopped?
China, of All Places, Sends Capital to U.S.
BY CRAIG S. SMITH
SHANGHAI, CHINA—A giant, developing nation bordered by an economic quag- mire is an unlikely source of capital for
the world’s industrialized powers. But China, with fat trade surpluses and bulg- ing foreign-exchange reserves, is buying U.S. government securities, especially Treasury bonds and bonds issued by Fannie Mae and Freddie Mac.
That’s good for America. Such in- vestments add liquidity to the U.S. hous- ing market and help hold down U.S. interest rates. And China is likely to con- tinue to buy a lot of U.S. debt for years to come.
Thanks to high domestic savings, a continuing inflow of foreign investment and tight controls on domestic spending, China is awash in capital. Last year’s capital surplus . . . reached an estimated $67 billion.
China squirrels more than half of that away into foreign reserves, which are invested abroad. Chinese companies funnel much of the rest directly overseas through bank transfers—sometimes skirting Chinese capital restrictions to do so. So while the financial crisis has transformed the rest of East Asia into a
THEIR SAVING HELPS US GET
CHEAP MORTGAGES.
capital-sucking hole, China has become a gushing fountain of capital.
This isn’t the first time a developing country has sent abroad funds that could
Key Concepts
trade policy, p. 690 capital flight, p. 692
Questions for Review
1. Describe supply and demand in the market for loanable funds and the market for foreign-currency exchange. How are these markets linked?
2. Why are budget deficits and trade deficits sometimes called the twin deficits?
3. Suppose that a textile workers’ union encourages people to buy only American-made clothes. What would this
policy do to the trade balance and the real exchange rate? What is the impact on the textile industry? What is the impact on the auto industry?
4. What is capital flight? When a country experiences capital flight, what is the effect on its interest rate and exchange rate?