Page 679 - The Principle of Economics

CHAPTER 30 A MACROECONOMIC THEORY OF THE OPEN ECONOMY 697
be used productively at home. Often, such money was fleeing instability, as it was in Latin America in the 1980s, Russia in the 1990s, and Africa in both decades.
Usually, however, developing coun- tries invest their capital in their own growing economies. And some Chinese officials believe that’s what China should be doing, too. One former Chinese cen- tral bank official calls it “scandalous” that a country of poor peasants is financ- ing investment of an industrialized power such as the United States.
Others complain that China isn’t even getting good returns on its invest- ments. It pays an average of 7 to 8 per- cent on its $130 billion foreign debt but earns only about 5 percent on the $140 billion of its reserves invested abroad. That’s partly because yields on U.S. debt—widely considered the safest se- curities in the world—are relatively low.
But China has good reasons to send some of its capital overseas. Its in- vestment in fixed assets as a percentage
of its gross domestic product was an ex- traordinarily high 34 percent in 1996, the latest year for which figures are avail- able. It’s doubtful that China could in- crease that ratio without wasting money or fueling inflation. Thailand’s ratio was 40 percent and Korea’s 37 percent before their overspending undermined those nations’ economies. . . .
“They’re already investing as much as they can absorb,” says Andy Xie, an economist for Morgan Stanley Dean Witter & Co. in Hong Kong.
Yet while investment is constrained, savings keep growing. The percentage of working-age people in the population has climbed to 62 percent from 51 per- cent in the past 30 years. And those workers, often allowed only one child on which to spend, are hitting their peak saving years. With consumption low, the pileup of money pushes capital offshore.
The result: Chinese capital is spreading everywhere. The country is a big buyer of oil fields, for example, having pledged more than $8 billion for
concessions in Sudan, Venezuela, Iraq and Kazakstan. Mainland capital also has poured into Hong Kong, where it helped inflate property prices before East Asia’s crisis began letting out some of that air. The capital surplus has even allowed China to help its neighbors when they got into trouble: Beijing pledged $1 bil- lion to the International Monetary Fund bailouts in Thailand and Indonesia. Most of the money, though, goes into U.S. Treasury bonds. China won’t say how much, but estimates run as high as 40 percent.
And China’s central bank, like 50 others around the world, lends money to Fannie Mae and Freddie Mac, which use the funds to buy mortgage loans that banks and others extend to ordinary Americans. The flood of money keeps the market liquid and reduces the rates that U.S. home buyers pay.
SOURCE: The Wall Street Journal, March 30, 1998, The Outlook, p. 1.
1. Japan generally runs a significant trade surplus. Do you think this is most related to high foreign demand for Japanese goods, low Japanese demand for foreign goods, a high Japanese saving rate relative to Japanese investment, or structural barriers against imports into Japan? Explain your answer.
2. An article in The New York Times (Apr. 14, 1995) regarding a decline in the value of the dollar reported that “the president was clearly determined to signal that the United States remains solidly on a course of deficit reduction, which should make the dollar more attractive to investors.” Would deficit reduction in fact raise the value of the dollar? Explain.
3. Suppose that Congress passes an investment tax credit, which subsidizes domestic investment. How does this
policy affect national saving, domestic investment, net foreign investment, the interest rate, the exchange rate, and the trade balance?
4. The chapter notes that the rise in the U.S. trade deficit during the 1980s was due largely to the rise in the U.S. budget deficit. On the other hand, the popular press sometimes claims that the increased trade deficit resulted from a decline in the quality of U.S. products relative to foreign products.
a. Assume that U.S. products did decline in relative quality during the 1980s. How did this affect net exports at any given exchange rate?
b. Use a three-panel diagram to show the effect of this shift in net exports on the U.S. real exchange rate and trade balance.
Problems and Applications