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1/9 An awful lot of prominent people still don’t understand how the balance of payments works. The vice-dean of Renmin University’s School of International Studies, for example, has called for China to continue reducing its USD holdings. https://sc.mp/78xma?utm_source=twitter&utm_campaign=3260814&utm_medium=share_widget via @scmpnews
2/9 In fact China isn’t reducing its holdings of USD assets. It is increasing them. The PBoC may be selling part of its direct holdings of US government bonds, but Beijing overall continues to increase its holdings of USD governments, agencies and other assets.
3/9 It has no choice. It runs the largest trade surplus in the world, and while its current account surplus is much smaller, there is strong reason to believe that the current account includes flows that would more correctly show up in the capital account.
4/9 That means it is acquiring a huge amount of foreign assets, and with the US running by far the world’s largest current account deficit, China has little choice but to acquire dollar assets, especially given its increasing reluctance to hold developing-country assets.
5/9 It is worth considering what would happen if China really did try to diversify out of the dollar. The most obvious way, of course, is for China to stop acquiring foreign assets, which just means for it to eliminate its trade surplus.
6/9 China’s large trade surplus, however, is the flip side of its very weak domestic demand, and so until it embarks on a major restructuring of its economy, China cannot reduce its trade surplus without a sharp contraction in GDP growth.
7/9 Alternatively, China can shift out of US dollars and into euros and Japanese yen. Of course this means that the US deficit would contract as the dollar gradually weakened to be replaced by a switch in Europe and Japan from surpluses to deficits.
8/9 That would cause consternation and anger in Europe and Japan as they too, suffer from relatively weak domestic demand, and the consequences for their economies would be weaker manufacturing and slower growth.
9/9 What many people still don’t understand, even those who should know better, is that the so-called “exorbitant privilege” is a privilege that only the US and the UK seem to be willing accept, and even then, I hope, not for much longer.
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weehingthong 