Krugman on American “addiction” to Chinese dollar purchases

I’m not an economist and am too timid to comment on abstruse financial issues that I only vaguely under4stand. But Krugman has a unique way of siumplifying things, and those who want to better understand the issues over the yuan and America’s heated rhetoric should read his column today.

Here’s how the U.S.-China economic relationship currently works:

Money is pouring into China, both because of its rapidly rising trade surplus and because of investments by Western and Japanese companies. Normally, this inflow of funds would be self-correcting: both China’s trade surplus and the foreign investment pouring in would push up the value of the yuan, China’s currency, making China’s exports less competitive and shrinking its trade surplus.

But the Chinese government, unwilling to let that happen, has kept the yuan down by shipping the incoming funds right back out again, buying huge quantities of dollar assets – about $200 billion worth in 2004, and possibly as much as $300 billion worth this year. This is economically perverse: China, a poor country where capital is still scarce by Western standards, is lending vast sums at low interest rates to the United States.

Yet the U.S. has become dependent on this perverse behavior. Dollar purchases by China and other foreign governments have temporarily insulated the U.S. economy from the effects of huge budget deficits. This money flowing in from abroad has kept U.S. interest rates low despite the enormous government borrowing required to cover the budget deficit.

Low interest rates, in turn, have been crucial to America’s housing boom. And soaring house prices don’t just create construction jobs; they also support consumer spending because many homeowners have converted rising house values into cash by refinancing their mortgages.

So why is the U.S. government complaining? The Treasury report says nothing at all about how China’s currency policy affects the United States – all it offers on the domestic side is the usual sycophantic praise for administration policy. Instead, it focuses on the disadvantages of Chinese policy for the Chinese themselves. Since when is that a major U.S. concern?

In reality, of course, the administration doesn’t care about the Chinese economy. It’s complaining about the yuan because of political pressure from U.S. manufacturers, which are angry about those Chinese trade surpluses. So it’s all politics. And that’s the problem: when policy decisions are made on purely political grounds, nobody thinks through their real-world consequences.

Here’s what I think will happen if and when China changes its currency policy, and those cheap loans are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we’ll suddenly wonder why anyone thought financing the budget deficit was easy.

In other words, we’ve developed an addiction to Chinese dollar purchases, and will suffer painful withdrawal symptoms when they come to an end.

When the Chinese stop buying dollars, Krugman says we’re all going to be in for quite a ride. And it’s not China’s fault.

Update: Joseph Bosco has written his own article on the Yuan.

The Discussion: 29 Comments

the New York Times has really done a great job on reporting this addiction – there’ve been several articles over the past few months.

It’s sad because the ability of the states to buy things for so cheaply is inexorably linked to china’s real estate boom. I really wouldn’t want to be a politician in either of these countries at the moment. Things could get very messy. They must be feeling an immense amount of pressure.

May 20, 2005 @ 8:49 am | Comment


China is worried more about a free-floating Yuan than it was joining the WTO.

A free-floating Yuan would reduce the value of their US currency reserves.

May 20, 2005 @ 9:55 am | Comment

No, the US wouldn’t directly benefit in any huge way if the Yuan floated but that might well completely change within a few years, such is economics and international trade.

But this is beside the point. The fact is that the chinese govt and, more importantly, the chinese banks couldn’t cope with the perils of a floating Yuan.

china already loathes the fact that it’s economy is subject to external/foreign influences (read ‘out of their control’) such as strong consumer demand in the US/Europe to continue export growth.

A floating Yuan would only add to potential instability….and that’s assuming that the govt and banks are up to scratch…which they are most certainly not.

By the way, Hong Kong this week changed the HKD-USD exchange rate to 7.75-7.85 and HK banks raised interest rates by a full half a percent. This is the first solid evidence that a strengthening of the Yuan is imminent.

May 20, 2005 @ 10:30 am | Comment

any that is why I can’t find a house in AZ, damn the low interest rate!

May 20, 2005 @ 3:17 pm | Comment

“When the Chinese stop buying dollars, Krugman says we’re all going to be in for quite a ride.”

Actually, if I read Krugman’s article correctly, all China has to do is slow down the rate of increase in $ purchases for there to be major repercussions. Not a good situation to be in, for sure.

May 20, 2005 @ 7:12 pm | Comment

China can achieve the sole ultra-superpower status within 30 years when with its awesome economic power and high technologies it could deploy the most formidable military power. And with such an invincible military power it could globalize the world in China’s image of universal justice, peace, and prosperity.

May 20, 2005 @ 7:20 pm | Comment

Oh my. I do hope you’re joking, Liang. I mean, you have to be being sarcastic. No?

May 20, 2005 @ 7:31 pm | Comment

Maybe Liang is one of those CPP-planted internet opinion swayers discussed in another thread? LOL ๐Ÿ™‚

May 20, 2005 @ 8:52 pm | Comment

Funny, Thomas! He certainly can’t be serious.

May 20, 2005 @ 9:09 pm | Comment

Liang must be a member of the Project for the New Chinese Century…

May 21, 2005 @ 4:21 am | Comment

C’mon, Peking Duck-ers, isn’t there a single economist amongst you?

May 21, 2005 @ 5:18 am | Comment

With the largest population in the world and the second largest territory in the world, China should be able to develop an economy that is 5 times the economy of America even if per capita productivity is the same. China should also be able to develop more advanced technologies given its absolute number of genius level peopel is some 5 times more than that of America. Therefore, China should be able to develop the most advanced and the biggest economy in the world to make China the richest and the most powerful. But America and Europe as well as India, Brazil, and other big countries also have the basic ingredients to become much more advanced than they are now. So the world will probably become multi-polar with more checks and balances. But since China will be the sole ultra-superpower it will surely play the role of leader rather than ruler.

May 21, 2005 @ 5:53 am | Comment

Calm down Liang, we barbarians really do need you to bury us with the foot binding shoe of kindness.

Mr. Bosco clipped off Krugman’s opinion, that which all one and two handed economist’s hold in their codpiece.

“I’m not saying we should try to maintain the status quo. Addictions must be broken, and the sooner the better. After all, one of these days China will stop buying dollars of its own accord.”
Paul Krugman-The China Connection

May 21, 2005 @ 6:59 am | Comment

Good of you to predict the emperor of the Chinese ultra, superduper, superpower will not be a dictator, but merely a leader it is hard to believe as there are not many role models in China for that kind of person.

May 21, 2005 @ 7:02 am | Comment

Why are you people so racist about the Chinese market?

May 21, 2005 @ 4:44 pm | Comment

Chin, where dfid you see racism? I don’t allow racism here, and if you see something racist please tell me so I can handle it. Thanks.

May 21, 2005 @ 7:10 pm | Comment

Another NY Times article on this subject:

May 21, 2005 @ 11:45 pm | Comment

From the above NY Times article:

We live in a wondrous world. It could just be that a Chinese Communist, leading a society hellbent on capitalism and prodded by a Republican administration, ends up helping what still passes for the left in America by driving the economic reality of personal debt home to the point where “values” issues become secondary.

May 21, 2005 @ 11:53 pm | Comment

Let’s hope.

May 22, 2005 @ 12:19 am | Comment



China is worried more about a free-floating Yuan than it was joining the WTO.

A free-floating Yuan would reduce the value of their US currency reserves.”

I won’t deny that China should adopt a more flexible exchange rate regime for its own good but you have also hit the nail. When China realised that their dollar-denominated Treasury bonds is suffering losses, they would pull the plug and Bush’s astonomical budget deficit monster would be let loose on the US and world economy.

May 22, 2005 @ 3:56 am | Comment

sp, china would pull the plug?….and risk affecting consumer demand for exports? I don’t think so.

china needs the US, Europe and Japanese markets a whole lot more than we need it.

I’m prepared to stand by that statement.

We can pontificate about the direct effects of a strengthened Yuan (at least it will stregthen under present circumstances) but it’s all besides the point and certainly not the main reason for the reluctance (of the PRC to float the currency).

The Japanese and Thais, for example, have been intervening in their national currency markets for decades and have central banks man-ed and woman-ed with experienced bods who know their stuff (1997 aside).

china does not and, as mentioned by Ron above, the govt does not want to add even more “external dangers” and therefore risk national stability.

Believe me, if there was ANY advantage for the chinese govt in floating the Yuan it would have been done years ago.


May 22, 2005 @ 4:22 am | Comment

Apparently Liang1ahost himself is one of the geniuses he was talking about – click on his name and you get a bulletin board discussion. He certainly has thought about it all a lot! I think he and I come from different assumptions about the world but gotta give him credit where credit is due. I can’t see how China will ever be able to achieve the same scale of income as the U.S. or Japan at the moment, or in the future – somebody please explain – but he’s got a formulaic set of economic panaceas and he sticks to it.

May 22, 2005 @ 1:06 pm | Comment


As the US trade deficit grows, the dollar would also hit south. Not only China, Japan and other Asian central banks would not buy US Treasury bills indefinitely because the slide in the US dollar would mean that their reserves would have a net capital loss. There is a limit as for how long the Asian Central Banks can hold out, not only China.

Talking about the Japs and Thais, we are facing a US trade deficit that our world has never experienced before, the dollar’s slide is going to happen just a matter of time unless something is done about the trade deficit. They not only the Chinese cannot keeping holding their reserves in dollar-denominated T-bonds if the dollar keeps heading south. They would have to diversify by buying say euros and other currencies.

China, unlike the previous years, is facing the evils of inflation. A lot of measures are being put in place by the Chinese to try to cool the economy. By keeping a rigid exchange rate, the Chinese is increasing money supply into their economy and thus fueling inflationary risks. So they would have to adopt a more flexible exchange rate regime so as to curb money supply, slow down export growth (noting that exports, X, is a component of GNP), curbs import prices and thus cools the economy. In summary, China would have to change their currency policy but a matter of time.

As much as China needs the US, Europe and Japanese markets, alot of US, Europe and Japanese firms have investments in China, mostly manufacturing plants, such that these US, European and Japan multinationals can make use of the cheap land and labour to remain price competitive. A lot of the profits make in China is being transferred back to their homelands. The Airbus, Boeing are all wooing the Chinese to buy their aircrafts, the Japanese mainly their automobiles, and the Germans and French the mega railway and infrastructure projects in China. China had just surpass US as Japan’s largest trading partner and Chirac and Schroeder are all anxious of getting a share of the China market for their home industries.

International trade and commerce is never about who needs who more, its always because of mutual benefits that trade and commerce ever take place.

So, MJO, we are talking a economics, purely economics here. If politics are involved, then you wouln’t really see the light of economics.

May 23, 2005 @ 1:20 am | Comment

From People’s Daily:

Around 2080, persistent economic growth will enable China to become a “developed country” and then to be in front of the world’s most industrialized countries within the next two decades, the experts and scholars say.

So average incomes should reach US levels at around 2080 if everything goes according to the government’s plan.

Modernization of the military will occur before then though. But, for the next century, China will still have plenty of its own problems to worry about before it can be a “leader.” What’s really troubling is that there are not enough resources (oil) in the world if every Chinese consumes as much as those of the industrialized world. China and India together will strip the planet bare before they can live like Americans.

May 23, 2005 @ 4:59 am | Comment

sp, I think we’re at slightly cross purposes here but your post was articulate enough to warrant a reply mate.

Yes, yes, yes, china suffers excess liquidity, fall in $ would result in net capital losses, there’s the alternative of the Euro etc.

If the $ weakens, the exchange rate peg and enormous foreign exchange reserves would make it more difficult for china to manage its domestic economy (in china’s case, the non-mature economy exasperates this effort).

The over-suppply of cash in china and excessive credit has fueled over-investment and a property bubble, increasing the risk of yet more bad loans.

china’s central bank can’t easily raise interest rates to cool down its economy, because that would attract more foreign (and ‘hot’) money.

The undervalued exchange rate subsidizes exports, discourages investment in the non-tradable sector and limits domestic consumption.

Arevaluation of the yuan WOULD help reduce chinaโ€™s reliance on exports as well as stemming the inflows of foreign money and allowing China to regain control of its monetary policy (as limited as that is).

However, the point I was trying to make above about the importance of the US market was that as china continues to finance the US budget defcit by buying Treasury Bonds, (and therefore keeping US intreest rates low), this prolongs/encourages US consumer spending and borrowing……ensuring that Americans can afford to keep buying chinese exports.

The return on Treasury bonds is lower than the returns china, but the chinese govt is prepared to pay that price to ensure export-led growth.

Also, iut’s never “purely economics” in china. Politics is always invovled. The threat of social unrest, whether it be from sudden mass unemployment, cronic inflation which wipes out everones savings or whatever.


May 23, 2005 @ 7:18 am | Comment


A speculation by currency speculators on the timing of re-valuation is precisely why China is keeping mum about when it is going to re-value the yuan.

Any clues of revaluation would not stem inflows of hot money; it actually encourages the inflow of hot money inot China betting on an imminent re-valuation and hence an overnight capital gain for the speculators.

Also an re-valuation would increase Chinese appetite for imports and dampen exports since imports awould become chaeper and exports of China becomes less price competitive on world market, hence cooling the Chinese economy. (Remember X is a positive and M is negative component of the GNP, since GNP= C+I+G+(X-M)).

When the US market is impt and China would galdly want to finance the US budget deficit, there is a limit as to how long China and the rest of Asia can hold out as US trade deficit continues to saor to historical levels. This mean that the US dollar is heading south in the long run and Asia including China cannot afford to indefinitely finance the US budget deficit till all their foreign reserves are being wiped out by possible enormous capital loss in an event of a dollar freefall.

While the US and other developed economies; markets continues to be impt to China, China is also a huge market that the US and other nations are tapping into for export-led growth. A rough estimate is that about 100,000 US jobs is dependent on the US-China trade and commerce. And also remember the cost-savings and profits that US corporations make are in billions. The US consumer also enjoy the low prices of Chinese products.

As China also has political concerns that goes to the US and Europe as well. If not why would Bush, a self-confessed free trade advocate slap steel tarrifs on other nations a few years ago despite the fact that it is already unable to compete? Why is the EU still insisting on the protectionistic Common Agricultural policy? Farmers are powerful lobbyists in France.

And more recently, Alan Greenspan had just said that the Yuan’s revaluation is not going to cure the US trade deficit. US consumers would just buy from Thailand and Malaysia instead.

Like China, the economics in US is also seriously being twisted by lobbies and trade unions and it is still about politics.

May 23, 2005 @ 8:13 am | Comment

sp, there’s a good article in todays’s sounth china morning post (subscription) written by columist Jake Van Der Kamp which I’m sure you’ll, like me, find of interest.

I’m sure richard won’t mind me cut+pasting it below:
“But Mr [United States Federal Reserve chairman Alan] Greenspan poured cold water on the idea that a revaluation [of the yuan] would shrink the record [US] trade deficit. Instead, it will mean that suppliers will turn to other countries such as Malaysia or Thailand for cheap textiles and other goods that China now supplies, he said.”

SCMP, May 22

Imagine the tables turned. What reaction would you expect if a Chinese government official who speaks no English and had only rarely visited the US were to pontificate on the US economy to an audience in New York?

Mr Greenspan, do me a favour. Look at the first chart and tell me again that suppliers will just turn to Malaysia or Thailand if they encounter a hitch in sourcing cheap garments out of China. Go on. We are a bit short of laughs here at the moment.

The mainland last year accounted for 70 per cent by value of all garments exported from Asia, including from the Indian subcontinent. Thailand’s share was 3.1 per cent and Malaysia 2.3 per cent. In case you ask, I have taken 80 per cent of Hong Kong’s garment exports here as having come from the mainland because, in fact, they did.

Now, just how precisely do you expand Thailand’s garment production capacity 10-fold to get a smooth and rapid transition from sourcing in China? How do you find and train all the skilled workers (garment-making is a skilled trade)? How do you have all the plant and equipment ready for them in sufficient time, how do you ensure the quality control, how do you make all the shipping and other needed arrangements so that everything goes tickety-tick as suppliers casually jump from China to Thailand?

How do you do it?

Answer: You don’t.

Mr Greenspan, you made your career as an investment banker, not as a manufacturer. The scale of the business you are talking about is much too great for rapid transitions. If you cut China off as a garment supplier to the US, then find yourself a quick source of fig leaves. You will not have much else to wear for a few years.

“In other words, the US has developed an addiction to Chinese dollar purchases and will suffer painful withdrawal symptoms when they come to an end.”

Paul Krugman,
Know-it-all economist,
SCMP, May 21

Yes, these pundits from New York do not come to us one at a time. If we had barter trade – goods exports from China to the US against hot air exports at $1 per breath from the US to China – it would be the US that runs a big trade surplus with China, not the other way round.

Mr Krugman’s point is the obvious one about how the balance of payments must balance. All those US dollars that China takes in from its big trade surplus must be invested somewhere outside of China. They are not invested in China because, if they were, China would not have a trade surplus.

And it is easy to see where that money is going, he argues. It is going into purchases of US government debt. Without this inflow to alleviate the pressure of a huge fiscal deficit, US interest rates would already be sharply up and they soon will be if China can no longer generate a big trade surplus.

Mr Krugman, do me a favour. Look at the second chart. It shows that the big buyer of US government debt paper in recent years has been Japan, not China.

Your own government’s figures show that China’s net purchases of Treasury bills, bonds and notes since that warmonger in the White House took office in 2001 amounts to less than 5 per cent of his blow-out in federal debt securities.

It was Japan that almost single-handedly took care of his growing fiscal deficit for more than two years until the end of last year.

But notice also that Japan has now grown tired of the game. It is buying no more. It wants out. If you now start to feel those painful withdrawal symptoms, Mr Krugman, look a little east of China for the reason.

May 24, 2005 @ 5:07 am | Comment

China’s dollar policy and a dose of reality

Or don’t believe everything you read in the New York Times (like you needed me to tell you that). With apologies to Billmon. Paul Krugman, I’ve two people and some facts for you to meet. Via TPD and Saru,…

May 25, 2005 @ 11:58 pm | Comment

The farmer in china is quite upset about the imbalance today. The vision of the fathers is gone. What will happen when another revolution hits China. We Chinese we want an emperor, one who will give us new vision and pride and bring religion back into the focus. All the mongolian people should be one. Taiwan belongs to us. Korea should be one, and we no longer need Mongolia as a buffer zone between us and Russia, we need Mongolia to join with their brothers. China can bring lasting peace to central asian republics.

June 23, 2005 @ 5:45 pm | Comment

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