Deck 3: China and the United States and the Balance of Payments

Question 1

Go to FRED (the Federal Reserve Economic Database) and update China's current account balances and foreign exchange reserve holdings both graphically and numerically. Determine the implied value of China's financial account + capital account + errors for the most recent three years.

Answer 1

Question 2

Explain why the chapter argues that China's foreign exchange capital structure has been "conservative" in recent decades. Relate this to questions of capital mobility and financial crises.
Discuss this in class in the context of the following notes:

Answer 2

Limited capital mobility, for example, reduces the risk of this major cause of financial crises-so does China really need to protect against such crises? Reserves in months of imports seem globally high. Cost of equity would be reasonable since risk is low from a CAPM approach. The only counter argument relates to a 2004 article by Obstfeld, Stambaugh, and Taylor, "The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility," which argues that a large money supply (which China has) relative to a paucity of assets creates an excess demand for alternatives-a key one would be foreign USD or Euro denominated assets. Therefore, the central bank must hold excess forex reserves as a contingency against a sudden shift out of RMB into USD.

Question 3

Consider the current account balances for China and the United States:
a. Explain the four different ways of looking at a current account deficit.
b. Discuss: If China stopped buying U.S. Treasury bills, the U.S. current account deficit would shrink. Which of the four views of a current account deficit is useful in this context?

Answer 3

a. i. Definitional Approach: Define current account as the difference between exports and imports.
ii. Absorption Approach: Domestic Supply - Domestic Demand yields GNP - (C+I+G) = Current Account Balance
iii. Sources of Funds - Uses of Funds yields Current Account = Savings - Investment.
iv. Buying more than we sell must mean we have to borrow: Current Account = Change in our External Debt position.
b. Method 4: Current Account = Change in our External Debt position.

Question 4

Choose among the four different ways of looking at a current account deficit or surplus and explain why China has run a historically large current account surplus and the United States has historically run a current account deficit.

Question 5

Discuss:
a. The balance of payments is a measure of a country's accounting cash flow while the current account is a measure of a country's financial cash flow.
b. In recent years, the United States has had a negative financial cash flow while China has had both a positive financial and accounting cash flow. The opposing balances are related.
c. We should not worry about cash flows for either China or the United States since a country is not a company and having too much or too little cash flow is not important.

Question 6

Determine the cash flow of the United States and China based on Table 3.3. Then update the data using FRED. Taking a quick approach we can just use current account balances and balance of payments measures for financial and accounting cash flows.
Source for United States: HYPERLINK "http://www.bea.gov/newsreleases/glance.htm" http://www.bea.gov/newsreleases/glance.htm

Question 7

Explain why as a conventional accounting measure, the balance of payments is equivalent to "the statement of cash flows" while for financial valuation purposes the current account is almost the same as "cash flow."