Saturday, March 20, 2010

Department of "Brad DeLong, Please Elaborate"

. Saturday, March 20, 2010

Brad deLong writes:

Needless to say, Paul Krugman is right: if China saves less and spends more, its capital exports drop. As its capital exports drop, its savers' demand for dollars in exchange for renminbi fall--and the value of the dollar falls relative to the renminbi. A revaluation of the renminbi is not an alternative to an increase in Chinese spending but rather part of the process of making that increase in spending come about.

What I continue to struggle to understand is, if China spends more, won't this shift China's demand for dollars from capital account transactions (buying fewer Treasuries) to current account transactions (buying more Boeings)? In fact, isn't this exactly what Krugman and DeLong hope will happen? If so, then Chinese savers' demand for the dollar falls, but Chinese spenders' demand for the dollar rises. Why would the renminbi appreciate?

So is the argument that China's marginal propensity to buy dollar-invoiced goods is lower than its marginal propensity to buy dollar-denominated assets so that increasing spending and reducing saving causes China to spend less on all dollar-denominated things (Treasuries and Boeings)? And, although it spends less, it could still purchase more because the real exchange rate has strengthened. So, Boeing sells more jets to China. If this is the argument, is there any evidence that it is correct?

I know I can't expect Krugman to drop by to clarify this for me. But DeLong swings by on occasion to keep Will in line; perhaps he could take a moment to fill in the pieces for me. No snark at all.


Unknown said...

You're assuming that the new Chinese spending would all be on American (or at least denominated) goods. This is unlikely. Much of the new demand would actually stay in the Chinese domestic economy. Some would be for European goods, and only a portion would flow back to the US in the form of new demand.

Net result, the dollar falls. Hopefully not too far, too fast.

Thomas Oatley said...

Thanks, Stewart. But isn't it the case that if China spends mostly on domestic goods then they must sell fewer goods to foreigners. If they sell fewer goods to foreigners, then foreigners demand fewer renminbi which counteracts China's lesser demand for dollars? Less demand for and less supply of dollars implies no change in the dollar-RMB exchange rate.

Department of "Brad DeLong, Please Elaborate"




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