trade and monetary imbalances

Monetary policy can not be determined independent of trade policy.

Here is an example where a trade imbalance between two parties leads to lower interest rates in both parties. An asymmetrical situation in one domain results in a symmetrical outcome in another.

There is a widespread misconception that the United States relies on the savings of other countries to finance its current account deficit. This is incorrect. During recent years, at least, the U.S. current account deficit has been financed primarily by money newly created by the central banks of other countries. Newly issued paper money is not the same things as a country's savings. The companies that earn money by exporting to the U.S. keep their savings. It is only that they keep them in their domestic currencies after having sold the dollars they earned from exporting to their central bank. In fact, the banking systems of the export-oriented economies all across Asia are burdened by too much savings. Deposits are accumulating in the banks more quickly than there are viable lending opportunities and, consequently, interest rates have fallen to historic lows...

Many countries around the world accumulate large stockpiles of dollars as a result of their trade surpluses with the United States. The central banks of those countries print their own currency and buy those dollars in order to prevent their currencies from appreciating when the private-sector companies that earned the dollars exchange them for the domestic currency on the foreign exchange markets. The central banks then invest the dollars they have acquired into U.S. dollar-denominated debt instruments, preferably U.S. Treasury bonds or agency debt, in order to earn a return. If the amount of dollars accumulated by foreign central banks exceeds the amount of new debt being issued by the U.S. government and the U.S. agencies during any particular period, then the central banks will buy existing government and agency debt instead of newly issued debt. By acquiring existing debt, they push up the price and push down the yield.

Duncan, The Dollar Crisis (Page 298-300)

Here are several clarifications. (Let's use China as an example.)

1) US interest rates go down basically because dollars circulating inside the US real economy gets drawn into the US financial markets.

2) Chinese goods get consumed by Americans, and Chinese exporters of these goods now hold newly minted renminbis. Once these new renminbis get deposited at local banks, Chinese interest rates experience a downward pressure.

3) Continuing trade imbalance forces the Chinese central bank to print more and more renminbis. Once the lending opportunities become present, this accumulation of printed money generates either an inflation in the Chinese real economy or an asset bubble in the Chinese financial economy.


Here are two explanations of how a country, which adopts export-oriented policies and pegs its currency to dollar, imports inflation from US when the dollar depreciates.

1) As renminbi depreciates along with dollar, Chinese exports become more competitive in the world market. More foreign currency gets deposited at the Chinese central bank as exporters sell more of their goods to foreign customers. For the acquisition of these incoming foreign currencies, the central bank prints more renminbis. Now that more local currency is circulating around the Chinese real economy, inflation picks up.

2) As renminbi depreciates along with dollar, imports become more expensive in terms of renminbi. (It is tough to tell whether this development will result in a decrease in the amount of local currency circulating. An imported good may have a close local substitute. Hence an increase in the price of the former may result in an increase in the demand for the latter. So some renminbis that was destined to be converted to dollars may now stay within the local economy and increase the amount of local currency circulating. On the other hand, some consumers may continue to buy the imported good at the increased prices. That means more renminbis may get deposited at the Chinese central bank then the usual. In other words, the amount of local currency circulating may decrease.)