Pity the Chinese (update)

I'm happy to report that the Chinese are no longer accumulating foreign reserves, which means they are no longer running a trade deficit with the rest of the world. Markets have forced the adjustments that politicians were demanding. Perhaps this will put a stop, once and for all, to all the foolish China-bashing that has only served to increase global tensions.

After more than 15 years of steady gains, China's foreign exchange reserves have been effectively unchanged at about $3.3 trillion for the past 18 months. Moreover, for the past two years, China's holdings of Treasuries have also been effectively unchanged at about $1.2 trillion. China is no longer accumulating foreign exchange reserves because it no longer needs to keep its currency from appreciating. We're likely quite close to the end of the ever-appreciating yuan.

After appreciating by 68% in real terms against a broad basket of currencies (as shown in the chart above), the yuan apparently has no need to appreciate further. The huge effective appreciation of the yuan relative to other currencies has meant that the cost of making stuff in China is now much higher relative to other country's costs. Capital is thus no longer flooding into China, and in fact, jobs are starting to leave China for cheaper destinations. China has achieved a measure of foreign trade stability.

The money that China was spending on Treasuries and other hard-currency bonds is now available to spend on goods and services from around the world. Indeed, since China stopped accumulating Treasuries in mid-2010, U.S. exports to China have grown at a 13% annualized rate. So here's the answer to all those who worried for so many years: "What will happen if the Chinese stop buying our Treasury debt?" It's simple: when they stop buying our debt they will instead buy our goods and services. And if China should want to reduce its holdings of Treasuries, then it will perforce buy even more of our goods and services. This is simply international balance of payments math.

A little over two years ago I wrote a post titled "Pity the Chinese," in which I said "Contrary to what you read in the press—which mistakenly believes that our large trade deficit with China is something we need to worry about—China is the one that needs to worry, not us."

They sell us mountains of cheap goods, then turn around and invest most of the proceeds (equivalent to our trade deficit with China) in U.S. Treasury securities. We get the goods, and we get to keep the money.

For most of the past 10 years, the U.S. has been working hard to depreciate its currency, in the mistaken belief that easy money and a cheaper dollar would stimulate the economy. China, in contrast, has been forced by relentless capital inflows and political pressure to revalue its currency even as it bought up massive amounts of foreign currency in an attempt to slow the yuan's rise. The result has been very costly for the Chinese, since they have put trillions of dollars of wealth into bonds with very low interest rates, denominated in currencies that have lost value against the yuan. In this manner, the Chinese have effectively transferred a significant amount of their wealth to other countries.

It really has been a pity, but at least now it looks like things won't be getting any worse.