Saturday, May 26, 2007


Suppose the U.S. President were to propose the following policy: "My fellow Americans, I have just asked the Congress to increase taxes on all of us. After they pass my tax increase, I will instruct the Treasury to lend the additional tax revenue to the government of China."

Most Americans would, I suspect, be opposed to this proposal. They would see it as beneficial to China but without much benefit to the United States. With America eager to lend, China would enjoy lower interest rates. Why should Americans pay higher taxes to finance Chinese borrowing and spending?

I agree that this would be a strange and not very sensible policy for the U.S. government to pursue. But isn't it a bit odd that many Americans today are objecting to precisely the opposite of this policy. China is not borrowing from the U.S. government but is instead lending to the U.S. government by buying large quantities of Treasury bonds. The money used to buy these bonds could be returned to Chinese citizens in lower taxes. In other words, Chinese taxpayers are financing American spending and keeping our interest rates lower than they otherwise would be. And many Americans, including the President and Treasury Secretary, are complaining.

Unlike Matthew Slaughter, I would not argue that Chinese policy is incapable of affecting the real exchange rate. In a world of imperfect capital mobility, Chinese policy can affect international capital flows and thus the real exchange rate that equilibrates trade in goods and capital. But I am skeptical that their policy intervention is adverse to broad American interests. What the Chinese are doing, to boil it down to its essence, is buying U.S. government bonds (and some other American assets). The U.S. government is in the business of selling these bonds. There is no good reason to object when a willing buyer steps into the market.

These purchases most likely affect the exchange rate to some extent--and indeed the effect on the exchange rate could well be motiviating the purchases. It is crucial to keep in mind, however, that the exchange rate is a price, and a change in a price has opposite effects on different sides of the market. Cheap Chinese goods are bad news for U.S. producers that compete with those goods, but they are good news for U.S. consumers who buy these goods.

The more difficult question is whether the Chinese are acting against their own self-interest by saving so much and investing in foreign assets. Perhaps they are worried about potential future crises and want a large reserve fund for such a contingency. One can argue that the fund is now excessive. But it harder to argue that their saving and investing in our economy is a problem for us.

Before you say, "They are stealing our jobs," let me point out two things. First, while some jobs are lost to import competition, other jobs are gained because of lower interest rates and greater investment spending that capital inflows finance. Second, the U.S. unemployment rate is now low by historical standards. Based on either theory or evidence, the canonical political refrain of "jobs, jobs, jobs" makes little sense in this debate.