Why would China NOT have Liquidity Trap Under Conflicted Virtue? Shuang Ni Yuze Chen Zidao Wang

Conflicted Virtue  Any international creditor country that cannot lend in its own currency cumulates a currency mismatch that we call the syndrome of conflicted virtue.  Countries that are “virtuous” by having a high saving rate tend to run surpluses in the current account of their international balance of payments

Conflicted Virtue  1. As the stock of dollar claims cumulates, domestic holders of dollar assets worry more about a self-sustaining run into the domestic currency forcing an appreciation.  2. Foreigners start complaining that the country’s ongoing flow of trade surpluses is unfair and the result of having an undervalued currency. ---Deflation and Liquidity Trap ---Trade Sanctions

CV in Japan  After the WW II Japan has a large trade surpluses with the US.  The trade friction become more and more serious between Japan and US.  The US want to reduce the trade deficit by influence the exchange rate. ----

Zero Interest Rate and Liquidity Trap  The interest rate parity relationship i = i* + Δse +φ i is the Japan interest rate i* is the US interest rate Δse is expected depreciation of the yan, ≈0 Φ is the risk premiun on yan assets  φ is negative for a creditor country such as Japan with private sector assets denominated in foreign currency

Zero Interest Rate and Liquidity Trap

How About China?  China is second largest nominal GDP country  China has a large amount of trade surplus with US, 318 billion dollars in 2013, 315 billion in  China is largest US Debt foreign holder, its holding of $1.2 trillion.  So, China also faces the Conflicted Virtue issue

Does China Occur the Liquidity Trap? NO

Why?  Compare to Japan, China can deal with the appreciation pressure from US.  In 1980s, Japan had to appreciate yen under the pressure from US because of the politic issue.

Stable Exchange Rate  The Exchange Rate Regime

Appreciation Pressure

Continue  US’s Quantitative Easing (QE) Policy make yuan appreciate after  QE1 in 2008, QE2 and QE3 in2010, QE4 in  However, US announced stop QE in  So China succeeds to stabilize its exchange rate.

China: Current Account and Net FDI inflows

Japan: Current Account and Net FDI inflows

China's Cumulative Surpluses on Current Account, Trade, and Net Foreign Direct Investment

Nowadays China  has benefited enormously from the massive FDI inflows  largely in joint ventures with domestic enterprises  have accelerated its access to modern technology  faces the “conflicted virtue” ?

Suggestions by Ronald McKinnon  take policy measures to reduce—and even reverse—its current-account surplus  reduce the financial magnitude of the FDI inflows by letting joint ventures finance more of their operations within China  push vigorously in expanding aggregate demand domestically

Short term  People’s Bank of China (PBC) must intervene in the foreign exchange market to buy the excess dollars  Not sterilizing these interventions relieves the pressure  As long as interest rates on renminbi assets remain well above zero, such increases in the monetary base could be effective in expanding the domestic economy while slowing the growth of official exchange reserves.

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