Impacts of East Asian Large-Scale Trade Surplus J.D. Han Eco 3370 PPP#2

Idea Under the gold standard system, where the amount of bullion is fixed in the short-run, a country (A)with trade surplus gets inflation, and a country(B) with trade deficits gets deflation. Thus, A’s exports falls and B’s exports rises. A and B will go back to trade balance. Under the current international monetary system(U.S. dollars as the Key currency; Fixed FOREX system with Sterilization Policy) and, A can have trade surplus with B running trade deficits almost indefinitely.

Historically In the Late 18 th Century -U.K. had a big trade surplus with the world -Non deflationary to other countries as U.K. invested surplus funds in the world

s The newly developing U.S. and Germany had a huge surplus They were highly deflationary to the rest of the world as surplus was used for domestic investment

China in the th Century China had a huge trade surplus with European countries. It was deflationary as a very little fund from trade surplus went back to the world.

Post World War II No longer ‘Species currency system” Change into the Key Currency System

1970s and 1980s Japan had a huge Trade Surplus with U.S. Somewhat deflationary U.S. could still run deficits and print liquidity

Eventually, Japan Developed “Conflicted Virtue” by Ronald McKinnon - with anticipated appreciation of Yen, the domestic interested fell to zero. Why? In Portfolio substitution theories, i us = i japan with no risks. But with risk i us = i Japan + positive risk premium, i Japan is driven to zero.

China after 1995 China has become the factory for U.S. China sends Capital back to U.S.

Key Issues of Current International Financial Flows between East Asia and U.S. 1)How did it start? By nature or by design? - J.D. Han’s short paper on the historical perspective of the U.S. Supply Chain in East Asia 2) Domestic Macroeconomic Conditions dictates the capital flows - U.S. domestic macroeconomic conditions ( relatively Strong Domestic Investment) dictates U.S. trade deficits; and China and East Asian ( relatively Weak Domestic Investment) happens to be the best fitting partner; - FOREX issues are ‘red herring’ Next Powerpoint 3) Still there are some Expected Problems -Ronald McKinnon’s paper on the Conflicted Virtue of China 4) Impact of Current World Recession - Erturk’s Paper on the Changed U.S. Absorption Capacity of Chinese Capital

“Conflicted Virtue” The current international division of labor between China and U.S. has worked on the premise that the Chinese do not fully trust the Chinese currency (or investment in China); Domestic investment or holding Yuan is an imperfect substitute for investment in U.S. dollars. There is a danger of” Conflicted Virtue” as the stability of the Yuan currency increases; If C.V. happens, then there will be Liquidity Trap in China -> Monetary policy would not work.