I n t h I s c h a p t e r y o u w I l L

C h i n a , o f A l l P l a c e s ,
S e n d s C a p i t a l t o U . S .
B
Y
C
RAIG
S. S
MITH
S
HANGHAI
, C
HINA
—A giant, developing
nation bordered by an economic quag-
mire is an unlikely source of capital for
the world’s industrialized powers. But
China, with fat trade surpluses and bulg-
ing foreign-exchange reserves, is buying
U.S. government securities, especially
Treasury bonds and bonds issued by
Fannie Mae and Freddie Mac.
That’s good for America. Such in-
vestments add liquidity to the U.S. hous-
ing market and help hold down U.S.
interest rates. And China is likely to con-
tinue to buy a lot of U.S. debt for years
to come.
Thanks to high domestic savings, a
continuing inflow of foreign investment
and tight controls on domestic spending,
China is awash in capital. Last year’s
capital surplus . . . reached an estimated
$67 billion.
China squirrels more than half of
that away into foreign reserves, which
are invested abroad. Chinese companies
funnel much of the rest directly overseas
through bank transfers—sometimes
skirting Chinese capital restrictions to
do so. So while the financial crisis has
transformed the rest of East Asia into a
capital-sucking hole, China has become
a gushing fountain of capital.
This isn’t the first time a developing
country has sent abroad funds that could
I N T H E N E W S
How the Chinese Help
American Home Buyers
T
HEIR SAVING HELPS US GET
CHEAP MORTGAGES
.
trade policy, p. 690
capital flight, p. 692
K e y C o n c e p t s
1.
Describe supply and demand in the market for loanable
funds and the market for foreign-currency exchange.
How are these markets linked?
2.
Why are budget deficits and trade deficits sometimes
called the twin deficits?
3.
Suppose that a textile workers’ union encourages people
to buy only American-made clothes. What would this
policy do to the trade balance and the real exchange
rate? What is the impact on the textile industry? What is
the impact on the auto industry?
4.
What is capital flight? When a country experiences
capital flight, what is the effect on its interest rate and
exchange rate?
Q u e s t i o n s f o r R e v i e w

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C H A P T E R 3 0
A M A C R O E C O N O M I C T H E O R Y O F T H E O P E N E C O N O M Y
6 9 7
be used productively at home. Often,
such money was fleeing instability, as
it was in Latin America in the 1980s,
Russia in the 1990s, and Africa in both
decades.
Usually, however, developing coun-
tries invest their capital in their own
growing economies. And some Chinese
officials believe that’s what China should
be doing, too. One former Chinese cen-
tral bank official calls it “scandalous”
that a country of poor peasants is financ-
ing investment of an industrialized power
such as the United States.
Others complain that China isn’t
even getting good returns on its invest-
ments. It pays an average of 7 to 8 per-
cent on its $130 billion foreign debt but
earns only about 5 percent on the $140
billion of its reserves invested abroad.
That’s partly because yields on U.S.
debt—widely considered the safest se-
curities in the world—are relatively low.
But China has good reasons to
send some of its capital overseas. Its in-
vestment in fixed assets as a percentage
of its gross domestic product was an ex-
traordinarily high 34 percent in 1996, the
latest year for which figures are avail-
able. It’s doubtful that China could in-
crease that ratio without wasting money
or fueling inflation. Thailand’s ratio was
40 percent and Korea’s 37 percent
before their overspending undermined
those nations’ economies. . . .
“They’re already investing as much
as they can absorb,” says Andy Xie, an
economist for Morgan Stanley Dean
Witter & Co. in Hong Kong.
Yet while investment is constrained,
savings keep growing. The percentage
of working-age people in the population
has climbed to 62 percent from 51 per-
cent in the past 30 years. And those
workers, often allowed only one child on
which to spend, are hitting their peak
saving years. With consumption low, the
pileup of money pushes capital offshore.
The result: Chinese capital is
spreading everywhere. The country is
a big buyer of oil fields, for example,
having pledged more than $8 billion for
concessions in Sudan, Venezuela, Iraq
and Kazakstan. Mainland capital also has
poured into Hong Kong, where it helped
inflate property prices before East Asia’s
crisis began letting out some of that air.
The capital surplus has even allowed
China to help its neighbors when they
got into trouble: Beijing pledged $1 bil-
lion to the International Monetary Fund
bailouts in Thailand and Indonesia. Most
of the money, though, goes into U.S.
Treasury bonds. China won’t say how
much, but estimates run as high as
40 percent.
And China’s central bank, like 50
others around the world, lends money to
Fannie Mae and Freddie Mac, which use
the funds to buy mortgage loans that
banks and others extend to ordinary
Americans. The flood of money keeps
the market liquid and reduces the rates
that U.S. home buyers pay.
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