A recent Economist article Global rebalancing The clock tic

. A recent Economist article (\"Global rebalancing: The clock ticks\", June 19, 2015, p. 75) discusses \"hopes for global rebalancing and the unsustainable \"twin deficits\" in the U.S. This week the WSJ had a large number of articles about a surprising policy decision by Beijing concerning China\'s foreign exchange regime. a) Briefly describe this policy move and how it might impact the so-called \"twin-deficit\' problems of the U.s. b) upon hearing of the unexpected news, U.S. stock markets initially rallied but after further \'contemplation\' fell back, and ended the trading session slightly down. Identify and discuss 2 reasons why this f/x policy change by China might not necessarily benefit the U.S.

Solution

a) China, and, twin deficit

An examination of the relationship between the trade deficit, and, the budget deficit - The then Federal Reserve Chairman Ben Bernanke expressed doubts over presumed causal relationships between the trade deficit, and, the budget deficit.

The twin deficits hypothesis

The Federal budget deficit exacerbates the widening trade deficit. US fiscal policy drives the trade deficit wider. The Government should raise taxes, and, reduce revenues. Twin deficits are not identical, but, are complementary.

Sterilization is a Chinese economic policy. It offsets the tendency of the currency to appreciate. This is due to the influx of hot money flows, due to the influx of the short-term capital. China maintains currency flexibility. China is thus encouraged to maintain greater currency flexibility.

b) The policy may not necessarily benefit the United States

There are costs involved in continuing to prop up the Dollar. China\'s accumulation of dollar reserves, and, the sterilization present major opportunity costs that cause one to question the policy\'s long-term sustainability.

The international system cannot sustain large current account imbalances; there are disparities in openness & growth between major trading partners, and, the United States.