Oct 09 2007
Trade Balance, Deficit, Financial Assets vs. Capital Goods
A discussion during the International Finance class got me thinking: what are China’s options with so much trade surplus?
We all know that at least 70% of China’s trillion dollar foreign reserves are in dollar denominated assets, mainly in treasury securities which yield around 4-5%. Take out the inflation factor, it is more like “deposit” than “investment”.
What is the alternative? Buying higher-yield securities at the expense of higher risk? It is easy to say but rather difficult to execute. For example, it is not a scaleable solution.
What else? How about buying capital goods from the U.S. (goods used for production) and produce more at home? For example, buying heavy equipments, high-end computers, etc. from the U.S. and produce more domestically. Instead, the Chinese choose to buy financial assets from the U.S., some of which will come back as FDI.
It is as if the Chinese are saying, we may have all the production factors–land, natural resources, labor, infrastructure, etc.–but we don’t know how to use them to generate returns higher than 4%. Therefore, we will give you the money and take just 4%.
It is a strange conclusion but seems to be a logical one. I asked the professor about the difference between buying financial assets and capital goods. I wonder whether it is the same as having the U.S. acting as a financial advisor/asset manager plus entreprenuer. I am not sure whether she got my question or not.