Feldstein: The End of China’s Surplus

Martin Feldstein argues that China's current-account surplus is likely to shrink dramatically over the next few years:

The End of China’s Surplus, by Martin Feldstein, Commentary, Project Syndicate: China’s current-account surplus ... is the largest in the world. ...China’s external surplus stands at $316 billion, or 6.1% of annual GDP.

Because the current-account surplus is denominated in foreign currencies, China must use these funds to invest abroad, primarily by purchasing government bonds issued by the United States and European countries. As a result, interest rates in those countries are lower than they would otherwise be.

That may all be about to change. ... It is possible that, before the end of the decade, China’s current-account surplus will move into deficit... If that happens, China will no longer be a net buyer of US and other foreign bonds, putting upward pressure on interest rates in those countries.

Although this scenario might now seem implausible, it is actually quite likely to occur. ... China’s national saving rate ... is now about 45% of its GDP, which is the highest rate in the world. But, looking ahead, the five-year plan will cause the saving rate to decline...

The plan calls for a shift to higher real wages so that household income will rise as a share of GDP. Moreover, state-owned enterprises will be required to pay out a larger portion of their earnings as dividends. And the government will increase its spending on consumption services like health care, education, and housing....

Since China’s current-account surplus is now 6% of its GDP, if the saving rate declines from the current 45% to less than 39% – still higher than any other country – the surplus will become a deficit.

This outlook for the current-account balance does not depend on what happens to the renminbi’s exchange rate... But the fall in domestic saving is likely to cause the Chinese government to allow the renminbi to appreciate more rapidly. Higher domestic consumer spending would otherwise create inflationary pressures. ... A stronger renminbi would ... cause a shift from exports to production for the domestic market, thereby shrinking the trade surplus, in addition to curbing inflation.

...Americans are eager for China to reduce its surplus and allow its currency to appreciate more rapidly. But they should be careful what they wish for, because a lower surplus and a stronger renminbi imply a day when China is no longer a net buyer of US government bonds. The US should start planning for that day now.

Plans are not action. I hope the Chinese government moves to raise the standard of living and to provide more social services, but I'll believe it when I see it happen. For now, interest rates remain very low -- markets are not worried about this -- and it's not the time to panic about the deficit, impose large budget cuts, and endanger the recovery.