I mentioned in last week’s blog entry that during my trips to New York, Washington and Hangzhou in the past two weeks one of the common themes was concern about rising debt levels and weaknesses in the banking sector. Another theme – one which I want to discuss in this entry – was the possible impact of China’s rebalancing on US and global interest rates. A lot of people were very concerned that if China does indeed rebalance, US interest rates will soar.
The argument runs like this. If China raises the consumption share of GDP faster than investment declines, this will result in a reduction in China’s current account surplus. Clearly if China’s current account surplus drops, the amount of capital it exports must drop in tandem – since a rising share of consumption means a declining share of savings and so a declining excess of savings over investment which must be exported.
But because it is recycling the world’s (and history’s) largest current account surplus, China is one of the world’s largest purchasers of US government bonds. If China’s current account surplus declines, and so China sharply cuts back on its purchases of US government bonds, this should automatically cause US interest rates to rise.
In at least half the meetings I attended this was the argument. Fortunately for me, just after I returned to Beijing Martin Feldstein made the same argument in a Project Syndicate blog entry. He starts out;