Abstract

The paper examines the external balance of the Chinese economy and the reliance on a fixed exchange rate regime. It is argued that the focus on the alleged misalignment of the RMB is misplaced. Despite an American focus on a large bilateral trade imbalance, China actually has only a small overall current account surplus. Instead, China’s “problem” is an excess of capital inflows that it does not need, given its own extremely high levels of domestic saving. Those inflows threaten to overwhelm China’s capital markets and risk a speculative bubble of domestic asset prices. An exchange rate adjustment would have significant effects of trade flows, but it is not the appropriate response to an excess of financial inflows. Instead, the paper addresses several alternative means of recycling the excess finance back into the global economy.