3) At the time of US experiencing current account deficit, China on the other hand has had

current account surplus. What factors contributed to this phenomenon?
Between 2000 and 2004, all net new supply of U.S Treasuries was purchased by foreigners.80% -
90% by foreign central banks particularly in Asia. The central banks increase their stock of dollar
assets by approximately $465billion in 2004. In fact, Asian accumulation of dollar reserves far
exceeded the region's large current account surpluses. China in particular has accumulated it's dollar
reserves from USD74 billion in 2002 to USD202 billion in 2004.
By intervening to prevent appreciation of their currencies against dollar, Asian central banks
maintained competitiveness of their countries' export sectors. The strategy was particularly important
to China's economy. Exports to the US accounted for 15% of China's 2006 GDP up from 8% in 2000.
This strategy also supported low U.S. interest rates, which served to increase the value of a wide
range of assets, including non-traded goods sector.
China has been on trade surplus over the past 25 years. This is shown from the aggregate output,
which has outpaced its domestic expenditure and reflected in saving exceeding investment and in
exports exceeding imports. China export-led strategy is essential for its growth. In order to sustain
the strategy, China Government enforces a central economic policy instrument through a tightly
managed exchange rate.
1. China wants to remain competitive, comparatively to U.S through Export-led
China wants to keep the value of the dollar high. This makes its own currency, the Yuan,
relatively cheaper by comparison. That helps China's exports to the U.S. seem more
affordable, which helps its economy grow. That's why, despite China's occasional threats to
sell its holdings, it's happy to be America's biggest banker, and largest foreign owner of U.S.

In order to retain China competitiveness, China needs the ability to produce that American
wants at the lowest cost. This is driven by the following factors:
a. Structural factors – legal and financial market imperfections which force the private
owned to increase firm efficiency and therefore, resulting lower standard of living in
China and allows companies in China to pay lower wages to workers.
China economy has been driven largely by state-owned enterprises. However since
1997, the ruling Communist Party has officially endorsed an increase in the role of
private firms in the economy. In short, the main reason for this rapid reallocation is
that private firms are more productive and more profitable than state-owned firms.
However, these private firms have limited access to credit markets, since the bankers
were keen to provide financing to state-owned enterprises. Therefore, these private
firms have been self-financing and rely heavily on retained earnings, personal savings
of entrepreneurs, and informal loans from family and friends. Due to the limited
access to domestic credit market, (i.e. hard to get loan from the local bank)
households increased their savings deposited with banks. As a result, Chinese banks
are oversupplied with cash and it is this excess of funds that has fed the purchase of
foreign bonds (through the central bank that formally has the monopoly on foreign
b. Government Led Exchange Rate Policy – A pegged exchange rate regime has been the
key to China’s export-led development strategy. People’s Bank of China (PCB) pegged
the Yuan (Renminbi) to always equal a set amount of a basket of currencies which
includes the dollar. In other words, China pegs its currency to the dollar using a fixed
exchange rate. When the dollar loses value, China buys dollars through U.S.
Treasuries to support it. In other words, an exchange rate for Yuan is partially set to
be always priced lower than the dollar. In this way, the Yuan's value is always within
its targeted range. As long as the Yuan's value is lower than the dollar, China's goods
are cheaper in comparison.