*Research Center for International Finance, Policy Brief
The “Asset Crisis” of Emerging Economies
Yongding Yu
BEIJING – In theory, the difference between capital inflows and outflows in developing countries should be positive – they should be net capital importers, with the magnitude of the balance equal to the current-account deficit. Since the 1997-1998 Asian financial crisis, however, many East Asian countries have been running current-account surpluses – and hence have become net capital exporters.
Even odder is the fact that while they are net capital exporters, they run financial (capital) account surpluses. In other words, these countries lend not only the money they earned through current-account surpluses, but also the money they borrowed through capital-account surpluses – and they do this lending mainly to the United States. As a result, East Asian countries are now sitting on a huge pile of foreign-exchange reserves in the form of US government securities.
While China has attracted a large amount of foreign direct investment, it has bought an even larger amount of US government securities. Whereas the average return on foreign direct investment (FDI) in China was 33% for American firms in 2008, the average return on China’s investment in US government securities was a mere 5% over the past 10 years, and it is much lower more recently. So, why does China invest its savings so heavily in low-return US government securities, rather than in high-return domestic projects?
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While China’s government should make greater efforts to rebalance the economy by conventional measures, it also should pay adequate attention to adjusting the currency structure of the country’s gross assets and gross liabilities. In particular, China should try to replace a good portion of its dollar-denominated assets with renminbi-denominated assets, and its renminbi-denominated liabilities with dollar-denominated liabilities.
If China cannot do very much about existing gross assets and gross liabilities, it should address the currency structure of new assets and liabilities. In short, China must take into consideration the ongoing asset crisis facing emerging economies, especially when considering highly consequential questions such as full renminbi convertibility and the currency’s internationalization. Undoubtedly, the valuation effect will complicate China’s policy on renminbi appreciation. The ideal solution is to eliminate excess saving gap without resorting to renminbi appreciation. Unfortunately, over the past 10 years, this approach has failed to work. The truth of the matter is still that the longer the adjustment progress takes, the higher the costs will be.
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