Donald Trump, US president, is to meet Xi Jinping, his Chinese counterpart, at Mar-a-Lago in Florida this week. Discussions of economics seem likely to focus on China’s trade and exchange rate policies. This would be a mistake even if the US president’s views of trade were not mistakenly fixated on bilateral imbalances. Far more challenging and important is integrating China into the financial system. US policymakers should worry about China’s capital account, not its current account. That is where danger now lies. Sample the FT’s top stories for a week You select the topic, we deliver the news. Select topic Enter email addressInvalid email Sign up By signing up you confirm that you have read and agree to the terms and conditions, cookie policy and privacy policy. Why does the capital account matter more? The answer is that this is where two interrelated aspects of an economy interact with the world economy: macroeconomic balances between savings and investment; and the financial system. In both respects, the Chinese economy is, to cite the celebrated words of former premier Wen Jiabao, “unstable, unbalanced, uncoordinated and unsustainable”. That was true in 2007, when he said it. It is truer today. As the Chinese authorities realise, but their western counterparts may not, the integration of China’s financial system into the global economy is fraught with peril. Consider a few facts. Annual gross savings in the Chinese economy amount to 75 per cent of the sum of US and EU savings, at over $5tn last year. China’s gross investment, at 43 per cent of gross domestic product in 2015, was still above its share in 2008, even though the economy’s rate of growth had fallen by at least a third. To sustain such high investment, the ratio of credit to GDP soared from 141 per cent of GDP at the end of 2008 to 260 per cent at the end of last year. The “shadow banking system”, in the form of “wealth management products” and other instruments, has exploded. Interbank lending has also soared. Last, but not least, the banking system is now the world’s largest. Financially, China is the wild east. Remember what the wild west did over the last century: the Great Depression and Great Recession originated in the interaction between US-led finance and the global economy. In view of its macroeconomic imbalances and financial excesses, China could deliver at least as much global financial mayhem. I have argued elsewhere that it is essential to understand the interaction of macroeconomics with finance. China’s external accounts already played a significant role in the run-up to the financial crisis of 2007-08. Now the dangers it creates are still greater. Related article Xi Jinping’s summit plan to tame Donald Trump The returns on China’s investment in the president’s family have yet to be seen The macroeconomic issue is simple: China saves more than it can profitably invest at home. In 2015, gross national savings were 48 per cent of GDP. World Bank data show that households contributed only a half of this. The rest came from corporate profits and government savings. International comparisons suggest that economic growth of 6 per cent warrants investment of little more than a third of GDP. This indicates that China’s surplus savings — surplus, that is, to domestic requirements — may be as much as 15 per cent of GDP. Where might such surpluses go? The answer is abroad, in the form of current account surpluses. That is what happened before the financial crisis. It is likely that this is what would also happen now if the government relaxed exchange controls and brought credit and debt growth to a halt. Capital would pour out, the renminbi would tumble and, in time, a globally unmanageable current account surplus would emerge.

Source: Financial Times

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