Saturday, July 10, 2010

J curve effect, Monetary Tightening Behind Bigger Chinese Surplus

After having fallen during 2009 and the first months of 2010 (briefly even falling into a deficit, though the fact that there was a deficit then largely reflected seasonal factors), the Chinese trade surplus increased in June, after a similar increase in May.

Ironically, this comes after a period when the yuan has been appreciating in value against most currencies (particularly the euro), while the previous drop coincided with a depreciation of the yuan against most currencies.

Does that mean that conventional wisdom got it all wrong and that a stronger currency increases net exports and that a weaker currency decreases it? No, not in the long run. In the long run, a stronger currency should all other things being equal reduce a trade surplus (though the effects are often exaggerated). But the short term effect of a stronger currency could in fact be to increase the trade surplus because of the J curve effect.

The J curve effect from the weaker euro was similarly probably a factor behind the drop in the German trade surplus in May.

Another explanation is the increase in reserve requirements and other tightening measures that Chinese authorities have implemented to limit bubbles and malinvestments. Monetary tightening will decrease import demand, and therefore increase the trade surplus.