Global Imbalances and Interest Rates

Readers Question: Why do global imbalances and the high demand for US securities such as US Treasuries and mortgage backed securities help keep US interest rates low “

To summarise, higher demand for bonds pushes interest rates lower. See: (why higher price of bond leads to lower interest rate)

In the mid 2000s, the global economy could be characterised in a few ways. This is a simplification, but it should help to understand.

  • US had strong economic growth, led by consumer spending. US had large current account deficit (imports were greater than exports)
  • China had strong export sales. China had large current account surplus (exports greater than exports)
  • With a current account surplus, China was receiving increasing foreign currency reserves. Therefore, China used these export revenues to buy US securities.
  • One reason China wanted to buy US securities is that by buying dollar assets, it increased the value of the dollar and reduced the value of the Yuan. This made Chinese exports more competitive and increased Chinese growth.
  • This increase in demand for US securities (e.g. US Treasury Bills) increased the price of US Treasury bills. When the price of bonds increase, it reduces the interest rate on bonds. See: explanation of (bond prices and bond interest rates)
  • Thus the flow of money into the US kept interest rates low. With low government bond yields, it also kept down other interest rates, e.g. on mortgage bundles and corporate debt.
  • With low interest rates in the US, this encouraged Americans to keep borrowing and spending. This contributed to the rise in US house prices and the continued US current account deficit.

If China hadn’t bought US Treasuries, there would have been lower demand for the price of bonds. This would have kept bond yields in the US higher. Higher interest rates may have moderated the economic expansion.

Also, if China hadn’t bought US treasuries, the dollar would have been weaker and the Yuan would have been stronger. This would have reduced the US current account deficit. It would have been good for US exporters, but led to lower demand for Chinese exporters.

Overcoming Global Imbalances

China’s growth is currently based on export demand. However, if there was an increase in consumer spending by the Chinese, they would be buying relatively more US exports. This would reduce China’s current account surplus.

Also, if the US saved a higher % of income, it would lead to Americans spending a lower amount on imports, which would also help reduce the US current account deficit.

2 thoughts on “Global Imbalances and Interest Rates

  1. Hi. You have been doing a great job all this while. Such great teacher. I have been encouraging my students to read your materials and it does work in sharpening their evaluation skills under the Edexcel board. Keep it up

  2. “One reason China wanted to buy US securities is that by buying dollar assets, it increased the value of the dollar and reduced the value of the Yuan”

    However, if China was exporting goods for dollars (much world trade is in dollars), then it would not have needed to buy them to purchase securities. There would still have been a lowering of US interest rates.

    I’m pretty sure the Chinese bank was printing yuan to keep the FX value low…they are now experiencing inflation.

Comments are closed.