With the global economy recovering, China s trade surplus began to grow.

As an immature debtor borrower, its trade balance and current account are also in deficit as a mature debtor borrower, its trade balance enters surplus and, as a debtor repayer, its current account moves to surplus.

It even began to tax exports in order to reduce the trade surplus.

In fact, China s trade surplus decreased by 6.4 in 2010 compared to 2009.

From 2005 to 2008, China s bilateral surplus with the United States increased by 41 , and its trade surplus with Europe more than doubled.

By definition, without a change in the saving gap, there will be no change in the trade surplus, and vice versa.

A reduced Chinese appetite for reserves would be reflected in an appreciation of its currency and a reduction in its trade surplus.

China s growth currently relies on an undervalued currency and a huge trade surplus.

This large, steady fall in the country s trade surplus makes the Chinese government hesitant to allow the RMB to appreciate significantly, for fear of the lagged impact on the trade balance.

Overall, China s trade surplus has decreased by 36 in absolute US dollar terms, and has dropped by more than half (53 ) in proportion to GDP over the past two years.

These data demonstrate conclusively that the exchange rate centered theory of the trade imbalance does not match reality.

Finally, the worsening of China s terms of trade will play an even more fundamental role in reducing its trade surplus in the future.

Previous recessions were often characterized by excess inventory accumulation and overinvestment in business equipment.

To be sure, the prolonged rapid increase in Chinese aggregate demand has been fueled by an investment boom, as well as a growing trade surplus.

Discussion of China s currency focuses around the need to shrink the country s trade surplus and correct global macroeconomic imbalances.

The policies that China will adopt as part of its new five year plan will shrink its trade and current account surpluses.

And, indeed, recent data point to a rapidly worsening economic environment in Germany, where the trade surplus has shrunk dramatically in recent months.

In any case, the central bank has already projected that Brazil s trade surplus will disappear this year, with a small deficit expected.

Only when a country invests less in fixed assets than the amount that it saves will the surplus savings show up in the trade balance.

This would cause a shift from exports to production for the domestic market, thereby shrinking the trade surplus, in addition to curbing inflation.

With imports still growing strongly and commodity prices beginning to fall as a result of the world slowdown, Argentina s large trade surplus is disappearing quickly.

China s purchases of American debt effectively transferred the official reserves gained via China s trade surplus back to the US market.

CAMBRIDGE China s current account surplus the combination of its trade surplus and its net income from foreign investments is the largest in the world.

As a result, the trade surplus continued to fall, to 20.4 billion, fueling growing concern about a Chinese slowdown.

But if exports continue to grow in the absence of consumption led import growth, distortions occur and the trade surplus and foreign reserves increase.

In 2005, the US trade deficit was 805 billion, while the sum of the surpluses of Europe, Japan, and China was only 325 billion.

With a trade surplus of 190 billion and the income from its nearly 3 trillion portfolio of foreign assets, China s external surplus stands at 316 billion, or 6.1 of annual GDP.

This invariably means that fiscal and monetary stability will become a priority while controlling the trade surplus has become a lower one.

Such a revaluation would also discourage exports and encourage imports, thereby reducing China s chronic trade surplus.

RMB appreciation should have started earlier and at a faster pace, when China s trade surplus was much smaller and its growth was much less dependent on exports.

Indeed, some Chinese authorities also maintain that renminbi appreciation would have no significant impact on China s trade balance because they believe that China s trade surplus is a reflection of excess saving and hence has nothing to do with the exchange rate.

(h) Surplus

And that decline follows a 30 drop in China s trade surplus in 2008, owing to the global financial crisis and subsequent recession.

And lagging household income clearly contributes to China s trade surplus, because low domestic consumption tends to keep exports higher than imports.

Over the past several years, much attention has focused on the role of China s trade surplus in creating today s global financial imbalances.

In the first seven months of 2010, China s trade surplus was 84 billion, down 21.2 from January July 2009.

The fall in China s trade surplus since late 2008 is attributable mainly to the global slowdown and the stimulus package introduced by the Chinese government, rather than to changes in the RMB s exchange rate.

Either way, the Chinese trade surplus is bound to shrink, but it would be much better for China if that happened as a result of rising living standards rather than global economic decline.

The End of China s Surplus

As a result, China s trade surplus with the US rose from 83 billion in 2001 to 258 billion in 2007, just before the recession. So far in 2009, China s surplus has accounted for 75 of the total US non oil goods trade deficit.

While the increase in investment reduced the saving GDP ratio, the resulting increase in imports lowered the trade surplus GDP ratio.

Yet, even as Japan s exports became much more expensive in dollar terms and its imports much cheaper in yen, its trade surplus rose from 6 billion in 1971 to 80 billion in 1989.

Moreover, a recession or a slowdown in the US and Europe would hit Brazilian exports, narrowing Brazil s trade surplus considerably. In fact, although America s trade significance has diminished, accounting for only 16 of Brazilian exports last year, Brazilian trade and growth typically go hand in hand with the US and Europe historically they have never decoupled.

China s rising trade surplus has led some observers to call for a revaluation of the renminbi to correct what they see as an unfair competitive advantage that China maintains in international markets.

Indeed, the huge increase in China s trade surplus in recent years is a consequence not of the renminbi s exchange rate, as many believe, but of the domestic savings increase.