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UK Economics Blog

UK Economics Blog
Latest news and views on UK economy. Also looking at wider global economy. Considers economic theory in an easy to understand and accessible way
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2010-03-19 13:10:00
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National Debt Ceiling
2010-03-16 10:47:00
What is the maximum that a government can borrow? What is the maximum debt ceiling at which markets will stop lending. It is certainly a crucial question for governments, especially at the moment.For example, why are markets currently very worried over UK national debt (at 60% of GDP) and yet seemingly ignoring the size of Japanese national debt (at 190%)If national debt is so damaging, why have so many economies survived periods of government borrowing which exceeded 250% of GDP?One thing is clear, there is no single point at which debt levels become unsustainable. You can choose an arbitrary figure like 60% of GDP, 100% of GDP or even 200% of GDP, but each case is different. Alot depends on the feelings of markets and investor sentiment.What Factors Enable Governments to Borrow Over 200% of GDPDomestic Consumers willing to buy government Debt . If the private sector has a high savings rate and a high willingness to buy government bonds this is a very beneficial for government borro...
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Forecasts for Pound to Euro in 2010
2010-03-15 10:26:00
2010 has been a dismal year for Pound Sterling so far. It has fallen against the dollar to just above $1.5 to £1. It has fallen against the Euro to Euros 1.1. Many commentators are betting on the Pound falling to parity against the Euro.The weakness of the Pound is primarily caused by the combination ofRecord Budget Deficit (close to 12% of GDP)Political uncertainties over general election and any concrete plan to tackle the deficit in the medium term.Investors fear that in the absence of a medium term plan to tackle the budget deficit, there is the prospect of a rating downgrade, and higher interest payments on UK debt. There is also the fear that continued government borrowing could lead to inflation in UK. This would reduce the value of Sterling further.The continued trade deficit (January's figures showed biggest deficit since Aug 2008) suggests the Pound was overvalued for a long time. And it is taking a long time for fall in the pound to help correct the underlying deficit. ...
Greece Bailout
2010-03-13 09:29:00
The EU have agreed to a bailout for the Greece economy. The UK will not be involved.The EU have hinted at a stricter implementation of fiscal rules. The EU used to have the Growth and Stability Pact, which limited government borrowing to 3% of GDP. But, countries have routinely ignored this. (Greek borrowing hit 12% of GDP)However, a strict implementation of the growth and stability pact could have damaging consequences for countries who don't have their own monetary policy.The bailout doesn't mean the end of the problems for the Greek economyDrastic Economic Measures
National Debt Facts
2010-03-08 09:23:00
Readers Question: The Daily Mail of March 5th says the Government is borrowing £600,000,000 a day ? That is 25 million an hour or £416,000 a minute. At present we have a Budget Deficit of £178 Billion which will be increasing by 4.2 Billion a week. When I read it I thought it was a mis-print Is this figure correct ? Am I right to be worried ? I just don't understand how the UK Economy will ever be OK ?Annual government borrowing is expected to be around £178 billion (or 12.6% of GDP). This is being added to the total national debt (accumulated over many years) of £848.5 billion.Reasons To Be Worried over UK EconomyThe annual deficit is a record level for peace time. (We have had higher annual deficits, but, only in wartime)In past few weeks, political uncertainty - prospect of hung parliament have made markets worry we don't have a concrete plan for reducing debt after election. This market uncertainty has caused the pound to have a rough weak.Sluggish nature of economic re...
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The Economy Could Have Been Worse
2010-03-05 12:04:00
One of the difficult things in economics is measuring the impact of a policy. For example, you could argue, the UK's recession was one of the deepest in Europe, therefore, this shows the failure of our fiscal policy and Monetary policy which included Quantitative Easing.However, such as a simplistic conclusion is likely to be misleading. There were several factors that made the recession very deep, and it could have been deeper and more prolonged without the unorthodox policies and unprecedented intervention.A report by Capital Economics suggests that Quantitative Easing has boosted GDP by 2-3%. That's not much considering it involved £200bn of asset purchases. But, without it the economy would still have been in recession. (link Telegraph)This indicates that since quantitative easing began last March, banks have hardly been in a rush to increase lending. But, it also means the scale of quantitative easing has created little if any inflationary pressure as some feared.It would be...
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Dealing With Greek / Euro Crisis
2010-03-03 14:35:00
As we mentioned earlier, leaving the Euro is not a realistic policy. So how does Greece deal with its economic crisis? How does it cut its debt and return the economy back to strong economic growth?The immediate answer which springs to mind - is with great difficulty.Unfortunately, Greece has no recourse to any real loosening of monetary policy. They can't devalue the exchange rate, they can't pursue an independent policy of quantitative easing, they can't leave the Euro.Yet, at the same time, bond market pressure is forcing them to cut their budget deficit - just at a time when the economy needs fiscal policy to provide a boost in aggregate demand not a tightening.One solution that springs to mind, is to cut public sector wages, and cut the bloated Greek civil service. This spending cuts would provide the markets with clear evidence of sincere efforts to tackle the budget deficit. But, if (and it is a big if - given political situation) the Greeks were able to cut wages there wo...
Criticisms of ECB
2010-03-02 14:25:00
A while back, I looked at the case for placing less emphasis on an inflation target of 2%.Axel Weber, a leading contender to succeed Jean-Claude Trichet as the next president of the European Central Bank has criticised Olivier Blanchard, chief economist at the International Monetary Fund, for his suggestion inflation targets should be raised to 4 per cent to help in fighting the economic crisis. Weber states raising the inflation target to 4% is not just “playing with fire”, but is “reckless and deeply damaging”. This highlights the predominance, the ECB, give to low inflation at all cost. via ( Telegraph)The ECB have a very strict attitude to keeping inflation low. This model of low inflation has generally served the German economy well. The post war period has been an era of prolonged expansion, against a backdrop of low inflation. After the trauma of the hyperinflation in Germany in the 20s and hyperinflation in countries like Austria and Hungary in 1945, 46, it is at lea...
Leaving The Euro
2010-03-01 14:19:00
The economic situation in some of the peripheral EURO economies like Greece, Italy and Spain is pretty grim - with a prolonged recession, prospect of deflation, uncompetitive exports, rising unemployment, and current account deficits. In the case of Greece it is compounded by record levels of government debt.A textbook solution to the above problems, is to allow a devaluation of the exchange rate and pursue a more expansionary monetary policy.But, being in the Euro , it would be very problematic to do it. Exchange Rates are permanently fixed, and the ECB show no signs of deviating from its religious devotion to low inflation whatever the costs.One question is can an economy actually leave the Euro and go back to it's original currency? Could Greece leave the Euro and readopt their own currency?Problems of Leaving the EuroFirstly, there are grave political problems, the fallout could affect the economies reputation and lead to less confidence and less investment e.t.c in the long ter...
UK Economy in 1990s
2010-02-23 10:51:00
The 1990s began with a severe recession, and a humiliating exit from the ERM.The mirage of the 1980s bubble had exploded. Inflation, once thought to be defeated once again had reared its ugly head. All the hard won gains of the 1980s seemed to be lost.Belatedly, the government sought to tackle the bubble inflation indirectly through the Exchange Rate Mechanism - a semi fixed exchange rate. This required exceptionally high interest rates which made a mild recession into a much deeper recession, - unemployment soared. More detail - ERM Crisis 1992The worst hit area of the economy was the housing market. After enjoying the heady days of the late 80s with 30% annual growth in house prices, the housing market slumped as people simply couldn't afford the record mortgage interest payments. House prices began falling in 1990, and were still falling in 1995. Adjusted for inflation, the real house price fall was even more dramatic.As the economy recovered, the primary objective of economic p...
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Chinese Economy Collapse
2010-02-22 10:27:00
Hi, I would like to ask if China went into a recession, would that make the economies in other countries that are currently in recession better off? In other words, would it improve relatively the state of the economy in other countries considering the standard of the market has fell?If China went into a recession, it would adversely affect other economies.China's economy is primarily based on exports. But, as one of the largest economy it is still a significant importer, especially of raw materials. If China went into a recession, global commodity prices and demand for commodities would probably fall. This would be bad for economies like Australia and Canada which produce significant amounts of raw materials.If China went into recession, there would be an adverse effect on world trade. China would buy less imports and this would lead to a slowdown in global trade. It could also have a significant effect on global confidence, causing sluggish global growth.I was interested to recen...
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The Thatcher Revolution - 1980s
2010-02-19 11:35:00
If the 1970s, ended with a feeling of powerlessness, who else could have taken power but Margaret Thatcher ? Before her election, few would have realised her conviction and rigid adherence to a new market based ideology. Few, if any could have predicted how she took the economy and reshaped it in her own image.Whatever, you might say about Thatcher, the period is certainly interesting for economic historians.The late 70s left two major economic problems - high inflation and industrial unrest. With her chancellor, Geoffrey Howe, she took to tackling inflation with a gusto and intensity rarely matched. The government pursued a new set of Monetarist policies - jettisoning the post war Keynesian consensus. Tax were raised, spending cut, interest rates increased, the pound appreciated, the money supply was controlled. All this reduced inflation.Money Supply targets (an intrinsic part of Monetarism) proved to be more or less useless. But, the deflationary fiscal and deflationary monetary p...
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The Economy of the 1970s
2010-02-18 11:19:00
See previous decade - 1960s.The 1970s was not just an era of dayglow trousers, lava lamps and the emergence of punk rock. It was a traumatic economic decade of stagflation, a three day week and the return of unemployment.Things got off to a bad start, with a combination of inflation and strikes. To deal with growing inflation, the Heath government tried capping wages. This was fuel for industrial unrest, leading to frequent and widespread strikes. In 1973, the miners went on strike and were also joined by sympathetic trades unionists- led by, amongst others, the young and infectiously strident Arthur Scargill. Growing up in Thatcher's Britain, it is hard to remember how powerful trades unions actually were at the time. During Heath's government 9 million working days were lost to strike action - plus more to practises such as 'working to rule'. Flying pickets successfully blocked coal and coke factories, which at the time produced the majority of the nation's power. Suddenly t...
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The Economy in the 1960s and 1970s
2010-02-17 11:11:00
The end of the 1950s was a period of rising living standards, summed up by Harold MacMillan's 'you've never had it so good' Yet, this period of undoubted prosperity and rising living standards helped to mask a decline in the relative competitiveness of the UK economy.Whilst our competitors like Germany, Japan and US roared ahead, Britain lagged behind. Our productivity growth was inhibited by both stuffy 'old school tie' managers unwilling to innovate and bring in change, and unions increasingly confrontational and belligerent. Industrial relations resembled more a war zone than anything meaningful and productive. Whilst Japanese workers sang company songs with zest and loyalty, British workers were more likely to be working to rule or plotting the next strike. Industrial relations certainly weren't a one way problem. But, the break down in industrial relations threatened the future competitiveness of UK industry.It was left to the Socialist Barbara Castle (an MP I admire) to...
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CPI Inflation Targets in UK
2010-02-17 11:05:00
Yesterday, the ONS reported that CPI inflation jumped to 3.5% in Jan. This record jump was partly influenced by the impact of rising VAT from 15% to 17.5%.But, stripping away temporary factors, is an inflation rate of 3% good news or bad news? A little inflation is much better than the threat of deflationAround the world, Central Banks have an inflation target of 2%. But, the costs of having an inflation rate of 3% are only marginally higher. A higher inflation rate would enable higher nominal interest rates and thus give Central Banks more manoeuvrability in cutting interest rates in the case of a slump we witnessed recently.More analysis at - Optimal Inflation RateRelatedThe Twin threat of Inflation and Deflation
Post War Economic Britain
2010-02-16 09:18:00
Pre War - It is worth remembering how bad the economic situation was before the war. Mass unemployment started in the 1920s. There was deflation, and falling wages which precipitated the great national strike of 1926. The Great Depression only exacerbated the problem of unemployment and poverty. As writers such as George Orwell memorably depicted in The Road To Wigan Pier - The 1930s was also a bad time to be unemployed - unemployment insurance was meagre, means tested and inadequate. Basically, in the 1930s, there was no welfare state, no universal health care - just mass unemployment, especially in the north.It was this grim period of the 1930s, that raised so much hopes that after the war things would really be better. A key element for this new hope was The Beveridge report which laid the foundation for the modern welfare state and the abolishment of poverty. Beveridge was not a socialist, but, a liberal. Yet, his vision of a universal welfare state laid the foundation of post w...
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Tobin Tax Proposal
2010-02-15 14:07:00
Some 350 economists (including Joseph Stiglitz) have signed a letter proposing a modest 'tobin tax' on speculative dealings on shares and currency movements. The tax would amount to 0.05% of transactions. "This tax is an idea that has come of age. The financial crisis has shown us the dangers of unregulated finance, and the link between the financial sector and society has been broken. It is time to fix this link and for the financial sector to give something back to society."This money is urgently needed. The crises of poverty and of climate change require an historic transfer of billions of dollars from the rich world to the poor world, and this tax would offer a clear way to help fund this." (from Independent)More on advantages and disadvantages of a Tobin Tax
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An Economic History of Modern Britain
2010-02-15 13:56:00
I've been enjoying watching Andrew Marr's BBC programme- A History of Modern Britain - from rationing to punk rock - from Enoch Powell to Arthur Scargill - modern Britain had everything (and at times, surprisingly violent into the bargain). You also realise how much economics influenced, life, living standards, politics and society. Looking back over the turbulent past few decades also puts the current economic crisis into perspective.This week I will be writing a brief and potted Economic history of Modern Britain.Economics of the 1920s - a legacy of war debt, deflation and life under the gold standardEconomics of the Great Depression 1930s - the economics of mass unemployment.This week:Economics of the 1940s and 1950s - Austerity, rationing, war debt, but full employment, new welfare state and rising living standards.1960s - The 'You've never had it so good era' starts to unwind.1970s - The Era of Discontent. Strikes, 3 day weeks, inflation, boom and bust. The 70s had everyt...
Steps to Avoid Future Financial Crisis.
2010-02-10 11:35:00
The current financial / economic crisis should be focusing the minds on economists of how to avoid a similar repeat. It will be difficult - human nature is unlikely to be changing in the near future. For example, we always have potential of more irrational behaviour and false exuberanceAlso, it is not a new situation, housing boom and busts seem to be, unfortunately, quite common - Why Boom and bust in Housing markets are common.Yet, though we cannot prevent any boom and bust, the magnitude, length and duration can be limited by a thoughtful range of policies.Better Mortgage ProductsIn the boom years, banks (especially in US) were offering teaser mortgages. - A great introductory rate for first year or two. Then the interest rate shot up. These teaser rates encouraged people into a false sense of hope they could afford mortgages. When teaser rates expired - then the problems began (see: subprime crisis). Legislation against teaser rates would avoid this.See also: Paul Krugman (NYT)...
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Problems With Spanish Economy
2010-02-09 09:41:00
There are many similarities with the problems of fellow Euro member - Greece. But, there are differences.Uncompetitivenesssource: Spain's problem P.KrugmanThe Spanish economy has become increasingly uncompetitive. Wages have risen faster than other countries leading to a decline in relative productivity. This has led to a decline in demand and rising unemployment. Again, like Greece, Spain has no ability to devalue to regain competitiveness.Boom and BustSpain had a spectacular boom - focused on housing and construction. This led to a rise in house prices and a rise in house building. Though Spain avoided the irresponsible subprime mortgage markets (in fact Spanish bank - Santander has made great strides in capturing market share in the UK), the rise in Spanish house prices was punctured, leading to a large fall in prices. Unlike the UK, Spain has now a large stock of surplus houses that nobody wants. This excess supply will depress house prices for much longer than in the UK.The fa...
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Debt Hangover
2010-02-08 21:09:00
Definition of Debt Hangover - A situation where agents (firms, governments, individuals) hold too much debt holding back normal economic activity.Definition of Debt Overhang - a similar situation. Debt overhang occurs when the interest burden of existing debt is greater than the profit the firm can generate from its core business. Debt overhang was a situation faced by many banks during credit crisis.Debt imposes the cost of debt interest repayments. A high level of debt increases the cost of servicing debt. If this cost of paying debt interest payments is too high then firms may be reluctant to invest and individuals reluctant to spend - governments may have to increase tax. Thus debt can be a constraint to economic recovery.A further problem is when debt interest payments are so high, firms or individuals lose hope of ever getting on top of their debts so are encouraged to default on debt.At the moment the cost of our debt hangover has been diminished by the record low interest ra...
Problem With Greece Economy
2010-02-08 10:21:00
As I mentioned last week, the Eurozone is far from being an optimal currency area. The current recession has made the difficulties of the Euro become more prominent - especially for the peripheral areas of the Eurozone - Portugal Ireland, Italy Greece and Spain.The Problem s Facing Greece are:Rising Government Debt to over 100% of GDP. A budget deficit of 12% for this year. This level of debt has started to make markets wonder whether the government might default. This fear has led to people selling Greek bonds and pushing up the interest rate. Greek debt is now much more expensive than German Debt.Uncompetitive Economy . The Greek economy is uncompetitive. Rising wages have not been matched by rising productivity. THe lack of competitiveness has led to a fall in demand for Greek goods and a very large current account deficit (imports greater than exports)No Ability to Devalue. If Greece had their own currency, the currency would devalue to help restore competitiveness. But, being in ...
Comparison of Recessions
2010-02-01 10:38:00
Graph showing comparisons of - A graph showing scale of different recessions in UKNote in the Great Depression output in UK fell 10% (In US GDP fell by 30% - but UK did not have boom in 20s or 30s - UK unemployment was already high by 1929.)In terms of GDP fall, the UK recession is the worst since the Great Depression. It is also the longest (6 consecutive quarters). Last quarters growth of 0.1% is so feeble it means it could have easily have been 7 quarters.Another feature of this great recession was the rapid fall in asset prices in 2008. A fall in asset prices is often an indication of a depression - rather than just recession. This is one reason why so many economists were worried in 2008Yet, other factors suggest it could have been worse.Comparing Unemployment, the rise has been relatively modest given output decline.source: B of E (pdf)See also: Why is UK unemployment not higherAlso, a positive sign for this recession, is the relative recovery ...
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Inflation Spikes
2010-01-27 11:19:00
We have been in the longest recession since the great depression, so it is somewhat suprising to see a rise in inflation. This includes both the RPI and CPI measures. CPI is 2.9%, RPI is 2.4%. When the inflation rate rises above 3%, the governor of the Bank of England has to write a letter of explanation to the Chancellor. He is already drafting a response as the Bank of England expect inflation to peak at over 3%, when the rise in VAT from 15 to 17.5% is included.Why Inflation ?Depreciation in Sterling makes imports more expensive. About 40% of goods are imported, when the pound devalues as it did in 2008/09, it makes imports more expensive.It is a reflection that prices fell in December 2008 by 0.4%. By contrast last month they rose by 0.3%.Oil prices rising relative to 2008Factors which aren't causing Inflation?Quantitative Easing. You might expect that if you create £200bn of electronic money this increase in money supply should cause inflation. However, money supply growth is ...
UK Bank Tax
2010-01-26 11:08:00
Since the 1970s, the UK government has been generally unwilling to subsides firms. The free market logic is thatGovernment subsidies encourage inefficient firms to remain inefficient.Subsidies encourage firms to expand beyond the economically efficient output. (remember the CAP was a government subsidy to farmers which led to all those wine lakes and butter mountains e.t.c)This logic explains why many UK industries had subsidies removed and were allowed to go under if necessary (e.g. British coal).There is a certain economic logic to this. As an economist, I would only justify subsidies if the industry had positive externalities to society. E.g. Trains help to reduce congestion on roads and pollution. Therefore a larger subsidy to train travel would be justified on this grounds. But, generally there is a real danger subsidies could lead to inefficiency and are wasted resources.So what about the Bank bailout? Is that not a subsidy? The answer is Yes - a contingent subsidy, but still ...
Better Off on Benefits?
2009-09-23 12:17:00
The poverty trap occurs when there is no incentive to get a better paid job because of the lost benefits, and increased taxes and other costs.The unemployment trap occurs when there is no incentive to get a job because, you are better off on unemployment benefits than working.Reading our local newspaper, the Oxford Mail, I was intrigued about their story suggesting many single mothers said there was no point for them to get a job. Quite a few people interviewed said, they would like to work, but, if they did they would be worse off because of the lost benefits and extra costs involved.For example, one mother said that currently she received £70 a week benefits (£40 of income support and £30 child tax credit. She is also exempt from paying council tax (about £800 a month) and her rent of £75 a week is paid for her. In addition their are many benefits in kind for people on income support (free prescriptions).If you include the free rent, the government is paying over £150 a wee...
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Interest Rate Forecasts 2010 and Beyond
2009-09-22 08:54:00
Readers Question: Where can I find a reliable forecast of interest rates over the next 5 years. I have seen wild claims of everything from a minus figure in 2010 to 15%. I am interested in likely mortgage rates. Is it likely that interest rates could rise by 1% a year over the next 5 years?Predicting interest rates is difficult. At the start of 2008, when interest rates were 5%, and inflation was above the governments inflation target, how many people would have predicted within 12 months, interest rates would have fallen to 0.5%?Like many economic factors, interest rate forecasts are more likely to be accurate in the short term than the long term. I think most economists would be reluctant to forecast interest rates more than 1 or 2 years in advance. To predict interest rates in 5 years time, you might as well throw a couple of dice - hence the variety of interest rate forecasts you may have come across. In fact many economists are reluctant to get into forecasting because you are ...
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The Problem With Saving
2009-09-21 10:14:00
As many taxi drivers will tell you, the problem with the economy is we got ourselves into too much debt. - Too much personal debt, too much corporate debt and too much government debt.So since debt is such an intrinsic part of the current crisis, it is perhaps counter intuitive to explain why debt is not always bad and a rise in savings may create problems as well as benefits.Source: B of E quarterly report 2009 (web link)As this graph shows, saving ratios fell since 1995. Even adjusted for inflation, the saving ratio fell to record levels in 2008. The graph also shows the decline in personal wealth - mostly linked to falling house prices and to a lesser extent falling stock markets.However, the factors that caused a fall in the savings ratio have been reversed and the savings ratio is likely to rise sharply over the next few months / years.These factors include:Greater uncertainty over unemployment. Fear of unemployment encourages people to save as a precautionary measureLower asse...
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Rise In Youth Unemployment
2009-09-17 11:31:00
The first signs of economic recovery are welcome, but, it can't hide the fact there is a huge amount off spare capacity in the economy. And perhaps the worst feature of this recession is the sharp rise in youth unemployment. Statistics suggest 1 in 5 of 16-24 year olds are unemployed. The number of jobless in this age group rose from 928,000 to 947,000. (link)It suggests that unemployment is worse than official figures suggest. Using the claimant count method we have an unemployment rate of 8%. But, this hides the people who are economically inactive but not counted as unemployed. It may also reflect demographic changes that are causing a shrinking working population at the older age group.Total unemployment rose 210,000 to 2.47m in the three months to July, taking the jobless rate to 7.9% as measured by the claimant count.RelatedUK Unemployment rateUnemployment in the UK
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US China Economic Relations
2009-09-16 09:07:00
The relationship between China and the US reminds you of a couple permanently squabbling with each other - but no matter how much they find fault with their partner, they know they couldn't live without each other.China and US is a classic love hate relationship. It is an intriguing example of how economic ties can bind in a way that political ideology never could.Statistics for US China Economic Relations .The US has a large trade deficit with China. In 2008, it stood at $268 billion. (US trade deficit stats)For every $1 China spends on US goods, US citizens spend $4.46 in China.Exports to the United States account for 6 percent of China’s entire economic output.US exports to China account for 0.5% of US GDP. In a trade war, there would be one clear loser. (China US trade at NY Times)Because of this large trade surplus China has substantial foreign currency reserves. With these foreign currency reserves, China has accumulated $2 trillion in foreign reserves, mostly in Treasury bo...
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