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China in the global production system
A schematic flow of funds
When people imagine the future of the international monetary system, as they are wont to these days, their arguments often take as given a specific hegemonic role, currently played by the United States and its dollar, and then propose a new order that gives some or all of that role to China and its renminbi. The country’s economic power and global influence do continue to rise—the recent struggle to contain the Omicron outbreak notwithstanding—and so, the argument goes, there are reasons to think that China could swap into the top spot.
I think this misreads the situation, but I don’t think I can prove the whole point in one newsletter post. Instead, let me try to improve the conversation more generally in the hope that we will all arrive at the right answer together. In this post, I offer a schematic flow of funds analysis for China, simple enough to sketch on a napkin. To demonstrate its utility, I argue that invoicing energy commodities in RMB does nothing to address China’s dollar FX hangover.
China in the international monetary system: the missing T accounts
These T accounts show China’s macrofinancial flows at the highest macroeconomic scale. They use sources and uses accounting, which is helpful because it easily captures flows of spending, like consumption, that get used up rather than accumulated.
I have put this together using three sectors, two for China and one for the rest of the world. Domestically, we can think of a sector of households absorbing wage and profit flows, spending on consumption and accumulating savings in the form of domestic credit. All other economic activity within China (business, government, finance) I consolidate into a second sector:
Note how investment is recorded. I think of some Chinese businesses as selling investment goods to other Chinese businesses, so both sides of the transaction are in the non-household sector. The sale of investment goods is a source of funds to the businesses who are selling, and in a national-accounts framework, it is recorded as part of GDP and labeled as investment. This investment spending represents some forty percent of national product, and so is a major source of household incomes.
That same spending, thought of now as a use of funds to the business that is buying investment goods, I record as capital formation, an increase in the stock of the means of production. Capital formation must be financed, but households buy a lot of domestic credit instruments, and so plenty of financing is available.
Finally I show a simple structure for gross international trade, which I take to be entirely in dollars, a simplification but not a huge one. China runs a current-account surplus, so exports are bigger than imports, and the balance is accumulated as dollar-denominated international credit instruments. The non-household sector includes China’s central bank, where much of this dollar credit was accumulated. These days it is accumulated elsewhere in the country’s financial system.
RMB invoicing for energy inputs
The shortcomings of this presentation are evident: it does not show the financial system, it shows gross trade flows (both exports and imports) but not gross international capital flows, it shows only dollars and not euros or yen, etc. It is an extreme simplification of a hugely complex situation. Despite these shortcomings, however, this simple picture of China’s macrofinancial flows does offer some help with the questions that are on people’s minds.
For example, in March of this year, there was talk of Saudi Arabia invoicing sales of oil to China in renminbi. How would such an invoice be paid? China could emit renminbi-denominated credit, but there is no sign of this happening yet. Or the country could offset RMB-denominated imports with RMB-denominated exports. But again, we do not see this happening, and even if it did happen, it would not amount to a new international monetary system.
What the accounting shows is that the story has to have two sides, funds coming and funds going. As long as we are only hearing one side, it’s just talk.