Accounting Identities and Trade

This post draws in large part on M. Pettis, P. Krugman, and S. Roach

To think about trade lets start by understanding that China's government engages in massive capital export, accumulating foreign assets funded with domestic liabilities. It does this in part due to restrictions on capital inflows.

Two basic accounting identities:

Capital Account + Current Account = 0

Current Account = Domestic Savings (Prod- Cons) - Domestic Investment

So, China has a capital account deficit, and thus a current account surplus - so we can say it exports its savings to the rest of the world. Thus, the rest of the world must import savings and spend in excess of what it produces. This is an accounting necessity.

Note - we can further break this down into:
Households + Business + Government + Current Account (foreign) = 0.

So if households and businesses decide to run a large surplus, then the governement and foreigners must run a deficit.

The accounting identity for the capital account is therefore : Domestic Investment - domestic savings (prod - cons). In other words, a country borrows the excess of its investment over its domestic saving.

This also means that domestic savings - domestic investment = current account.

Note - this says nothing about causality. If (Krugman) argues that foreign currency intervention forces China to export capital, then other must import it. If Chinese are forced to save, then either domestic or foreign entities are forced to borrow. If American's went on a consumption binge, someone must sell them their goods.