Reciprocal demand

A question from Yahoo! Answers:

What is the importance of the doctrine of reciprocal demand in the theory of international trade?

Depends on how you define reciprocal demand. If you consider two trading countries without considering the rest of the world, reciprocal demand is not necessarily a good theory. Take China and the U.S., for example. China has a substantial trade surplus with the U.S., so the reciprocal demand theory suggests that China must have a lot or demand for U.S. goods. Well, not really; China has a lot of demand for U.S. ASSETS (such as Treasury bonds). When it comes to goods, China uses its trade surplus with U.S. (as well as with EU and Hong Kong) to finance its modest trade deficits with Japan and Taiwan. Generally, though, China has been using its trade surplus to buy foreign assets…

Reciprocal demand is a good theory when you consider a single country vs. the rest of the world (i.e., exports create demand for imports from somewhere, not necessarily from the same countries the country in question exports to) and consider asset markets along with commodity markets (i.e., exports may create demand for imports, but they may create demand for foreign assets as well).

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