Brad Setser

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Cross border flows, with a bit of macroeconomics

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US economic policy does not pass the Chinese test

by Brad Setser
November 22, 2004

You could sort of see this headline coming: China tells the US to put its house in order.

Lenders never like receiving lectures on sound economic policy from their borrowers.

John Snow might have been well served if had asked the Europeans to leave the G-20 meeting (temporarily) and then started his comments with “my creditors, thanks for $400 billion plus in 2003, and, I hope, something similar this year.” As Steve Roach noted today, we need China to keep lending to us at low rates to keep our current credit fueled expansion going —

Still, it seems the Chinese are getting a bit cocky. We knew China was going after the Carolina (textiles) and even Ohio (autoparts). But Kansas and the rest of the agricultural Midwest? The logic behind the statement that “The appreciation of the RMB will not solve the problems of unemployment in the US because the cost of labour in China is only 3 per cent that of US labour they should give up textiles, shoe-making and even agriculture probably” is, I suspect, a bit off as well. Some agricultural production is labor intensive, and China may have an advantage — apple picking and apple packaging, for example. But never underestimate the power (the efficiency) of a tractor, a combine and a big expanse of flat land …

China is right to note that the US — and US policy makers — bear primary responsibility for the US trade deficit. But China also needs to recognize that the US cannot import more than it exports indefinitely. The explosive growth in China’s exports to the US will have to slow unless US exports to China really, really take off — and it won’t happen unless the US exports a few things other than planes.

For the past ten years the US has consumed more than it produced. In one or another, the US and the world will have to adjust, now or later. Adjustment will likely require more than just a smaller US budget deficit; the real exchange rate also will need to adjust. Chinese wages won’t continue to be 3% of US wages forever. If the exchange rate stays constant, the adjustment will come through some combination of Chinese inflation and US deflation. Far better, in my view, to let the exchange rate move.

China is right to note that the process of closing the current account deficit will be much harder if the US does not get its house in order: even considering ways of excluding the extra borrowing needed to finance the partial privatization of Social Security from the reported budget deficit sends the wrong message. Borrowing is borrowing; someone still has to lend you the money, accounting gimmick or not. But I hope China’s policy makers also recognize that it is in their own interest to think through the steps they can take to support domestic Chinese demand should US ever start taking their advice to tighten its belt.


  • Posted by Debbie Kennedy

    Is there some way to protect the savings that some of us have currently? Unlike most Americans, I have been a saver, not a spender.


  • Posted by glory

    hmmmm… but isn’t US agricultural heavily subsidised? (like in most of the rest of the industrialised world?) and i just saw this blurb in the WSJ: “The USDA predicted farm imports next year will equal exports, marking the first time since the 1950s that the U.S. failed to run an annual agricultural surplus.”


    “The agency said the steep rise in agricultural imports was ‘the result of higher prices of popular value-added products.’ Two-thirds of the increase in farm imports since 2002, the USDA said, came from seven categories of goods: ‘essential oils’ used in food- and beverage-processing, snack foods, wine and beer, red meats, processed fruits and vegetables, fresh vegetables and miscellaneous grocery products.

    “The vast majority of those products – around 75% – came from the European Union, Mexico, Canada, China, Indonesia, Brazil and Australia, the USDA said.”

    so, doesn’t look too good for the USTD…

    debbie, they’re some ideas in this post 😀


  • Posted by IJ

    The Economist had very informative article last month about the disorder in exchange rates. “The Fund’s [IMF’s] original mandate was to manage the orderly adjustment of the balance of payments between its members. The G7 usurped that role at the Plaza hotel [in 1985], but no one performs it now.”

    The article goes on to mention a research paper that proposes the introduction of effective control over the management of global economics, if of course there is consensus that globalisation should be managed. This is a huge ‘if’.

    Where can this be discussed officially? The G7/8 may be the only forum.

  • Posted by calmo

    Is this the lull before the storm? The absence of support for the falling dollar from Japan and China was not given much attention by the media. There is the jawboning and then there is the inscrutable postures of these 2 major players.
    Maybe it is not quite at that tipping point as General Glut points out ( 100y, not 105).

    Much has been made of the deficits driving this uncertainty but not much of Iraq and the idea that Europe, if it comes to the support of the dollar to save its own currency, is in effect financing the military action in Iraq.

  • Posted by General Glut

    Brad, I thought the line from Li deserved some extended commentary, too (click on my name below). Suffice to say that there will never be enough world-wide demand for airplanes, satellites and travel services to pay for all the clothes, shoes, TVs and furniture Americans import.

  • Posted by brad

    debbie — i don’t give investment advice. you should talk to a pro. there are definately options out there — unhedged bond funds that invest in euros/ yen are one, everbank is another, etc. there was a thread on this stuff on delong’s webpage a few days back. the key is funds that do not hedge — you want the euro risk in this case.

    the challenge now is that the safest currency diversification strategies — i.e. buying euro/ euro denominated assets — may have run much of their course. logically, the next major adjustment should come v. east asia, and it a bit harder to diversity into east asian currency risk than euro risk (unless you want equity risk as well).

  • Posted by brad

    Glut — there is also the small matter of airbus, which apparently is going compete directly with boeing on the 7E7 market segment.;jsessionid=2QTOVB3QMORZ4CRBAEZSFFA?type=businessNews&storyID=6896585

    boeing looks to be giving the super-jumbo market to airbus (no new 747 derivatives to compete with a380, or even just to update the 747). its 150 seater is based on an older design than the a320 (though the 37 of today is basically a new plane). And brazil and I suspect others who make regional jets are eyeing the 100 plus seat market too. that said, airbus has a lot of us content (engines, etc).

    I don’t think we have to stop importing consumer goods by the way. logically, we could import some consumer goods and oil in exchange for a range of other things — including aircraft, and perhaps high end consumer goods (italians export lots of suits). but what is clear is that our imports of these goods cannot continue growing at its current pace — which is a problem both for us, and for those in e. asia investing now on the assumption that nothing will change over the next five years.

  • Posted by ahu

    I would like to learn what you think about the idea of rebalencing of demand in the world to solve the US C/A problem. Obstfeld and Rogoff has a paper about this: “the Unsustainable US current account position revisited”.
    it does not seem possible to me that US will stop consuming, and it seems even less possible that Asia will start consuming more…

  • Posted by IJ

    “You could sort of see this headline coming: China tells the US to put its house in order.”

    The paper that ‘ahu’ mentions was discussed in the Economist last month. University research papers from the US have been saying similar things in the past, but they haven’t had much effect on Treasury policy. This alone raises interesting questions about the political acceptability, and therefore value, of research on economics at the nation’s intellectual centres.

    Anyway, the article is at:

  • Posted by brad

    Will it be possible for the US to stop consuming (or at least slow the rate of increase in consumption) — absolutely. what has to happen will happen: if the financing is not there (or more expensive), the us will consume less. if import prices go up, the US will import (relatively) less. Just look at what happened in brazil and argentina — both went from running large current account deficits to running significant surpluses. Will it be easy — I fear not. Changing established patterns is not easy.

    Same is true in Asia. Remember that pre-97, Asian countries were running current account deficits to finance their boom — many of the economies have always been export oriented, but large, structural current account surpluses are a fairly recent phenomenon (UBS did some work on this). Will it be easy for asia to shift from producing for a rapidly growing US consumer market to producing for (one hopes) a rapidly growing consumer market in asia (not that there is not one now, but clearly, consumption has not been growing faster than income, and that is what needs to happen)? Who knows.

    But policy choices both here in the US and in Asia could make the shift harder, or make it easier — one hopes easier, one fears harder. IJ, hey, the academics try. Rogoff has not exactly had a low profile But academics the world over only have influence when those in office lend a receptive ear …

  • Posted by IJ

    Rebalancing the world economy is one of the themes of an article this week at ‘’.

    It questions whether rebalancing on the existing rules is practical. The claim is also made that the United States is the only nation in the world (of nearly 200 nations) that sticks to the economic rules of the ‘Washington Consensus’. But what about the rules of the United Nation, eg the IMF Articles?

    Extracts from the article are:
    “In reality, the national ambitions and competitive energies of globalization, at least as currently practiced, persist in developing new productive capacity–more factories–faster than they generate rising incomes and adequate demand to absorb the surplus of goods. This leads inevitably to falling prices and stiffer pressures for cost reductions. The convenient remedy–somebody, somewhere has to shut down factories–has typically begun by closing America’s and moving its high-wage production offshore for cheaper labour. The resultant political backlash has manifested itself through ongoing complaints about “offshoring” during the most recent Presidential campaign.”

    “But the [USA] is about to be seriously affected, at which point something more than the piecemeal (and soon to be widely ignored) remedies put on the table after the recent G-20 summit in Berlin will be required.”

    More problems for the G7/8, in the absence of the IMF?

  • Posted by brad

    IJ — have a different take than you on the imf. tis true that the imf has a very loose affliation with the UN system, but it is VERY loose. IMF has its own governing articles (founding treaty) and its own governance system: the IMF works on a one $ put in, one vote principle, not on a one country, one vote principle. So in practice, the G-7 countries have the majority of the votes on the IMF board.

    That said, the IMF does face some serious challenges dealing with the US (and with big emerging economies with tons of reserves like China). The IMF’s leverage recently has come when it lends hard currency reserves to countries that are short reserves during a crisis. China obviously has no shortage of reserves, so IMF has no leverage. And US is so big (absolutely, and relative to the IMF … )– and so capable of borrowing funds from abroad without the IMF’s help — that the IMF has no real leverage over US policy, at least traditionally.

    Want to write more on what the IMF should be doing to further global rebalancing — it is an interesting question. I suspect it means going back to Keynes founding structure, and the notion that “surplus” countries (China) as well as deficit countries (USA) should adjust — china to increase demand, US to reduce demand — to limit the risk that adjustment in the deficit country alone = hurts global activity. Whether the imf has the leverage needed to exert such a role is an open question; it looks increasingly clear though that relying on the us alone for global economic leadership is a very risk proposition.

  • Posted by IJ

    Brad – an interview with someone recommending a system not unlike ‘Time dollars’ was on BBC radio this morning. Such systems have their roots many decades ago when unemployment and the threat of instability were high – it was a way of exchanging labour in the community.

    For example, taking a dog for a walk might entitle a person to five credit points, which could then be exchanged for, say, a haircut. Money changed hands only if materials were involved.
    The website is:

    There were about 1,000 local currency systems worldwide back in 1995.

    It is interesting that publicity is being given to this now. Moreover the website says it has government support. Clearly the idea needs considerable refinement if it is to be a big employment provider in the future; however, as prudentbear suggests, the present form of globalisation will have difficulty holding onto political support in some countries.

  • Posted by Daniel

    There’s something more at work than galloping US consumption. US consumption actually has not grown outlandishly in the past several years. What has changed is the steady offshoring of US consumer goods manufacturing. When perfectly profitable firms like Rubbermaid are abruptly forced to the wall because Wal-Mart doesn’t think they’re getting a good enough wholesale price, there’s a major problem. I realize this may sound like hyperbole, but Wal-Mart’s pursuit of profits is a major cause of the US trade deficit. When a firm gets to the point that it is doing $260 billion plus in sales, and is five times the size of its nearest competitor, and indeed handles one-seventh of all retail transactions in the US, it can abuse its suppliers however it wants. Wal-Mart represents a form of market failure that needs to be addressed and soon.

  • Posted by Mark T

    The US household IS saving as a look at the Fed flow of funds data immedaitaly shows. The savings ratio is simply a measure of current income and expenditure, it takes no account of the state of the balance sheet. Saving is done for 3 reasons, pesnions, precaution and speculation. If your pension is fully funded and you have precautionary insurance then whether you “save” or not depends on your appetite for risk and speculation.With negative real rates of return on cash, most of america is consuming now rather than specualting. There is plenty of balance sheet for deferred consumption (pension)The rest of the world has had its pension raided (UK), is unable to get a real return on capital to mantain its value (Japan) or has just realised that the govt was lying when it said they had a pension (europe) THEY are all saving (not consuming) like crazy and the US is the only place that will buy their goods. The debt the US is selling is going up in price and the goods they are buying are coming down. Looks like the US has got all the pricing power. The problem is with the rest of the world, not the US

  • Posted by Josh

    When a firm gets to the point that it is doing $260 billion plus in sales, and is five times the size of its nearest competitor, and indeed handles one-seventh of all retail transactions in the US, it can abuse its suppliers however it wants. Wal-Mart represents a form of market failure that needs to be addressed and soon.

    Your wish is the market’s command:

  • Posted by IJ

    More on rebalancing the global economy.

    In praise of the market, Stephen Roche comments (document linked on the Nourbini website):
    >Financial markets have an uncanny knack in restoring a sense of order to a dysfunctional world. The dollar is now center stage. . . But dollar depreciation is not the endgame of global rebalancing. It is the means toward the end — a potential trigger for a long overdue realignment in the mix of global saving and consumption. By failing to face up to the imperatives of rebalancing, the world has collectively created the ultimate moral hazard — a US consumer that is now “too big to fail.”< Mr Roche suggests intervention. His answer is to increase US interest rates, which in turn will cut consumption there. Jude Wanniski agrees with intervention. However Mr Wanneski thinks the answer instead is to re-establish the link between the dollar and gold.

    Both solutions will no doubt slow the growth of the global economy, and cause much harm.

    Perhaps the UN’s IMF has a view?

  • Posted by Guest