Chieuropa?
The thesis that China and America should be viewed as a single economy – or at least as a single currency area – is due for a comeback.
After flirting with change, the RMB is once again pegged tightly to the dollar. 6.85 is the new 8.27. I would not be surprised if China’s external surplus and the United States deficit prove to be roughly equal in size in 2009 The obvious argument is that while the US runs a big deficit, Chimerica doesn’t. East Chimerica’s surplus offsets West Chimerica’s deficit. No worries. At least so long as China’s government is willing to finance the US.
The fact that the Chimerican currency union required unprecedented growth in China’s reserves was always my main objection to the Chimerica thesis. A currency union in theory shouldn’t require that kind of government intervention to keep in balance.
But Chimerica never was really financially integrated. Back when the RMB was (correctly) considered a one way bet, China erected capital controls to keep American (and other) capital from speculating on its currency. And for most of this decade, the net outflow from China to America came not from a desire on the part of Chinese savers to hold dollars but rather from a desire of China’s government to hold the Chinese currency down against the dollar. That policy required that China buy dollars in the foreign exchange market, and in the process finance the US deficit.
However, another objection may be more important. The argument that Chinese and America formed a perfect union – with US spending generating demand to offset Chinese savings, and Chinese savings financing the borrowing associated with US spending – hasn’t quite worked for the past couple of years. It leaves out Europe. And Europe, not the US, was the big spender in the world economy in 2006, 2007 and the first part of 2008.
My colleague at the Council’s Center for Geoeconomic Studies, Paul Swartz, has produced a clever graph (available on the CGS website) showing that the growth in Asian exports hinges on the growth in US and European imports. Makes sense. Paul also plotted Asian export growth against American import growth and European import growth separately — and the chart of European import growth against Asian export growth highlights just how large Europe’s contribution to Asian export growth has been recently.
This shouldn’t be a surprise. The depreciation of the Japanese yen and Chinese yuan against most European currencies over the past several years (and yes, I know that things changed in the past few months) was the big currency move of the past several years – at least as economically significant as the depreciation of the dollar against the euro. That depreciation produced the expect result: a surge in European imports from Asia, and a big increase in Europe’s deficit with Asia in general and China in particular.
That is a clear change from earlier this decade. Back in 2003 and 2004 and even 2005, it really was the US consumer that was driving the expansion of global demand.
The coupling of China’s export machine to European demand explains why China’s exports and surplus were both able to increase over the past couple of years even thugh the US non-oil deficit peaked in late 2005/ early 2006. It doesn’t take that much leg work (the data tables at the end of the IMF’s World Economic Outlook are always a good place to start … ) to figure out that a swing in Europe’s current account balance made this possible.
Let’s say that the US runs a $500 billion current account deficit next year, and the United States’ bilateral deficit with China is around $250 billion. Let’s also assume that China runs a $500 billion current account surplus next year (that makes the math easy – and it isn’t out of line with China’s November trade surplus). That implies that China is running a big surplus with the world not just the US. And Chimerica only works, in some sense, if China lends the (large) surplus it earns with the non-Chimerican world (and Europe in particular) to the US, allowing the US to run a deficit with the non-Chimerican world.
To make everything (too) neat, let’s assume China runs a $250 billion surplus with Europe and its trade with the rest of Asia and the oil exporters is balanced. And let’s assume that Europe runs a $150 billion surplus with the US and a $100 billion surplus with the oil exporters (offsetting its deficit with China) – and that the US has a $150 billion deficit with Europe and a $100 billion deficit with the oil exporters.
That simplifies a lot. It leaves out private inflows and outflows for one, which can drive China’s reserve growth above or below its current account surplus. It also leaves out Chinese purchases of European assets and European purchases of US assets. It ignores intra-European flows – and reduces Asia to China.
But it captures something important as well. China’s surplus can expand even in the absence of a rise in the United States deficit if Europe’s deficit rises, for one. And in my little thought experiment, the global flow of funds only balances if China lends its surplus with Europe to the US.
Or, to put it a bit differently, if Chieuropa lends to the US …
Chimerica – US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the Chinese produce goods and services that fiat dollars can buy at “market prices” quoted in dollars.
The vast expansion of US-led globalized trade since the Cold War ended in 1991 had been fueled by unsustainable serial debt bubbles built on dollar hegemony, which came into existence on a global scale with the emergence of deregulated global financial markets that made cross-border flow of funds routine since the 1990s. Dollar hegemony is a geopolitically-constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars, not backed by gold or other species since President Nixon took the dollar off gold in 1971. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973. After that, everyone accepts dollars because dollars can buy oil, and every economy needs oil. Dollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank. Dollar hegemony enables the US to own indirectly but essentially the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little monetary penalties. World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the Chinese produce goods and services that fiat dollars can buy at “market prices” quoted in dollars.
Despite all the talk about globalization as an irresistible trend of progress, the priority for the United States in the final analysis has been to advance its superpower economic objectives, not its obligations as the center of the global monetary system. This superpower economic objective includes the global expansion of US economic dominance through dollar hegemony, reducing all domestic economies, including that of the US, to be merely local units of a global empire. Thus when the US asserts that a healthy and strong economy in Europe, Japan and even Russia and China is part of the Pax Americana, it is essentially declaring a neocolonial claim on these economies.
The concept of “stakeholder” in the global geopolitical-economic order advanced by Robert B. Zoellick, former US Deputy Secretary of State and now president of the World Bank, is a solicitation from the US to emerging economic powerhouses to support this Pax Americana. The device for accomplishing this neo-imperialism is a coordinated monetary policy managed by a global system of central banking, first adopted in the US in 1913 to allow a financial elite to gain monetary control of the US national economy, and after the Cold War, to allow the US as the sole remaining superpower controlled by a financial oligarchy to gain monetary control of the entire global economy.
http://atimes.com/atimes/China_Business/JG30Cb01.html
Given the Rothschild agreement with Bank of China, Investments made by Citigroup and other banks to set up shop in China; the future private flow might be to borrow at near zero rates in the US and lend in China. The major constraint in expanding Chinese consumption is infrastructure. It’s hard to induce consumption in rural hinterlands where telecom connectivity, transport linkages, irrigation facilities,power supply, etc are all a big question mark.
World development — China’s capital controls continue to make it hard to move funds from outside china into china. And there is no shortage of domestic chinese savings to finance more domestic Chinese infrastructure …
The economic headwinds Bernanke is facing are ferocious. Consumer debt is at an all-time high, more than $13 trillion. And, as journalist Stephen Lendman notes, “As a per cent of GDP, total credit market debt is now double its 1929 level at about 350 per cent.” We have reached peak credit, a tipping point where consumers are forced to curtail spending and hunker-down for leaner times. The conventional strategy of pump-priming with low interest credit or stimulus checks from Uncle Sam will only soften the blow from the hard landing ahead. The fear of job loss, insolvency and even destitution is gnawing away at the psyche of maxed-out consumers. Hardship is reshaping attitudes towards spending. Bernanke’s “zero down”, “no doc”, “adjustable rate” easy money is out of step with the times. Profligate consumption is no longer cool. With Housing prices crashing and the Dow Jones on track for its worst year since the Great Depression, people are no longer feeling flush. In fact, tumbling property values have chopped a hefty $4 trillion from household balance sheets already while wages have continued to stagnate.
The Fed’s persistent price-fixing and market interventions can only succeed as long as there’s a reliable pool of speculators willing to borrow capital and put it to work to turn a profit; that’s the basic premise of bubblenomics. With the financial system deleveraging, the broader economy contracting, and commodities, stocks and housing flat-lining; there are fewer and fewer opportunities for even the most risk-tolerant investor. That’s why Bernanke is planning to force-feed credit into the system via untested methods that, many believe, will engender hyperinflation when the recession winds down. If the economy kicks in faster than Bernanke figures, he’ll have to mop up $8.3 trillion of liquidity or watch while the dollar gets torn to shreds.
By allowing the banking giants to conceal their mountainous debts, Bernanke and Paulson are following the same spotty path to disaster creating a zombie financial system that depends on regular infusions of state largesse to maintain operations and avoid liquidation. It’s a lose-lose situation. It is now clear that policy makers in the United States are determined to apply every available resource to underpinning failure, misallocation and executive excess. The market has failed, and officialdom is collaborating in perpetuating that failure.
http://www.counterpunch.com/whitney12172008.html
I certainly agree with the Chiamerica thesis. There may have been two reasons why the US was a better initial partner for China: 1) younger population easier to sell consumer commodities vs. Europe needing services, 2) easier to shift high paying manufacturing wages from US.
If globalization must preceed in stages, then maybe we are at end of Stage 1 Chimerica and Stage 2 is in fact Chimericaope. I don’t see the ‘merica’ being tossed out the side.
Asset bubbles served two functions: 1) US worker shell game – reduce income for increased paper wealth, 2) mechanism for humongous (that would be the technical term) capital flows. Problem with Europe/China is that asset bubbles aren’t available, so what might the next set of techniques look like?
Question: so if China capital controls make it difficult to move funds from outside China to inside, how were Chinese huge raw material purchases financed? Understand that much of this was export-oriented infrastructure, but how are capital controls for export-infrastructure vs. internal-infrastructure investment manifested?
@ Brad:
Chimerica is a great linguistic invention! The broader direction of US foreign policy is FDI in major growth sectors in India and China; FDI laws are the operational blocks for converting China into an OCA.
1) India:
The medium term foreign policy objective in India is to have sectoral FDI caps removed altogether.
1 a) Banking: State owned banks in India have a 20% FDI limit and it’s about to be reached. Profitable segments of banking in India have already been penetrated by foreign banks; such as retail lending for housing, autos, and credit cards; plus, you guessed it … extravagant weddings. State owned banks in India conduct policy-directed lending to sectors such as agriculture, education, etc that aren’t too interesting right now.
1 b) Growth sectors:
Telecom, Retail, Mass Transport Systems, Airports, Ports, Highways, Bridges, .. are the growth sectors. All these sectors are being aggressively targeted for import growth and FDI.
1 c) Telecom: Congressional Telecom committee’s currently is negotiating to remove 74% FDI cap on Telecom in India, to help Verizon’s (etc) entry into the 3G space.
2) China:
2 a) China’s banks – efforts are on since 2004 for FDI stakes, recent moves are of note: Rothschild has negotiated with Bank of China for entry into retail lending (yet to be approved by CBRC). Bank Am recently hiked their ownership to 20% in one of the biggest banks in China. Citigroup owns controlling stake in Guangdong development bank. One of the Japanese banks was also bidding for stake in a China bank.
I have a number of links on FDI in Chinese banks and will try to post them.
2 b) Treasury continues to negotiate on FDI with China. Other than banks I’m not sure about FDI levels in any industry in China.
Why is all this baloney better than import tariffs?
Bank Am recently hiked their ownership to 20% in one of the biggest banks in China
And use TARP money to do it. The big US banks are hoarding a lot of cash now , which is going to be used to scoop up crashed assets globally in a few years.
From casinomics through chickenomics to pinballnomics. Call it Liquidity, Chinese or even German (these days) trap, eating own tarp does feel odd.
Brad,
Those who think that the China and US economies are joined in any way other than the way predator and prey are joined is remarkably ignorant. Last year China exported more than 4 times as much to the US as it imported, and the ration this year will probably be worse. China steals US industry by lending to the US. US gives away industry by borrowing from China.
Moreover, the ideologies of the two governments couldn’t be more different. China supports dictators no matter how brutal (e.g., Sudan, Burma, N. Korea) and fears democracy. US promotes democracy and opposes evil.
The real parallels, drawn on Wednesday by Michael Pettis (see my blog for the link) are between China and Germany. Both are trade surplus countries that are not participating in the global stimulus packages except in ways that beggar-their-trading-partners.
He holds the exact same view as me about the macroeconomic outcome of the United States stimulating its economy without addressing trade. He wrote:
“The overconsuming trade-deficit countries cannot reduce their overconsumption except with a collapse in production (and sharply rising unemployment) if the overproducing countries do not also adjust.”
Howard Richman
http://www.tradeandtaxes.blogspot.com
when submitting posts – i never do the sum.
so the system rejects my post – but i then immediately submit again, doing the sum which is now the current sum, and not, as before, the last sum but two or three.
my text is always intact upon returning to the thread.
Correction: Pettis doesn’t hold the exact same view as me as far as what actions should be taken. He shares the same understanding as to what the dynamics are in the world economy today.
My view is that if the solution to the United States economic problem is balanced trade, not stimulus packages. Stimulus packages are causing the United States to lose much of its remaining industry. (The impending Detroit bankruptsies are just the first of many to come.)
Were we to balance trade using Warren Buffett’s Import Certificates plan, we would again be prosperous.
here is an interesting thought experiment – in what way would chinese-american trade relations have been different in the last few years if instead of pegging its currency china had simply dollarised its economy?
or to put it another way, germany runs a big surplus with other eurozone countries. is this good, bad or indifferent?
answers on a postcard please..
china is too big, too far away, and too culturally different.
you only have to look at the time and expense that it took west germany to absorb and harmonise with east germany, to see that. two economies so much closer in prosperity and language, and in immediate proximity.
if the production line workers of china, as opposed to the elite, were employed at the same wages and living conditions – but in america – it would be seen as a return to slavery. or suppose that slavery had been reformed instead of abolished ? it might not now look a lot different from current chinese conditions.
in america such a chinese underclass, once it had become indispensible, might unionise, strike, or revolt – for better terms. so maybe it might do the same thing in china ?
the bankers and multinationals may reach the political limits of sinoamerican wage arbitrage before they run into purely financial or currency limitations ?
outsourcing may not cause unemployment in america or in europe – but how long before the radical left starts to tell people that it does ?
globalisation may suffer a pause or a retreat for a decade or two. i think that that has happened before ?
gillies.
pay and work conditions for the urban working class is largely a function of the elasticity of supply of cheap migrant labourers coming off the land.
thus has it ever been.
gillies – “globalisation may suffer a pause or a retreat for a decade or two. i think that that has happened before?”
Yes indeed. We have been down this path before. The End of Globalization: Lessons from the Great Depression, by Harold James, is one of the essential books to understand what’s happening.
gillies: china is too big, too far away, and too culturally different.
There are a lot of commonalities. One is that both China and the United States have a lot of internal diversity so one challenge is to define a national identity that merges those differences.
gillies: you only have to look at the time and expense that it took west germany to absorb and harmonise with east germany, to see that. two economies so much closer in prosperity and language, and in immediate proximity
On the other hand, you didn’t have too many people in one germany get educated in the other during the cold war. Part of the commonality between the United States and China comes about since you have large numbers of Chinese educated in the United States and absorbing the culture.
gilles: if the production line workers of china, as opposed to the elite, were employed at the same wages and living conditions – but in america – it would be seen as a return to slavery.
Actually no. Wages are low but so are costs, and the important number is what you are making now versus what you otherwise would be making. Also, lots of Chinese are employed at low wage, low skill jobs in the United States, as any visit to a Chinese restaurant will illustrate.
gilles: in america such a chinese underclass, once it had become indispensible, might unionise, strike, or revolt – for better terms. so maybe it might do the same thing in china ?
If you can plausibly argue for better terms. The trouble is that you can’t.
bena:
or to put it another way, germany runs a big surplus with other eurozone countries. is this good, bad or indifferent?
Depending on what you call ‘running a big surplus’ am I allowed to say it’s wonderful?
Think Mercedes-Benz. DaimlerChrysler AG was formed 1998 when Daimler AG acquired Chrysler. The structural change was a shift of auto assembly and component manufacturing to Japan, China, Korea, etc. The Daimler side streamlined all their processes and systems and expanded into markets in 13 countries in the Asia-Pacific region. The Daimler factory was in Stuttgart I think and they later set up in East London (South Africa) and later in China. Meanwhile Chrysler VPs toured the world making speeches about the changes but I don’t know how much they did to develop a truly global footprint. Even as the Mercedes Benz came to be used as a Taxi cab in Singapore, I find it hard to name the global markets for Chrysler predominance.
Dc sold a majority stake in Chrysler to Cerebrus in 2007 and continued to retain only ~20% of Chrysler, renaming itself as Daimler AG. Consolidation of the books of a corporation which dominates large swathes of its industry across Europe, APAC and the rest of the world in German Corporate HQ is what I call ‘running a big surplus’. And at least in this case my humble opinion is that it’s really wonderful.
“And at least in this case my humble opinion is that it’s really wonderful.”
everyone’s allowed their opinion, especially when it’s humble.
at the risk of being labelled a luddite, in mine humble eyes, the new benzos look & feel like every other piece of cheap plastic crap that litters the roads these days.
instead, for my FED notes, give me one of those old-school W123 models with the single-block bulletproof diesels with less than 200k miles on it and i’ll have that baby running ’til all the bubbles pop.
we may not realize it now, but one of those cars will have more *value* someday soon than DAG’s entire 20% of C (speaking of int’l ponzi schemes)…
…especially if you live close to a chinese restaurant and can say ‘may i have your grease please?’ in cantonese…
but i digress.
Chimericaope rules…until it doesn’t.
what kind of logic is this? Chinese produce things and lend money while Americans spend and borrow money. It doesn’t make sense to me. If Americans can’t sell their goods or services to China, the only way left is to cut spending. Americans have to decide where they want to put their limited resources to produce the maximum use value for themselves. Reducing consumption on unnecessary,discretionary and non-environmentally friendly goods aren’t really bad. It reduces import from China and reduce pollutions in both China and the US.
For my view, bailout auto sector is just the same as bailout of financial sector. The government should bailout people instead of business and put money in good use such as alternative energy, technology, research,science,education etc. It also needs to maintain certain degree of social justice. Social welfare is needed not only because it could generate consumption immediately from the poor but also give people some hope for the future and reduce social cost. It’s one of the most efficient way to redistribute the wealth from the rich to the most needed.
Expanding balance sheet probably will not solve problems this time. By solving short term problem, the fed is committed to create long term problems again this time. It also prompted governments all over the world to loosen their monetary policies to be in line with the US. So far, nothing has been done to strength the regulatory body of the US financial sector. Consumers have no confidence that their government will save them. We are heading towards an unknown territory.
Ying: For my view, bailout auto sector is just the same as bailout of financial sector. The government should bailout people instead of business and put money in good use such as alternative energy, technology, research,science,education etc.
The problem with that approach is that it’s useless to have alternative energy technology if you don’t have an auto industry to manufacture cars with that technology. If you just spend money in research and don’t have a financial system and industrial system to use that research, you end up with great ideas that never go anywhere.
Ying: Social welfare is needed not only because it could generate consumption immediately from the poor but also give people some hope for the future and reduce social cost. It’s one of the most efficient way to redistribute the wealth from the rich to the most needed.
You then run into the non-trivial problem of figuring out who do you give money to, and how much do you give them. If you rush then chances are you are going to do it wrong, and in some situations very wrong.
Ying: So far, nothing has been done to strengthen the regulatory body of the US financial sector.
Which regulator do you want to strengthen and what do you mean by strengthening them. Right now, the focus in the US has been on emergency measures because it simply cannot make non-emergency decisions without a new Congress and President in charge. Once you do have a new Congress and President, then it will take a year to figure out what to do, because once people get past the generalities and into the specifics (who, what, and how) it gets very messy.
The problem with the concept of “Chiamerica” is that it really implies that there is somehow this special relationship between China and the United States. You can just as easily talk about “Chieuropa”, “Chindia”, “Indiropa”, or “Mexicmerica”.
Pick any two places in the area that Thomas Barnett calls the core world and you’ll see that they are very, very tightly linked. What makes it complex is that you have close linkages but complex linkages. If you look at US-China relations, they are close but different than US-Mexico, US-Canada, Mexico-Canada, China-Europe, etc.
I really don’t think that it makes any sense to think of nation-states as the primary unit of economic activity. It makes more sense to think of the world economy as a single unit in which nation-states are parts of integrated whole.
bsetser: Back when the RMB was (correctly) considered a one way bet, China erected capital controls to keep American (and other) capital from speculating on its currency.
No. Capital controls were put in place during the era of central planning when the RMB was basically valued at a state fixed rate that had nothing to do with the actual market value. The official exchange rate in the 1980’s was 3 RMB to 1 dollar, which meant that there was a huge black market for dollars.
bsetser: And for most of this decade, the net outflow from China to America came not from a desire on the part of Chinese savers to hold dollars but rather from a desire of China’s government to hold the Chinese currency down against the dollar.
Because in 1993, when China moved off the old central planning system, the conventional wisdom was that emerging markets needed to peg their currency to the dollar. It wasn’t until 2002, that this started to break, and changing currency policy isn’t something you do overnight.
Also there is this underlying assumption that somehow there is a “natural” value of currency that is independent of government action, which doesn’t make any sense to me. The reason the dollar dropped in the early 2000’s was because of US government fiscal and monetary policy, and there is this odd idea that somehow US state action that resulted in a drop in currency is legitimate while Chinese state action to do otherwise is illegitimate.
bsetser: . A currency union in theory shouldn’t require that kind of government intervention to keep in balance.
That’s not true. Currency unions require massive government coordination and intervention to work. Look at how difficult it was (and is) to create the euro.
bsetser: The depreciation of the Japanese yen and Chinese yuan against most European currencies over the past several years….
This actually points out one reason why I don’t think that most of the discussion about the trade deficit with China really wasn’t about the trade deficit. What in 2003, was everyone talking about China and no one talking about Japan, which had broadly very similar policies.
Two reasons:
1) During the early 2000’s China was the new “evil empire.” China sort of became the symbol of a rising power standing for what America was against, and so the trade deficit was just part of this view of China.
2) There were also specific trade issues that were new and had yet to be resolved. In the 1990’s, Chinese manufacturing massively increased and there as a lot of adjustment to be done.
Both those factors are gone. I don’t think that the United States views China as an “evil empire” any more largely because the neo-conservative view of the world that saw China in those terms has been so thoroughly discredited by the Iraq War. The US has human right issues with China, but the US also has human right issues with Saudi Arabia, Pakistan and Singapore.
The other factor is that deals have been made. No one complains about Japanese auto imports because deals were made, and the in the main industries with Chinese imports, similar deals have also been made.
One other thing is that you have to look closely at language because the terms that people use have some deep and subtle assumptions about the way the world works. For example the notion of “government intervention” has the assumption that the action of the government is “unusual”, “unnatural”, and “abnormal.” I’ve never heard people talk about “market intervention in the government.” Take a piece of text that talks about “intervention” and replace it with “regulation” and vice versa.
The interesting thing about a lot of this language is that it is designed around assumptions about how the world should work and how the world does work that have totally fallen apart. There is this idea that there is this market that somehow acts “naturally” to distribute goods and services and that any state action to change how the market operates is bad unless proven otherwise.
Having assumptions is not a bad thing. Thought because impossible otherwise. But one does have to be very careful in times like this when no one has any clue what is going on that one shouldn’t be trapped by the assumptions.
[...] Notes on China/United States trade Filed under: china, finance — Tags: china, finance — twofish @ 10:47 am http://blogs.cfr.org/setser/2008/12/19/chieuropa/ [...]
2fish — china’s capital controls were initially designed more to keep funds in than to keep money out; controls on inflows were tightened once specultive pressure for appreciation started to build. and the intellectual consensus on exchange rate regimes for emerging markets started to change well before 02. dollar pegs were widely considered a cause of the crisis in asia — and caused no shortage of trouble in russia and latam as well. i was a party in this debate while at the treasury, so i can provide no shortage of references.
the us it is true wanted china to keep its peg rather than devalue v the USD in 97/98. but that was not because of conviction in dollar pegs. rather it was because the rest of asia needed to devalue against something, and korea got more bang for the buck with a won that was weak v both the USD and the CNY than a won than was just weak v the USD. the key point then is that China was pegging to an appreciating currency.
and finally, the eurozone has plenty of government intervention, but capital flows to italy aren’t financed by a buildup of german reserves. rather they come because italian gov bonds offer a premium over bunds. intra-european capital movements don’t balance because of central bank intervention inside the currency area. I take the point about coordination of policy among europeans — but this is still a key difference.
@Brad: As you say there might be sufficient domestic savings in China for infrastrcuture investment. Then do you have an explanation for the data above? Negotiations on with China for FDI liberalization and increased FDI levels in China’s banks?
Secondly I’d like to know your opinion if possible on cause-effect relationship between credit expansion and current account imbalances. My thinking is that classical economists thought of credit expansion as the cause and current account imbalances as the effect. In a gold standard world deleveraging leads to a run on gold reserves and forces immediate re balancing of current accounts. That’s not true in a non gold standard world. We’ve seen systemic banking crises in the UK (1970s) US (S & L – 1980s), Japan (1990s) etc and as far as I can see it didn’t lead to an immediate re balancing of current accounts.
Most importantly I think that availability of long term credit at say 6% doesn’t automatically mean that people will borrow more than they can comfortably service with their cash inflows. While lower interest rates reduce cash outflows for a given amount of debt, a rational borrower should see the interest rate independently of the cash outflows they can provide for servicing.
[...] http://blogs.cfr.org/setser/2008/12/19/chieuropa/#more-4211 [...]
bsetser: The intellectual consensus on exchange rate regimes for emerging markets started to change well before 02.
True, but once you’ve committed yourself to an exchange rate system, you can’t suddenly change just because the intellectual consensus has changed. And if the intellectual consensus changes once, it can change again.
The reason that the Chinese government was slow to move on exchange rates just like everything else is that it didn’t want to be in a situation where the academics come back after a few years and say “oops, it looks like we were wrong about appreciating the RMB a few years back, sorry for destroying your economy.”
Once you’ve decided to make a major policy decision like changing exchange rate systems or invading a country, it’s impossible to turn back time. This is why the Chinese government moves slowly so that if something bad happens, it can roll things back. This puts them at cross purposes with a lot of academics that want to burn bridges precisely to make political and economic change irrevocable.
The idea is that if you don’t move quickly then the “evil hardliners” might take control and roll back the changes. The problem here is what if the “evil hardliners” happen to be right.
bsetser: The key point then is that China was pegging to an appreciating currency.
And therefore a pegged currency was beneficial to US exports whereas it isn’t if the currency is depreciating. China should peg when it is good for the United States for it to peg, and it should float when it is good for the United States for it to float. It’s not unexpected for the US Treasury to come up with policies that are in the US interest, what is strange to me is the huge amount of effort that is spent denying that this is the case.
There is nothing wrong with the US advocating policy for its own self-interest. The strange things happen when the US tries to argue that it is doing thing in the name of principle or in China’s self-interest, at which point it destroys the credibility of that principle.
bsetser: and finally, the eurozone has plenty of government intervention, but capital flows to italy aren’t financed by a buildup of german reserves. rather they come because italian gov bonds offer a premium over bunds. intra-european capital movements don’t balance because of central bank intervention inside the currency area. I take the point about coordination of policy among europeans — but this is still a key difference
Key difference for what? If the name of the game is to say that what Europe is doing is legitimate and what China is doing is illegitimate there is no shortage of things that you can point to.
One thing you can argue is that Europe consists of multi-party parliamentary democracies that therefore everything it does is good, and China has a one party state and so everything it does is bad. And people did argue that.
But I’m not sure what the point of this argument is. The United States has shreded its own economic and political credibility over the last decade, and so it is not in a position to persuade countries to do anything because “Uncle Sam knows how to run an economy.”
It’s also not in a position to force China or Saudi Arabia to do anything, since the US economy is critically dependent on loans from China and Saudi Arabia, and that is very unlikely to change in the next few years.
China has really no need for foreign capital at this point since China has more capital than it needs. What China is really is interested in is technology and skills that are associated with that capital.
I do suspect that China is going to become increasing strict about FDI limits because increasingly it will be possible for China to get technology without FDI. This can happen through indigenous development or by having Chinese companies recruit overseas Chinese with international experience, or by having China open branch offices overseas.
Also the areas in which China is willing to open the door wide open in order to get technology are areas in which other governments don’t want to transfer technology. I’m sure that China would remove any FDI restrictions on having Intel design its latest chips in China or having Lockmart or Boeing manufacture high performance fighter jets in China, but someone else will say no.
Is the corresponding adjective “Chimerican” or “chimerical”?
I guess “Eurina” just isn’t as catchy.
@Twofish: I have a very basic thought question, would be nice if you or anyone else were to answer.
Why do current accounts need to be balanced? As long as it’s possible to finance the current account deficit, it should be fine, right?
I really don’t think that it makes any sense to think of nation-states as the primary unit of economic activity. It makes more sense to think of the world economy as a single unit in which nation-states are parts of integrated whole.
December 20th, 2008 at 6:36 am
Twofish – You are realistic most of the time but you really have a blind spot here. Nation states create the conditions that result in some countries’ economy growing faster than others because they have a trade surplus. Japan and China are the prime examples with other Asian states using the same strategy.
The notion that U.S. and China should be thought of as one unit also is not sensible. The U.S. IRS has no right to go to the residents of China and insist that they share with the U.S. the profits and earnings gained from their manufacturing sector.
Twofish: I have a very basic thought question, would be nice if you or anyone else were to answer.
Why do current accounts need to be balanced? As long as it’s possible to finance the current account deficit, it should be fine, right?
Good question. The U.S. trade deficit results in manufactured goods consumed in the U.S. being producedd overseas. This reduces the goods produced by the U.S. economy. Adam Smith was right when he said that the wealth of evey nations depends upon the guantity and quality of goods and services produced by the domestic economy.
A trade deficit reduces the wealth of that country in two ways – reducing the productive abilility of the nation, as described above, and by sending overseas the money needs to pay for the trade deficit.
Unbalanced trade can continue so long as the paying nation (U.S. in this case) can keep creating wealth internally or has a large storehouse of wealth created in previous generations. The U.S. has done both and thus has been able to sustain a trade deficit much longer than most economists thought possible.
When there was no strong nation state in China, foreigners came in and exploited the people. Memories of that event served the current leaders of China well. The refused to let foreigners come in and take over their country. More than any other nation, they limited access of foreigners to what their government wanted them to have.
So, Twofish, China has been the strongest nation state in recent history in that it defends the interests of China against all the rest of the world.
The argument of one world serves the interests of the stongest nation state.
China has adopted expansionary monetary policy recently. The goal of money supply for 2009 is set at 3-4% higher than the sum of GDP growth rate and inflation rate. The broad measure of money supply is targeted at 17%. Policy banks will also increase loans by 100 billion yuan before the end of this year. Commercial banks will be encouraged to invest in projects governed by the central government. The target RMB loan should increase at least 4 trillion yuan before the end of this year.
It also plans to strengthen monoline insurance sector by injecting capital and sharing risk etc. It plans to establish multilayer insurance trust and insurance organizations to serve small and medium companies and increase loans to these firms. For those who met the criteria as monoline insurance companies, no tax will be levied on them. It plans to establish monoline insurance system in rural area and develop various forms of guarantees to solve capital shortage problems.
It is going to increase consumer credit on cars, house and consumption credit in rural area.
It continues to increase multilayer capital market and uses market function to allocate resources effectively. It will increase bond issuance significantly especially for infrastructure projects, social housing, environmental projects and projects related to disaster effected area.
It is going to increase functions of insurance in the whole society. It encourages insurance business on car, health and retirement. It encourages insurance companies to use the proceeds to invest in infrastructure, communication and energy sector and projects in rural area in the forms of debt purchase.
It encourages financial innovation. By using loans for merger and acquisition,real estate trust and other various forms private investment, companies have access to more capital.
The bottom line is that China wants to develop a fully comprehensive capital market to facilitate the need of capital shortage in private sector. It gives banks, security firms and insurance companies more freeways to expand their markets and develop new business. By developing comprehensive monoline insurance companies, it hopes to diversify specific risk to systemic risk. It is still unknown whether this policy will sow the seed for bad loans in the future or help China to shift from export oriented economy towards domestically aimed development.
@ Reformer:
Thanks a lot. Why do you think it’s tough for the US to ‘keep creating wealth internally’? The Chinese have accumulated dollar denominated sovereign debt. It should be possible to keep creating that wealth indefinitely.
Of course Adam Smith in a gold standard world was right to be concerned.
It is going to be tough for the U.S. to “keep creating wealth internally” because past wealth creating ideas (in the financial sector) have blown up in their face.
The bubbles of stock market and housing were the means of creating wealth by creating debt. No longer possible (I hope).
Second, U.S. should reject this relationship because it reduces U.S. real wealth. The notion that wealth can be created free by some action of the government will also be seen to be false just like the previous reliance upon “instruments” by the financial sector. Real wealth will be created by goods and services created and sold by the private sector.
“6.85 is the new 8.27″ – great line !
World Development: Why do current accounts need to be balanced? As long as it’s possible to finance the current account deficit, it should be fine, right?
It really depends on the currency system. If you have a system in which only dollars are accepted for American goods and only yen are accepted for Japanese goods, then things have to end up balanced because if they aren’t either the US runs of out yen or Japan runs out of dollars.
However that isn’t the world we live in. It’s hard to get people in the US to accept Chinese Yuan whereas it’s very easy to get people in China to accept US dollars.
Given the currency system we live in in which the dollar is the world reserve currency and the currency of last resort, I think it would be extremely foolish for any developing country *NOT* to run trade surpluses with the United States. If are a developing country and you are not running a trade surplus, then you run out of dollars, and in a crisis, your economy will collapse.
I’d argue that the trade deficit actually benefits the United States because by having manufacturing done offshore, it leaves Americans free to do other things which generate more wealth.
ReformerRay: It is going to be tough for the U.S. to “keep creating wealth internally” because past wealth creating ideas (in the financial sector) have blown up in their face
I don’t think so. Think about the “dot-com boom.” There was a lot of craziness, misinvestment, and general stupidity, there.
But in the end, I think that if you add up all of accounts, you’ll find that far more wealth was generate by the companies that came out of the dot-com boom even if you could the insanity. And the insanity had a purpose in that no one knew in 1995, which industries would help the economy and which one’s wouldn’t.
Boom-busts are an inherent part of market economies. The trouble with this bust is:
1) the boom wasn’t directed into something particularly useful, and
2) the bust very nearly caused the economy to collapse
Also people like to “bash bankers” and say that we need to just give money to engineers and workers that generate real wealth and kill the bankers. The trouble with that idea is that if you look at any startup either high-tech or low-tech, you are going to find some banker funding it. If you come up with a brilliant idea, it’s going to be totally useless unless you have the capital to do something with it.
a lot of common sense up there from twofish.
on the subject of spin : i cannot see the chinese paying the slightest attention to being hassled about their exchange rate. mr. paulson and his advisors must be aware of this too, more than anybody. so either it is some kind of haggling preparatory to some future anticipated deal, or it is spin for home consumption, not aimed at persuading china at all.
each chinamerican transaction is a deal – so chinamerican trade in general is a deal – and a deal is in all cases the best possible one acceptable to both sides.
likewise i find the term ’stimulus package’ to be largely spin. in a deteriorating situation – the politically possible measures are almost invariably too little by the time that they come into effect. they thus slow the decline (whether of a corporation or a company) but do not reverse it.
the term for this process should be – ‘a soft lending.’
on the question of ‘freedom and democracy’ : more spin ? it never seemed to be an issue in the usaudi (!) economy.
Ferguson seems rather found of chimerical … presumably for the classical allusion, even if it suggests that Chimerica isn’t all that stable.
2fish — there is a plausible debate over whether China depends more on access to US markets than the US depends on Chinese loans … in some sense the shocks of the past year have reduced US dependendence on China (as the trade balance is poised to correct due to lower oil prices) more than China’s dependence on the US
and i sure hope that the US isn’t relying on new Saudi lending, as with oil at $40 (or less) there won’t be any. The us only needs Saudi lending if oil is high …
the US has an underlying stock vulnerability that is huge — as a major fall in Chinese or Saudi holdings would have a huge impact. but my sense is that the flow dependence next year will be substantially lower than in the past
ReformerRay: Memories of that event served the current leaders of China well. The refused to let foreigners come in and take over their country. More than any other nation, they limited access of foreigners to what their government wanted them to have.
There is a balance here. From 1949 until 1978, China economically cut itself off from the rest of the world, and that was a total disaster.
Also since 1978, the Chinese government has been quite open about adopting foreign ideas. Part of the reason that American academics like to talk a lot about “what China should do” and not so much about “what Japan should do” is that the Chinese government will listen to American academics whereas the Japanese government really won’t.
ReformerRay: So, Twofish, China has been the strongest nation state in recent history in that it defends the interests of China against all the rest of the world.
This is false. China has nowhere close to the power of the United States, and this is not going to change for decades. The United States is an amazing country because you can put total idiots and incompetent fools in charge of its political and economic system, and still not have it collapse.
China has had a good thirty years because it’s tried almost every political system imaginable over the last two hundred, and finally has come up with a mix that seems to have worked.
[...] Chieuropa? Brad Setser [...]
Two fish:
It is a value judgment who should get government assistance.
@ Twofish:
Think about the “dot-com boom.” There was a lot of craziness, misinvestment, and general stupidity, there.
Yes, and people said it was the end of the internet folks. I think there’s going to be more and more demand for structured finance people going forward. Imagine what it will take to start very close to scratch and convert large parts of rural China and India into modern human habitations rather than medieval swamps.
Trillions of bubbly CDOs financing electricity lines and telephone connections!
Ying:
“If Americans can’t sell their goods or services to China, the only way left is to cut spending”.
The U.S. should have started this along time ago. Everyone stopped talking about the “twin deficits” and “crowding out”.
Spending cuts and higher taxes are coming. I.e., they will be forced upon us.
Howard Richman:
My view is that if the solution to the United States economic problem is balanced trade, not stimulus packages.
Yes, there is no such thing as “free trade” but there is such an animal as a “dirty float”.
And unfortunately you will be right, i.e, a balance of payments will be forced upon us if nothing is resolved.
The “Taylor Rule” for the 3rd qtr is an ex-post FFR of (-)3.25%.
I’ve been reading Greenspan’s book “the Age of Turbulence” (haha)and he makes a couple of good points that are relevant to the discussion of the widening current account deficit/surplus across the world.
His first point is that the flow of goods and services across national borders has to be viewed in the context of the specialization of labor. It’s not merely that we are buying goods from China, we are also free to apply our labor in more value-added industries such as IT and banking. It is fully possible that we can go back to manufacturing shoes and TVs, but an opportunity cost would be incurred.
Secondly, the underlying phenomenon that forms the basis for the current account deficit is the growing leverage in American households, businesses and government. While the increase in foreign liabilities is merely a reflection of decreasing home bias of foreign capital, the growth of leverage (liability vs. assets) is a domestic phenomenon. The rapid growth of assets of financial intermediaries serves as a proxy for this growth in leverage of various economic actors.
So really, the growth of international trade is not harmful insofar as it helps free domestic labor for more productive uses, and the growth of international credit is merely a reflection of increasing domestic leveraging.
Brad: in some sense the shocks of the past year have reduced US dependendence on China
If the Chinese were to suddenly stop buying Treasuries it would cause a run on Sovereign US Debt. It would be an immediate choice between default and Weimar-style hyperinflation.
The real issue is not who is more dependent; the issue is whether the gradual re balancing can be managed smoothly in a reasonable time frame.
I’m hoping for an opinion on whether credit expansion causes current account imbalances, or is it the other way round?
World Dev. The end of Chinese purchases of treasuries would be a shock, but so to would the end of US purchases of Chinese goods … my point is mostly that relative to the time last year when China was maybe supplying $500b of credit to a US that was running a $750b deficit, in 09 it seems likely that China will be supplying a bit less credit and the us will be running a substantially smaller deficit.
I agree tho that the challenge is gradual rebalancing. but in the shortrun china seems likely to prioritize export growth over rebalancing, which means ongoing financing of the us.
Observer — the “value-added” in finance over the past five years is rather subject to debate.
What Greenspan leaves out is that the current division of labour between the US and China isn’t determined by the market, b/c the fx market between the US and China doesn’t clear. Rather it is a function of Chinese government policy, which has effectively favored the export sector over other sectors of china’s economy and conversely favored interest-sensitive sectors of the US economy over other sectors (by building up reserves, it provides the US with credit — lowering borrowing costs).
THe notion that the US had an intrinsic advantage building houses and selling China mortgage backed paper strikes me as a bit strange … and when you get down to it, that is more or less what comparative advantage at finance meant … what the US did have in the agencies was a technology for turning the best quality mortgages into an acceptable reserve asset.
@Brad:
I agree that Chinese intervention in foreign exchange has distorted the relative values of currencies. I think this is beyond debate. However, to the extent that we measure the value of currencies as the demand for labor in certain geographical regions, I think we also need to factor in the vast disparity in demand for labor in the different geographical regions within China itself. This bring up an interesting question for the Chinese, which is that should the wealthy East coast regions be allowed to impose somewhat of a ‘dutch disease’ effect on the labor costs of other underdeveloped areas? In other words, would the difference in labor costs and wealth be better reflected by adopting different currencies within China itself? And viewed in a broad context across nation states, wouldn’t the appreciation of the Yuan merely benefit other low-cost nations like Vietnam or India rather than serve the labor force of the US?
I also agree with your assessment that the valued-added in finance is very much subject to debate. However, would you agree that US financial institutions have better expertise, mainly experience and technology to serve as a conduit for capital? Whatever advantage the US has in finance right now may very well erode in the near future, but is there a bigger market in the US for financial intermediation (as measured by wealth and investment demands) and also greater financial knowledge (as reflected in the sophistication of IT platforms and financial models)?
you know, the true sophistication of the financial models that said levering up a portfolio of super-senior tranches of CDOS built out of subprime mortgages (which require a fiendish IT platoform to assemble, model and price) is very much open to question. My bet is that neither Chinese banks for US financial institutions did a very good job of allocating capital over the past few years.
Credit expansion in the US has largely been used for consumer consumption and speculation instead of productive purpose. The increase of consumer consumption is reflected in increasing current account deficit. The speculation is reflected in high leverage in institutions and asset bubble.
Credit expansion itself is neutral. It can be used to speed up technology innovation in very short period of time or deal with financial stress.
It’s very true that there is a limit to the usefulness of financial models. But on the other hand, the absence of financial models shouldn’t be taken as a sign of superiority. It’s interesting that a firm like Sequoia and other venture capital firms has had a lot of success in China, and not all of their success can be captured by having better financial software. The experience gained from having worked in the underlying industries also gives US financial professionals a big lead in credit decisions.
With the retirement of the baby boomers and the concentration of wealth in the US market, isn’t it also inherently natural for there to be more financial intermediary professionals in the US?
Ying responds:
Credit expansion in the US has largely been used for consumer consumption and speculation instead of productive purpose. The increase of consumer consumption is reflected in increasing current account deficit. The speculation is reflected in high leverage in institutions and asset bubble.
The desire to leverage is the reason why leveraging has occurred. If we look at this from a cause and effect angle, that’s the cause. No one forced LTCM or owners of McMansions to engage in such leveraging activities. The mere condition that foreign capital is available for these actors to engage in leveraging does not explain the motivate. Leveraging has been on the rise long before the Chinese started to invest in the Treasuries; let’s not blame the gun for the crime.
Corrections for Twofish –
Twofish is a very smart guy but when he tries to correct what I have said, he needs correction himself.
1. He said that any country that dose not ’t have a trade surplus with the U.S. will run out of dollars. Totally false. Yen can always be traded for dollars. That is what happens on the international currency exchange. When Yen are exchanged for dollars, the total of financial assets in the two countries do not change. Thus, no nation can gain wealth by exchanging currency. However, if a nation has a trade surplus, the trade deficit country has exchanged dollars for goods. If the goods are used to increase productivity, that is one situation. If the goods are shirts, shoes, pineapples or anything else that has a short life span, the surplus country, after 1year, has increased its wealth and the deficit country has consumed consumer goods. By this means, China transfers wealth from the U.S. to China.
2. “wealth creating capacity of U.;S. economy”. I said that the financial sector has lost ability to create wealth – that what they were doing blew up in their face. I stand by that statement. The finance sector was where all the money hungry young men went because that was where the bonuses were. The finance sector’s share of corporate profits has grown steadily since 1980, neatly replacing the void left by manufacturing. I claim the profits “earned” by the finance sector will drop like a rock (in the national accounts) because they can no longer book false profits assuming that mortgages will be paid. So much of the past “profits” will not reappear because the rest of us will not stand for a repeat of the whipping we have taken.
Instead of talking about this issue, Twofish talked about the dot-com bubble. That was was not a finance sector bubble. It was a bubble in laying fiber optic cable and IT software. It created “wealth” in companies like Corning Glass, until the boom blew up. Twofish did not explain how the finance sector will create great wealth in the future.
I have other responses to other Twofish comments, but not tonight. I am tired.
[...] are now seeing what looks to be “devil take the hindmost” behavior. China has quietly gone back to a hard peg against the dollar (as opposed to letting the RMB do what it would otherwise do, appreciate). This is very [...]
Ray,
Well said. I considered responding myself, but I have seen that debating with Twofish is unproductive, and he makes too many comments to take issue with many of them.
You are of course right. It is not necessary to run a trade surplus with the US to obtain dollars. It is not even necessary to run a surplus in goods. I dare say that there are countries in the Caribbean, for example, that run a goods deficit with the US, but obtain their dollars from tourism. Other countries will run trade deficits with the US balanced by transfers from migrant workers in the US, inward FDI etc.
A current account imbalance is essentially an intertemporal consumption trade. It is not possible to run a large current account imbalance permanently, but temporary imbalances can make sense. This is one reason why I reject mandatory balanced trade. But it is vital that the individuals that are accumulating obligations as the result of a current account deficit understand what they are doing, and I fear that, in the US and UK, the political process has obfuscated this reality.
It is not possible to run a large current account imbalance permanently, but temporary imbalances can make sense. This is one reason why I reject mandatory balanced trade.
Rebel Economist and I agree on many points. Same with Howard Richman. I salute our areas of agreement. But I am stubborn – like most of the commentators on this blog.
How long is temporary? The U.S. has had a trade deficit in goods every year since 1976. THAT IS 32 YEARS!!! I agree that it should not have happened but it did. The U.S. has so much wealth, in 1976, compared to other nations and increased its wealth (if we include bubbles)regularly that it was able to sustain a trade deficit for 3 decades. Those three decades were long enough to place the U.S. manufacturing sector in big, big trouble.
That is the reason I support mandatory balanced trade. No other way to get it. And it must be dictated by the U.S. Three decades of negotiation should have convinced anyone that negotiations is not the way.
TWOFISH SAYS: argue that the trade deficit actually benefits the United States because by having manufacturing done offshore, it leaves Americans free to do other things which generate more wealth.
This is a frequently stated position. It is possible to allow China and other low wage countries to produce goods in which they have a comparative advantage and for a country with more advanced technology (such as Germany and Japan) to produce the tools and machines and electronic controls used by the less developed countries. That is the strategy used by Germany and Japan. Germany and Japan both have a trade surplus with the world, in part because they can sell advanced machines and controls overseas.
Please notice, Twofish, that it is the manufacturing sector that produces that trade surplus. (other reasons exist for the trade surplus in those two countries – which will be ignored here).
The U.S. and Great Britain have been the dominant financial powers all during the last 3 decades. Why has that financial power not translated into a trade surplus for those two countries? Answer – the services that are traded across international borders have been less valuable than the goods traded. In 2007, the U.S. had a trade deficit in goods of 819billion and a trade surplus in services of 119 billion, resulting in a trade deficit of the two products of 700 billion.
The record shows that moving an economy into a more high-valued activity produces satisfactory trade (not a trade deficit) when the high-valued activity is manufacturing.
Twofish takes exception to my statement that China is the strongest nation state in the world right now because its government defends the interests of the country against all other countries.
His answer was a bald statement that the U.S. is stronger.
I will agree that the U.S. has a stronger military – today. But military superiority is emphemeral – as the U.S. will discover in the next decade, probably.
Adam Smith convinced me of two important lessions – the wealth of a nation ultimately depends upon the quality and quantity of goods and services produced domestically. All those who use Gross Domestic Product as the measure of wealth created by a nation in a given time period are implicitly accepting that viewpoint.
GDP excludes changes in market value of products (including values in the stock market). They measure only goods and services produced by the domestic economy.
Smith argues, correctly in my view, that armies and navies can be produced and equipted if a nation is producing enough of what we call GDP to be able to pay for all the military equipment (and to sustain the value of their currency).
U.S. GDP includes profits earned each year in the financial sector. These profits inflated U.S. GDP in recent years. I believe that era is over. Future GDP growth will not include “false” profits.
Future GDP will depend upon what the U.S. can produce. The manufacturing sector is the source of most of what the U.S. produces and sells overseas. The global economy will continue to grind down any economy that cannot sell somethning on the international market.
China is the strongest nation in the world right now because their manufacturing sector is the world’s most productive in selling on the international market. The quality of their educational system, the focus of their government in strengthening the manufcturiing sector means that they will continue to expand their manufacturing capacity in the years ahead.
The U.S. could imitate Germany and Japan, and find a way to live with China. But our leaders and our citizens are not willing to face reality.
Ray,
32 years does not surprise me at all, and the fact that the current account deficit has been around so long suggests that its cause is more American than Chinese. The US emerged from WWII as the wealthiest country in the world, but the terms of trade have steadily moved against it ever since. First Germany and then Japan, and now China realised their potential and emerged as competitors to the US, both making rival products and bidding up resources such as oil. The US can expect its standard of living to regress towards the mean (at least, the mean of developed countries).
To mitigate the severity of its relative decline the US has chosen to borrow. That is rational if abrupt change is painful, but it is essential that the borrower realises how they are able to live as well as they do. The trouble is that it is career suicide for any American politician or even central banker to be other than bullish, so that even when the constraints bind, people see no harm in borrowing until things get better.
Balanced trade would impose the abrupt adjustment immediately, but it would not make Americans richer unless they were shocked into an improved economic performance. It would also serve as a bad example that countries more inclined to protectionism would use as an excuse, and the USA has more to lose from restricted trade than any other country.
bsetser: THe notion that the US had an intrinsic advantage building houses and selling China mortgage backed paper strikes me as a bit strange … and when you get down to it, that is more or less what comparative advantage at finance meant …
Very well said. While it may be true that US banks are more sophisticated at securitization etc, how can this comparitive advantage ever be realized as a trade surplus? Only if the Chinese govt allows these institutions to function in China and passes finance-friendly laws like in the US.
It may be argued that this is actually good for China because the US banks can use their greater expertise and achieve superior allocations of capital in the Chinese economy.
But by now it is clear that US banks are essentially criminal enterprises who caused a misallocation of capital, in the process of enriching themselves.
Does anyone (besides Henry Paulson) really believes that China will allow these banks to loot China the way they have looted the US? And if not, then what good is the US comparitive advantage in finance for the trade deficit?
“It would also serve as a bad example that countries more inclined to protectionism would use as an excuse, and the USA has more to lose from restricted trade than any other country”.
Reducing U.S. imports to the level of U.S. exports cannot be a bad example to any one. All deficit nations should take steps to insure that they follow the U.S. example.
It makes a whale of a lot of difference what laws the U.S. passes to move toward equal trade.
My proposal, which I have repeated many times, is to restrict (not eliminate) imports from the 5 countries that were responsible for 60% of the U.S. trade deficit in 2005.
Changing U.S. trade policy so the U.S. can participate in global trade without reducing the Net Wealth in the U.S. or reducing the capacity of the domestic manufacturing sector is the most import action available to Obama.
He has a golden opportunity. But he must get the new law governing trade exactly right.
The restrictions must be produced from tariffs. The tariffs must allow for many imports into the U.S. The tariffs must be implemented gradually, 10% at first, increasing by 5 percentage points each 4 months. The Federal Reserve Board must be granted the power to delay implementation of any scheduled increase when they think the increase would produce excessive inflation.
The U.S. has more to gain and less to lose from restricting tariffs because the trade deficit is so large.
Error – I typed “tariffs” in the above sentence. “trade” is the word I want.
Someone compared the US and China as “two scorpions in a jar”.
Jack – My proposal is explicitly designed not to treat China as different from other countries. All five countries will be treated the same.
It is not necessary to harm China to benefit the U.S. Europe has replaced the U.S. as the main export destination for China. For the future, trade among Asian countries appears to be the growth source for all the Asian countries.
Protectionism and tariffs need a rethink.
My rethink is inspired by the article “The battle of Smoot-Hawley” in The Economist magazine, Dec. 20, 2008 pg 125. I knew before reading the article that this act caused recriporical tariff increases my other nations and that it helped prolong the depression.
I learned that the average rate on duitable goods was 40% BEFORE the act WAS PASSED and that the act increased tariff rates on 890 products and decreased them on 235.
My main conclusion, from reading this article, is that tariffs should not be set at different rates on individual products but should be set by some universal standard which would reduce imports to the level desired but would leave competition to determine which products survived to be imported into the U.S. Second, retailation is to be avoided, if at all possible.
World Development says: “The real issue is not who is more dependent; the issue is whether the gradual re balancing can be managed smoothly in a reasonable time frame”.
Bester responds: ” agree tho that the challenge is gradual rebalancing. but in the shortrun china seems likely to prioritize export growth over rebalancing, which means ongoing financing of the us.”
Why not advocate that the U.S. take charge of the needed rebalancing so as to see that it is done gradually and intelligently ?
“But by now it is clear that US banks are essentially criminal enterprises who caused a misallocation of capital, in the process of enriching themselves.
Does anyone (besides Henry Paulson) really believes that China will allow these banks to loot China the way they have looted the US? And if not, then what good is the US comparitive advantage in finance for the trade deficit?”
December 22nd, 2008 at 7:13 pm
No comment.
ReformerRay:
Excellent postings.