U.S. - China trade imbalance

[RC]

While some folks here are in an economics frame of mind, I would be very glad to see a prognosis (preferably in terms a child could understand) on this huge and ever-accelerating imbalance.

[John Self]

Er... first you're going to have to explain the status quo, to me at least, preferably in terms a child could understand... :oops:

[Jerkass]

Well--in its simplest form, China has frozen its currency, which has kept it from strengthening in response to its rapid economic growth, as it normally would have done.

This makes the renmibi (think I've spelled that correctly) artificially weak, and the dollar artificially strong--meaning it's artificially cheap for the US to import Chinese stuff, and artificially expensive for China to import US stuff.

As for American trade imbalances in general, I think many people don't understand that a lot of this is a symptom of being a large, wealthy country. We buy lots of stuff.

I hope that made sense.

[RC]

Right. The US buys lots of stuff. Do you pay, or is it on credit? My understanding is that the US trade deficit is not only to China, but to the world in general. If it's on credit, will not the credit at some point run out? If on the other hand the deficit is made up in dollars, will not those dollars at some point become unwanted, internationally? I just don't get how it can go on and on. It seems that at some point the world will want to somehow cash in the chips, at the source. I hate to show myself so iggerunt but I can't make head nor tail of this situation.

[Jerkass]

Well...don't think of it as the US government buying stuff from the Chinese government and making a big wholesale payment in US dollars. The "trade deficit" really only reflects normal business being transacted between the two countries. People/companies (and sure, government, too) in the US buy things in the regular course of business from people, companies in China. As long as people/companies in the US can pay for the stuff, the people/companies in China agree to sell it. There is some credit involved in this sort of transaction, of course--banks for the people/companies issue letters of credit and that sort of thing--but it's just normal business. It's not like people in other countries are lending stuff to us..."here, you can borrow this banana, but I may call for you to give it back at some point."

Really, it appears to me that the trade "deficit" can be carried as long as people in other countries want to sell stuff to people in the US. It's only a reflection of business transacted across borders, and it shows that people are selling more stuff to the US than the US is selling to them. I don't think this should be surprising.

The budget deficit is something else entirely. It does in fact represent spending above income (an actual deficit), and someone needs to think the government is capable of paying back its debts for someone to finance them. Nobody seems too concerned about the government paying back its debts, it doesn't appear--because people keep buying up the debt. Really, it does turn into a system of the government issuing debt to pay off debt, which can of course turn into a problem if people suddenly think the government isn't capable of paying off the debt. I can't see any empirical evidence for this, though.

Christ, there I go again. Sorry.

[rick green]

Isn't that exactly why so many stock markets crashed in the 90's? Thailand, Korea, Russia and others if I recall. I mean because investors lost confidence in the banks/governments ability to return their deposits. There may not have been a run on the banks in recent American memory, but it has happened before.

[Jerkass]

Oh dear...now we've lumped currency markets, trade deficits, budget deficits, and emerging market financial system/currency devaluation/political crises all together into one big jumble. Even I can't see the way out now...

Er...er...Rick, please just take my word that we're talking about different matters here, although some of the matters we've discussed (particularly revaluations of fixed exchange rates) might have had a hand in some of these crashes you've mentioned...and please don't ask me to elaborate. You don't even have to believe me, if you don't want...but those crashes were not due to a weakening dollar, the US trade deficit, or the US budget deficit.

Also, I can't see anything in an orderly retreat in the dollar, a government budget deficit, or import/export imbalances that would create a US banking system crisis of the nature that occurred in some other markets.

[RC]

Oyoyoy, my head. Yes, the budget deficit. Peter Peterson, chairman of the Council on Foreign Relations and the Institute of International Economics, says:

The United States is now borrowing about 540 billion per year from the rest of the world to pay for the overall deficit funding Americans' consumption of goods and services and US foreign transfers. This unprecedented current-account deficit is paid through direct lending and the net sales of US assets to foreign business or persons: everything from stocks and bonds to corporations and real estate. The United States imports roughly $4 billion of foreign capital each day, half of it to cover the current-account deficit and the other half to finance investments abroad. At 5.4% of GDP (gross domestic product) in the first quarter of 2004, the deficit is substantially higher than its previous record (3.5% of GDP) in 1987, when the dollar fell by a third and the stock market took its "Black Monday" plunge.

Am I correct in thinking the principal creditor is China?
In common parlance I think that's called losing the farm. What are they thinking of? They surely must have a plan.

[Jerkass]

Here, the economist is now talking mostly over my head, as well. Either that, or my eyes glazed over half-way through. I will only note that the 'Black Monday' plunge he mentions was followed immediately (seriously) afterward by 12.5 years of stock market rally, which he doesn't mention.

Obviously, we have problems if people suddenly decide en masse (and the unthinking, herd-driven, momentum-based mentality pervasive in financial markets do tend to overemphasize moves in markets, sometimes) that they don't want US dollars for their goods, or that US bonds (debt) are not attractive assets. My only point is that there isn't any evidence of that at the moment. There also have to be more attractive assets out there to take the place of US bonds--and one of the reasons the US attracts so much "lending" from other places is that the US is perceived as the safest haven among all the alternatives.

But, anyway. I will summarize my views as: trade deficit = don't care. Budget deficit = not at point of causing widespread financial crisis at the moment, but would prefer to see it going down.

[RC]

Here is an article which discusses the issues in what I find to be a very lucid way:
www.counterpunch.org/roberts11162004.html

Roberts says:

Currency markets cannot correct the undervalued Chinese currrency, because China does not permit its currency to be traded and there are insufficient stocks of Chinese currency in foreign hands with which to form a currency market.
Sooner or later the peg will come to an end--perhaps when China fulfills its WTO obligations to let its currency float. When the peg ends, it will deliver a severe shock to US living standards. Suddenly, Chinese manufactured goods--including advanced technology products--on which the US is now dependent will cost much more. Overnight, shopping at Wal-Mart will be like shopping at high-end department stores.

---------------------------------

So then I guess the US can bring the factories home again, is that right? But to compete in world markets, will they have to keep a tight lid on wages?

Here in Canada, it hasn't been so long since a Made in China item was a novelty on a store-shelf. Then in a very short time, anything not made in China was rare to find. Now products from India are gaining ground. Seems like that will become an important new factor in the equation.

Off to the Wal-Mart now to stock up...

[Jerkass]

Oh no, we won't bring the factory jobs home again, because we still won't be the cheapest manufacturers in the world. If China floats its currency and causes this huge swell in prices for Chinese manufactured goods overnight, China will no longer be the cheapest manufacturers, and someone else, or several someone elses, will fill the gap.

I think the fundamental problem with the argument here is that the globalisation of markets and the dismantling of trade barriers (and the pegged renmibi is a protectionist trade barrier, although it has, as the Chinese have argued, other functions) have resulted in lower levels of prices over time, at least as a percentage of income. In the US, for example, spending on 'staples' (toilet paper, soap, etc.) used to take up 37% of disposable income; now, it's closer to 25%.

Floating China's currency properly, although it would result in higher exported prices for China's goods and therefore would be expected to result in higher prices around the world for Chinese goods, would then, due to these effects, slow down Chinese economic growth...which would, then, cause China's currency to decline. If everything moves according to the laws of supply and demand, international macroeconomic theories and such, of course.

One problem at the moment--one I didn't mention yesterday--is that you can't take moves in commodities such as metals, oil, or the dollar at face value...put another way, don't assume that such moves are rational moves based upon actual economic variables. The omnipresent-and-breeding-like-rats hedge funds, in an ever-more-desperate attempt to make easy money, have been piling in and out of such commodities and ridiculously magnifying moves, just as they have done with the US stock market in recent years. Oil, for example, recently trading around $55/barrel...normal historical relationships of supply, demand, and inventories point to a price closer to $30-35. I think the people who made money by bidding up oil ridiculously have now moved on to bidding the dollar lower over the past few weeks. After these moves happen, all sorts of experts pop up to explain why they've happened...when, in fact, most of these things are moving because they have been moving, so more people jump in, and they move more.

This is one of many reasons why I would like to see the hedge fund industry, first, regulated by someone (our SEC is just now getting around to it), and, second, shrivel up and go away. Unless one of them wants to give a bright young equity analyst a job in London, that is.

Anyway, sorry, I'm boring even myself now.

[Jerkass]

An important point in this article:

"When other countries conclude that their hoards of dollars represent claims that the US cannot meet, dollar dumping begins."

Not sure I've noticed any signs that the US won't be able to meet its debts, and that's where the alarmist talk falls apart, I think--but, if this happened, that would in fact be worrying.

[RC]

I see that the US House of Reps yesterday approved the raising of the national debt ceiling by 800 billion to nearly 8.2 trillion. That's the third rise in 3 years.
Calculated per head, each citizen is already $25 000. in debt.

[wshaw]

Thanks for this discussion. I've been learning much.

Maybe I'm being economically naive here (which is very possible) but I'm surprised you're not more concerned with the size of the budget deficit, Jerkass. Isn't the problem with a growing budget deficit simply that it radically restricts what governments can or cannot do?

Treat me gently here, because you clearly have a lot more knowledge about this stuff than I do, but if you're spending considerably more than you raise in tax then persumably a proportion of what you're taxing people for is simply to service the government's debt.

And - unless spectacular US economic growth wipes out the debt - doesn't that mean that in the long term either higher taxes or drastic spending cuts? As most in the West are reluctant to accept higher taxes, and as America is committing itself to spend an unusually high percentage of the pot on the military, doesn't that inevitably require swingeing public spending cuts on social security and Medicare?

And with a rapidly aging baby boom generation just approaching retirement age, isn't that a time bomb waiting to go off?

[RC]

Another dollar-related article I found intelligible, this time from the Independent (informationclearinghouse.info/article7343.htm).

I am startled to learn that the US dollar has lost 40% of its value in the last two years.

The more I read, the more I wonder at how calm the reporting continues to be. To me it seems like the poo is very nearly in the fan.

[Jerkass]

All right. Everyone look me up when we have a worldwide economic collapse because of the dollar settling back to its normal historical levels and because everyone suddenly decides the US isn't capable of repaying its debts.

When that happens, I promise that I'll say that you told me so.

[Maggie]

RC ---- JA

Are you two having a "One Year Anniversary" ? so to speak ?


Maggie