US and China Start Economic Meetings
The US and China opened their twice yearly Strategic Economic Dialogue with currency issues on the front burner:
BEIJING (AP) - The deepening world economic crisis and a possible spat over currency levels hung in the air as the United States and China sat down Thursday to discuss the future of their economic relations.
U.S. officials say Treasury Secretary Henry Paulson will press Beijing to let its yuan rise against the dollar to ease trade tensions at the two-day Strategic Economic Dialogue. American companies contend that China keeps the yuan undervalued, giving its exporters an unfair advantage and adding to its swollen trade surplus.
The Chinese sent a clear message earlier this week when they let the Yuan fall the daily limit against the dollar Monday and Tuesday. This is dangerous ground we are treading. US politicians have threatened tariffs before if China didn’t allow the Yuan to rise. They are apparently still convinced, despite the evidence, that we can devalue our way to prosperity. That hasn’t been a brilliant strategy to date but we seem intent on doubling down and finding that magic exchange rate that will solve our trade deficit “problem”.
Our trade deficit, if it is a problem at all, is our problem not China’s. It is in our power to solve the trade deficit or at least reduce it dramatically with no help whatsoever from our currency manipulating Chinese creditors. All we have to do is consume less and save more. The root of the trade deficit is not the exchange rate - it’s the savings rate. The Chinese have allowed their currency to appreciate by 20% against the dollar in the last year with no discernible affect on our balance of trade. That approach is obviously not working or at least not doing enough to dramatically alter the balance. The exchange rate does affect trade, but it is only one factor. If Americans continue to increase their savings and reduce their consumption the trade deficit will shrink.
Take a look back to the early 90s recession and you can see that when savings rebounded after the 1987 stock market crash, the trade deficit stablized and then shrunk into the recession:
As I said the currency has an effect too although evidence of it being positive is hard to find. From 1985 to 1988 the dollar fell by almost half and yet the trade deficit continued to rise:
From 1988 into 1989 the dollar generally rose and the trade deficit narrowed. From 1989 until the end of the recession the dollar fell and the trade deficit continued to narrow. What does that tell us? Not much. It’s tempting to say there is a lagged effect but that doesn’t hold up when you extend out to the 1990s:
The dollar was generally falling in the first half of the 90s and the trade deficit rose. The dollar rose significantly from 1995 to 1998 and the trade deficit rose more. The savings rate though was falling the entire time:
The exchange rate seems to be correlated sometimes and non correlated at others. It is obvioius that something else is driving the trade balance. The changing savings rate would seem to be a better explanation.
We have no leverage with the Chinese anyway. China holds about $800 billion of our debt and we can’t afford to tick off our biggest creditor just as we are about to spend a lot of money we don’t have. If we don’t get it from China, where exactly are we going to get the money for this economic recovery, infrastructure pork, green investment spendathon? It seems to me that China holds all the cards right now and Paulson is likely to have little success in convincing them to sacrifice their export business just so some politicians can brag about how they forced the bad Chinese to fix their currency to solve our problem.
The last thing we need right now is a trade spat with China. Imposing tariffs against Chinese goods would merely punish US consumers by rasing the price of imorted goods at a time when we have enough problems paying our bills. Yes, it will hurt China too, but don’t we want to export things to them? If we reduce imports from them how will they get the dollars to buy our exports and our new bonds?
The new Obama administration needs to rethink our approach to trade with China and how to reduce the imbalance between our countries. The right approach is for both countries to concentrate on solving their own problems and pursuing their own best interests. And it isn’t in either country’s best interest to devalue their money.
- December 4th
You said, “The exchange rate seems to be correlated sometimes and non correlated at others. It is obvioius that something else is driving the trade balance.”
Your post suggests that savings rate may be that “something else.” Would you be willing to consider another potential factor?
I am the author of a book titled “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.
This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density - rising unemployment and poverty - are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.
One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!
Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one fifth of the world’s population.
Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.
If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface, join in the blog discussion and, of course, buy the book if you like. (It’s also available at Amazon.com.)
Please forgive me for the somewhat spammish nature of the previous paragraph, but I don’t know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.
Pete Murphy
Author, “Five Short Blasts”
Pete,
I am also not a trained economist thank God. My background, like yours is engineering and US Navy (submarine service), so I can appreciate your desire to understand economics in a concrete and methodical way. I cannot however, agree with your thesis.
In the preface to your book, you say:
“Things weren’t always like this. Until the last few decades, this was a land of limitless opportunity.”
You are right about that but your population density thesis doesn’t explain this. Did population density suddenly change a few decades ago? I’m sure there have been changes but Japan for instance was densely populated in the 1960s too. That hasn’t changed. There is only one thing that changed, and changed dramatically in that last few decades you reference. We ended the US dollar link to gold. The things you lament such as wage stagnation, affordable health care and budget deficits are much more easily explained by monetary inflation than by changes in population density.
Differences in per capita trade are also partially explained by differences in productivity. Our per capita deficit with China is a prime example. Chinese workers are not even close in terms of productivity. Neither are the workers in almost any developing economy you care to mention.
I also do not believe there is any such thing as an optimum population density. People choose where they live based on the incentives they are given. Hong Kong has a very high population density because of its low tax rates among other things. There is an incentive to live there. Savings and consumption patterns are also more easily explained by incentives. Hong Kong basically has no social safety net and therefore savings are more highly valued than they are here.
If you want people to save more and consume less and therefore reduce our trade deficit, you have to give them incentives to do so. A stable currency is the first step to getting the US back to where we were in the golden age after WWII. When Nixon removed the last link to gold, the government signaled to the US public that it didn’t value the dollar very highly. It is no surprise that the public doesn’t either. If you know that the government can destroy the value of your savings by fiat, it makes no sense to hang onto it. Better to spend it before the government steals its value through the printing press. Here’s a post about the differences between gold standard eras and floating rate regime eras: http://alhambrainvestments.com/blog/2008/11/09/a-new-bretton-woods/
I can appreciate your frustration with mainstream economics but there are alternatives to the Keynesian dogma taught at most universities. If there were an economic philosophy that predicted the Great Depression, the inflation of the 1970s and the current blow up, would you want to know more about it? Well, there is only one economic philosophy that can claim all that - the Austrian school of economics as explained by von Mises, Hayek and Rothbard. Visit the von Mises website: http://www.mises.org/
I would be happy to continue this conversation as you discover more about Austrian economics. You can email me (you can find it on the website) or just come back here. You’ve obviously put a lot of thought into this and I like that, but there are simpler explanations than the one you’ve offered. Economics is really not that hard. Capitalism works best when there is little government intervention and when there is sound money. Given those two things, our economy, with the most productive workers in the world, would be fine. Without them we look for solutions from polticians who got us in this mess to begin with. Join the movement for liberty and you’ll find the answers you are looking for.
Joseph, first of all, I’ll tackle the “optimum population density” thing. When I speak of an “optimum” population density, I’m talking about the point at which over-crowding begins to drive down per capita consumption. You mentioned Japan, a nation ten times as densely populated as the U.S. Using them as an example, consider the impact of their over-crowding on their per capita consumption of dwelling space. The average Japanese home is less than a third of the average American’s, not because they like living in tiny houses but because there’s simply no room for anything bigger. Now, imagine what that does to the per capita consumption of everything that goes into the construction, furnishing and maintenance of their homes. It’s cut dramatically. The same holds true for vehicles and many other products. I found this same population density effect on per capita consumption all over the world. It’s undeniable that once a certain population density is reached where people are forced to crowd together, it begins to drive down per capita consumption.
You said “You are right about that but your population density thesis doesn’t explain this. Did population density suddenly change a few decades ago?” No, but what changed dramatically was that, in 1947, the U.S. signed the Global Agreement on Tariffs and Trade, abandoning 171 years of successful trade policy to roll the dice on the concept of “free” trade, hoping that it would contribute to lasting peace.
At that point in time, Japan and Germany had been bombed into oblivion. So there was very little effect from this change in trade policy at first. But soon both rebuilt their industrial base and before we long we had big trade deficits with both. Then in the early ’90s, with the collapse of communism, China was unleashed on the global market.
Just for argument’s sake, let’s say that the U.S. is somewhere close to (maybe even slightly beyond) this optimum population density I explained above. The U.S. has a population density of about 85 people per square mile. Consider what happens when the U.S. engages in free trade with a nation like China, with a population density of 360 per square mile. By engaging in free trade, our economies essentially combine and become one. The population density of this combined nation is now 223 people per square mile. In effect, the population density of the U.S. has soared while the population density of China has dropped dramatically. The effect is that the unemployment will rise in the U.S. and decline in China.
But this is kind of an abstract way of looking at it. So think of it this way: China gets free access to a healthy, high per capita consumption market while all we get in return is access to a low per capita consumption market, emaciated by over-crowding. The result is a transfer of jobs to China, a transfer of unemployment and poverty to the U.S., and an automatic trade deficit for the U.S.
Here’s an even easier way to think of it: if we engage in free trade with China, their manufacturers pick up half of our market while our manufacturers get half of theirs. But their market is so badly stunted that the half of their market we get amounts to almost nothing. Again, the result is a loss of jobs, rising unemployment and a trade deficit.
For further proof, please re-read the trade data I included in my original reply. The relationship between trade and population density is dramatic.
Joseph, this is a hard concept to explain in a few paragraphs. I’d be very happy to send you a complimentary copy of my book if you’ll just E-mail me a shipping address.
Pete
October was the worst month in the last 21 years of the Standard