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Home Publications Blogs Beat the Press The End of China Bashing: Toward a Serious Discussion of the Trade Deficit

The End of China Bashing: Toward a Serious Discussion of the Trade Deficit

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Monday, 22 October 2012 15:00

Paul Krugman and Ezra Klein both say, following Joe Gagnon, that the time for criticizing China for "currency manipulation" has passed. This is partly true in the sense that China's currency has risen substantially in real terms against the dollar over the last few years. However this does not mean either that the relative value of the dollar and the yuan is now at a sustainable level or that China is not continuing as a matter of policy to prop up the dollar against its currency.

To see the former point, it is important to remember that China is a fast growing developing country. Ordinarily such countries are expected to run large trade deficits. The idea is that capital can be better used in fast growing countries like China than in slow growing wealthy countries. Since capital will get a higher return in developing countries, we expect capital to flow from rich countries to poor countries. The flow of capital would imply a trade deficit for developing countries. Effectively this trade deficit would allow developing countries to sustain consumption levels even as they build up their capital stock. 

China, along with many other fast developing countries, is running a large trade surplus. This is not sustainable. To see this point imagine we have a developing country that is growing at the rate of 7 percent annually, the slower rate of growth that China is now seeing. Suppose it sustains a trade surplus of 3.5 percent of GDP, roughly the amount projected by the IMF for the next five years. For simplicity we'll make the United States the only other country in the world and have it grow at a 2.5 percent annual rate.

If China and the U.S. start at the same size, after 20 years China's annual trade surplus will be equal to 8.3 percent of U.S. GDP. To have sustained this surplus it will have bought an amount of assets that exceeds 100 percent of U.S. GDP in 2032. If we carry this out another twenty years then the annual deficit in the U.S. will be 19.5 percent of GDP and China's holdings of U.S. assets will exceed 300 percent of 2052 GDP. Clearly this does not make sense and we will not see these sorts of deficits running in the wrong direction indefinitely.

As far as the second part, China is still accumulating U.S. assets as part of an official policy of pegging its exchange rate. In other words it is deliberately propping up the dollar against its currency.

The point that Gagnon makes is that China is not alone in this exercise and it is not even the biggest culprit, relative to the size of its economy. In this sense the China-bashing that Governor Romney and other politicians have practiced is inappropriate.

 

Nonetheless the United States should still view it as essential to further lower the value of the dollar against China's yuan, along with other currencies. The yuan is key because other countries are likely to follow the value of the yuan with their currency as they did in 2005, the last time that China had a major revaluation of the yuan against the dollar. 

It is also important to remember that the bad guys in this story are at least as likely to be sitting in corporate suites in the United States as in China or other developing countries. Major U.S. corporations like Walmart and General Electric have profited enormously from low-cost labor in China and elsewhere. They have little interest in seeing prices on the goods produced in the developing world rise and their profit margins fall.

The other part of this story is that we really have no choice about seeing the dollar fall, especially for those ferocious deficit hawks who want to see the United States balance its budget. It is an accounting identity that the trade surplus is equal to net national savings. This means that if we have a trade deficit, net national saving is negative. There is no way around this fact. The deficit hawks may not like it, in the same way that they may not like 2 plus 2 being equal to 4, but there is nothing they can do to change it.

If we have negative national saving, then either we have a budget deficit (negative public saving) or we have negative private saving, or some combination. At the moment, we have a large budget deficit that corresponds to our trade deficit. How could we have negative private saving?

In a dream world, we could see private investment go through the roof as we build up the capital stock at a record pace. That is not going to happen. The non-residential investment share of GDP has fluctuated in a fairly narrow range over the post-war period. If the deficit hawks tell you they have some elixir that makes it suddenly soar through the roof, then they have been smoking something funny. That ain't going to happen.

The one way we know to get negative private savings is a housing bubble. That can lead to surge in residential construction, while the bubble generated equity will cause consumption to boom and household saving to plummet. What a great idea!

Okay, if we want to have something near a balanced budget without a bubble driving our economy then we have to get the dollar down to get our trade closer to balance. This is not an optional policy or a debatable point. It is a simple matter of logic. If you disagree, think about it more until you understand why there is no choice.

So by all means, let's stop the China bashing. And let's start talking seriously about getting the dollar down to level consistent with more balanced trade.

 

Comments (12)Add Comment
Thanks!
written by Harry Gindi, October 22, 2012 4:02
Brilliant article! Answered all of my questions!
It is interestiing to think about the reason that
written by Floccina, October 22, 2012 6:50
It is interesting to think about the reason that the Chinese Government is keeping the dollar up. It is to keep their goods flowing rather than because they really want claims on our wealth. It seems quite foolish on their behalf and nonthreatening. I do not worry about it. If we had better fed policy I think that we would be fine.

BTW I have been doing something about it myself by investing in stocks of companies based in China.
That's exactly right! Thank you for your clear headed analysis!
written by Alex Hamilton, October 22, 2012 7:22
China-bashing is an extremely offensive term, by the way for gays. Remember, the term is borrowed from the original "gay-bashing" --- China is, needless to say, not a long abused and powerless sexual minority that is constantly being ridiculed and physically threatened...
...
written by A Populist, October 22, 2012 9:09
Dean,

Paul Krugman seems to be saying that, since China's trade is balanced (if I read the graph correctly), that we no longer need to worry about the value of the dollar.

Well, it seems to me that, as US citizens, we should be concerned about the *US* trade deficit.  Which means, we need to lower the value of the dollar, until our trade is balanced - period.

I can hear all the "anti-protectionists" clearing their throats to shame me about "wanting to start a trade war"!

Well:  They only call it a trade war when we fight back!

Put another way:  So long as we have a trade deficit, by definition we are not (on net) protectionist.

"Oh, but we just need to be better able to compete!".

Yep! And what better way to compete, than to lower our prices while raising theirs, until trade is balanced.

Back to criticism of Paul Krugman's column:  It seems a little bit obtuse, to suggest that because China's trade surplus is disappearing with ROW, that China's huge trade surplus with the US is therefore irrelevant, and therefore the dollar/renminbi exchange rate is irrelevant.
...
written by Fed Up, October 22, 2012 9:58
"To see the former point, it is important to remember that China is a fast growing developing country. Ordinarily such countries are expected to run large trade deficits."

But these countries have figured out (correctly I believe) that trade deficits eventually lead to some kind of problem and then the IMF shows up with bad consequences for them. Run trade surpluses, and no IMF shows up.
...
written by Fed Up, October 22, 2012 10:02
"As far as the second part, China is still accumulating U.S. assets as part of an official policy of pegging its exchange rate. In other words it is deliberately propping up the dollar against its currency."

How about having them buy some assets that can go down in value or default?
...
written by Fed Up, October 22, 2012 10:11
"If we have negative national saving, then either we have a budget deficit (negative public saving) or we have negative private saving, or some combination."

And, "It is a simple matter of logic. If you disagree, think about it more until you understand why there is no choice."

I have thought about it, and I disagree. I'm pretty sure you are assuming all new medium of exchange has to be borrowed into existance.
...
written by Fed Up, October 22, 2012 10:15
Is there some setting that I have to wait 240 seconds between posts? If so, can you please get rid of that? Thank you!
...
written by Fed Up, October 22, 2012 10:23
"A Populist, October 22, 2012 9:09

Dean,

Paul Krugman seems to be saying that, since China's trade is balanced (if I read the graph correctly), that we no longer need to worry about the value of the dollar.

Well, it seems to me that, as US citizens, we should be concerned about the *US* trade deficit. Which means, we need to lower the value of the dollar, until our trade is balanced - period."

Exactly! And, almost all of the trade deficit is china and oil. One thing that would help is to have zero public debt and zero private debt.
...
written by Luke Lea, October 22, 2012 11:40


"not even the biggest culprit, relative to the size of its economy."

Ha Ha. Given a billion and three hundred million people and the volume of our imports in low-wage imports from China it is absolutely the biggest culprit far and away.
Japan and the Swiss currency manipulators?
written by Brian Dell, October 23, 2012 12:46
What I find oddest is Ezra Klein's claim that Japan is "arguably" a worse currency manipulator than China. Or Switzerland. Ezra is quite smart but I still wonder how this 20-something with an undergrad degree in Poli Sci became an authoritative economist.

Yes, the Swiss have interfered with a free float and so have the Japanese from time to time. But their exchange rates are not fixed by a central authority like China and more importantly it seems absurd to me to complain about Japan or especially Switzerland when the price levels there are far higher than the US. To the extent that Swiss or Japanese exporters are currently outcompeting US exporters it is IN SPITE OF their currencies.
Re: Outcompeting
written by A Populist, October 23, 2012 3:36
So, what if a particular nation (or, collectively, all nations) finds a way to "outcompete" us (Whether fairly or unfairly - and by what standards)?

In a world economy constrained by lack of Demand, suppose we don't believe it is acceptable for other nations to reduce *our* nation's aggregate Demand, by collectively pegging their currency to a level which sustains a large and chronic trade imbalance?

Suppose we find it unacceptable that these sustained imbalances result in large chronic Unemployment, as well as continually increasing our nations debt?

Should we just say:  Oh, well - Nothing we can do?

One example:  Our Nation's corporations (such as Boeing), are giving away our Nation's technical advantages (and other advantages), in exchange for access to China's markets.  In other words, we give concessions, in exchange for access to more of the much-coveted Demand which is holding back the world economy.  All while we are giving China (relatively) free access to what once was the world's largest source of Demand.

Well, OK.  If lowering the US currency is too problematic, then we should compensate for the decrease in Demand due to the trade deficit.  Since China has effectively taken an amount of Demand equal to our cumulative trade deficit, suppose we give all US citizens an equal "tax credit" (whether they pay tax or not).  We can target an amount which (spread over some limited number of years), which equals the accumulated "trade DEBT" with foreign nations. 

Now, one problem, is that those at the high end won't spend much (or any) of theirs.  Yes, but those at the high end are few enough that this would still be fairly efficient at increasing Demand.

Another possible complaint:  This would be like printing US dollars, and artificially creating Demand.  Yes, and China's central bank purchases of US financial assets, combined with their chronic trade deficit, are equivalent to burning US dollars, and stealing the Demand needed by US business in order to thrive.

I say that on net, that's a wash.

Of course, debt-free spending on infrastructure would be great, as well.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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