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Home Publications Blogs Beat the Press The Fault for a Trade Deficit is by Definition the Value of the Currency

The Fault for a Trade Deficit is by Definition the Value of the Currency

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Thursday, 03 May 2012 05:02

Eduardo Porter told readers in his Economic Scene column that because China's trade surplus overall has fallen, Treasury Secretary Timothy Geithner:

"will have a harder time making the case that America’s trade deficit is somehow China’s fault."

Actually, he will have no problem at all making the case that the U.S. trade deficit is the result of an over-valued dollar, which China helps to sustain by buying hundreds of billions of dollars of government bonds.

In a system of floating exchange rates, like the one we are supposed to have, trade imbalances are corrected through a decline in the value of the currencies of deficit nations, like the United States. The mechanism is that more dollars are being supplied to buy imports than are needed to purchase imports from the United States. This leads to an excess supply of dollars, which then causes the dollar to fall in value against other currencies. In a system of floating exchange rates an excess supply of dollars is supposed lead the dollar to fall in the same way that an excess supply of shoes is expected to cause the price of shoes to fall.

A lower valued dollar makes imports more expensive for people in the United States leading people to buy fewer imports. It also makes exports cheaper for people living in other countries, leading them to buy more U.S. exports. This process then continues until the trade balance adjusts.

By explicit policy China is preventing this process of adjustment. It has an explicit policy of pegging its currency against the dollar. This means that it buys as many dollars as necessary to maintain the peg. (This is done in broad daylight, it is not a mysterious process of "manipulation" that is done in secret.)

Therefore Geithner would have no problem at all making the case that America's trade deficit is China's fault, this is exactly what textbook economics maintains. (He likely will not want to make this case, since many media accounts have suggested that Geithner is more interested in directly pressing issues that will help businesses in the United States rather than addressing the trade imbalance, which would benefit millions of workers.)

It is also worth noting that standard economic theory predicts that fast growing developing countries like China will have a trade deficit, while slower growing wealthy countries like the United States will have a trade surplus. The argument is that capital is relatively scarce and gets a better return in China than in the United States. This means that the U.S. should be lending vast amounts of money to China, not the other way around.

Comments (3)Add Comment
We need a We Are The World moment for economics
written by Robert Salzberg, May 03, 2012 6:52
Dr. Dean Baker, Dr. Paul Krugman and others continue to point out how if those in power simply understood Econ 101, we would live in a much better world.

The press no longer functions as the forth estate when it comes to basic economics.

How do we infect the world with basic economic intelligence?
...
written by Robert K, May 03, 2012 9:16
The strength of the dollar does not arise out of the Chinese purchases of Treasury
securities. It arises out of the dollar's global reserve status, which, in an expanding
period of world trade, produces an ever growing need for the "settlement currency"
on the part of all national economic participants. No doubt you are familiar with
the Triffin dilemma, and Robert Triffin's warning to Congress in 1961. This accumulation has now reached the breaking point, as all nations who hold dollar
reserves understand that they can NEVER be converted to ANYTHING of VALUE at
present prices. How could 6 trillion USD ever be spent on real things in an
economy which, year after year, consumes, via Government, 4% more of GDP
from foreign sources than it produces? I also find it "amusing" that not a peep
is uttered regarding our OTHER trade deficit, with global oil imports. Perhaps
that is a "too touchy subject"?
Basic Economic Lessons Needed
written by johnwisco, May 03, 2012 10:07
Dean,
You were great on Kudlow. OK, so what does the government do to maintain this "strong dollar?" What should we be doing to let the dollar float against other currencies?

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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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