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Home Publications Blogs Beat the Press The West Is Indebted Because China Is Not

The West Is Indebted Because China Is Not

Friday, 25 July 2014 04:30

The NYT ran a confused column by Kwasi Kwarteng, a Conservative member of the U.K.'s parliament, calling for China to adopt the gold standard. The piece has many bizarre claims, most importantly attributing the U.K.'s prosperity in the 19th century and the U.S.'s prosperity in the post-World War II period to the gold standard, as opposed to the strength of their manufacturing sectors and overall economy.

However the most misleading item is the contrast of China, which does not have much government debt, with the rich countries, that mostly do. These are not unrelated situations. As the piece notes, China has pursued a mercantilist policy of deliberately keeping down the value of its currency in order to make its goods cheaper to people in other countries. This allowed it to increase its exports to the West. (It's important to note that U.S. corporations have also been major beneficiaries of this policy, taking advantage of low-cost labor to gain a competitive edge and increase profits.)

The flip side of this policy is that the rich countries, most importantly the United States, ran large trade deficits. This created a huge hole in demand. There is no easy mechanism for a market economy to make up this sort of gap in demand, which now passes under the name "secular stagnation." In the late 1990s the gap was made up with a stock bubble, in the last decade it was made up with a housing bubble. The bursting of these bubbles left nothing other than government budget deficits to fill the demand gap. 

As a practical matter, when rich countries have large trade deficits, their choices are bubbles, large budget deficits, or high unemployment. They also could look to redivide work with shorter workweeks and longer vacations. (The standard economic story is that rich countries should have trade surpluses. Capital is supposed to flow from rich countries that have lots of it to poor countries where it is scarce. But economists never have much problem ignoring their theory when its implications prove inconvenient.) In any case, the issue of China's trade surpluses and rich country government debt are directly related, not independent events.


Comments (12)Add Comment
Debtors can profit at the expense of creditors.
written by Ralph Musgrave, July 25, 2014 5:07

As more than one MMTer has pointed out, a country like the US which issues its own currency can pay any rate of interest it likes on its debt, if it gets its act together. So what rate of interest should the US pay its creditors? I suggest a rate that is a bit below inflation. That amounts to a NEGATIVE REAL RATE: so the debtor profits at the expense of the silly old creditor!!!!!
written by Dryly 41, July 25, 2014 5:37
Again Dean is spot of with respect to the terrible agreement with Communist China that the Clinton administration made. It was one sided, unfair and with no mechanism to deal with China's cheating.

In my view there is more to this. The Bush I-Baker-Skowcroft administration engaged in one of the most despicable and sordid acts in the history of American foreign policy by actually rewarding Communist China a half hour after the Tiananmen Square massacre. It's one thing to have diplomatic relations with your adversary but Nixon and Kissinger should never have gone to Beijing and kowtowed to one of the three genuine monsters of the 20the Century. It also makes sense to talk to your adversary to try to find parallel courses of interest, and, to have cultural exchanges as a means to a modus viviendi. But if I had my way we should have zero trade with China and the EU should have zero trade with Russia. I doubt Europe's Neville Chamberlain II will work out well.
NY Times Strange Editorial Page Decisions
written by sherparick, July 25, 2014 6:45
What I find strange is that NY Times editorial page editors chose to run an article by a complete crank on a crank subject. This is sort of a classic "Opinions on the Shape of the Earth Differ lets publish a "flat earther's" viewpoint."

By the way, because the value of the dollar has appreciated against "Euro" and "Yen" and there has been constantly surprising bull market in U.S. bonds for most of the last 5 years, the Chinese have not only successfully kept their currency pegged at undervalued rate against the dollar, but made a (paper) profit in the bargain.
A Cranky Austerian
written by Larry Signor, July 25, 2014 6:59
Predictions of a hegemonic economic powerhouse, 20 years hence, are bedtime stories for addled conservatives.

It could eventually — in, say, 20 years — peg the renminbi to gold...Such a move would truly mark its return as the “Middle Kingdom.”
The Unintended Consequences of this Policy Might be Welcome
written by sherparick, July 25, 2014 7:06
I note that if the Chinese authorities took an acid trip and decided to adopt Kwarteng's suggestion that China peg the Renminbi to gold and delink it from the dollar, and thereby become the international reserve currency,it would have a result much desired by Dean and sensible economists. The value of the dollar would drop against the Renminbi. Eventually, that decline in value would eliminate the $300 billion annual trade deficit with China would disappear as China's labor and transaction costs appreciated and U.S. labor costs would relatively fall. U.S. corporations would become cautious about investing overseas and decide to invest domestically, substituting for imports and taking advantage of lower U.S. labor costs to produce exports for foreign markets. (Which by the way was the story Adam Smith told, of merchants preferring domestic investments because of the fearful risks of overseas investments, in which he used the metaphor "invisible hand" just the one time in Wealth of Nations. (See WN IV.ii.9, and the web site "Adam's Smith Lost Legacy).
This kind of thing causes me to repeatedly cancel my subscription!
written by Dave, July 25, 2014 10:11
Newspapers make more money by running crazy ideas from cranks. It is a frustrating problem that I'm personally trying to fix with technology.

Anyhow, Dean has nailed the problem perfectly. But let's talk about a gold standard for a minute:

The Gold standard cannot help any economy, not China's economy, not the US economy, not any economy. Fiat currency has proven to be the only way a country can maintain a healthy economy it the face of some headwinds. We need fiat currency.

So why to we have these gold bugs in the US, people like Steve Forbes, etc...?

There are problems with fiat currency that require regulation, either through the monetary system itself or through regulations such as Glass Steagall that control how fiat currency is used. It was a huge mistake to allow banks the discretion to create money out of thin air to invest into mortgage-backed securities. It was a game of arbitrage that led directly the trillions in wealth destruction for the working people of America!

I favor fixing the fiat monetary system by moving towards a modified Chicago plan. The Chicago plan as written is not good, but the idea of controlling the creation of currency at the central bank instead of thousands of profit-driven banks is a good idea.

It needs a lot of work to make it a better plan, but nobody is taking it seriously.
written by Tzimiskes, July 25, 2014 12:10
China has no history with the gold standard. If it is going to peg the renminbi to a metal silver would be the least arbitrary due to China's historical association with silver. You could make an argument for copper due to its association with strings of cash, but that was always more of a nominal value than a metal value so that's weak.

The suggestion of gold, however, is entirely Eurocentric and makes no sense whatsoever for China.
What we hope for...
written by Dave, July 25, 2014 1:23
Pk, please comment on the trade deficit. PK is very respected on trade, and we need him to weigh in on this discussion of the effect of the trade deficit on domestic demand.

I keep hoping for it. Is he afraid for his job if he mentions it? It seems possible.
written by skeptonomist, July 25, 2014 3:42
Actually, when countries have large trade deficits one alternative is wage reduction. This is what the EU forced Greece to (try to) do, since all the countries have the same currency. Everyone should be aware that currency adjustment does the same thing - it reduces real wages. It means serious inflation in all the things that are imported - which is a lot in the US. At this point (which should never have been reached with proper trade policy, as Dean says) there is no gain without inflation or real-wage pain. There are major political implications to this.
PK and BD are bad
written by Dave, July 25, 2014 4:03
The popular duo of PK and BD are actually pretty bad people.

Their unwillingness to talk plainly about the trade deficit caused all of this. They allowed it all.

Bad people covering bad mistakes.

Trade deficit is not secular stagnation
written by Doug Rife, July 25, 2014 7:28
The US ran a trade deficit averaging about 2% of GDP long before secular stagnation became a topic, even back in the 1950s and 1960s, the golden age of US growth. Today it's only a little higher at 3% Secular stagnation refers to the slowdown in the growth of domestic demand starting in roughly the year 2000. How much of domestic spending goes overseas is not significant to the issue. It's domestic spending growth that's slowed as can be seen in the very long term chart of real final sales to domestic purchasers:


It's very clear that since 2000 domestic demand growth has slowed markedly, even over two business cycles (secular not cyclical) as compared to history. Trade cannot explain why domestic demand growth is waning. What can explain it is stagnant real median wages. Productivity gains today accrue only to the 1% where it is saved and not spent thus lowering demand growth.
Long term chart of trade deficit
written by Doug Rife, July 25, 2014 8:04

The chart is the delta between domestic demand and sales of domestic product divided by real GDP. It shows trade subtracted 2% for decades in which US growth was very strong. Note that in the middle of the 1980s when real growth was much higher than today the trade subtracted 3% of GDP just as today.

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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.