China currency bill is about US politics, not trade

Below is a video of my appearance on RT International last night discussing the recent bill to authorise sanctions against the Chinese for currency manipulation. I see this bill as all about the politics and little about the economics.

Protectionism is always the fall back when the going gets tough. As I predicted over three years ago, this was always going to be a preferred political solution for some when this downturn dragged on:

The global economy, now supported in the main only by the overextended U.S. consumer, finds itself at stall speed, susceptible to any number of potential exogenous shocks. Ultimately, the economic malaise created by this confluence of events will take years to unwind. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.

This process will be extremely painful in the short term, but will lead to a healthy economy long-term. Unfortunately, experience shows that these painful steps will only be taken as a last resort. Moreover, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. Protectionism is a natural outgrowth of nationalist economic policy as it transfers wealth from foreign producers to domestic producers by cutting off access to lower cost excess capacity in the goods in service sectors. However, this also serves to transfer wealth from domestic consumers to domestic producers by increasing the price of goods in the protected sectors, ultimately reducing consumption demand.

Notice that basic economics tells you protectionism makes goods more expensive, not less expensive. How does this help the economy again?

What’s more is the US has a trade imbalance with 90 countries, a greater trade imbalance with the rest of the world ex China than with China.

Scott Sumner rightly points out:

the Germanic/Nordic current account surplus is vastly larger, despite the fact that the countries lying between Switzerland and Norway have a combined population only a tenth as large as China’s. The smaller East Asian countries also have vastly bigger surpluses on a per capita basis. So why focus on China?

The answer: the political economy of depression. The trade deficit is not about China, it is about the US and its desire to return to an asset-based economy of over-consumption and excess credit growth. And because the US has failed to do so within the time frame that allows for political re-election, targets for blame must be manufactured. China is really the bad guy then.

The cure to what ails America is private sector savings. This is exactly why stimulus is no panacea. It is the lack of household savings that creates the trade imbalance. The true twin of America’s current account deficit is not a government deficit but rather it is the household financial balance. As the savings rate in the US has dropped, so has the trade deficit increased. And of course, this should make sense as most of the trade deficit comes from tradable consumption goods.

You are not going to increase household sector savings by either (a) keeping interest rates at zero percent for “an extended period” or (b) by diverting all of the private sector savings into the corporate sector or (c) allowing all of the income gains to flow to the top while reducing domestic median wages and employment. These are the hallmarks of banana republics and point to a well-entrenched level of corporatism.


  1. Mister Jinx says

    I think this is an attempt by Democrats to force Republicans to vote “against jobs” and “for China” by refusing to go along with the legislation. The Democrats know it is bad policy and won’t pass, like it hasn’t before, so they want to be able to say that they tried to get China under control but Republicans sided with big business interests and failed to do so.

  2. Dave Holden says

    I think their is a valid politic and or economic reason for “protectionism” although I don’t think this is the driving force here and that’s to counter environmental and wage arbitrage. If politicians create laws in their country to protect the environment and prevent slave labour is it right that corporations are allowed to circumvent those laws by off shoring.

  3. chp says

    Totally wrong.

    “What’s more is the US has a trade imbalance with 90 countries, a greater trade imbalance with the rest of the world ex China than with China.”

    Yes, that’s because of oil – a different but equally important issue.

    “It is the lack of household savings that creates the trade imbalance.”

    Umm, no. If a lack of saving (i.e. excess consumption) was the key issue, we would see a domestic economy running at full speed trying to keep up with demand. We would have a trade deficit because we were unable to meet all of the demand from domestic production, and had to import the difference.

    That’s not what we see at all, because that’s not the kind of trade deficit we have. What we see is most of the population trying to save, and directing what spending they have to the cheapest goods available i.e. artificially cheap imports.

    1. Edward Harrison says

      For someone who starts their commentary out “:Totally wrong” you have no idea what you’re talking about. The US has a trade deficit with Germany, Japan not because of oil but because of goods. Moreover, if you actually read the links, you will see that the trade deficit has moved exactly in concert with the fall in household savings.

      1. chp says

        Oh dear. Your ad hominem doesn’t disguise the fact that you have this argument totally wrong.

        Ex China, the trade deficit is almost totally explained by oil. This is a simple and very relevant fact, that you don’t even acknowledge. Yes, there are other currency misalignments/mercantilists including Germany and Japan, but the big two in the trade deficit are oil and China.

        Secondly, I have read the links. They don’t show that “It is the lack of household savings that creates the trade imbalance.” (BTW Parenteau’s argument is about saving, not savings. They’re different things).

        All that Rob Parenteau shows is that the household financial balance and the current account are correlated. Even if we make the leap to assume that the household balance causes the CA balance (and not the other way round, or something else causing both), it doesn’t say much. It just says that the CA deficit increases when households increase consumption. Big deal.

        The much more relevant questions, are why does this increase in consumption go to imported, rather than domestic goods, and why is it not matched by an increase in exports? When you answer those questions, then you understand the trade deficit.

        And the answers to those questions are pretty clear. The major reasons are: first it’s because in some goods we currently have no choice (oil). Second it’s because of currency manipulation (the mercantilists).

        The evidence that you’re making an incorrect inference is right in front of you. If the trade deficit is caused by excess consumption, then why is this excess consumption leaving so much unused capacity sitting idle? How come excess consumption doesn’t create demand?

        1. Edward Harrison says

          That makes no sense whatsoever. The reason it is not matched by an increase in exports is because exports are consumed abroad and not domestically. Believe what you want but the numbers speak for themselves.:

          1. chp says

            Of course exports are consumed abroad. The question was, if we assume that an increase in household consumption leads to more imports, why doesn’t this then lead to an increase in our exports (as would logically happen with floating currencies) and so lead to a balanced CA?

            Your comment suggests you don’t understand the argument. What is it that you think makes no sense? What specific point do you dispute?

            If my argument is so badly wrong then show me the simple flaw.

  4. hutrade says

    GREAT ARTICLE here Ed. I completely agree.

    I find Scott’s comments fascinating too. I have a few questions regarding his comment:

    #1. Is he saying that savings fuel domestic purchasing? Since domestically produced goods are more expensive, consumers will consider them more often when they have more savings in their pockets? That relationship is very intriguing to me.

    #2. I don’t agree with him about Federal spending (which for some reason he seems to demonize as federal “stimulus” whatever that means). How else can households in our economy increase their net savings levels without larger Federal Deficits considering our economy? It seems to me that based on the sectoral balances there is only one way and that is through larger federal deficits. Why doesn’t Scott accept this fact?

    Thank you again Ed and great article and points all around.


  5. SunZU says

    Mister Jinx hit the bullseye, purely political bill with no chance of ever passing. The Republicans should call the bluff and vote for it, then watch the Dems veto it at the final hour HA!

    Good article Ed.

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