This isn't news to many readers, but it will be to some. We tend to think of the trade deficit with China as an almost genetic aspect of our consumer economy — they make it, we buy it.
But the size of the trade deficit is also a function of currency exchange rates.
Let's say one dollar is worth one euro. If we buy $1000 of German goods and Germany buys 800 euros of U.S. goods, we have a small
$200 trade deficit with Germany ($1000–$800 in euros). We also have 800 euros worth of big screens. (Not much, but we are a modest people.)
Now what if the euro becomes weaker, say one dollar = two euros? German goods become more attractive to U.S. buyers, and at the same time, U.S. goods become
less attractive to German buyers. We might now buy $1500 of German goods (because that gives us 3000 euros worth of big screens at bargain prices). At the same time, German purchases of our stuff tanks, let's say to 500 euros. The
trade deficit is now $1250 ($1500–$250 in euros).
Notice that there's leverage. In the example, the dollar doubled in value, and the deficit increased five-fold — all because of the effect on consumers in
both countries.
Now what if that weaker euro were manipulated?
With that in mind, read
Krugman on the Chinese (my emphasis):
If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality — namely, that China is deliberately keeping its currency artificially weak.
The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.
His problem is not that this is true, but that the Japanese are confronting the Chinese, while we're not (and by "we" he means the U.S. in general). Krugman adds:
Aside from unjustified financial fears, there’s a more sinister cause of U.S. passivity: business fear of Chinese retaliation.
Consider a related issue: the clearly illegal subsidies China provides to its clean-energy industry. These subsidies should have led to a formal complaint from American businesses; in fact, the only organization willing to file a complaint was the steelworkers union.
He goes on to quote a
NY Times report:
[M]ultinational companies and trade associations in the clean energy business, as in many other industries, have been wary of filing trade cases, fearing Chinese officials’ reputation for retaliating against joint ventures in their country and potentially denying market access to any company that takes sides against China.
The Professor also notes that one of our fears is that the Chinese will stop buying our bonds (and then we'll be sunk for sure). But as he points out here and elsewhere, their buying our bonds is the very mechanism by which they're strengthening the dollar. It's simple market behavior — more buyers for something, higher prices for it. Buying U.S. bonds is almost the definition of buying the dollar.
So something to ponder as we enter the next economic phase. It's counter-intuitive for a "we're number 1" mindset, but a weaker dollar is our friend these days; and needless to say, China isn't. (Thank you, Japan, for standing up for us.)
GP
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