Shrinking our Trade “Imbalance” is the Least of our Worries

We are in the midst of the worst economic and financial crisis since the Great Depression. Last week's revelations have made it clear that the twin frauds—the mortgage fraud and the foreclosure fraud—represent the worst financial scandal in human history. Even in the face of overwhelming evidence that the Bank of America is a “control fraud” (a criminal enterprise run to enrich its top management), the US Treasury refuses to take any action to stop its illegal seizure of homes. Things are so bad that the attorneys general of all fifty states are investigating “foreclosuregate”, and the NYFed has sued BofA for its fraudulent securities business. And just what is Timothy Geithner doing about that? On the weekend he was off in South Korea lecturing the Chinese about their excessively low interest rates—that he purports to hurt their savers, who need higher interest income so that they can spend more. Say what? Chairman Bernanke is doing his best to get the whole spectrum of US interest rates to zero—meaning OUR savers get nothing. Why isn't he lecturing Bernanke on the evils of “QE2” instead? Meanwhile, the Chinese have raised their rates in the face of fears that their economy is overheating. Yet Geithner lectures them on the necessity of pumping up their already booming domestic demand so that they can buy more US output. At the same time, he wants trade deficit countries like the US to boost saving and cut spending. Hold it, China is booming and he wants it to raise demand, while the US is slumping and he wants it to reduce demand? And he wants the Chinese to depreciate their currency to try to put their products out of reach of Americans who have lost their jobs. That is supposed to somehow help American consumers by raising the price of the stuff they can barely afford at Wal-Mart? I do not know what, if any, economic theory guides Geithner's thinking but it sure looks awfully confused—and what he advocates for China is precisely the opposite of the policy he played a role in adopted in the US. For example, the US appears to be doing everything it can to trash the US dollar—low interest rates, high job losses and unemployment, tanking financial markets, and dismantling the rule of law and any pretense that ethical behavior is expected of US firms. In other words, while the US accuses China of currency manipulation designed to increase its net exports, the US is trying to force a run out of the dollar to appreciate the currencies of our trading partners so that the US can export its way out of its Great Recession. How bizarre! China's economy is already booming. It is developing its internal markets at a rapid pace in order to substitute domestic demand for exports. It realizes it cannot rely on the developed Western nations for its sales—because, well, the Western nations have embarked on policies to ensure they will remain in recession if not depression for the next decade. Round after round of fiscal austerity is the order of the day in the West—ensuring domestic demand cannot recover. All of them are looking at exports as the key to recovery—but among the developed nations only Germany and Japan (an honorary member of the Western club) could succeed at that game. Yes, China maintains close control over its exchange rate. Since when is a stable exchange rate an international crime? Wake up and smell the coffee—many developing nations adopt exchange rate pegs. Indeed, for decades the IMF and World Bank have encouraged them to do so! And not that long ago, the developed nations thought pegged exchange rates were good for them, too—remember Bretton Woods? And what is the European Union but a group of nations that adopted the most stringent kind of peg possible: they abandoned their own currencies in favor of a currency-board type of arrangement based on a foreign (euro) currency. If pegging an exchange rate is good for exports, then Germany's pegged exchange rate with the rest of Europe must account for much of its export success, in combination with its austerity at home that depresses domestic demand. Currency manipulator! Now, I am no advocate of fixed exchange rates. With some exceptions, they constrain domestic policy space and invite speculative attacks (remember George Soros and the UK?). I have long encouraged China to gradually move to a floating rate. But to insist that China is an international pariah because it (at least for now) prefers currency stability is ridiculous. And how to explain Japan's floating and strong Yen, that produces a current account surplus? Or the US's floating Dollar that produces large deficits? No, ability of exchange rates to fluctuate does not generate movement toward “balanced” trade. In truth, exchange rate movements have more to do with financial flows than with trade, and trade has more to do with complex production decisions made by corporations operating with international supply chains than with exchange rates. Look, international balances always balance. It takes at least two to tango—a willing buyer, a willing seller. Countries with current account deficits have capital account surpluses; those with current account surpluses have capital account deficits. The US's current account deficit supplies the dollars the rest of the world wants to accumulate as net dollar financial assets. The US cannot run such a deficit unless someone wants dollars. That demand for dollar denominated assets “balances” what is called our trade “imbalance”. Talking about a trade “imbalance” is like saying that a household has “imbalanced” trade with the local grocery store—buying more from the store than it sells to the store. In truth, the household wants the goods and the store wants the dollars—it is balanced trade. No one in her right mind would worry about, say, a current account deficit for Manhattan or the State of New York, exactly equal to its capital account surplus. The rest of the nation (and world) produces the consumption goods NY wants, and NY produces the financial assets the rest of the nation (and world) wants. (OK, OK, in reality those were toxic waste assets that nobody wants, but bear with the hypothetical example.) No one admonishes the rest of the nation for running a “beggar thy neighbor” current account surplus against NY, or NY for “profligate” consumption based on “borrowing” from the rest of the nation. Yet when we discuss trade across national borders we do just that. Why? I suspect it is because we are then going across currency exchanges, which is just too confusing for most analysts—in large part because they instinctively think in gold standard terms. That is, the confusion is a relic of the gold standard, when the exporting nation got all the gold and the importers had to impose austerity to impoverish their populations to stem the flow. But since we dropped gold, that criticism of net exporters is no longer applicable. In the case of China, it is claimed that its central bank “intervenes” into currency markets to keep the RMB low. What actually happens is that Chinese exporters accumulate dollars—but since their domestic expenses are in yuan, they trade the dollars for domestic currency. The Chinese central bank supplies the yuan on demand, creating them in exchange for the dollar reserves. All central banks do this—there is nothing nefarious about it. Yes it is true that in China the government tightly limits nonofficial holding of foreign currency—as do many other governments around the world. Capital controls are not unique to China and often accompany government control of exchange rates. Washington might prefer that China loosen its financial markets, but from China's perspective that is a matter for domestic policy. And China can smugly point out that the West's recent experience with unregulated capital flows and financial markets has not quite gone swimmingly! In any case, to label this “intervention” is misleading—Chinese exporters need to exchange the dollars for RMB and the Bank of China is the only source of the RMB they need, so it is inevitable that the dollars will end up in official holdings as it supplies yuan on demand. Further, to blame China for the US's crisis is also ridiculous. There is no RMB exchange rate that will get the US on the road to recovery. Even a complete blockade of products from China—a terrible idea—would not improve our economy. I happen to believe that the net impact on US employment and production from trade with China is probably positive (China's exports mostly involve low added value intermediate products or final assembly); and even if it weren't it is easy to formulate policy to replace any jobs lost. I also look at US net imports as a net benefit—we get to consume more than we produce—so long as we adopt sensible policy to keep everyone employed. But I do not want to argue about that now because it is all really beside the point: our economic and financial crisis requires immediate policy action and there is nothing that will come out of the G-20 trade talks that would have one iota of impact in the relevant time frame. We created our own crisis. Our policymakers—most importantly Geithner and Bernanke—have no clue what to do. Indeed, most of their policies only make matters worse—such as protecting the banksters that continue to commit fraud. Blaming China is nothing but a diversionary tactic so that Americans do not recognize that their emperor policy makers have no clothes. Please, Timmy, come back home and deal with the fraudsters that created the crisis.