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Trade Deficit myth

February 18th, 2010 by Embedded I · 12 Comments · Uncategorized

Over at The Rational Capitalist, a sympathetic commenter, using the moniker C.W., wrote, “we are exporting inflation, in the form of our trade deficit.

“What is a trade deficit?  How does it export inflation?

Surely the idea of a trade deficit disregards the principle of value-for-value trading, regardless of national borders?

Money is an abstract symbol of values traded (concretized as coins & notes).  If a Chinese manufacturer obtains American money from an American, for goods the American has purchased, then the two men, and the two nations. are value even!  There can be no deficit between them.

The trade deficit idea treats the American *dollar* as a concrete, and as an “American item” being depleted.  It does not consider the value of the goods Americans have imported, & by which Americans will benefit.

Walmart, above all, has understood the economic meaning of Chinese labor, however implicitly, and capitalizes on it. Americans receive an enormous material benefit—whilst economists fret about a trade deficit with China.  American lives are massively eased by the cheap Chinese products bought by American money.  Despite talk of sweat shop labor, American money improves the lives of those Chinese. No, their lives do not match those of Americans, but their lives are improved because of Americans (despite the Chinese Communist government).

If there is any sort of deficit, would it not be a human-value deficit, on China’s part?   China’s  2007 GDP/capita is ~ $5,000.  The province of  Guizhou, with 40 million people, is as poor as Nigeria or the Sudan at only $1500, see GDP/cap  by Chinese province.  Most Chinese labor for a few dollars a day, working Americans earn as much in half an hour.

C.W. may have a point about exporting inflation.  Imagine measuring the economic impact of an increase in fiat American money on the economies of countries that are busy printing  their own money?

12 Comments so far ↓

  • Grant

    There are certainly people, nationalist conservatives and trade unionist mostly, who use the term “trade deficit” to stir up unjustified worry using the notion that somehow, automatically, Americans are worse off as net importers, better off as net exporters, and perpetually “fine” being trade-neutral. Nevertheless, what I think most people are trying to express concern about when they invoke that term is the hard-to-grasp fact that, in toto, the status quo of Chinese-American trade is a net loss for both parties.

    If you look at the reason why the Chinese have replaced Americans as manufacturers, it isn’t simply because Americans reached a level of technological advancement that their labor was no longer needed. If that were the case, the Chinese wouldn’t have replaced us. Machines would have. The reason is artificial distortions in the labor market ranging from pro-union laws to minimum wage to taxes.

    Similarly, if you look at the reason why China, suddenly and fairly unexpectedly, rose to prominence as world’s factory, it isn’t primarily because of a cultural shift, but rather a function of a centrally-planned economy. In the short-term, such massive movements forward can happen quite easily – much easier than in a free economy – in a centrally-planned one. From the outside it looks like progress, but actually it’s just opportunism. China is similar to post World War Two Japan in it’s embrace of capitalism. It’s a kind of “national capitalism” – fueled more by a desire for national greatness, and each individual citizen’s “responsibility” do his part and avoid shame, more than it is an authentic desire for a better life; which would be a true cultural shift.

    So what is the result of America being artifically low in manufacturing output while China is correspondingly, artifically high? What happens is that while Americans are free to pursue other things, being actually unqualified, what they produce are cultural and political distortions which weaken their own country and strengthen ideologically opposed countries (like China). China, meanwhile, has it’s citizens toiling under conditions which, over all, really aren’t that much different than how they’ve always been. The settings have changed – from farm to factory – but the overall quality of life doesn’t change much. At least not for those who are not politically connected. And, worst of all, it all occurs under the pretense of “capitalism” (when it’s actually a mixed economy). Eventually, because of the collectivized culture that China has always had, public sentiment in the county is going to conclude “well, if this is capitalism, we want no part of it” (not to make any mention of the wiping out of what little improvement this experiment has brought them once the delicate, sham American economy – which has been keeping theirs humming – collapses).

    What this relationship between the US and China – this “trade deficit” – really describes is an aggregate of growing, very real cultural and political conditions that will wipe out whatever the current, precarious, momentum-based relationship has brought both sides, and to go further towards an overall reduced standard of living.

    On the micro level, you’re right: “trade deficit” is a meaningless, collectivist concept; but not so much on the macro level. It’s not nearly good enough in what it attempts to describe, but it points in that direction better than any other mainstream concept.

  • madmax

    Peter Schiff has been very hard on America relative to other nations. He has constantly stated that America is a “net drain” on the world economy and that we are, in essence, stealing from the other economies of the world. Is Schiff right? Are we a “net drain” and does this trade deficit mean that we are redirecting money away from productive uses in order to finance our welfare state? Schiff obviously deserves respect but he is a libertarian. And in the end, libertarians are always wrong on fundamentals.

  • C. Andrew

    I originally posted this on an open thread on Noodlefood. There is some discussion about how a trade deficit exports inflation.

    C. Andrew

    I was talking with my brother last night. He’s an economist. We were discussing the impact of Obama’s deficit on America’s
    recovery prospects. He pointed out that we’re doing the same thing that Japan did in 1990 and that Hoover did in 1929 in order
    to “forestall” the recession.

    Japan’s present debt to GDP ratio is 160%. He thinks the tipping point for debt to GDP ratio is about 1:1; that is, when debt approaches 100% of GDP, there is no coming back. There are some niggling issues about the percentage of govt spending vs market growth but that
    is his rough estimate.

    He also said that there is some wiggle room because much of what happens in financial markets is relative, and, believe it or not
    the US is apparently one of the better players (relatively) when it comes to fiscal policy. Apparently the EU is even worse than we are and as far as the non-OECD countries, they make the EU look good.

    In fact, the greatest threat to the US economy would be someone else putting their fiscal house in order. But it would probably take
    50 years before the track record of stability would threaten the US unless we continued to do stupid things. Which, of course, is entirely possible.

    One of the reasons the US has been able to export their inflation for the past 40 years is that America is still a safer place to
    put your money than any other place on the planet, both because our economy is relatively more stable than the rest of the world and
    even though we are moving away from the rule of law we’re still much better than anywhere else. As he put it, “If you become rich in
    China, the last place you want to leave your money is in China.” Because of the question of stability and the lack of the rule of law.

    So, what about the trade deficit we’re running with China and the fact that they hold so much US debt? He kind of chuckled and pointed out
    that the fact that China was willing to give us goods in exchange for dollars illustrated that, relative to the rest of the world, our currency still has the advantage of longer ranged stability. And that the fact that the US is running a trade deficit is one the mechanisms whereby we export our inflation. And on a larger note, he is skeptical of the idea that trade deficits are bad for a country.

    Historically, there have only been two economies that were in trade surplus and had the cash position vis a vis their GDP that China has today. Those were, America in 1929 and Japan in 1990.

  • Anon-D

    Hi all, long time lurker first time poster. This is a topic that I’m very much interested in so thought I’d join in.
    From my understanding a trade deficit means that you are indebted to the nation with the surplus export. Meaning that whatever your monthly deficit is you will repay with interest in the future. However, the rise of unions, taxes, regulations have turned US industries into the “rust belt”. This makes the prospect of ever paying back the months and years of accumulated trade debt plus interest unlikely.
    Then you have China. As correctly pointed out China is an ancient collectivist society that generally has no idea what it’s doing. Today they have discovered that if they create free trade provinces like Guizhou then any products produced there will be cheaper than the equivalents in the overregulated US. This has put US companies out of business or they have simply shifted their manufacturing bases to China’s free trade areas.
    China has an even more clueless central bank and monetary policy than the US. This together with their artificially low currency makes it so the Chinese can’t afford the products of their own labour. This leaves China with a huge surplus of consumer goods which they export to the US which can afford to buy it only because of the artificially low value of China’s currency. This has created an unhealthy symbiotic relationship where the Chinese produce and the US consumes. This is what Peter Schiff is talking about I believe.
    Now imagine China discovers sound monetary policies (ie free private gold standard 100% reserve banks) and float their currency. Then suddenly the Chinese will be able to consume their products. They won’t be exporting much – there are 1.5 billion of them! Furthermore the US would not be able to afford to import anything from China even if they were. A country that doesn’t produce enough for itself by $70 billion dollars a month can’t trade with a country that produces enough for a trade surplus as it literally has nothing to trade. The Chinese will find themselves with a huge surplus of consumer goods reducing costs and the standard of living for the Chinese will soar while the standard of living in the US will plummet to what it should be in such a regulated economy.
    But this of course will never happen, as Mark Steyn puts it: “China will get old before it gets rich”, meaning they have epic demographic issues with no historical precedent. And more crucially as posters here have identified: China has no ideas. They are a philosophically bankrupt culture. Sooner or later, for one reason or another, this dysfunctional society will collapse and this is where the true danger of trade deficit lies. See it’s not the American economy that keeps China’s “humming”. That’s just an illusion made possible by China’s epic bad monetary policy. It is China’s economy that keeps the US humming. If you have regulated all of your manufacturers out of existence or to China on whose broken monetary policy you now rely in order to maintain your first world standard of living, what are you going to be consuming once China collapses?

  • Gideon Reich

    Grant writes:
    Similarly, if you look at the reason why China, suddenly and fairly unexpectedly, rose to prominence as world’s factory, it isn’t primarily because of a cultural shift, but rather a function of a centrally-planned economy.

    If this article from the Hoover institution is correct, then the above notion is mistaken. It was Russia that was attempting to change their economy from the top down even though there was no substantial cultural change (after decades of communism) and failed miserably, apparently returning now to a kind of fascism. China, on the contrary, was responding to better influences coming from the bottom up. It can be hoped that these influences will eventually overwhelm the current dictatorial regime.

  • Doug Reich

    China pegs it’s currency to the U.S. Dollar. So, when the U.S. inflates (creates a bunch of dollars), in order for the Chinese currency not to appreciate (relative to the U.S. Dollar), they must create Chinese currency.

    Recently, as the U.S. has been inflating, the Chinese have created a massive amount of their own currency. If they did not, their currency would appreciate and prices for their exports would go up. The central planners wish to keep their export prices low to encourage their export industries.

    It is in this way, that the U.S. “exports its inflation.” The Chinese have created a massive inflation which has found its way into their real estate and security prices. Many believe they have created an enormouse bubble of malinvestment which can be seen in ghost town developments and empty skyscrapers.

    This is exactly the position the U.S. was in vis-a-vis Britain in the 1920’s – with U.S. in the 1920’s acting as China is now. In other words, the U.S. was a huge exporter to Britain and the British had inflated the pound post WW 1. The U.S. created massive amounts of money so as not to allow the dollar to appreciate too much and kill the U.S. export industries.

    Well, we know how the 1920’s ended which is how China is likely to end at some point.

  • madmax

    “The U.S. created massive amounts of money so as not to allow the dollar to appreciate too much and kill the U.S. export industries.”

    Would it have killed the US export industries? I ask because it sounds like both the 1920s US and current China have no choice but to inflate – that it is necessary for economic survival. Is that true? What would happen if China kept a stable currency? Would they suffer?

  • Anon-D

    If China had a stable currency then they would be able to consume the products of their own efforts and enjoy a far higher standard of living.

    China doesn’t need the US consuming their goods – they can consume their own goods.

  • C.W.

    Well, this is really nice. I’m sorry that I didn’t know the party was happening.

    When I said that we are exporting inflation I meant only that the number of dollars outside the U.S. has grown from about $1T in 1982 to over $11T today. At the same time, the number of dollars inside the country has had almost the same increase in the number of dollars. I was not making any reference to the relative productivity of different countries, etc.

    The dollars overseas has spread everywhere, not just China. Japan has almost as much. The Europeans combined have a lot. There is the about $1T in private hands, including the EuroDollar.

    So, there are trillions of dollars out there without any impact on our domestic prices or dollar numbers. The increase can only be inflation. That is, if you correctly understand inflation to be the increase in the money supply. All of the dollars overseas are created dollars, made-up dollars.

    The build up ocurred for several reasons, but most importantly, it ocurred because the other countries and individuals wanted to keep the dollars, rather than spend them. That is all we really have to be concern with in this discussion. If they had wanted to spend them the dollars would have come back, our prices would have increased, and we would have twice as many dollars running around here as we do now. Instead, we got to buy lots of stuff with dollars that never came back. Our standard of living got a temporary lift. Temporary because those dollars are still claims on the U.S. Sometime, in some way, those dollars will come back to roost, and our prices will head up, way up.

    Today price inflation is being caused by direct input of dollars into the economy via federal expenditures on medical care (the government spending just surpassed 50% of all medical spending), stimulus, and the federal payroll. But there are some dollars coming back. As our economy gets into more trouble, more of those dollars will come back, and our exported inflation will be domestic.

    C.W.

  • Steve D

    I have a horrible trade deficit with my local grocery store. So, I guess I shouldn’t be worried about that?

  • C. Andrew

    Steve,
    Not to worry. You just need to inflate your currency. Oh wait! It’s a crime when we do it!

  • C.W.

    Steve, You would have a trade deficit if the grocery store didn’t cash your checks. Instead they put the checks in a special locked drawer called “reserves” and patted themselves on the back. You got the food and stuff, and still had your money, which means your own production. It is a nice deal until they realize that the checks won’t be worth much later, and when they do start cashing them, you have to come up with the goods in short order.

    C.W.