Groundwork for Trade Conflict Being Laid?

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We have worried out loud that the policy remedies being pursued by the US amount to trying to restore the status quo ante to as great a degree as possible, particularly in trying to resturn US overconsumption to something approaching its former levels. Although it may be difficult to work two agendas, crisis response and addressing the root causes of our economic mess in parallel, focusing solely on the former runs the considerable risk of that we will see only a shallow recovery, with many of the elements of the crisis soon reasserting themselves in more virulent form.

Similarly, the Chinese, who at least in theory had accepted that they needed to let their currency rise (and presumably over time move to a more balanced, less export-dependent economy) have similarly gone into full reverse gear. The RMB has now been more or less re-pegged to the dollar, and China is moving in other ways to shore up exporters (such as pressuring banks to lend).

Michael Pettis points to a related, troubling development: other emerging economies are seeking to restore or increase trade surpluses. That in turn means SOMEONE has to import. But the US wants to increase exports (and the move by the Fed to quantitative easing will have the side benefit, from its perspective, of weakening the dollar). Euroland is neither keen nor able to step into the US role of importer of the last (and first) resort (boldface ours):

One consequence of the financial crisis will inevitably be capital outflows from developing countries. The necessary corollary of capital outflows is trade surpluses. Without running a trade surplus no country can consistently support capital outflows, and as obvious as this is, it also seems to be a source of tremendous mystery to many experts and policymakers. Keynes for example pointed this out in his fury at the way Germany was required to post war reparations in the 1920s while its ability to generate export surpluses was all but eliminated by the victorious powers. Capital exports by definition require trade surpluses.

This is just another way of saying that a lot of developing countries that had been running trade deficits will soon be, if they aren’t already, running trade surpluses. Instead of contributing their net demand to the world economy, as they had via their trade deficits, they will now be contributing their net supply.

This will not help the world imbalances. The biggest contributors of net demand are the US and non-Germany Europe, and both of these regions are seeing a rapid decline in their net demand contribution (i.e. their trade deficits are expected to shrink). To adjust to this decline the world needs new sources of net demand or else global production must contract sharply via factory closings and rising unemployment. But the largest net supply country, China, is increasing its export of net supply (its trade surplus has been rising) while several trade deficit countries in Asian and elsewhere are switching to trade surplus or otherwise trying to reduce their deficits.

This cannot be sustainable. We cannot expect production to rise while consumption declines except if it comes with a dangerous rise in forced investment (also known as inventory). The crisis cannot even begin to be considered in its final stages until this issue is resolved.

Pettis addresses another issue, namely, that China’s interest rate cuts will do little for consumers, and will instead exacerbate global imbalances:

For me, interest rate cuts in China will have very different effects than they might in the US. In the US, where a great deal of credit goes to consumption, lowering interest rates can be seen as boosting consumption as much as boosting production. At any rate the US, which contributes the largest amount of excess net consumption to the world and must bring it down, has every reason to focus on production-boosting measures as well as consumption-boosting measures.

But China is different. First of all there is little to no consumer credit in China, so cutting interest rates won’t do much to boost consumption. It might do so indirectly by reducing mortgage payments (Chinese mortgages are all floating-rate mortgages) and perhaps by slowing the decline in real estate prices, but it is not clear how big an effect that might have on increasing consumption, especially since even lower interest rates aren’t likely to create much buying interest for real estate. In fact there is some evidence in China that households may actually contract spending when deposit rates are cut since they need to save more to achieve their precautionary savings targets.

On the other hand with most credit going to investment, lowering interest rates definitely reduces further the cost of production. I know that the idea of lowering interest rates in an economic contraction is firmly entrenched in economic wisdom, and I am taking what may seem like an extremely opposite viewpoint, but I doubt that cutting interest rates is what China needs to do if it is expecting to adjust to the global payments adjustment. Every domestic policy must be aimed at boosting demand, and anything that increases China’s “competitiveness” is a dangerous detour since it can only exacerbate global imbalances and increase the likelihood of trade friction.

In down times, it’s every man for himself. The interesting question is whether these conflicts come to the fore in 2009 or take a bit longer to become acute.


Originally published at Naked Capitalism and reproduced here with the author’s permission.

4 Responses to "Groundwork for Trade Conflict Being Laid?"

  1. Adam Smith   January 1, 2009 at 10:53 am

    Quantitative Easing Won’t WorkIn a Liquidity Trap although Saving (S) is abnormally high investment (i) is next to 0. The Keynesian Paradigm I=S is not verified.The purpose of Quantitative Easing is to lower the yield on savings but it doesn’t create $1 on investment. It does diminish the yield on long-term Treasury Bonds but marginally lowers the asked yield on savings.This and other issues are explored in our Tract:A Specific Application of Employment, Interest and MoneyAbstract:This tract makes a critical analysis of credit based, free market economy, Capitalism, and proves that its dysfunctions are the result of the existence of credit.It shows that income / wealth disparity, cause and consequence of credit and of the level of long-term interest-rates, is the first order hidden variable, possibly the only one, of economic development.It solves most of the puzzles of macro economy: among which Business Cycles, Stagflation, Greenspan Conundrum, Deflation and Keynes’ Liquidity Trap…It shows that no fiscal or monetary policy, including the barbaric quantitative easing will get us out of depression.It shows that Adam Smith, John Maynard Keynes, Karl Marx and Alan Greenspan don’t contradict each other but that they each bring a meaningful contribution to a same framework for understanding macro economy.It proposes a credit free, free market economy as a solution that would correct all of those dysfunctions.In This Age of Turbulence People Want an Exit Strategy out of Credit, an Adventure in a New World Economic Order.Read It.http://edsk.org/

  2. Adam Smith   January 1, 2009 at 10:53 am

    Quantitative Easing Won’t WorkIn a Liquidity Trap although Saving (S) is abnormally high investment (i) is next to 0. The Keynesian Paradigm I=S is not verified.The purpose of Quantitative Easing is to lower the yield on savings but it doesn’t create $1 on investment. It does diminish the yield on long-term Treasury Bonds but marginally lowers the asked yield on savings.This and other issues are explored in our Tract:A Specific Application of Employment, Interest and MoneyAbstract:This tract makes a critical analysis of credit based, free market economy, Capitalism, and proves that its dysfunctions are the result of the existence of credit.It shows that income / wealth disparity, cause and consequence of credit and of the level of long-term interest-rates, is the first order hidden variable, possibly the only one, of economic development.It solves most of the puzzles of macro economy: among which Business Cycles, Stagflation, Greenspan Conundrum, Deflation and Keynes’ Liquidity Trap…It shows that no fiscal or monetary policy, including the barbaric quantitative easing will get us out of depression.It shows that Adam Smith, John Maynard Keynes, Karl Marx and Alan Greenspan don’t contradict each other but that they each bring a meaningful contribution to a same framework for understanding macro economy.It proposes a credit free, free market economy as a solution that would correct all of those dysfunctions.In This Age of Turbulence People Want an Exit Strategy out of Credit, an Adventure in a New World Economic Order.Read It.http://edsk.org/

  3. Paul Walker   January 2, 2009 at 8:27 am

    An observation that could be made regarding the subject of this article is the striking resemblance in the actions over the past few years between the fiscal & monetary policies in China & the US. Both countries emphasized heavy expansion of bank balance sheets, in China to fund industrial expansion and with it consumption within their industrial sector for more and more raw materials and feeder parts for their finished products from nearby nations to fuel the governments efforts to rapidly expand international trade imbalances and collection of the surpluses associated with those imbalances and in the US to expand the traditional levels of residential real estate ownership and with it the continued expansion of household consumption and debt loads. While there has been considerably more notice made of the ongoing situation of shrinking bank balance sheets and an ever expanding federal reserve balance sheet in the US it would appear as though there has been little notice of the same effect in China with respect to their ballooning loan failures in the industrial sector, the losses suffered in locking in essential commodities prices near their recent peaks and the measures taken by Chinese officials to offset these losses and maintain the semblance of propriety with the balance sheets at their financial institutions through the opaque operations between central authorities and their banking sector.Both countries appear to be following a policy of printing money as quickly as possible to maintain appearances. What I am reminded of here is the old adage that one is not considered bankrupt until it is generally recognized that the entity in question in, in fact, bankrupt. With all of the discussion swirling around decoupling, recoupling and the net differences between the western & eastern financial models I am reminded that the more things change, the more they remain the same.

  4. Guest   January 6, 2009 at 5:27 am

    This will not help the world imbalances. The biggest contributors of net demand are the US and non-Germany Europe, and both of these regions are seeing a rapid decline in their net demand contribution (i.e. their trade deficits are expected to shrink). To adjust to this decline the world needs new sources of net demand or else global production must contract sharply via factory closings and rising unemployment. But the largest net supply country, China, is increasing its export of net supply (its trade surplus has been rising) while several trade deficit countries in Asian and elsewhere are switching to trade surplus or otherwise trying to reduce their deficits.