I know some of you like a bit of economic comment from time to time. Today I saw something that really got me steamed up. This is the email that I banged out to some friends. Although there are some macroeconomic technicalities, it’s fairly self-explanatory. Just over two and a half years ago (wow it seems longer), I warned you about the credit crunch. Now I’m warning you about a trade war and the implosion of the Eurozone.
From today’s Financial Times:
China has curtly dismissed a US proposal to address global economic imbalances, setting the stage for a potential showdown at next week’s G20 meeting in Seoul. Cui Tiankai, a deputy foreign minister and one of China’s lead negotiators at the G20, said on Friday that the US plan for limiting current account surpluses and deficits to 4 per cent of gross domestic product harked back “to the days of planned economies”.
What are these guys on???? China IS a planned economy: closed current account, fixed exchange rate, policy directed lending, interest rate controls, deposit rate controls, GDP per capita targets for municipalities….I could go on but you get the idea.
Either the Chinese are being disingenuous or they are totally stupid. The reason for quantitative easing (QE) is their economic policy which produces a huge bilateral trade imbalance with the US. Don’t these morons realise that their trade surplus is preventing US consumers from adjusting their balance sheets, inducing large government budget deficits, deficient demand and ultimately QE.
A simple accounting identity shows this: Domestic Private Sector Financial Balance (i.e. savings minus investment) + Fiscal Balance + Foreign Financial Balance (i.e. the inverse of the current account balance) = zero . You can’t bend it. Let’s make it simple and say that the fiscal balance is zero. If the DPS wants to save, there has to be a trade surplus (i.e. capital is exported). Think of it the other way round if the DPS is a net saver (as it is now with both corporate and the personal sector) and there is a trade deficit (i.e. foreign capital is flowing in), then the government is forced to run a (big) budget deficit. With a strong desire to save and the inability of the US to adjust its current account through the rigidities of the Chinese capital account and currency peg, the government has to run a large deficit. Thus when the Chinese complain about the profligacy of the US, they (the Chinese) are the ones that are causing it.
What is the way out? The US could deflate hoping that imports fall faster than exports ( a disaster for Chinese exporters and the world in general but the US isn’t going to do it because they don’t want another Great Depression) or it say to China, you are not playing ball, we’re going home and we’re taking our ball with us. If the US decides to make its economy more closed (i.e. trade barriers), it can solve its problems through shrinking its FFB. This will also have the impact of allowing the fiscal deficit to reduce (but not disappear until normal behaviour returns to the private sector).
Unless the Chinese wake up and smell the coffee, it is inevitable that the US will put up trade barriers. They simply have to, because it is the only way out of the impasse. The US can remake its economy. It has a lot of land, quite a lot of resources, a flexible economy and an efficient financial system (you could argue too efficient!!!). It will be at the expense of another recession, the end of the dollar as the world’s reserve currency and an inflationary problem. Apart from that it will be easy!
China on the other hand is stuffed. Exporters will be smashed. Other parts of the world won’t want to be dumped on (i.e. trade barriers go up everywhere). I could say a lot about the Chinese economy and its imbalances but it’s better to go the GMO web site (you need to register) and read Edward Chancellor’s “China’s Red Flags” , suffice it to say, China has no chance of switching smoothly from its mercantilist model to a domestic consumption driven one.
The observant of you will notice a parallel between the US/China situation and the Germany/Eurozone periphery problem: trade imbalances, capital flows and fixed currencies. The periphery can’t put up trade barriers to control its FFB and it is being forced to reduce its fiscal deficits. The only thing the periphery can do is to deflate like crazy and hope that export demand is more robust than import demand. The only problem is that a lot of trade in the Eurozone is intra-Eurozone, so it will become a self feeding deflationary debt liquidation spiral.
Why don’t these guys read an economics text book. It’s not that difficult!!!!