Asian Myopia on the Imbalances – Deficit Importers will Revolt in Time…

This week, I explained the issue of imbalances in my classes, as well as the general failure of the Seoul G-20. For all the talk of Korean ‘leadership’ at the G-20, it fizzled. Instead of leading by example to actually push through a deal, Korea ethnocentrically took the G-20 as an opportunity to grandstand to the world that “Koreans are great.” So self-congratulatory G-20 concerts took the place of any real leadership on the most obvious thing Korea could have done – finish the US-Korea free trade agreement (FTA) – to help unwind those imbalances. Instead, President Lee choose to sink the FTA at the behest of rabidly protectionist, consumer-punishing Korean auto and agricultural interests. So, with no help from Korea’s ‘world leadership,’ global imbalances have worsened this year.

So let’s go over this once again – with economic logic in the place of raw nationalism.

1. In a closed system, like world trade, some one needs to buy stuff. Everyone cannot export; everyone cannot run a permanent trade surplus; it is mathematically impossible. We cannot export to the moon or God. There must be global demand somewhere, and for much of the last two decades, the US was that anchor – so much so that we even re-packaged the business term  ‘buyer of last resort’ to apply to the US. So, as my students protested, it is true that the US government and consumers, as well as many EU countries, went wild in the last decade with their credit cards and created their own debt problems. But it is also true that without their demand, Asia and the Germans would have nowhere to export to. Now that the US and many other places are deeply in debt, it is obviously time to return the favor. The old exporters should become new importers in order to restore some balance to the system. ‘Diffuse reciprocity’ in trade is a basic requirement, in order that no one feels too much like they are being rooked by the other side. Without rough balancing over time, political disruption ensues (think Greece this year). This threatens the whole system in the long-term. Why is the Korean media too myopic to not see that?

2. The near permanent trade surpluses (above graph) in Asia are not, NOT, natural. It is mathematically all but impossible that a free-trade environment would return a situation where Korea, Japan, China and Germany would run 30 years of trade surpluses while the US ran corresponding deficits in the hundreds of billions USD. Why is this nearly impossible? Because the currency of such super-exporters would go up and up as their exports went up and up. In laymen’s terms, if the whole world wants to buy your stuff (Japanese cars, Korean TVs, Chinese everything), then the whole world needs more and more of your currency to buy all those amazing exports. So all those foreigners buying your stuff exchange their currencies for your currency. All this bidding to buy your currency (so they can buy your exports) means that the price of your currency goes up and up. So if you are permanently exporting more than importing, your currency should be permanently rocketing to the moon as foreigners scramble to buy it. Of course this has not happened. If you look at east Asian currencies, they all are pretty soft against the dollar, frequently moving downward. This is mathematically impossible to square with a permanent trade surplus. The only possible explanation is currency interventions to keep their currencies undervalued. In other words, cheating. And this is in fact well documented. China’s currency is pegged at a ridiculously low value to the dollar (estimates rage around 40-50% undervaluation!), and the Koreans and Japanese regularly ‘sterilize’ their currencies’ appreciation through massive dollar purchases. The Korean central bank’s euphemism for such raw mercantilism is ‘fine-tuning.’

3. Trade must be a two-way street in the medium-term, or the permanent deficit countries will eventually revolt. Here the Korean media is totally unhelpful with its nationalist and short-termist thinking that Korea’s success requires a surplus. This is also logically incorrect. There is no especial value to piling up dollars. Foreign currency cannot be spent in another country, so why stockpile hundreds of billions of dollars, or in China’s case, trillions, of someone else’s currency? If you don’t spend it back by importing, then at some point your export targets run out of money. And this is precisely what has happened in the great recession. The importers of yore are broke, and they need some of their dollars recycled back as export sales. But if you politically refuse to countenance a trade deficit by buying imports from your trade partners, then eventually you anger them: you are trade manipulator, and you provoke trade conflicts. Japan learned this the hard way. Its currency and trade gaming lead to two US backlashes – first when the US broke the Bretton Woods system and inflated in the 1970s, and then again the 1980s with the Plaza Accord. And this is what the Fed’s current quantitative easing is today. The US, unable to convince the surplus countries (esp. China) to import for the collective good of the system, is going to force them to do so, or they will see the value of their dollar reserves evaporate in inflation. Quantitative easing is a declaration of war by the Fed on the People’s Bank of China. This is extremely risky for everyone, as it throws the dollar’s reliability in the air, but it shows you just how head-in-the-sand obstinate the surplus countries are. In order to maintain short-term trade surpluses, they risk the inflation of the very currency they have stockpiled.