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


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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.

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

  1. I disagree with the notion that trade imbalances can’t be kept up forever. We often forget that trade deficits are balanced out by capital account surpluses. Consider two nations. Nation K only makes cars. Nation CA only has english schools. Nation CA buys cars from Nation K. Nation K sends its children to Nation CA to learn english, paying tuition, rent, etc. The money spent on education would never appear on an import/export balance.

    This hypothetical case is a reality for Canadian/Korean trade. What Canadians spend on Korean cars, Koreans spend in Canada on education. Trading knowledge for something real sounds like an excellent deal to me.

    • Well, the real problem is not Korea of cours; it is China. No amount of Chinese tourism, education, etc. will recycle the huge surplus which becomes net unemployment in the deficit countries – hence they revolt. Nor does tourism/ed alleviate the cultural problem of Asian mercantilism – that far too many Asians believe buying imports is a betrayal of the nation. Without less mercantilist/nationalist attitudes towards imports, Asians will never run the occasional deficit the global economy really needs right now.

      Thanks for reading.

  2. The unemployment rate during 2000-2008, while the USA was running such huge trade deficits, was actually pretty good. The recession of 2000 was notably mild. The crash of 2008 has been fairly moderate in Canada. Trade deficits don’t necessarily lead to unemployment. As I’ve noted, if the money is being recycled back as investment: in their kids education, in MSFT, in property, in shopping malls, etc. then it leads to employment. If a condo developer thinks he can make a profit building a condo in Vancouver and sell it to chinese investors, that results in jobs.

    The problem is what the Chinese are investing in, which has led to the crash. Remember the crash was caused by cheap debt, not because people didn’t have job or manufacturing was being hollowed out. The USA is still the world’s largest manufacture and it grew during the decade of the 2000s. Through 2000-to today, the Chinese found it most profitable to buy US treasuries and finance the US government deficit. If the US government is telling foreign nations “forget having to invest in the ups and downs of markets and property, we’ll give you a non-brainer steady rate of return” it’s entirely logical for China to finance debt.

    As I noted Canada’s exposure to the 2008 crash was considerably less so. Canada ran budget surpluses through the decade of 2000 and paid down existing debt.

    If the USA decided to balance its budgets, instead of borrowing $1 trillion a year, China would need to recycle that money some other way.

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  7. The United States has not had a current account surplus since 1975. We have not had a trade surplus with Japan since April, 1976. We have been in deficit with the EU since 1983. We have run trade deficits with both Russia and China for more than 20 years. How did America go from being the largest creditor nation in 1975 to the largest debtor nation by the end of the 1980’s? To understand what has happened one must go back in time. Prior to 1860 much of the Western World practiced Mercantilism. After 1860, led by Great Britain, Mercantilism was abandoned in favor of the teachings of John Locke and the free trade principles of Adam Smith. Trade barriers throughout Europe came down. A great debate on economic policy took place in America. Lincoln for instance was a Mercantilist. For the next 110 years the Western World basically traded with itself. Good flowed across the Atlantic and trade disputes if they arose were generally settled quickly. By 1970 the world was changing. The post world war II era produced the eventual rise of Japan as an economic machine. Goods started to flow from Japan to the United States and to Europe. The problem was that goods were only flowing one way. America for instance was banned by Japan from selling rice or apples to Japanese consumers. While disputes like this in many industries were festering, Japan was quietly becoming a world power in automobile and electronics manufacturing. Auto’s and electronics were exported out of Japan at an ever faster clip. By 1977 Japan was running steady trade surpluses with the United States and American politicians were raising alarms that Japan was simply practicing protectionism. What Japan was really doing is practicing a new form of Mercantilism which I have pegged, “Asian Mercantilism.” Japan was more concerned with full employment in Japan than the loud voices of western politicians. By the late 1980’s the United States and Europe were both running huge trade deficits with Japan. After 15 years of trade deficits America had found herself in the position of having gone from being the world’s biggest creditor nation to being a debtor nation. The rise of China over the past 20 years has given the world another Japan but this time on steroids. If Japan practices Mercantilism then China practices Supra Mercantilism: Goods are exported, imports are controlled. The currency is massively controlled, not free floating. Production is favored over consumption. With a population of 1.5 billion China has been able to give Mercantilism a whole new dynamic. What we have in the world today are two competing economic models for prosperity. We have the Western model with relies on the system of Free Trade and we have the Asian system with relies on a super sized form of Mercantilism. We have the West running trade deficits and the Asians running trade surpluses. China, Japan, and South Korea are the producers of goods while Europe and America are the consumers. Who is winning the battle between Western Free Trade and Asian Mercantilism? Asia is clearly the winner. The question going forward needs to be how we reverse a trend that is leaving America and much of the western World indebted and economically broken. What the West now calls protectionism, the Asians call Mercantilism

    • I don’t really disagree with any of that. But classical trade theory says that it still is economic rational to trade with protectionists. You still gain even as they try to gimmick the system, because those gimmicks impose costs on them from which you gain. What do you think?

  8. One has to look at how much Koreans pay for their domestically produced items. It’s cheaper to buy a Hyundai in America. It’s cheaper to buy Samsung in America. Compare costs of coffee, fruit, and vegetables as well. Korean pay exorbitant prices. The corporations profit handsomely from this protectionism but citizens pay through the nose for domestic and imported goods.

    As I noted originally in November, current account only reflects half the trade balance. If we buy cars from Korea and Koreans buy condos and education for their children, what Koreans spend on education and real estate purchase are not reflected in the current account figures.

    There is no necessary danger to running that kind of imbalance. If you can get cars and send people slips of paper why not? As Ames noted himself the USA has had a current account balance for decades and the USA had done quite well. It had done quite well because Japan and Europe and the Middle East recycled dollars into education, health care, real estate, buying equity in companies, etc. What changed was China wasn’t doing that. They were recycling dollars into treasuries. They were in essence offering cheap debt, keeping interest rates down. Americans themselves over consumed on that cheap debt (just as the Greeks over consumed on cheap debt brought about by the security of the Euro and historical low interest rates for Greece).

    The blame lies not in taking advantage of the fact you can get real stuff in exchange for slips of paper. The blame lies in Americans building McMansions. If Americans said no to cheap debt and had decided to live within their means, the Chinese would have been forced to recycle US dollars as Koreans, Japanese, Saudis, and Europeans have always done.

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