China and the Trade Deficit: Whose Fault Is It?

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Right now, we have a high-level delegation in China discussing our trade deficit with that country. But what is it we expect China to do? How do we expect them to fix our problem?

One of the issues is the Chinese government's fixing the value of the yuan to the U.S. dollar. The assertion is that the yuan is undervalued, so China is selling to us on the cheap. So let's say a widget costs 9 yuan to produce, and the Chinese sell it to us for 10. Let's also assume that the yuan is pegged at 10 to the dollar. (I'm making up these numbers.) So we get the widget for a dollar. But the yuan is really undervalued, and should be, let's say, 8 for a dollar. So the widget should have cost us $1.25. Essentially, the artificially depressed yuan valuation just resulted in the Chinese' giving us 25 cents. What was the problem again?

Well, the reason the yuan's depressed valuation is considered a problem is that it increases our trade deficit with China. Well, if it weren't China, it would be someone else. If a nation has a trade defecit, it means that it is buying more than it is making. If we were not buying more than we are making, the value of the imports we bought would have to be offset by the value of the exports we sold. So whose fault is this, anyway?

Look in the mirror, folks. Let's assume that our per capita GDP is $100,000. (Again, I'm making these numbers up for illustration only.) If we have a per capita trade deficit of $1000, where does that extra $1000 come from? We did not make it, or our per capita GDP would have been $101,000. No, that $1000 comes from debt.

Our trade deficit is a direct result of our willingness to go into debt. Nothing China does can fix that.

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39 Comments

stay puft said:

not bad.

part of the reason china pegs it's currency is that the country is so unevenly developed. what that means is that the yuan is worth something different in different parts of the country. we have this to a degree. In farm country USA you can get a burder for $2.50, in NYC you'd be lucky to find one under $10. But even this doesn't compare to the difference in values between rural and urban china. ...but china likes investment, and investors like stability, so by pegging it's currency china gives the impression that it's economy is more stable than it really is

Had Enough said:

Communist china should be treated like cuba.

china is building a major port in mexico to ship their cheap goods to. bush signed the SPP and it includes a Super Highway that will start in Texas and go to Canada via mexican truck drivers to deliver china's cheap worthless goods. Just another bush attempt to put US workers, ports, truckers, etc. out of work.

Texas has been fighting the highway (10 football fields wide with rail). It will eliminate many farms, etc. But now they have been told if they continue to fight this they may lose their federal highway money.

clinton liked to turn a military base in the USA over to china so they could sell weapons to gang members.

Did I read this post correctly to say that by pegging their currency to ours, the Chinese are GIVING us money, and that our leaders want to REDUCE the trade deficit?!

The author of this post is way off the mark and I don't want to address his points one by one; they are based on a set of false fundamental assumptions. (I say this with all due respect because I do think the post was written in the right spirit and from a patriotic author).

In a free market, the value of a product is what the consumer is willing to pay for it (aggregate demand). Foreign currency manipulation doesn't change that fundamental truth. We don't buy Chinese products with yuan, we buy them with dollars.

A trade deficit does not mean that we are "buying more than we are making". It means we are importing more than we export. Total GDP still TOWERS over imports. In the GDP equation the quantity (exports - imports) is added to the total and is a small, although growing, part of the total figure. Even in this unfortunate free trade economy, we still have a lot of domestic production for domestic consumption (which is the most efficient and productive use of scare economic resources; Adam Smith).

Please don't read this to mean that our trade deficit is not a terrible problem; it is! But understand that these foreign imports are not 'cheap' or 'cheaper' or any sort of benefit. They are the primary cause for 10% GDP growth in China and massive economic problems in the United States (such as the drastic loss of real wages when correctly expressed, and the drastic increase in the number of people employed just to make ends meet).

Remember, our President is using trade policy to encourage a transition to a global market (global government, global system, one world government, new world order, call it what you will; it's the same thing)

Secretary Paulson (perhaps a better friend to the Chinese than Americans) recently announced that he intends to devalue the DOLLAR in relation to the yuan (this was picked up by Australian news, but not U.S. media of course).

ANYTHING these people do is designed to INCREASE the trade deficit and INCREASE global INTERdependence, not decrease it. These folks do not even consider the trade deficit to be a problem! (they *say that a trade deficit simply means that the Chinese are 'investing' in America. what a sham; that investment comes in the form of ownership of domestic land, domestic companies, and domestic debt instruments).

For more information on these topics, check out or website:

www.americanprotectionist.com

For a primer on free market economics and the American system (as originally designed) check out www.americanprotectionist.com/Archives/

thanks.

Wayne

Jack said:

Wayne:

Nice of you to join us.

Yes the trade deficit is the difference between our imports and our exports. But we must buy those imports. All that we create is our GDP. If our per capita GDP is $100,000 per year, let's say, and we export $1000 of that production, and import another $2000 of products, then our per capita trade deficit is $1000.

So where did that extra $1000 come from? Debt or the depletion of savings.

A trade deficit does indeed mean that we are buying more than we are making.

For a primer on economics, try "The Wealth of Nations," by Adam Smith: http://www.econlib.org/LIBRARY/Smith/smWN.html

stay puft said:

Hey, Adam Smith has a nice book, but it's a bit dated. There are better resources for understanding trade in a global economy. Try Stiglitz.

according to "comparative advantage," domestic production for domestic consumption is typically not the most effective use of resources. Look it up.

domestic production for domestic consumption is AKA "import substitution" and it has a checkered history. A number of Latin American countries used this model of economic growth and, well...

I gotta say, Americanprotectionist is a great name for your website, though.

Jack said:

Funny, puffalump -- you say Adam Smith is dated, then use his arguments. Beautiful.

stay puft said:

beautiful like classical economic theory, or beautiful like when a know-it-all is wrong?

Jack, Adam Smith never mentioned comparative advantage or import substitution.

but as far as dated goes, I think Ricardo came up with the theory of comparative advantage, so I guess it's an older one, too. But both Smith and Ricardo were pretty much opposed to protectionism (read: free market distortion), so I'm not sure why Wayne was quoting Smith anyway.

Anyway, it's not to say that these old guys works aren't worth anything, only that it's worth keeping in mind that there are also contemporary economists examining contemporary issues.

Comparative Advantage is a faulty theory designed to answer the question: "why would a nation superior in the production of all things trade with a nation inferior in the production of all things".

I've also written briefly on the topic of the flaws and failed assumptions of comparative advantage. Even an undergrad can drive a truck through the flaws in comparative advantage, and text books ADMIT that it's a flawed theory. I quote one in the article linked below.

www.americanprotectionist.com/Archives/

And as for Jack's statement that Smith was opposed to protectionism; JACK needs to read the book he so kindly linked. There is no more protectionist author than Smith. I use Smith as a litmus test, in fact, to ferret out those that have READ him (who know he was a protectionist) and those who have not (those that have read Samuelson and didn't verify the misleading information about Smith being presented).

I would suggest to Jack a careful look at Book 4 Chapter 2, as a starting point, which includes near the end this very famous quote.

"By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."

In fact the whole section is a long proof of the superiority of domestic production, and the good that is done when capital is invested domestically.

Smith shows in this great work that domestic consumption of domestic production employs twice as much labor as domestic consumption of foreign production (which is not really all that complicated to grasp).

VERY FEW people have actually read Smith, Mises, Ricardo and others, but they all read ABOUT them. Unless you've done your homework yourself, you have to be very careful what kinds of statements you make about these authors.

Economics is a "dismal" science, in my opinion, because many have accepted and do not question the flawed universal of comparative advantage. Progress in economic science is very slow because the logic being employed is flawed and results do not bear out hypothesis. Theory is being ignored and now the so called 'best economists' are really just 'really good economic statisticians'. Ricardo is being questioned now, a bit, and as his untenable theory is destroyed and scientists recheck their universal propositions, progress in this so-called 'dismal' science will bloom again.

But anyway, I don't want to get into a long, protracted free trade debate here, (come to our site for that if you like) as the original post was about the political motivation behind the trade deficit, particularly the deficit with China.

Thanks for the discussion all,
Wayne

stay puft said:

I said Smith was opposed to protectionism. more on that later...

it's so sweet that there's an americanprotectionist website that has archived articles on the flaws in comparative advantage!!

stay puft said:

Hey, this doesn't have much to do with China's monetary policy, but I just wanted to say nice piece on "CA". Of course I disagree somewhat.

While I haven't read Adam Smith's entire body of work, I am aware that he was fairly critical of mercantilism and the protectionism that goes along with it. Is this incorrect?

For example, our economy has grown fastest in periods of less protectionism, right?

And what about S. America's experience with import sub. ??

and while Asian countries protected infant industries, but it wasn't until after they opened their economies that they took off (Japan, Taiwan, S. Korea)

Jack said:

I have indeed read The Wealth of Nations, Wayne. I fear that our friend Jacob has my copy at present. I did not take him to be a protectionist at all.

Even so, the point is moot. The point of my post was that it is our going into debt that provides the extra money to purchase more foreign made goods than we export.

Noonan said:

Between the trade deficit, hemorraghing of U.S. jobs overseas and the "race to the bottom" which empowers developing nations such as China or India to provide far cheaper labor to lure away our businesses, our government needs to act to protect its interest.

Since this site seems dedicated to opposing the influx of cheap immigrant labor to offset the economic globalization as has been happening here and in Europe, the alternative would seem to be pressing our good more into foreign markets, maximizing consumption of American goods in America, penalizing companies who take American jobs overseas (rather than subsidize them), and incentivize new manufacturing sectors into the U.S. It all comes back to strengthening our manufacturing base. Every dollar we lose there is like losing $3 in the economy because many services and non-essential goods markets are sustained and strengthened by the dollars generated in the manufacturing sector.

We should be looking, therefore, for a leader who is smart and tough enough to strengthen our foreign trade policy and come up with initiatives that will incentivize creativity and entrepreneurial risks that will strengthen our manufacturing sector and generate U.S. jobs.

PUBLIUS JR: said:

We only need to remember two things: We had the highest standard of living and the highest degreee of individual freedom and liberty the world has ever known under the authentic economic sytem of protectionism given to us by the Founders.

This period covered the years form the fouding of the Republic until at least 1913 perhaps up to as late as 1960.

Why we are always trying to ´´improve upon´ our System by destroying it with the anti-American philosophy of free trade always puzzles me.

Free Trade is bad economics and creates interdepence with all the countries of the world and fosters big government, high taxes, lots of regulations and diminishes our freedoms.

When will the professional economists stop lying to us about the philosophy of free trade and when will we stop being duped?

Stay Puft,

Economic growth occurs as a result of increasing per capita, capital investment.

So yes, third world nations will see huge growth rates when they allow foreign capital investment from developed nations.

however, there is no advantage for the developed nation to invest their capital in foreign workers (although there is profit in it; the labor arbitrage makes the balance sheet of multi-national corporations look nice).

Comparative Advantage was invented to convince Americans to spread the capital they built up under protectionism so that the world could be united into a single market; a single system.

But it's a flawed idea, and economists are proving it.

Jack,

Indeed, we certainly are going into debt as a result of our trade deficit; I would not argue with that.

We are borrowing from future generations of Americans, and we are paying the interest to foreign corporations, communist governments, and enemies of everything we supposedly believe in as Americans.

ps - Jack, I see that I incorrectly attributed Stay Puft's incorrect statement about Smith to you. Indeed, it is Stay Puft who should come to our website and snag a copy of Smith's Wealth of Nations.

Jack said:

"Indeed, we certainly are going into debt as a result of our trade deficit; I would not argue with that."

That is exactly the REVERSE of my theory. I contend that our willingness to go into debt -- to buy with credit cards, car loans, and home equity loans, is the CAUSE of our trade deficit, not the result of it.

Whether you attribute it to puffalump or to me is irrelevant. Neither he nor I think that Smith favored protectionism.

stay puft said:

Jack!

Publey,

nope, economic openness = economic growth. name one empire that didn't bother to establish and maintain complex networks of trade.

look at this article:
http://tinyurl.com/24jmh2

It's all about political coalitions supporting openness or protectionism based on political and economic circumstances. I know it's long but it's what I had on hand and it's pretty interesting. But what you should look at are the graphs on p. 6-8. Every dip in wages in these western economies corresponds with eras of increased protectionism; Every upturn to a period of economic openness. Note the trend upward since 1950s (and Bretton Woods)

After the definitive failure of import substitution in latin america in the the 1980s, the world was on board with the "washington consensus" that an export-oriented economy was the way to go, and profits have correspondingly continued to climb since.

If you're going to convince anyone that free trade is bad for American, you're going to have to address the failure of import substitution and the fact that export-orientated economic integration = increased profits and wages (I didn't see where on the americanprotectionist site these issues were dealt with)

jacob said:

Marshmallow,
I am not sure Jack's main point even was 'Free Trade, BAD (ugh, grunt, slurp)'. I think his point was that there is a strong link between the trade imbalance and the National Debt.

The imbalance is causing debt, because we are buying more goods than our GDP can afford. The demand for goods is outstripped by our abiliy to buy. So the imbalance takes on the form of debt.

As for free trade, it currently does not really exist with China. There market is fairly closed to us, and ours is wide open to them.

Jack said:

Almost, jacob. Not our National Debt, so much as our Personal Debt.

And you, too, are getting it backwards. The imbalance is not causing the debt, our going into debt is causing the imbalance.

stay puft said:

for the first time ever I was actually agreeing with Jack!!

The rest of my previous comment (after "Jack!") was addressed to a guy from the americanprotectionist group. I was debating His points, not Jacks.

jacob said:

Jack,
Ok, you are correct in this. Looking at the trade imbalance as a national credit card binge gone amuck is probably correct from an accounting standpoint, with the whole country as the cardholder.

However, this is the result of thousands of individual wholesalers buying from oversea's. While these individual wholesalers are not over budget, it is the country as a whole that is in debt.

So, does your analogy not breakdown a bit at that point?

jacob said:

Marshmallow,
I agree fundementally with both Jack and you w.r.t. the fact that we and not the Chinese are the ones who are responsible for our national debt and resulting trade imbalance.

You are correct, it did not occur to me that you were in agreement with Jack. This is one of those 'firsts' that blows the mind a bit.

jacob said:

Jack,
China is deflating the real value of its currency so as to further entice the wholesalers to buy from them. According to Adam Smith, this only further increases the over all transfer of wealth to our country. OK, so be it.

But does this not provide the Chinese with walking around money ('real' dollars) to purchase armaments? They are converting labor and material into gold to build up thier military.

Should that not give us pause w.r.t. our willingness to go into debt in this manner? Knowing what they are doing with the cash, should we not be a pain at the summit table?

Jacob,

Yes, our trade imbalance is like a giant national credit card debt, but don't blame the wholesalers or consumers; they are doing what people always do; look for what is best for them from their point of view.

It's the job of GOVERNMENT to take away the incentive to invest all of our capital on foreign products. This is the whole POINT of the protectionist argument and how austrian economics proves our point (by accident).

Anyone that has read Von Mises knows the points he made about praxeology and human nature in his great book Human Action.

If government does NOT protect the domestic market from dumping of products from communist systems, socialist systems, dictatorships, and undeveloped third world pseudo market systems, the distortion causes dramatic pain for the developed nation.

Government simply has to level the playing field with a tariff; then we can peacefully trade without disruptions of OUR system and OUR market.

Jack said:

Wayne,

I contend that, in some degree, we consumers ARE responsible for our trade deficit, not because we are looking for the best deal, but because we are, individually, going into debt to subsidize our purchases. Because we are buying more than we make, the excess products MUST result in a trade deficit.

Now, Jacob has a good point that the trade deficit does not have to be with China. If they let the yuan float, then our deficit with China will go down. However, it will go up with other nations. With the inflow of cash, they would probably start buying things from China, and the money will go to the Chinese anyway. However, since the yuan would have a higher value, they may not have to produce as much to get it.

stay puft said:

tariffs are market distortions. what distortion is it when countries can capitalize on their cheap labor to become more competitive? Developed economies do the same with technology.

it seems that China and India's ability to compete with US is an indication that the playing field IS level

Jack said:

I agree, puffalump. (Dang, zimzo and Joe agreeing, now Puffalump and I are agreeing. Didn't Nostradamus say something about that?)

Tariffs are market distortions. So are minimum wage laws and payroll taxes, which make our workers much less competitive.

jacob said:

Wayne,
I was not 'blaming' the wholesalers. They are pursuing the there own self interest. Which is the definition of the 'invisible hand', and a good thing.

As you pointed out, they are not responsible for the state of our macro-trade policy. From a purely economic standpoint, the market is the _best_ solution.

The trouble I see is that other governments tamper heavily with markets. Are we at a disadvantage because we encourage free (untampered) trade when the market we are trading with is closed?

jacob said:

Marshmallow,
"it seems that China and India's ability to compete with US is an indication that the playing field IS level"
I see a big leap in logic there. Care to fill in the gap?

I see tariffs, and import barriers in China's case. I also see slave labor. In the case of India, I see an true, emerging capatilist economy.

But in either case you need to proove your assertion. Because in the case of China I disagree with you.

stay puft marshmallow man said:

The fact is that Chinese and Indian businesses are competitive, which they weren't 20 years ago. That's a level playing field. Protectionism advocates for a slanted field by insulating domestic businesses from unfavorable market forces.

No Relation said:

What's a widget?

jacob said:

Marshmallow,
I would argue that the Chinese business' are under an protectionist umbrella. We cannot sell things in China w.o. being subject to Chinese government meddling. How is that competitive?

No Relation said:

Oh, you left out a bunch of stuff. First of all, you have to grease the local politicians for the sudden zoning problems that always come up. Then there's the kickbacks to the carpenters. And if you plan on using any cement in this building, I'm sure the teamsters would like to have a little chat with you, and that'll cost you. Don't forget a little something for the building inspectors. There's the long-term costs, such as waste disposal. I don't know if you're familiar with who runs that business, but I assure you
it's not the boy scouts.

Jacob,

on the invisible hand; it's a 'good thing' BECAUSE the investors of capital invest it domestically, and BECAUSE the consumer prefers domestic production.

read the whole section, not just the (intentionally) chopped quote that Samuelson uses in his entry level text books.

jacob said:

Wayne,
OK. I have Jack's copy of the "Wealth of Nations" at home. I will go investigate.

Jack said:

Jacob -- how many years have you had my copy? Anyway, you can keep it. I finally bought another one. Unfortunately, I lent it to my mom. Fortunately, it's all online: http://www.econlib.org/LIBRARY/Smith/smWN.html

Stacy said:

Reducing the trade deficit requires increasing exports and decreasing imports. That requires inducing foreigners to buy more U.S. made goods, and inducing Americans to “switch” their spending from imports to domestic made goods. Market economies accomplish this through changed relative prices. That calls for exchange rate adjustment that makes foreign goods more expensive for US consumers, and US goods cheaper for foreign consumers. The U.S. deficit with China reflects that US need export more to China.
Demand for many US products in China are very strong,but there are few, if any, effective methods for US SMF's to access Chinese buyers and meet the demand. AC-Ali enables US businesses to list their company and product descriptions in English. AmeriChinaB2B will translate these descriptions in Chinese and put them on its China Business platform www.acb2b.cn. which attracts a large number of Chinese importers and distributors looking for American products to import to China.
Welcome to AmeriChinaB2B( http://www.acb2b.com/ ) to begin your business trip of China.

Ames Tiedeman said:

The dollar, as predicted is being crushed. We are now at Par with the Canadian Dollar, the Loonie as it is called. This was all so predictable. You cannot run an 800 bilion dollar trade deficit and have your currency in demand. We have a lot farther to fall. Within 5 years from 2008 we should see the Canadian Dollar worth 25 % more than the U.S. dollar. The Euro at 1.40 now, should move to near 2.50, as China buys more and more of the Euro.
The pound at 2.04 as I write this will be near 3.00. Be ready for CHINA. When they finally let their currency float it will appreciate 70% over a 36 month period. The US trade deficit will be cut in half and then some by 2020.

Ames Tiedeman said:

The dollar, as predicted is being crushed. We are now at Par with the Canadian Dollar, the Loonie as it is called. This was all so predictable. You cannot run an 800 bilion dollar trade deficit and have your currency in demand. We have a lot farther to fall. Within 5 years from 2008 we should see the Canadian Dollar worth 25 % more than the U.S. dollar. The Euro at 1.40 now, should move to near 2.50, as China buys more and more of the Euro.
The pound at 2.04 as I write this will be near 3.00. Be ready for CHINA. When they finally let their currency float it will appreciate 70% over a 36 month period. The US trade deficit will be cut in half and then some by 2020.

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