2008 July 31 Thursday
East Asian Bond Purchases Seen As Cause Of US Trade Deficit

A lecture by Financial Times writer Martin Wolf in 2005 entitled "Will Asian Mercantilism Meet its Waterloo?" correctly called attention to Asian purchases of US debt as the cause of the massive US trade deficit and the housing bubble.

Thus, the job of sustaining demand in the context of the huge drain on demand of the current account deficit shifted from the private sector to the government sector. If the US government had not gone so massively into deficit, what would have happened? Either a big recession, which would have reduced the current account deficit somewhat, or a still more aggressive monetary policy. Fed Funds might well have hit zero, as the Federal Reserve tried to sustain a huge private sector financial deficit in the post-bubble era.

The widely held view that the fiscal deficit is causing the current account deficit is, therefore, the wrong way round. It is much closer to the truth to say that the current account deficit is causing the fiscal deficit.

It is equally wrong to argue that the current account deficit is merely the consequence of relatively fast US growth. It is rather the consequence of relatively fast demand growth, in relation to supply, itself a function of the overall real exchange rate or, to put the point in less technical terms of US (un)competitiveness.

This story can be told in the following way: US demand has had to grow faster than potential GDP to accommodate foreign lending. Technically, at the real exchange rate of the dollar created by the policies of the rest of the world, US demand has had to grow faster than potential output, if actual output is to grow in line with potential output. And that is again precisely what has happened. From 1997 to 2003, inclusive, real demand grew faster than GDP in every year, except 2001, the year of the slowdown. Cumulatively, the difference was more than 4 per cent of GDP. The price that had to be paid was policies that promoted what may well prove to be a housing bubble, after the earlier stock market bubble.

We had a massive misallocation of capital, huge US government deficits, and a housing bubble so that the Chinese could build up large foreign reserves and grow their factories.

We live in a world of manipulated currencies and mercantilistic countries competing with countries which have lower barriers to trade. When the Doha trade talks finally collapsed recently a major reason was that the Chinese leaders decided that protecting their farmers was more important than a new world trade agreement.

After nine consecutive days of high-level talks, discussions reached an impasse when the United States, India and China refused to compromise over measures to protect farmers in developing countries from greater liberalization of trade.

Supporters of the so-called Doha round of talks, which began in 2001, say a deal would have been a bulwark against protectionist sentiments that are likely to spread as economic growth falters in much of the world.

Peak Oil is going to cause major economic contraction. Will this strengthen trade barriers?

Share |      By Randall Parker at 2008 July 31 11:53 PM  Economics Trade

Stephen said at August 1, 2008 12:54 AM:

Randall, you've provided a warped perspective that doesn't give any weight to the reasoning of the 3rd world. How about looking at it like this:

The US walks into the room and says, "Hey, you 3rd worlders listen here. You're to drop food import tariffs while allowing the US to continue to provide enormous subsidies to our exporting farmers."

The 3rd world said, "Why are subsidies good but tariffs bad"? "Just because", replied the US (believing that it still had the power to impose its will).

The 3rd world says "We can't afford to pay subsidies to our farmers, but you can afford to pay subsidies to your farmers. If we agree to stop tariffs without you also agreeing to stop subsidies, then our farmers will be wiped out."

The US says, "Just do what we say - just like you always have in the past."

China stands up and says, "Sod off you hypocritical bastards, you're not the boss around here anymore."

It begins to dawn on the US that things might be changing...

Snouck said at August 1, 2008 11:45 AM:

Randal: "We live in a world of manipulated currencies"

Fiat currencies can be manipulated. What is the alternative? What nations would be able to do it?



Dragon Horse said at August 1, 2008 1:41 PM:

Something you might want to take a look at Randall:


Randall Parker said at August 1, 2008 9:13 PM:


I do not understand your question, What nations would be able to do what? China manages their exchange rate against the US dollar. Are you asking me what is the alternative to their doing this? You mean, like how can we stop them from doing this?

We could just ban new Chinese purchases of US Treasury bonds. Or place limits on their purchases.

HellKaiserRyo said at August 2, 2008 9:00 PM:

Dragon Horse, the information in that NYTimes article is compatible with the hypothesis of Richard Lynn and Tatu Vanhanen.

Kenelm Digby said at August 3, 2008 4:34 AM:

1/. The USA buys substantially more from China than the Chinese buy from the USA.So much is obvious.
2/. To fund the continuining, massive oone-sided purchase of Chinese goods,the USA borrows dollars from China, which of course must be paid for by an interest rate premium.
3/. These dollars flow back to China, due to the Chinese trade surplus as outlined in (1) above, and are leant out to fund more uS purchasing as in (2) above plus an extra premium - enriching China even more.
4/. Go back to point (1) and repeat the cycle ad infinitum.

This is what I think is called a 'positive feed-back loop' - mathematically it can be shown to produce an exponential type growth graph (think of an electric guitar placed too near a speaker), which is ultimately unsustainable and destructive.

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