For all their sins, foreigners should not be blamed for the US' large trade deficits. China especially is doing nothing worse than producing goods that are cheaper than those produced elsewhere.
Never mind the stupid Chinese policy to keep their currency artificially weak. In all events, this is doing them more harm than good. China gives Americans things that they want in exchange for green bits of paper that are depreciating.
Nonetheless, misguided politicians in the US are threatening restrictions on trade with China. Extreme language depicts China's export engine as the cause of most of the US' economic ills.
As is usually the case with Washington windbags, these claims are hyperbolic. Of America's US$162 billion trade deficit, only one quarter of the total last year was from trade with China.
Senator Charles Schumer introduced a bill whereby all Chinese imports would face a 27.5 percent tariff. This ill-advised move is reminiscent of the disastrous Smoot-Hawley tariff that contributed to a collapse on the eve of the Great Depression.
And Fred Bergsten, director of the Institute for International Economics in Washington, proposed a pre-emptive 50 percent tariff on China. There must be something strange in the water they drink in that town.
Meanwhile, the US and EU approached the WTO for permission to restrict Chinese garment imports that boomed after global textile quotas ended in January. And the US Trade Representative's office placed China on a blacklist for "rampant" copyright abuses that undermine US intellectual property rights.
But is China guilty as charged? Partly, yes; but mostly, no.
Politicians and technocrats in the US and Europe are displaying a breathtaking lack of information concerning what is the principal cause of trade deficits. From the standpoint of the US, most of the blame is homemade.
And the culprit is the US Federal Reserve. US central bankers are either unwilling or unable to understand their role in this mess. It is bad enough that Congressional lawmakers and their staffs are unable to comprehend the nature of economic processes and the functioning of markets. But it is inexcusable that economists cannot comprehend that a policy of artificially cheap credit and monetary pumping is the primary source of most of the ongoing economic imbalances.
Fed Governor Ben Bernanke blamed a "global savings glut" that portrays an urge to save as a scourge. Despite his supposed Monetarist credentials, he has revived one of the worst notions of Keynesian economic theory, the "paradox of thrift."
Instead, consider how Bernanke and his mates inflated the US money supply. From December 1995 to last December, M1 rose by 18 percent while M2 increased by 76 percent. As such, the Fed helped create the biggest liquidity bubble in history by pushing interest rates down to an artificially low level for so long. Beginning at 8 percent in July 1990, the benchmark federal funds rate was continuously lowered to 3 percent in September 1992, when it began to creep back up again incrementally. It peaked at 6 percent in February 1995.
After peaking again at 6 percent in January 2001, it started a long drop to 1 percent in June 2003 where it remained until June last year, before slowly creeping back up. The federal funds rate is now 2.75 percent, slightly below the annualized increase in the headline Consumer Price Index of 3.1 percent and a bit above the core CPI rate of 2.3 percent.
The US' inflated money supply caused asset bubbles, beginning with the dotcom boom that morphed into the ongoing property and bond market bubbles, along with global commodity bubbles in the prices of oil and gold. Low interest rates helped push US domestic savings to record lows and cheap credit encouraged consumer debts to record highs. On average, Americans save less than 1 percent of after-tax income today compared with 7 percent at the beginning of the 1990s.
Over-leveraged US consumers flooded world markets with dollars, causing trade deficits to soar. The US current account deficit has risen continuously from US$120 billion (1.5 percent of GDP) in 1996 to US$414 billion (4.2 percent of GDP) in 2000 to US$635 billion last year (more than 6 percent of GDP).
The resulting excess supply of dollars on the world market has also driven down its global value. Therefore, the trade deficit and the weak dollar were caused by an inflated US money supply.
Ultra-loose monetary policy created a global Ponzi scheme whereby Americans print paper to buy goods from foreigners, who then use it to buy other pieces of paper from them. Of course, Washington's profligate political class eagerly engaged in deficit spending to provide a surfeit of public-sector debt to close this circle. Instead of blaming China for the US' problems, the direction of causation should be reversed. A global tsunami of dollars has funded China's massive credit boom that will eventually turn into a bust.
Other emerging-market economies are exposed to pressures similar to those in China. Low returns in the US have sent investors scouring the world for higher yields. This has also induced them to seek and accept more risky placements.
As was the case before 1997,these countries are vulnerable to a rapid exodus of capital. At the same time, a sharp decline in US consumption will reveal excess capacity in the export sectors of those countries.
It is bad enough that the US' central bankers have made such a mess out of their own economy. Unfortunately, they are likely to have put into motion what may be a mammoth global economic correction afflicting countries far beyond the shores of the US.
So, stop bashing Beijing. And by the way, bulls, get out of that China shop before it is too late.
Christopher Lingle is visiting professor of economics at Universidad Francisco Marroquon in Guatemala and global strategist for Econolytics.
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