Monthly Archives: June 2018

Brad Setser On The U.S., China And The New “Adjusted Trade Balance”

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Since Donald Trump considers the US trade imbalance as the root of all problems and there is—understandably for many reasons—a resistance to Trump, there is a tendency to deny anything he says. This movement is led by Paul Krugman who repeatedly attempts to play down the supreme importance of the critical imbalance of US trade.

One is the trade imbalance with China. In the pre-globalised world, trade deficit would mean what it means. But because of offshoring of production to exploit low wages in Asia, things are more complicated.

Consider the manufacturing of iPhone by Apple Inc., everyone’s favourite example. Although it’s more complicated with involvement of countries such as Taiwan and Ireland (or maybe more), let’s simplify and assume that the whole process is just between the US, China and a third country where the phones are exported to.

This is recorded as a service export to China, goods produced in China, adding to its exports and GDP. The profits of Apple Inc.‘s investment in China adds to the United States’ primary income account of the current account of balance of payments, not the goods and services account.

But if the price was the same had Apple directly exported its phones to the third country (which wouldn’t be the case in reality, since producing in the US is costlier, but let’s ignore), the goods and services account in the current account would have been counted differently.

To put it differently, the goods and services account might give a misleading picture of the trade deficit. But some have exploited this fact to somehow try to convey that somehow, the US trade imbalance with China is nothingburger. 🤦🏻‍♂️

Brad Setser has a great post on his blog Follow The Money addressing the issue. He says:

… rather than providing a better measure of trade, the “augmented” trade balance simply adds to the confusion. It suggests that China doesn’t run a surplus with the U.S. when in reality it does, and it suggests that China isn’t a creditor to the United States when in reality it is.

Brad’s point is that the ones trying to underplay the trade deficit do so by adding gross sales to the US goods and services account in the current account of balance of payments instead of adding profits of US firms’ overseas investment. He gives the true picture.

Link

Pankaj Mishra – The Mask That It Wears

At London Review Of Books, Pankaj Mishra has an excellent review of two books on politics today and the liberal world order and captures its essence:

The most audacious surfers of the bien pensant tide, however, are wealthy and influential stalwarts of the ‘liberal order,’ whose diagnoses and prescriptions dominate the comment pages of the Financial Times, the New York Times and the Economist. They depict the tyro in the White House as an unprecedented calamity, more so evidently than the economic inequality, deadlocked government, subprime debt, offshored jobs, unrestrained corporate power and compromised legislature that made Trump seem a credible candidate to millions of Americans. Hoping to restore their liberal order, journalists, politicians, former civil servants and politically engaged businessmen jostle on both sides of the Atlantic in an air of revivalist zeal.

…

Moyn’s stern appraisal may not appear new to long-standing critics of Western moral rhetoric in the global South. Anti-colonial leaders and thinkers knew that the global economy forged by Western imperialism had to be radically restructured in order even partially to fulfil the central promise of national self-determination, let alone socialism. Western liberals were widely perceived as ‘false friends’, as Conor Cruise O’Brien reported from Africa in the 1960s, and liberalism itself as an ‘ingratiating moral mask which a toughly acquisitive society wears before the world it robs’.

The Burden Of Adjustment And Keynes’ Solution

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Argentina had a balance-of-payments crisis recently and required help. The IMF has agreed for a stand-by arrangement of $50 billion on the condition in the IMF’s own words:

“At the core of the government’s economic plan is a rebalancing of the fiscal position. We fully support this priority and welcome the authorities’ intention to accelerate the pace at which they reduce the federal government’s deficit, restoring the primary balance by 2020. This measure will ultimately lessen the government financing needs, put public debt on a downward trajectory, and as President Macri has stated, relieve a burden from Argentina’s back.

So Argentina has to agree on policies with deflationary bias to its output. John Maynard Keynes made this observation, had a completely different attitude than the IMF and proposed to change it. From The Collected Writings Of John Maynard Keynes, Volume XXV: Shaping The Post-War World: The Clearing Union, Chapter 1, The Origins Of The Clearing Union, 1940-1942, pages 27-30:

III. The Analysis of the Problem

I believe that the main cause of failure (except in special, transient conditions) of the freely convertible international metallic standard (first silver and then gold) can be traced to a single characteristic. I ask close attention to this, because I should argue that this provides the clue to the nature of any alternative which is to be successful.

It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments,—that is on the country which is (in this context) by hypothesis the weaker and above all the smaller in comparison with the other side of the scales which (for this purpose) is the rest of the world.

Take the classical theory that the unlimited free flow of gold automatically brings about adjustments of price-levels and activity between the debtor country and the recipient creditor, which will eventually reverse the pressure. It is usual to-day to object to this theory that it is too dependent on a crude and now abandoned quantity theory of money and that it ignores the lack of elasticity in the social structure of wages and prices. But even to the extent that it holds good in spite of these grave objections, if a country is in economic importance even a fifth of the world as a whole, a given loss of gold will presumably exercise four times as much pressure at home as abroad, with a still greater disparity if it is only a tenth or a twentieth of the world, so that the contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors. Nor is this all. To begin with, the social strain of an adjustment downwards is much greater than that of an adjustment upwards. And besides this, the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion.

…

… Thus it has been an inherent characteristic of the automatic international metallic currency (apart from special circumstances) to force adjustments in the direction most disruptive of social order, and to throw the burden on the countries least able to support it, making the poor poorer.

…

I conclude, therefore, that the architects of a successful international system must be guided by these lessons. The object of the new system must be to require the chief initiative from the creditor countries, whilst maintaining enough discipline in the debtor countries to prevent them from exploiting the new ease allowed them in living profligately beyond their means.

So Keynes proposed to change this so that creditors also share the burden. In his plan for Bretton Woods (page 80), he proposed to impose a penalty on creditor nations and also require them to take measures such as:

(a) Measures for the expansion of domestic credit and domestic demand.
(b) The appreciation of its local currency in terms of bancor, or, alternatively, the encouragement of an increase in money rates of earnings;
(c) The reduction of tariffs and other discouragements against imports.
(d) International development loans.

Of course we are past the Bretton Woods system and have a system of a mix of fixed and floating exchange rates but it hasn’t provided the market mechanism required to resolve imbalances. The adjustment is still on output and employment. Hence the need for an official mechanism to resolve imbalances. Bancor isn’t relevant now, but official intervention is.

Sergio Cesaratto — Alternative Interpretations Of A Stateless Currency Crisis

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I recently referred to a paper by Sergio Cesaratto on the Euro Area crisis. There is another paper, Alternative Interpretations Of A Stateless Currency Crisis, written for the Cambridge Journal Of Economics, written last year which I somehow missed referring on this site.

CJE link (no paywall at the time of writing), Wayback Machine link.

Abstract:

A number of economists warned that a political union was a prerequisite for a viable currency union. This paper disputes the feasibility of such a political union. A fully fledged federal union, which would likely please peripheral Europe, is impracticable since it implies a degree of fiscal solidarity that does not exist. A Hayekian minimal federal state, which would appeal to core Europe, would be refused by peripheral members, since residual fiscal sovereignty would be surrendered without any clear positive economic and social return. Even an intermediate solution based on coordinated Keynesian policies would be unfeasible, since it would be at odds with German ‘monetary mercantilism’. The euro area is thus trapped between equally unfeasible political perspectives. In this bleak context, austerity policies are mainly explained by the necessity to readdress the euro area balance-of-payments crisis. This crisis presents striking similarities to traditional financial crises in emerging economies associated with fixed exchange regimes. Therefore, the delayed response of the European Central Bank (ECB) to the sovereign debt crisis cannot be seen as the culprit of the euro area crisis. The ECB’s monetary refinancing mechanisms, Target 2 and the ECB’s belated Outright Monetary Transactions intervention impeded a blow-up of the currency union, but could not solve its deep causes. The current combination of austerity policies and moderate ECB intervention aims to rebalance intra-eurozone foreign accounts and to force competitive deflation strategy.

As the abstract says, the ECB alone cannot resolve the crisis.

I agree almost everything in the paper except that in my opinion, a political union—a central government—is the only way to solve the Euro crisis. But Sergio’s arguments about his view are solid.