TCS Daily

Stop Blaming China

By Christopher Lingle - May 24, 2005 12:00 AM

For all their sins, foreigners should not be blamed for America's large trade deficits. China especially is doing nothing worse than producing goods that are cheaper than those produced elsewhere.

Never mind the 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 for most of America's economic ills.

As is usually the case with Washington windbags, these claims are hyperbolic. Of America's $162 billion trade deficit, only one quarter of the total last year was from trade with China.

Senator 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 of international trade 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 2005. And the US Trade Representative's office placed China on a blacklist for "rampant" copyright abuses that undermine American intellectual property rights.

But is China guilty as charged...? Partly, yes; but mostly, no.

Politicians and technocrats in America 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 Fed. 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.

As a 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 December 2004, 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 down interest rates artificially low for so long. Beginning at 8% in July 1990, the benchmark federal funds rate was continuously lowered to 3% in September 1992 when it began to creep back up again incrementally. Then it peaked at 6% in February 1995.

After peaking again at 6% in January 2001, it started a long drop to 1% in June 2003 where it remained until June 2004 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.

America's inflated money supply caused asset bubbles beginning with the dot-com boom that morphed into the ongoing property and bond market bubbles along with global commodity bubbles in the prices of oil and gold.

Meanwhile, 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% of after-tax income today compared with 7% at the beginning of the 1990s.

Over-leveraged American consumers flooded world markets with dollars causing trade deficits to soar. The US current account deficit has risen continuously from $120 billion (1.5 percent of GDP) in 1996 to $414 billion (4.2 percent of GDP) in 2000 to $635 billion in 2004 (over 6 percent of GDP).

The resulting excess supply of dollars on the world market also drove 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 that 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.

Christopher Lingle is Global Strategist for eConoLytics.



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