May 03, 2012
Eduardo Porter told readers in his Economic Scene column that because China’s trade surplus overall has fallen, Treasury Secretary Timothy Geithner:
“will have a harder time making the case that America’s trade deficit is somehow China’s fault.”
Actually, he will have no problem at all making the case that the U.S. trade deficit is the result of an over-valued dollar, which China helps to sustain by buying hundreds of billions of dollars of government bonds.
In a system of floating exchange rates, like the one we are supposed to have, trade imbalances are corrected through a decline in the value of the currencies of deficit nations, like the United States. The mechanism is that more dollars are being supplied to buy imports than are needed to purchase imports from the United States. This leads to an excess supply of dollars, which then causes the dollar to fall in value against other currencies. In a system of floating exchange rates an excess supply of dollars is supposed lead the dollar to fall in the same way that an excess supply of shoes is expected to cause the price of shoes to fall.
A lower valued dollar makes imports more expensive for people in the United States leading people to buy fewer imports. It also makes exports cheaper for people living in other countries, leading them to buy more U.S. exports. This process then continues until the trade balance adjusts.
By explicit policy China is preventing this process of adjustment. It has an explicit policy of pegging its currency against the dollar. This means that it buys as many dollars as necessary to maintain the peg. (This is done in broad daylight, it is not a mysterious process of “manipulation” that is done in secret.)
Therefore Geithner would have no problem at all making the case that America’s trade deficit is China’s fault, this is exactly what textbook economics maintains. (He likely will not want to make this case, since many media accounts have suggested that Geithner is more interested in directly pressing issues that will help businesses in the United States rather than addressing the trade imbalance, which would benefit millions of workers.)
It is also worth noting that standard economic theory predicts that fast growing developing countries like China will have a trade deficit, while slower growing wealthy countries like the United States will have a trade surplus. The argument is that capital is relatively scarce and gets a better return in China than in the United States. This means that the U.S. should be lending vast amounts of money to China, not the other way around.
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