Recently I’ve seen a lot of misleading posts on international economics. Here’s one by Paul Krugman. And this one by the normally reliable Ashok Rao repeats some of the misconceptions:
Dean Baker is concerned that America’s persistent trade deficit is a result of East Asian mercantilism, contradicting the textbook story on international capital flows. Baker’s argument is correct – demand for dollars originating from an Asian “savings glut” forced us to run a trade deficit. But where Baker worries about declining employment from an overvalued dollar, I see potential for America to provide yet another international service and profit in the process.
True, a shirt imported is a shirt an American could have made, so a trade deficit costs us jobs on the margin. On the other hand, you can think of that really cheap shirt you’re wearing as a free good: a gift to America in exchange for liquidity. You’re still getting all the utility of wearing the shirt and loosing nothing in the process (unless you drive with a “Buy American” bumper sticker in which case you were probably screwed to begin with).
A stronger point still: as an American, it’s your moral duty to consume. The odd way the international monetary structure is set up gives us the responsibility of issuing the reserve currency. If India wants to buy oil from Saudi Arabia, it has to sell us something first. This guarantees that we run a trade deficit.
I’m afraid this is mostly wrong. Let’s start with the term “mercantilism.” What does it really mean? Does it mean a policy of discouraging imports and encouraging exports? Well a 10% tariff on all imports and a 10% subsidy on all exports nets out to zero. Nada. At least according to standard trade theory. Does it mean depreciating your nominal exchange rate? Yes, that may “work” in the short run (although it may not, as we saw when the US depreciated the dollar in 1933.) But even if it works in the short run it doesn’t work in the long run. The effects are offset by inflation, and the real exchange rate doesn’t change. Check out Latin America over the past 100 years if you don’t believe me.
Maybe is means a “pro-saving” policy, as the current account (CA) surplus is domestic saving minus domestic investment. OK, but I wouldn’t call that sort of policy “mercantilism.” I’d call it “smart” at least compared to the vast majority of countries that discourage saving. Contrary to Rao, Americans have a moral obligation to save more, not consume more. And it’s not even clear that the big East Asian surplus countries achieve those surpluses from government policies. In Japan the government spent enormous sums on wasteful infrastructure, which actually reduces the CA surplus. And they still has surpluses. Northern European countries tend to have larger surpluses than East Asian countries, and they aren’t accused of mercantilism. Some claim Germany benefits from the euro, but they’d run large surpluses even if they were outside the euro. The CA surpluses of Sweden, Switzerland and Norway are larger than in Germany (in per capita terms) and they are outside the euro. CA surpluses reflect saving/investment imbalances, not (in most cases) “mercantilist” policies, whatever you wrongly think mercantilism might mean.
And no, India does not have to sell anything to us to buy oil from Saudi Arabia. Nor does anyone else, if “selling” means goods and services. If we accept the odd claim that Treasury securities are somehow needed for the forex reserves of other countries (but why would that be true?) then those countries could get all the T-bonds they need by selling us assets of various sorts. It doesn’t require the US to run a CA deficit.
Nor do imports cost us jobs “on the margin.” If we import more than we export then we save less than we invest. So every extra dollar of imports means an extra dollar of investment or consumption, as long as the Fed targets NGDP. And if the Fed doesn’t target NGDP, then it’s monetary policy, not imports, which are costing us jobs. We had an even bigger CA deficit when our unemployment rate was 4.5%, and a few years earlier Germany’s unemployment rate was 10%. Trade is not the issue, NGDP is.
Then Ashok makes some excellent points about the real problem being a soaring demand for dollars, and not enough money. But then he gets off track again:
An excellent substitute for the United States dollar is a promise to pay a dollar later – known as Federal debt. Increasing the supply of the former requires us to print money and increasing the supply of the latter requires us to run budget deficits. Okay, I lied. It’s your moral duty to provide liquidity. The really sweet side effect of doing that is more stuff. Did someone say pre-school? Or solar power? In other words, the solution to the trade deficit “problem” is to allow for a larger budget deficit—U.S. government debt is one of our most important export goods.
The problem here is too little NGDP, and issuing more bonds won’t help. Otherwise Japan’s huge budget deficits would not have led to an astonishing decline in NGDP over the past 20 years. A much better solution for Japan would have been a 3% NGDPLT. Had they done so over the past 20 years their NGDP would now be almost double current levels, and the debt/GDP ratio would have been far smaller, for at least five reasons:
1. More inflation.
2. Slightly more RGDP growth.
3. Less unemployment comp.
4. Less discretionary stimulus on wasteful infrastructure projects.
5. Lower real interest rates (due to the zero bound problem with falling NGDP.)
Their monetary base would also be smaller, as a share of GDP.
As Paul Krugman asks, if we don’t run a deficit who will? Some things are zero sum. Better the issuer of the world’s most in-demand currency run a deficit than the guy who prints Rupees, which nobody seems to want. We provide the public good of liquidity in return for the free good of imports.
This argument was more problematic in the sixties when economists like Robert Triffin argued that we’d be forced to run a deficit forever causing an inflationary spiral. But in the sixties neither the domestic nor global economy was anemic, and inflation was a real problem.
Triffin was of course wrong, he confused running budget deficits with printing money. Reagan showed we could run big budget deficits and reduce inflation at the same time. Foreign central banks want T-bonds, not dollar bills. The inflation of the late 1960s did not come from the modest budget deficits, but rather from the acceleration in the growth rate of the monetary base. We printed too much money.
People should not mix up monetary and fiscal policy. Nor should they mix up international economic issues with macro issues. Yes, under fixed exchange rates they are linked, but that’s why we should have flexible exchange rates. And if you have flexible rates there’s no need for such massive holdings of international reserves.
I believe in K.I.S.S.:
1. Use monetary policy to do NGDPLT.
2. Enact pro-saving policies (a la Singapore) to offset the other anti-saving policies.
3. Let the market determine exchange rates and CA balances.
And for God’s sake let’s all stop acting like there is a qualitative difference between German workers building cars and exchanging them for Chinese built iPads versus Australian workers building condos and exchanging them for Chinese built iPads. Does geographical location of the German/Australian export really matter? Of course not. Then why do most pundits act like Germany is a muscular success while Australia is a feeble weakling?
Apologies to Ashok, most of this tirade had nothing to do with what he actually wrote. I actually agree with Ashok that we should not worry about the CA deficit. In contrast, I’d have to take some medication before addressing Krugman’s post.