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China is not the problem

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01/13/2005

Yesterday it was revealed that the US trade deficit rose sharply in November, to a record high $60.3 billion, an increase of $4.3 billion against the upwardly revised $56 billion in October and also far higher than the consensus estimate of $54 billion. And it was a sharp increase against the $40 billion deficit in November 2003. That caused the dollar to fall roughly 1% against the euro and most other major currencies. It also meant that fourth quarter GDP growth estimates will be sharply downwardly revised. It also started a new round of China-bashing.

CNN Money's Kathleen Hays wrote a article blaming China for the deficit as well as quoting a phony mercantilist study from a left-wing foundation. But while some of China's policies can rightly be criticized, the fact remains that they are not to blame for the trade deficit. What is overlooked is the following 1) China has had the currency peg for more than a decade and it has actually reduced its trade barriers significantly in recent years, so that is hardly the reason for the increase in the US deficit. 2) Not surprisngly given the first point, China has a almost equally large deficit against the rest of the world, a deficit which has increased just as fast as its surplus against the U.S. 3) The U.S. deficit has in the latest year increased almost as much against the rest of the world as against China. Between November 2003 and November 2004 the deficit against China increased from $10.8 billion to $16.6 billion, a 54% increase, while the deficit against the rest of the world increased from $29.2 billion to $43.7 billion, a 50% increase. In fact, the deficit excluding China in November 2004 was bigger than the deficit including China in November 2003. Many countries including Canada increased their bilateral surpluses even faster than China despite the significant appreciation of the Canadian dollar.

Instead, the blame must be laid on Bush and Greenspan. If you have lower interest rates to negative levels in real terms ( The Fed funds rate is even after the small increases lately at only 2.25% while the CPI has risen 3.5% and asset prices even more) then this will discourage savings and encourage investments. And a country which has lower savings than investments will have a trade deficit (or more strictly a current account deficit). And of course, the large budget deficit and the large dis-savings that constitute has further aggravated the problem. There is of course a very close relationship with this statistic and the one Robert Blumen recently discussed on this blog.

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