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The US Economy - Part II
Trade Deficits and Exchange Rates


A brief look at Trade Surpluses and Deficits

INDIA

The indian rupee is one of most undervalued currencies in the world. According to the IMF, the fair value for rupee/usd would be 16:1, but it is trading at 48:1.

This means the Indian currency is 300% undervalued, but yet India has one of the worst current accounts of all major economies. India still has consistent trade deficits with the world. The cheap currency doesn't help India to produce a trade surplus.

CANADA

Since 1971 the Canadian dollar has fluctuated between US$0.66 and US$1.21, moving through that range more than once. In the past 10 years, the Canadian dollar has appreciated about 50% against the US dollar. Yet the US has had consistent trade deficits with Canada for the past 30 years, regardless of the exchange rate.

Canada's economy is largely natural-resource and export-oriented - metals, minerals, lumber, oil and gas, wheat. Canada produces many things the US needs, while the US produces few things that Canada wants.

JAPAN

Since 1960, the Japanese Yen has consistently strengthened against the US dollar, rising from 360:1. In 1985, the year of the Plaza Accord, the Yen was at 240:1. In the 3 years following, the Yen doubled in value to 120:1, and now sits at about 90:1 - and is now 30% or 40% over-valued.

But through all those years, the US consistently had increasing trade deficits with Japan, in spite of the Yen rising more than 300% in value.

Japan, like Canada, produces many things the US needs, but wants little of US production.

CHINA

For many years the RMB was firmly pegged only to the US dollar at about 8.25:1, but was released from that peg in 2005 and has since appreciated about 25%. But the US has persistent trade deficits with China - and these have markedly increased in spite of the recent 25% upward movement of the RMB.

China produces many things Americans want and need, while the US produces less of what China wants.  As well, the US retains strict control over the higher-tech exports that China might be willing to purchase, claiming national security concerns.  That's all nonsense, of course; the US has always used this excuse to contain competitors and slow the rise of challengers.  But this cold-war attitude does hurt US exports to China.

EUROPE

After the signing of the Plaza Accord in 1984, the major European currencies doubled against the US dollar almost immediately. But the US trade deficits persisted with most of its trading partners.

Will Revaluing the RMB Help the US Economy?

In an economy that is functioning normally, increasing the exchange rate will make a country's goods more expensive on international markets, so we would expect exports to decline. Also, the goods of other countries would now be cheaper, so we would expect imports to increase. This is typically a self-correcting mechanism that can help a current account to balance.

But when an economy has structural defects, when it is sick, the normal rules don't hold. In the case of the US, there will always be huge trade deficits because the country makes few things to sell and because the economy is excessively dependent on consumer spending.

In this latter case, varying the exchange rates will not significantly affect the trade balance. It will affect inflation and interest rates and other factors, but trade surpluses or deficits will remain. The situation will not change until that economy undergoes substantial changes in structure and composition.

This means the exchange rates of the 60+ countries with which the US runs trade deficits, are irrelevant to the problem. Canada’s currency has appreciated by 50%, Japan’s 300%, Europe's 50%, China’s 25%, and the US deficits increase. The US is fond of accusing China of cheating by keeping its currency low, but surely all 60+ countries with which the US has persistent deficits have not all been 'cheating' for the past 30 years.

Even Ben Bernanke, the Chairman of the US Federal Reserve Board, testified to the Congressional Finance Committee that revaluing the RMB "would have little effect on the US Trade Deficit."

In the recent past, I did much importing from China to Canada and the USA. Here is a live example: I can buy a small gyroscope made in the US, at a factory cost of US$7.50 + shipping and taxes. Or, I can buy the identical item in China for US$0.55

If, as does the US Right, you believe China's currency is 20% undervalued, let's increase it. Now the item costs me US$0.65. What do you suppose I would do? Run to the US to buy it?

China's manufacturing advantage is not 10% or 20%. It's more like 1,000% or 2,000%, and revaluing the currency will not change that. More importantly, even a large revaluation of the RMB will not cause those jobs to migrate to the US.
Some General Observations

There are politicians in the US, and even in the White House, who blame China for the recent US subprime financial crisis. In their view, the crisis was caused by the Chinese 'saving too much'.

The US must stop blaming everybody else for their economic problems. The US government insistently claims that their trade deficit and economic problems are caused by China's RMB being undervalued.

We now have much of the Western Media, including economists like Paul Krugman who writes for the NYT, suggesting that either China revalue the RMB by 25% or the US levy an import duty of the same amount.  Krugman recently won a Nobel Prize for Economics, then in my view totally lost his brains, so I won't waste time debating his motives other than to opine that someone in the US government must have paid him a lot of money for his support of something that is almost criminally wrong.

With an import surcharge of 25%, China might again have 40 million unemployed, while the US might gain 20,000 jobs in return. The idea that raising prices in China would create jobs in America, is simply absurd.

In any case, it is not China's responsibility to worry about, or to create, jobs in the US. China's job is to worry about China. And that is what the US does. There has never been an example of the US cancelling some policy initiative because it might create unemployment in other countries - and there never will be.

Pressing for change in others which is not in those others' best interests is the normal US way to avoid hard decisions back home. This is precisely what the US did to Japan with the Plaza Accord. It didn't reduce the US deficits; in fact they increased, but it did kill Japan's economy, and that's just as good.

The reason it's just as good is that this exchange rate debate is not about economics; it's about politics. Any country presuming to threaten the US' full-spectrum global dominance, is going to get hammered.

But in fact, China is doing things slowly so as not to destroy its own progress. It's doing the right things in the right way. Maybe the RMB does need to rise, but knowingly pushing a policy (in the name of freedom and democracy, of course) that would kill China's economy, is hardly enlightened and should have no public support.

And to fully float a currency is to lose control of it altogether and open yourself wide to speculators like Goldman Sachs who would happily destroy your economy for the sake of a quick profit. China must do it's best to stay the course and try to avoid inflaming the situation or getting too deep into a trade war.
To Improve the US Economy:

The US must reinstate the taxes on the rich and very rich. They must restore funding for universal education and institute a universal health care system. Americans must return to the time when thrift was a value and again save at least 8% to 10% of their incomes.

Americans must stop living on credit, stop spending tomorrow's money today. Mortgages must be paid down, credit card balances and demand bank loans must be paid off and remain paid off.

Regulations must be reintroduced to the banking sectors as was done after the 1930s depression, to ensure a catastrophe cannot recur. Deregulation in many sectors of the US economy was a bad idea which needs to be rethought and reversed.

US politics have degenerated into a vicious stand of opposing partisan mindsets that effectively prevent considerations of what is best for the country. The only employment sector in the US that is growing is lobbyists, and that must be killed. The US government has become virtually paralyzed by all the payments from all the private interests that make a few very rich while preventing the country from healing itself. It is becoming widely recognised that the US today has one of the most dysfunctional governments in the world.

Americans must understand that most manufacturing (except for very high-end items) consists of $10 jobs, and cannot return to the US at wages of $30 per hour.

US credit-fueled consumer demand has significantly escalated the wage levels. If Americans cease borrowing, begin saving, and using excess cash to pay off debt, consumer demand will collapse, creating substantial unemployment. That unemployment will eventually drive down all wages.

I've mentioned educational and social needs, but the US also has a badly deteriorating physical infrastructure that has been ignored for decades - highways, railroads, bridges, dams, airports - and is in danger of physically collapsing.

So, additionally, if the US Government raises taxes to pay for the infrastructure and social costs after decades of neglect, real incomes will fall further. And the government will need more money to recover from the huge accumulated budget deficits as well as to repay all its foreign debt - to say nothing of the cost of its senseless wars.

By this time, imports will have dimished markedly, partly because Americans will have seen the light but mostly because they will no longer have the money to spend. And by this time, wages will have dropped to the $10 range and manufacturing can begin to return. The standard of living will probably have fallen by something like 30%, but the country will now have a solid base on which to build for the future.