Notes for tonight’s debate: Faster growth without growing budget deficits requires a more competitive U.S. dollar
Tonight’s presidential debate will mostly focus on issues out of my wheelhouse, but there are a couple of international economic issues that will come up that people should be prepared for. This post tackles one (currency management by our trading partners, particularly China) and a subsequent post will tackle the other (alleged reliance of the U.S. on China to buy our public debt).
The primary reason why the United States ran large (and generally-growing) trade deficits over the past 15 years was that the value of the U.S. dollar was too expensive. This expensive dollar prices our exports out of too many global markets. The source of this too-expensive dollar has actually varied over that time, but over the past decade it has been clearly driven by the policy of foreign governments buying hundreds of billions of dollars of dollar-denominated assets, hence increasing the demand for dollars, which pushes up the price of dollars on world markets.
In the late 1990s and early 2000s, it was largely private investors demanding dollars to buy into the U.S. stock market, and to find a safe haven for their investments in the fallout of the Asian (and then Russian and then Brazilian and Argentine) currency crises. As these private investors pulled out of dollar-denominated investments following the burst stock market bubble, U.S. trade deficits with these private investors’ countries (largely Euro Area countries and Canada) have actually shrunk to manageable levels.
However, overall demand for dollar denominated assets remained strong, and this kept overall trade deficits from falling. The reason for this is that starting in the early 2000s, foreign governments (not private investors) began buying hundreds of billions of dollars of Treasury bills and the debt of Fannie Mae and Freddie Mac.
There are a number of reasons why these governments started doing this. For one, many countries saw the austerity demanded by the International Monetary Fund (IMF) as a precondition for assistance following the currency crises of the late 1990s and were determined to self-insure against possible future crises by accumulating plenty of safe, liquid assets. Like U.S. Treasury bonds.
Whatever the initial spur for these countries to begin accumulating dollar-denominated assets, the effect of this policy has been to make U.S. products less competitive on global markets and the products of the managing countries more competitive. And this mercantilist benefit for these countries has shown up clearly in rising U.S. trade deficits.
Reversing this flow of capital from poorer countries to the rich U.S. economy would be good policy for a range of reasons. It would boost the purchasing power of China’s emergent middle-class. It would allow countries like Malaysia and South Korea to boost their currencies’ value without worrying about losing U.S. market share to China and other currency managers. And it would reduce U.S. trade deficits and provide a boost to employment—particularly in the manufacturing sector.
Republican presidential nominee Mitt Romney often boils all this down to a need to stop China’s “cheating.” What he doesn’t note is that the blockage of U.S. policy measures to address this stem from the desire of influential American corporations to preserve the status quo. For corporations that either produce in China for American (or third-country) export or who purchase intermediate inputs sourced in China, this policy of currency management acts like a generous subsidy. And this corporate support of the status quo explains why movement on this issue has been so slow.
But it’s time for this corporate support for the status quo to be upended. During the teeth of the economic downturn, international trade flows actually boosted U.S. growth as imports declined substantially. Since the recovery began, however, the trade deficit has ticked up again and become a (mild so far) drag on growth.
Addressing the issue of currency management can reverse this drag imposed by growing trade deficits. And the economics of this are clear: The only way that the U.S. economy can grow as American households work off the debt overhang of the 2000s housing bubble is if federal budget deficits remain very large or the trade deficit is reduced.
The optimal outcome is probably a combination of both. But every bit of economic boost provided by a reduced trade deficit is a boost that does not need to be provided by a rising budget deficit. And given the (misguided but powerful) zeal among D.C. policymakers to begin rapidly cutting the budget deficit, it seems wise to use the lever of currency re-alignment to spur as much growth through trade as possible.