Friday, February 26, 2010

The US and China: Trade and Currency in the Balance


Cavernous trade deficits and high unemployment are an unhappy combination, for governments and for open trade. When unemployment rates are high, as they are now - around 10 percent in the United States, and higher in some parts of Europe - politicians wishing not to join the ranks of the jobless find it harder to argue that what domestic demand there is should support jobs elsewhere. Thus, when times are good, deep trade deficits - and their inevitable counterpart, large surpluses in other countries - tend to be the subject of largely ignored warnings about global imbalances. But during recessions, they become politically explosive.

During the early 1980s, trade tensions pitted the United States against Japan and Germany, both of which were running substantial trade surpluses with the US. Today, it is the US and China, a relatively new export powerhouse, that have come to epitomise global financial imbalances (though they are hardly the only countries with significant surpluses or deficits).

A country’s balance of trade depends on a wide range of factors, such as domestic savings and investment. But in times of crisis, countries with deficits seeking a quick fix for imbalances often single out exchange rates as the main culprit. Key surplus countries’ currencies are too weak, they argue, making their exports unfairly cheap and imports unduly expensive.

In the first half of the 1980s, Washington pushed for the revaluation of the yen and the deutsche mark. Today, it is the Chinese renminbi that stands accused of being artificially weak.

Part of the contention over China’s exchange rate arises from the fact that its currency has been effectively re-pegged to the dollar since July 2008, making it the only major economy without a floating exchange rate. Read more here.