TRADE WITH CHINA, THE VALUE OF THE YUAN AND CHINESE OWNERSHIP OF U.S. GOVERNMENT DEBT

Three questions that I hope you’ll be able to answer for yourselves:

1. Is our current trade policy with China negative in and of itself?
2. Does the “artificial” value of the Yuan have a positive or negative effect for the United States?
3. What effect does the U.S. Governments current external debt have on the equation?

Trade between Nations:

If you took Econ between the mid-1930s until the mid-1980s for certain and maybe even since then, you textbook would have told you something like this: “The currencies of economies with large current-account deficits should depreciate relative to those countries with surpluses. This will stimulate their exports and curb imports, thereby helping to slim the trade gap.” This is kind of the mercantilist world view, which even they understand is not always the case due to a number of reasons; i.e. carry trade, political considerations in the perceived value of a currency, etc.

The somewhat countervailing view, which proponents of the Austrian school of Economics (for which the University of Chicago is famous) is probably best laid out by Adam Smith in book 4 of Wealth of Nations: “ Each nation has been made to look with an invidious eye upon the prosperity of the nations which it trades, and to consider their gain it’s loss…A nation may import to a greater value than it exports for half a century…even the debts too which it contracts in the principle nation with whom it deals, may be gradually increasing; and yet it’s real wealth, the exchangeable value of the annual produce of its land and labor, may, during the same period, have been increasing in much greater proportion.” So to summarize the anti-mercantilist attitude trade deficits don’t really matter, only the size of the economy.

• University of Santa Barbara (paraphrased: could not find again without paying): Apple I-Pod sells for $299; the Chinese plant makes about $5, the Chinese about $30, the retailer about $80, Apple about $130 and the rest is eaten up in various transportation costs. Who’s the big winner here.
• If the mercantilist view is correct does that make a deficit with S.D bad, how about a Northfield deficit to the other cities in MN?

Value of the Yaun:

A variety of sources have been consulted and the consensus is that the Yuan is approximately 40% undervalued, versus where it would be if its value were allowed to float on the open market.

There are many calls for sanctions against China by a great number of Democratic and a few Republican lawmakers (kind of lead by Rep. Rangel) for sanctions against China for this unfair devaluation of their currency, in essence to impose a revaluation of China’s currency through sanction.

Economics Nobel laurite Milton Friedman write in chapter 4 of Capitalism and Freedom, “There is much experience to suggest that the most effective way to convert a market economy into an authoritarian economic society is to start imposing direct controls on foreign exchange (thesis borrowed from Economics Nobel laurite F.A. Hayek in Road to Serfdom)…To suggest that restrictions on transactions in foreign exchange may be necessary as a ‘cure.’ This cure would be vastly worse than the disease.”

Just to make sure we understand what China is actually doing, and we don’t want to follow, Friedman points out , “…full fledged exchange controls and so-called ‘inconvertibility of currencies’…were invented by Hjalmar Schacht in the early years of the NAZI regime.”

• Theoretical countries and their gas stations: 1^st with floating currency, gas is $4.00 a gallon. The 2^nd devalues it currency 50%, so you pay $2.00 a gallon. Which provides you greater value? Which benefits you and your neighbors more?

U.S. Government external debt:

Current debt is $9.5 trillion. It’s rising by approx. $1 million a minute. It is the equivalent of approximately 38% of GDP (high was in 1950, when it was 80.2%).

Wikipedia: “A traditional defense of the national debt is that Americans “owe the debt to ourselves”, but that is increasingly not true (see hand-out). The US debt in the hands of foreign governments is 25% of the total, virtually double the 1988 figure of 13%. Despite the declining willingness of foreign investors to continue investing in US-dollar–denominated instruments as the US Dollar has fallen in 2007, the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public. About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt.”

Don’t worry: Wikipedia: Arguments against paying down the national debt. “Since the money supply is reduced when the U.S. Government pays down its debt, the unintended result of a government surplus could be a deflationary recession as the money supply contracts in the reverse of the process of monetization described below. The government can avoid this consequence by instead focusing on expanding its GDP and thereby “reducing” the percentage of GDP that debt represents. The hope is that the deficit spending that increases the debt will increase GDP by a greater amount, and thus — in relative terms, at least — the debt would decrease. This worked to great effect in the U.S. between the end of World War II and 1980, even though the debt showed a net increase in absolute value over the same period. Kenneth L. Fisher’s (notable writer, portfolio manager and really rich guy) May 1, 2007, article “Learning to Love Debt” is a good representation of the argument that “more debt is [a] good thing” because of after effects the resulting money creation will have on the economy.”

Worry! Wikipedia: Arguments for paying down the national debt. “Economists from the Austrian School point out that the United States experienced depreciation of 43% of CPI (from CPI of 51 to 29) from 1800-1912: a period of strong economic growth in U.S. history.

Furthermore, it is not always true that an increase in the money supply leads to an expansion of the economy. For example, consider the failure of Japan’s Central Bank to do just that. In an attempt to follow Keynesian economics and spend itself out of a recession, Japan’s central bank engaged in ten stimulus programs over the 1990s that totaled over 100 trillion yen. Even enacting this policy Japan has been left with a national debt that is 194% of GDP.

In the absence of debt monetization, when the Government borrows money from the savings of others, it consumes the amount of savings there are to lend. If the government were to borrow less, that money would be freed to work in the private sector and would lower interest rates overall.

Lastly, raising interest rates is one of the traditional ways that the U.S. Federal Reserve uses to combat inflation (which can be brought on by government debt), but a large national debt figure makes it difficult to do so because it raises the interest paid in servicing that debt.

Net interest on the U.S. national debt was approximately $240 billion in fiscal years 2007 and 2008. This represented approximately 9.5% of government receipts. Interest was the fourth largest single disbursement category, after defense, Social Security, and Medicare. Paying off the debt would theoretically free up these funds for other purposes.”

• So is the debt a problem for national sovereignty? (how about the Suez Crisis)?