Tuesday, October 23, 2012

US Trade Deficit With China And US Budget Deficits

Dean Baker has been having a debate with some of his fellow liberals about US trade policy.  Krugman and others argue that it is time to stop bashing China for our problems.  Baker is not a China basher, but he argues that we will have budget deficits as long we have a large trade deficit with China.  The only way to balance trade with China is to have the US dollar depreciate relative to the value of China's yuan.  China has been purchasing the US dollar so that it does depreciate relative the to yuan.  If China persists in that policy we will continue to have a trade deficit with China.

I posted this article, however, not to get into a debate about China bashing.  Dean Baker makes an important point about trade deficits and budget deficits that everyone should understand.  We can't balance the US budget, and have a large trade deficit, unless something unusual takes place.  Baker's logic is quite simple to follow.  It is an accounting identity that national savings in the US will be negative when we have a trade deficit.  National savings consists of three factors: government savings, business savings and household savings.  If we balance the US budget, we must have negative savings in the business or household sectors of the economy.  Non-residential business investment fluctuates widely, and there is little reason to believe that it will increase dramatically, and produce negative savings.  We can create negative savings in the household sector by encouraging a housing bubble.  The housing bubble is deflating, however, and household's are net savers as they pay down their debt and reduce consumption.  The implication of private sector savings is that negative savings must come from government.  Our budget deficits today are pretty close to our trade deficit.

I should also point out that we had a budget surplus, which represents government savings,  under Bill Clinton.  We also had a large trade deficit.  That occurred because of the dot.com boom in the US.  Business was investing heavily during this period, and contributing to large negative private savings.  The household sector also increased spending during this period of low unemployment. Therefore, private sector negative savings was sufficient to match the trade deficit. We can only balance the US budget under similar circumstances, like those that prevailed in the dot.com boom, and still have a trade deficit.

Baker also reminds us that a lot of our imports, and much of our trade deficit with China, results from the policy's of US corporations.  They can make larger profits by producing in China, at lower cost, and importing them from China to the US.  They will continue to do so as long as costs in China are much lower than costs in the US.  China's cost advantage would be reduced if its currency would be allowed to appreciate relative to the dollar. That would reduce our trade deficit with China, and it would also allow us to cut our budget deficit.

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