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US economy, growth and trade deficit fallacies
Gerard Jackson
Many critics of the Bush administration are focussing on the growing trade deficit as proof that the US economy is heading for trouble. Bush supporters counter with the argument that the trade deficit is simply evidence that the economy is growing faster than its trading partners.
Scott McClellan, White House press secretary, supported this line of defence with the assertion that the US economy “is the economic engine for world growth. Our economy is growing faster than many across the world …” White House press secretary
This was followed by: “Because of that prosperity, Americans are shopping in the global marketplace, buying more goods and services than other countries which are not growing as fast. Just as we have taken steps here to strengthen our economy and increase growth, it's important for other world economies to grow as well.” (12 January 2005). It’s time to be blunt — McClellan is talking nonsense.
Growth does not fuel trade deficits, though trade deficits can fuel growth. Until 1870 America ran a trade deficit, particularly with England. Now this was not because the US economy was growing faster than the British economy but because huge amounts of British savings were being borrowed by American entrepreneurs in the form of capital goods.
In that sense and that sense alone, it can be said that the deficit fuelled growth. Moreover, the US economy was, with the exception of the years 1862-1879, on a gold standard. This meant that all borrowings had to be denominated in gold. So long as this remained the case the trade deficit merely signified that Americans were borrowing genuine savings.
The abandonment of the gold standard left monetary policy adrift, a situation that was quickly compounded by the adoption of Keynesian fallacies. This brings us the present situation. Since 2001 M1 has leapt by more than 30 per cent. It is this monetary expansion that is driving the trade deficit, not economic growth.
Let me put this simply: When the money supply increases nominal incomes rise and the demand for imports increase. In other words, when America expands its money supply not only is the demand for American goods and services increased, so is the demand for imports because the increased stock of money now exceeds Americans’ demand to hold money
When we examine the situation more closely we must conclude that by running a trade deficit America is actually exporting its inflation. The immediate consequences of this process is that countries like China will direct more production to exports for the US market, completely unaware that the Fed is the source of the increased demand for imports. How this is supposed to stimulate growth beats me.
The obverse of this for the US economy is that American industry will tend to become oriented to more to domestic production. Firms that cannot make the switch will have to close their doors or move offshore to places like China.
When America eventually moves to rein in the deficit by tightening monetary policy, China and others will find that they have been lumbered with large amounts of idle capacity in their export industries. Therefore the longer this process continues the greater the pain of readjustment will be. Moreover, if China chooses not to sterilise its dollar inflow this will fuel inflation, which will create even more malinvestments. This is called this a double whammy.
Regardless of what Mr McClellan thinks it is clearly consumption, fed by a loose monetary policy, and not growth that is driving the trade deficit.
There is no joy here for Democrats. The above analysis demolishes their contention that American workers are being victimised by low-paid labor in countries like China. The truth is that in this ever increasingly integrated world all workers are becoming victims of the Fed’s Keynesian policies regardless of national borders.
What monetary policy and the state of the trade deficit tell us is that Greenspan has laid down the foundations for another recession. It is not case of if but when.
New Voodoo Economics
What is causing the falling dollar?
Peter Costello’s trade deficit fallacies and the credit crunch, part I
Peter Costello’s economic fallacies and the credit crunch, part II
Australian Reserve Bank blames others for its own folly
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 7 March 2005