THE TRADE BALANCE AND THE PIGGY BANK 

"Countries that save a lot have surpluses. Countries that don't save a lot, like the United States, have deficits."

A Capitol Hill Economist

On January 27, the Global Business Dialogue held an event at the National Press Club on the topic "China Trade: Five American Views." Naturally, there were a number of references to America's large trade deficits of recent years, both overall and with China. In the Q and A session, an economist from Capitol Hill weighed in with the above observation. His comments represented an important and frequently heard perspective on the issue of trade balances and trade deficits. Here is some more of what he said:

"One thing I think is getting lost in this whole discussion is basic economics. ... You have to ask yourself, why does the U.S. run a trade deficit in the first place? What does economics tell us? Well, the number one reason is, we don't save a lot and other countries do. China saves a lot. Countries that save a lot have surpluses. Countries that don't save a lot, like the United States, have deficits. We have deficits because we have to borrow a lot of investment. We have a trade deficit with China. And what do they do, they pour like a trillion dollars and they buy our Treasury securities. When they buy our Treasury securities, our interest rates go down. We have more money in our pocket. Because we're borrowing this money, we're buying more of their stuff." 

 
This same economist went on to argue that many of the issues raised earlier in the program - things like China's industrial policies and significant overcapacity in certain industry-do need to be addressed. His point was simply that the bilateral trade deficit is the wrong target. And indeed, one of the panelists, Erin Ennis of the U.S.-China Business Council made a similar point. As she put it, "The trade deficit is a false tool [to use] to look at what the health is of the U.S. economy."

Yesterday, The Wall Street Journal ran an opinion piece by Peter Navarro, the new head of the new National Trade Council. Among other things, Mr. Navarro directly addressed the argument-the accounting identity - argument that was raised by the Capitol Hill economist at the GBD event in January. He wrote: 

 
"The national-security argument that trade deficits matter begins with this accounting identity: Any deficit in the current account caused by imbalanced trade must be offset by a surplus in the capital account, meaning foreign investment in the U.S.

"In the short term, this balance-of-payments equilibrium may be benign, as foreigners return our trade-deficit dollars to American shores by investing in U.S. bonds and stocks and perhaps by building new production facilities. The extra capital keeps mortgage rates lower, the stock market abundantly capitalized, and Americans more fully employed.

"But running large and persistent trade deficits also facilitates a pattern of wealth transfers offshore. Warren Buffett refers to this as 'conquest by purchase' and warns that foreigners will eventually own so much of the U.S. that Americans will wind up working longer hours just to eat and to service the debt."

We have listened to the argument about the trade deficit simply being a function of America's low savings rate over many years and through countless meetings. Our frustration has been that it has too often been a show stopper. For that reason alone, we are glad to see the argument revived. It could be that there is no significant meaning to graphs, like this one, of the U.S. trade deficit, that there is nothing to worry about here.

 


Savings and Investment. Separately, and perhaps because your editor is not an economist, we find parts of the picture confusing. To begin, we suspect that there is more to the story than simply the fact that China has a high savings rate. And clearly, there are a lot of experts-George Soros among them-who are worried about the high debt carried by Chinese companies. Some may be comforted by the fact that many of those firms are state owned enterprises. For us, the role of the state in these firms makes us less inclined, not more, to rely on the savings-investment differential as an explanation for the lopsided trade. 

Politics: Rare Earths. Beyond savings and investment, there are politics and economics. Our own reading of history is that there is no hard and fast rule as to which is the horse and which is the cart. In America, politics has often been driven by economics. In the larger world, however, we tend to think of politics and power as having the upper hand. China's willingness to cut off Japan's access to rare earths over the Senkakus in 2010 - however briefly - was a clear indication that leaders in Beijing have no qualms about using economic muscle for geopolitical aims. 

 
Politics: THAAD. More recently, China's decision to get tough with the Korean retail company Lotte Mart Stores is, to say the least, troubling. According to Reuters, the Chinese authorities have forced the closure of nearly a dozen Lotte Mart Stores in China. Why? These two paragraphs from the Reuters story sum up the issue:

"The Lotte closures are the latest in a series of incidents affecting South Korean companies in China after cyber attacks and a ban on sales of travel tours to South Korea. Lotte Mart had 115 stores in China as of January contributing to group sales there of over 3 trillion won ($2.6 billion) in 2015.

"The incidents come after Lotte approved a land swap outside Seoul last week that will allow South Korea to install the U.S. Terminal High Altitude Area Defense (THAAD) system, in response to missile threat from North Korea."

And the THAAD system is purely defensive. To quote the Wikipedia entry on THAAD, "The missile carries no warhead, but relies on the kinetic energy of impact to destroy the incoming missile. A kinetic energy hit minimizes the risk of exploding conventional warhead ballistic missiles, and nuclear tipped ballistic missiles will not detonate upon a kinetic energy hit."

No, we are not missile experts either. A simple reading of headlines over the years, however, all but forces the conclusion that it is a mistake to ignore the non-commercial elements of China's commercial relationships, including those with the United States.