Thursday, March 26, 2009

Trade Wars

There have been plenty of concerns throughout the past year that countries will repeat the mistakes of the '30s and start a trade war.  The fact that we don't have a gold standard anymore makes this a little less likely in general, but there are a couple of interesting fronts.  

In China, because of the currency peg, there are fewer ways to manage trade relations other than putting up tariffs and protectionist barriers--which both countries are doing.  Ultimately this will hurt China, the country with the trade surplus, much more than the US, which is why its rhetoric is actually more free trade.  

Trade squabbles have most recently broken out over China's half-hearted proposal to replace the dollar as the dominant reserve currency.  America's monetary boost threatens inflation and a weakening of the dollar, which suggests that the value of China's massive stock of Treasury bills is about to depreciate significantly.  

Still, no one made China run out and buy trillions of dollars of American debt.  It's not--as some domestic spendthrifts would have it--a sign of permanent American decline and Chinese ascent.  Rather, it's the result of long-held, essentially mercantile, policies of the Chinese government to support economic growth through supporting exports over domestic consumption--a tactic which requires undervaluing the currency and compensating by holding large amounts of dollar-denominated assets.  This has proven to be a profitable strategy in the past, but one that carries risks exactly of the sort playing out now.  Admittedly, it's also a little hypocritical for the United States to, simultaneously, demand that China both 1) Properly appreciate the Yuan's value to benefit American exporters and 2) Continue to buy debt to fund the stimulus plan.  

There are also some potential frictions with Europe, which isn't following either fiscal or monetary stimulus.  I'm not sure why that's happening--Euro rules reining in deficit spending?  Everyone is waiting for some other Euro country to spend and bail them all out?  But with a fixed Euro, the best way for some countries to cope might be to put up import barriers.  The longer the gap persists between American and European policy, the easier it will be for American politicians to (rightly) claim that they're pulling all the weight.  Keynesian Economics tells you these barriers let you put up a higher multiplier for you own spending.   

Given the massive collapse in trade that we've already seen, I find it a little hard to imagine that further trade fights would amount to anything major.  These risks seem overplayed relative to the pretty substantial damage that has happened already, which few people spent much time moralizing over.  While I (of course) support free trade, the downright moralizing sanctimoniousness of some of the boosters makes me uneasy.  Still, there's a lot of populist anger out there, and populism has a bad habit of leaving behind (potentially justified) targets and hitting anything that moves.  

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