Misguided China Bashing

As economic troubles around the world continue to mount there is increasing pressure upon politicians to do something forceful to revive their economies while deflecting criticism from themselves. One traditional method has always been to blame foreigners for one’s domestic troubles. In the 1980s the US blamed Japan and worried that its economic strength would soon lead to a diminished US presence. Today the same process is playing out only this time China is the presumed enemy. 

This week Senator Schumer from NY introduced another bill that would brand China as a currency manipulator and allow the US to take more forceful action against their presumed unfair trading policies.   This action follows on a report issued earlier this month by the Economic Policy Institute indicating that the US trade deficit with China has cost the US 2.8 million jobs.   Their line of reasoning is immensely popular and goes as follows:  because China fixes its currency at a value deemed too low by US observers, Chinese goods are kept artificially cheap, inspiring larger US imports of Chinese goods.  The relatively high $ value makes US goods more expensive to the Chinese thereby discouraging US exports.  Thus, if only China would allow its currency to rise in value, then Chinese imports would fall, US exports would rise, trade will be balanced and US jobs will be created.  It is a convincing story … except for the fact that is not entirely correct  …  the errors lie in the parts of the story that are missing, the untold story that make the causes and effects quite a bit more complicated.   

Let’s first look at the 2.8 million jobs supposedly lost due to the trade deficit.  Now to be fair, if you read the report correctly, EPI doesn’t actually say that jobs are lost, only that the jobs are “lost or displaced.”  Displacement is a more accurate term because the jobs are less likely to have been lost due to the trade deficit than they are to have been moved to the non-tradable sectors in the economy.  In other words the trade deficit doesn’t cause a loss of jobs as much as it causes a displacement to other sectors of the economy. 

To see why let me illustrate the fallacy of trade deficit induced job losses.  Between August 2010 and July 2011 the US imported $288 billion more from China than it exported.  If trade had been balanced instead, then either there would be $288 billion more in exports (thereby creating millions of jobs) or $288 billion less in imports (creating millions of jobs in import-competing US industries), or some combination of the two.  Seemingly the deficit resulted in more money flowing out of the country to buy the extra imports, than flowed back in to buy our exports.  That lost money and the corresponding lost jobs is what EPI is counting in its estimate.  The fallacy is that the money is not lost and it does not stay in China.  What China has done with that extra money is purchase assets in the US.  In other words, they have lent the money back to us and are allowing us to use it instead.  More technically, any trade deficit (current account deficit really) is offset by a financial account surplus of equal value, implying that our balance of payments with China is always in balance … there is rarely any money lost. 

Most of the money that China has lent back to the US has been loans to our federal government.  During the past decade China has purchased around $1.1 trillion dollars of US treasury securities.  This is money the US government borrowed to finance its deficit spending.  In other words, that $1.1 trillion of money was spent by the US government, inducing demand for US products and creating jobs for US workers.  

So how many jobs were created by that $1.1 trillion of spending?  Well, for that we could use EPI’s own estimates of the job creating effects of fiscal stimulus.  Across a variety of articles (See here or here), EPI’s estimates range anywhere from 5,000 to 10,000 jobs created for every $1 billion of additional government expenditures.  Because $1.1 trillion of those expenditures were made possible by Chinese loans during the past decade, EPI should conclude that the Chinese trade deficit “created or displaced” 5.5 – 11 million jobs during the past decade because of the added fiscal stimulus made possible by their loans to us.

Thus, using EPI’s methods, but evaluating the FULL effects of the trade deficit with China, could actually lead one to the conclusion that there was a net increase in the total number of jobs.  (I’m not saying this happened, I’m just applying their method in a more complete fashion.)  It is worth mentioning at this point that if you look at a graph of the US trade deficit with respect to the world, and compare it to the US unemployment rate during the past 30 years a very curious thing is seen:  whenever the US trade deficit is rising, US unemployment is falling and whenever the trade deficit is falling US unemployment is rising.  This is exactly the opposite of what you would expect if trade deficits really did cause job losses!    

So EPI’s report is propagating a fallacy.  It is suggesting that the trade deficit with China is costing the US millions of jobs.  It is inspiring politicians to stoke up populist support against external entities, surely as a way to divert attention from their own mismanagement at home.   This is a common political ploy used by politicians many times before.  When economic times get rough at home, better to stoke up anger against an external threat, instead of turning attention inward.  This political inclination has led to damaging trade wars in the past and even more damaging shooting wars sometimes. 

The Chinese economy is currently in a precarious position.  Although the impression in the West is that their economy is booming at the expense of ours, in reality the Chinese government may have run out of tools to keep things bubbling along.  China is facing rising goods inflation and rising wages.   They have a property bubble that looks ready to burst.  They face another round of slow demand for their exports and rising anxiety at home.  Put that together with a rickety financial sector, a legal system that is years behind the West, and a government that often corrupt and determined to remain in power, and you have an economy and a society that is just trying to keep things together …  not one ready to take over as leader of the world.  

Even if China responded to US demands right now and gave up defending their currency value, the result might not be what the US hopes for.  Suppose for a moment that the Chinese suddenly allowed the yuan to float freely.  No more currency manipulation!  Because of the new uncertainties in the Chinese economy though and the prospects of property price declines, many wealthy Chinese might take that as an opportunity to move money to the US and other countries.  In other words, in the present environment, the effect might be capital flight form China.  If that were to occur the yuan would fall even further in value making Chinese goods even cheaper.  Stranger things have happened in international currency markets. 

My point then is that our ability to adjust simple levers, like the exchange rate value, (or force other countries to do so) and generate improved outcomes such as job creation at home is extremely limited.  The world economy is too complex to expect that a simple adjustment in the dollar-yuan exchange rate will suddenly create millions of US jobs.  Our politicians would do better to get our own house in order instead of trying to pin the blame for our troubles on other countries.  The blame game is a diversionary tactic and US citizens would be smart not to buy into it.