I’ve been looking for an excuse to scratch out a few lines about the connections between full employment, the trade deficit, and dollar policy—connections that understandably don’t jump out at everyone—and I’ve found a particularly good one.
Ever since this oped re “Dethroning King Dollar” ran, I’ve gotten lots of love and hate mail regarding the suggestion that we not defend the dollar as the preeminent reserve currency. I’ve often favorably cited the work of economist Michael Pettis on these points and he just posted a long blog on the subject. It’s an thorough review of the argument and I’ll amplify some of the key points in a moment, but first let me lay out why I think this is such a critical area of inquiry for US economists, especially those of us who seek the path to enlightenment full employment.
–The persistent US trade deficit is a real barrier to full employment. Dean Baker explains this assertion in the paper he wrote for CBPPs full employment project, but the arithmetic is straightforward. Negative net exports—a trade deficit—are by definition a drag on GDP. Slightly more technically, when we run a trade deficit we are consuming more than we produce, and in doing so, exporting jobs to the countries with whom we’re running trade deficits.
In the first three postwar decades, when full employment was much more the norm, the US trade balance as a share of GDP was slightly north of zero on average. Since 1976, full employment periods have been much less common and we’ve run trade deficits every year, averaging -2.4 percent of GDP, and -4 percent since 2000.
Of course, that’s not the whole story. I’ve long touted the full employment period of the latter 1990s and we posted significant trade deficits in those years, including almost 4% of GDP in 2000 when the unemployment rate was also 4%. So no question we can offset the demand drag caused by persistent trade imbalances. But we’ve done so at the cost of bubbles and budget deficits and that’s proven to be a costly strategy.
In fact, as Pettis argues, the fact of these reoccurring bubbles is not a coincidence. It’s intimately related to the global imbalances wherein capital inflows from surplus to deficit countries “result in some combination of a speculative investment boom, a consumption boom or a rise in unemployment. What typically happens is that in the beginning we get the first two, until debt levels become too high, after which we get the third.” Sounds uncomfortably familiar, no?
–These deficits are not the result of over-spending, under-saving US consumers. They are the inevitable outcome of actions undertaken by other countries who strategically under-consume and then export their excess savings. As Pettis notes, “an excess of savings over investment in one part of an economic system requires an excess of investment over savings in another.”
What do I mean by “strategically?” Why would a nation fail to domestically invest its savings or consistently consume significantly less than they produce? Many do so in order to accumulate dollar reserves so that their imports will be cheap relative to our exports.
In other words, this is no morality tale about profligate Americans versus thrifty Chinese or Germans. If these trade-surplus countries suppress their own consumption and use their excess savings to accumulate dollars, trade-deficit countries must absorb those excess savings to finance their excess consumption or investment. In doing so, the deficit countries export labor demand, in the US case in the form of millions of better-than-average jobs.
–The dollar as preeminent reserve currency is part of the problem. This is the heart of Pettis’s essay: what was once an exorbitant privilege is now a burden. It is the point of my “Dethrone…” piece above, drawn from recent academic work by Ken Austin, who modelled the dynamics of “currency issuers” and “currency accumulators.” Back to Pettis:
“When governments systematically accumulate huge amounts of dollars, the reason has almost always to do with creating or expanding the trade or current account surplus, which is just the obverse of expanding the export of net domestic savings. The mechanism involves suppressing domestic consumption by taxing households (usually indirectly in the form of currency undervaluation, financial repression, anti-labor legislation, etc) and subsidizing exports. These mechanisms force up the savings rate while making exports more competitive on the international markets, the net effect of which is to reduce domestic unemployment.
…If these savings are exported to the US, for example if the central bank buys US government bonds, the US must run the corresponding trade deficit. This has nothing to do with whether the exports go to the US or to some other country. It is astonishing how few economists understand this, but if Country A is a net exporter of savings to Country B, the former must run a surplus and the latter a deficit, even if the two do not trade together at all.”
Or, as I put it in my “Dethrone” piece:
“Note that as long as the dollar is the reserve currency, America’s trade deficit can worsen even when we’re not directly in on the trade. Suppose South Korea runs a surplus with Brazil. By storing its surplus export revenues in Treasury bonds, South Korea nudges up the relative value of the dollar against our competitors’ currencies, and our trade deficit increases, even though the original transaction had nothing to do with the United States.”
[I note that my exposition here has followed my favorite model: that of the four noble truths of Buddhism! Suffering exists, the causes of suffering can be understood, this understanding can be put to use to end suffering, and that use is the enlightened path.]
–But what could possibly be done about this? The enlightened path is not always obvious, and here there is a lot more work to do by all of us in this debate, Pettis, Baker, Ralph Benko, Austin, Martin Wolf, even Bernanke, whose work first got me thinking about all this.
I’ve offered a number of policy ideas, and among them, I’ve always thought Sen. Levin’s currency bill and Daniel Gros’ reciprocity ideas are the most promising. Joe Gagnon and Fred Bergsten are also “must reads” in this space (Bergsten’s piece on the need for a currency chapter in the TPP is a very important entry in the debate; if you read nothing else other than the Pettis essay, read this).
But those of us advocating for US international economic policy to stop defending the dollar’s reserve status need to do better than “assume a solution.” And while I certainly don’t mean to close off any useful paths, my gut suggests that neither bancor, SDRs, nor gold will work.
Bergsten (see above link) offers five ideas for actions against currency manipulation that he argues should be built into free trade agreements (FTAs): “withdrawal of concessions made in the FTA itself, imposition of countervailing duties, import surcharges, monetary penalties (fines), and countervailing currency intervention (CCI).” Like myself, he appears to believe the CCI—what Gros calls reciprocity—is most promising.
Pettis ends where I am (and he’s been following this a lot longer than I have): there may be a disturbance in the force as economists of many different stripes are beginning to coalesce around these insights. After all, most of them are based on identities and easily observable phenomenon such as currency pegs. And I must say, many of the arguments I heard against my “Dethrone…” piece were of the form, “I don’t know why, but I’m sure you’re wrong.”
So stay tuned, friends. Our persistent trade deficits represent not only a tall barrier to full employment, but an ingredient into the toxic “shampoo cycle”—bubble, bust, repeat—in which we’ve been stuck for decades. Whether it’s ultimately a movement of enlightened economists or a disparate group of renegades, the fact that many of us are making similar noises about the problem is surely an advance.