–The China trade deficit myth

An alternative to popular faith

For years, there has been increasing concern about our growing trade deficit, especially with China. But do trade deficits really benefit us?

China creates the goods/services we want and sends them here in exchange for dollars. The goods/services are scarce to China. Time, manpower and physical resources are necessary for their creation. By contrast, dollars are not scarce to the U.S. Our government has the unlimited power and authority to produce dollars, without using any resources, whatsoever. The press of a computer key sends billions of dollars from our government to anywhere. Lately, many have gone into our economy as a stimulus.

A trade deficit is an example of one country devoting great effort to creating scarce materials for another country in exchange for something that requires no effort by the other country. In that sense, China is our servant. They work, sweat and strain and use their valuable resources to create and ship to us the things we want, while we, hardly lifting a finger, ship dollars to them. Who has the better deal?

Obviously, for any given individual, the situation is different. None of us has the unlimited ability to create dollars. We have to work hard for our dollars. Dollars are scarce to each of us. But when we talk about trade deficits, we are talking about governments, and there the situation changes. Dollars are not scarce to the U.S. government.

To satisfy our desires, China could ship us every yard of cloth and every ounce of steel in their country; they could burn all their coal and oil; they could employ every man, woman and child in dismal sweatshops; they could empty their nation of all physical resources, and still we would have plenty of dollars to send to them, simply by touching a computer key.

This may be more easily understood by looking at Saudi Arabia, with whom we also have a trade deficit. One day, the Saudis will have sent us every drop of their oil, leaving their country a hollow, empty sand dune, while we blithely will go on producing dollars. Who has the better deal?

Of course, as monetarily sovereign nations, China and Saudi Arabia are able to create as much of their own money as they wish. They don’t need to work so hard to send us their precious resources in exchange for our money. But that’s a discussion for another posting.

Rodger Malcolm Mitchell

-Is inflation too much money chasing too few goods?

An alternative to popular faith

In the post “Do deficits cure inflation?” we saw that contrary to popular faith, deficit spending (i.e., too much money) has not caused inflation. We also saw that inflation can be cured by increasing the reward for owning money, i.e. by increasing interest rates.

Now we question another piece of popular faith: Is inflation caused by too much money chasing too few goods?

Begin with the notion of “too much money.” We already have seen that federal deficits are not related to inflation. What about another definition of money: M3? Please look at the following graph:

Clearly there is no immediate relationship between money supply and inflation. What about a subsequent relationship. Could “too much money” today, cause inflation later?

The graph indicates no such cause/effect relationship, with M3 peaks preceding inflation peaks by anywhere from 2 years to 10 years. It is difficult to imagine a graph revealing less relationship.

What about “too few goods”? If too few goods caused inflation, this would manifest itself with GDP moving opposite to CPI. Again, that does not seem to happen:

There seems to be no regular pattern, with GDP and CPI sometimes rising together and sometimes separately. In today’s international economy, it is difficult to substantiate the idea of a wide-spectrum commodity shortage when sufficient purchasing power exists.

Individual nations can experience shortages of individual commodities. Individual poor nations can experience shortages of a broad basket of commodities. But can a wealthy nation, with plenty of money to spend, suffer a shortage of a broad basket of commodities, thereby causing inflation? Has it recently happened?

Seems unlikely these days as products are made in multiple nations and shipped to multiple nations, with easy international shipping and instantaneous money convertibility. Your cotton shirt may have been grown in Egypt, woven in India, assembled in China, labeled in Italy and sold in the U.S. Clearly, a cotton shirt shortage would be rare, as any of these steps could occur in various countries, and that’s just one product. A nationwide “too-few-goods” situation, coincident with “too much money,” seems impossible.

There is however, one exception: Oil.

The graph below compares overall inflation with changes in energy prices, which are dominated by oil prices.

Oil is the one commodity that has worldwide usage, affects prices of most products and services, and can be in worldwide shortage. That is why, when oil prices rise or fall steeply, inflation rises and falls in concert.

The large oil price moves “pull” inflation in the same direction. When oil prices increased or decreased the most, inflation came along for the ride.

In summary, inflation is not caused by deficit spending or by “too much money chasing too few goods.” Inflation is caused by a combination of high oil prices and interest rates too low to counter-balance the oil prices.

The high oil prices can be caused by real shortages and/or by price manipulation.

Hyperinflation is a different beast, altogether. Every hyperinflation has been caused by shortages, most often shortages of food.

Zimbabwe, Weimar Republic, and Argentina had food shortages that created hyperinflations.

Rodger Malcolm Mitchell

-Smoot-Hawley revisited

An alternative to popular faith

Just a quick thought: President Barack Obama’s decision to impose trade penalties on Chinese tires has infuriated Beijing. This is eerily reminiscent of Smoot-Hawley. Continued political cave-ins to unions could take us to a depression. At a time like this, the world needs the freest possible trade, not protectionism.

Rodger Malcolm Mitchell
For more information, see http://www.rodgermitchell.com