Intro: To accumulate foreign reserves, central banks must buy dollars, weakening the value of their currency to the benefit of foreign importers. While there is no doubt that such measures by trade surplus countries such as China have undermined low-end manufacturing in deficit countries such as the US, this has been more than offset by the support given to real incomes from lower import costs. The real risk to deficit countries comes from the end of reserve accumulation rather than more of it.
When politicians talk about a country’s trade deficits they talk as though that country is doing the world a favour by buying their produce. President Trump claims that China has ‘stolen’ money from the US by making their goods artificially cheap encouraging Americans to buy Chinese goods rather than domestic ones. Who is really winning and who is really losing here?
By keeping its currency artificially week in the past, China has managed to accumulate around USD3trn in reserves. Economists and politicians have convinced themselves that China has benefitted at the expense of the US, but in actual fact, US consumers have seen a major windfall at the expense of Chinese workers who have seen their real incomes grow slower than they otherwise would have.
What About Jobs?
There is no question that as manufacturing has moved from the US to China, jobs have been lost, but it is important to remember that for every person that has lost a job, thousands of other have seen their real consumption power increase due to lower imports from China. This is a classic case of the seen versus the unseen.
Furthermore, there is no guarantee that the jobs Americans have lost would have not been lost due to the normal shifting tides of the free market. The world changes so fast that industries die and are born every single day. The only difference in this case is that the ‘culprit’ is easily identifiable. From a purely macroeconomic viewpoint (to say nothing of inequality or other societal issues) the US has clearly benefitted from cheap Chinese goods. In fact, if we judge economic success in terms of consumption, US real consumer spending growth shows how much the US has benefitted.
Who Would Suffer Most From Dollar Weakness?
Politicians believe that with a weaker dollar the US economy will be able to raise its exports, reduce its imports, and bring manufacturing jobs back to the country. With a weak enough currency this would almost certainly happen, but at what cost?
Just as the US has benefitted from a strong currency, allowing people to borrow and spend beyond their means, a weaker dollar would mean the exact opposite. The economy would need to shift towards increased saving and reduced spending acting as a major shock to the industries that have built up to benefit from high levels of consumption. In contrast, China is in a relatively stronger position where it has the productive capacity and although a stronger currency would undermine certain export sectors, it would also allow Chinese residents to be able to purchase their own domestic produce. A rather exaggerated analogy by Peter Schiff provides an interesting take on the situation:
“Assume that a group of castaways are stranded on an island. Let’s say five of them are Asian and one of them are American. And when they are stranded on this island, they need to divide up the workload. So one of the Asians is given the job of hunting, looking for meat. Another one is going to be fishing, trying to get fish. Another one is in charge of scourging the island for vegetation. Still another one gets the job of looking for wood to build a fire and cook the meal. And then it comes down to the American and they say “what job should we assign the American”? Well the American gets assigned the job of eating. And so at the end of the day, all these Asians gather around this big table after a hard day of forging and hunting and fishing and they prepare to feed this American who did nothing all day but sun himself on the beach – he had a service economy.
At any event, a modern economist who is looking at this little island’s economist would say that the American is the key to the whole thing. Without the American, and his ravenous appetite, these poor Asians would have nothing to do all day. They would all be unemployed. Well, the reality is that the Asians are perfectly capable of consuming the food themselves. Now, perhaps if they didn’t have to spend all day feeding this fat American, they wouldn’t have to work this hard. Maybe they could pursue other interests that they had. The best they could do to improve their own standards of living is to kick the American off the island.”