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Global Balancing Act

 
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PostPosted: Sun Apr 16, 2006 8:33 am    Post subject: Global Balancing Act Reply with quote

The global economy, in recent years, have shown a dynamic U.S. economy, a lagging E.U. economy, and spectacular growth in many Asian economies. Overproduction in the E.U. and Asia are offset by overconsumption in the U.S. For the global economy to remain in balance, offsetting shifts in the goods market, money market, and foreign exchange market must take place through changes in interest rates and currency exchange rates.

In trade wars, there are rarely winners and losers, because each trading partner wins through the Law of Comparative Advantage, at least initially. However, some countries win a larger marginal proportion of the gains of trade than other countries. It's clear, the U.S. has benefited more than its major trading partners, generally, because the U.S. is relatively stronger than the rest of the world.

The U.S. trades from a position of relative strength. Many U.S. major trading partners have adopted policies that created relatively weaker trading positions. In E.U. countries, there are wage rigidies and labor immobilities that create overproduction in some industries and restrict resources. Japan must overproduce to maintain lifetime employment. Also, China must overproduce to maintain "acceptable" levels of employment.

The U.S. has fewer production restrictions. For example, in 2000-2002, the U.S. had a quick and massive "Creative-Destruction" process that freed-up and shifted resources from inefficient Information-Age firms into emerging industries. Consequently, Information-Age firms quickly became more efficient, while new industries (e.g. biotech firms) expanded at greater rates. Fewer production restrictions allow greater flexibility.

In recent years, major U.S. trading partners lost all the major trade wars, and most minor trade wars, to the U.S. China has made remarkable progress in raising its living standards through increased production. China's economy is estimated to be the sixth largest economy in the world, and in terms of Purchasing Power Parity is estimated to be the second largest economy in the world. However, China is in position to lose more than it already lost.

China has generally adopted a "Growth at any Cost" policy. Consequently, China is selling its goods too cheaply, because it doesn't take into account negative externalities, e.g. cost of pollution. Most goods China produces are heavy goods. So, high commodity prices, e.g. steel and oil, increase production costs more than "lighter" economies. It's estimated China exports about half of its output to maintain employment. China's economy is expanding too quickly, which may create a severe boom/bust cycle.

China has been large buyers of U.S. Treasury Bonds to keep the Yuan weak to maintain export growth. However, China will lose much of its investment when U.S. Treasury Bond prices fall (and yields rise). Also, China will lose further when the Yuan becomes relatively stronger than the Dollar (i.e. China will receive fewer Yuan per Dollar in the foreign exchange market). Moreover, U.S. inflation will reduce real foreign debt, since China's exports and output will fall.

The U.S. was able to maintain above trend growth with huge negative net exports, while most U.S. major trading partners needed export-led growth. Consequently, U.S. consumers benefited greatly, while U.S. producers lost little. However, major U.S. trading partners lost a great deal in consumption for temporary higher production. Moreover, much of the foreign consumption losses, from investments and currency rates, will be permanent.

What China needs to do (and what some European countries and Japan failed to do) is induce domestic consumption e.g. by facilitating U.S. exports into China. This will cause some shift from Chinese production into American production. However, it will lower Chinese production to a more sustainable rate, raise consumption, lower saving, increase foreign investment, into China, provide greater competition, etc. Ultimately, China's gains from trade will increase.

A precipitous rise in U.S. Treasury yields, with a further depreciation of the U.S. Dollar, may create stagflation in the U.S. and recessions in major export-led economies. The adjustment process may be sudden or gradual. It's uncertain if the adjustment process began in early-2006. It's possible the massive U.S. current account deficits peaked, U.S. Treasury yields will continue to rise, and the U.S. Dollar will stay low or fall lower, against large exporters, particularly China and Japan.
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