Protectionism by Any Other Name

By James Kwak

One thing you can probably get 99% of economists to agree on is that a global trade war in the middle of a global recession is a bad idea. If every country increases import tariffs, hoping to protect its domestic industry from foreign competition, global trade will fall in all directions, hurting everybody. Put another way, increased tariffs are a negative-sum game.

To date, we haven’t seen much in the way of higher trade barriers during this crisis, although you could argue that some bailouts constitute subsidies favoring local over foreign companies. Instead, however, we are seeing friction over currency valuations. If you want to boost your net exports but don’t want to do the obviously unfriendly thing and increase tariffs, the other option is to devalue your currency: a weaker currency increases the price of imported goods and reduces the price of exported goods, hence reducing imports and increasing exports.

Yesterday, Tim Geithner accused China of “manipulating its currency,” something we’ve heard periodically over the last several years but not much in the last few months. (Of course, Geithner then said that “a strong dollar is in America’s national interest,” whatever that means.) Switzerland threatened to intervene on foreign exchange markets to suppress the value of the Swiss franc. And the French finance minister criticized the U.K. for letting the pound depreciate. (Hat tip Macro Man for the last two.)

Theoretically, devaluing your currency is not as bad as import tariffs. If every country tries to devalue its currency at the same time, exchange rates will remain the same; this is a zero-sum game in that sense. It’s a little more complicated, because there are at least two ways of devaluing your currency. One is for the central government to sell its own currency and buy everyone else’s currency on the foreign exchange market. The other, however, is to run an expansionary monetary policy (lower interest rates, more money creation, etc.), which is inflationary. So one possible outcome is that every country runs an expansionary monetary policy, exchange rates remain the same, but commodity prices go up because there is more money floating around. In today’s environment of low or negative inflation expectations, however, that might not be such a terrible thing.

But the other side of competitive currency devaluations is that not all countries are equally well armed. In particular, countries that use the euro cannot devalue their currencies, because they don’t control their monetary policy and they don’t have the scale to intervene significantly on the market for euros. In short, other countries can devalue their currencies at the expense of Eurozone members. This is one of the reasons why, as we (and Martin Feldstein) have warned, the economic crisis will increase tensions within the Eurozone. The New York Times just ran an article on this exact topic:

Germany, France and the Scandinavian countries are mounting billion-dollar stimulus plans and erecting fences to protect their banks. But the peripheral economies are being left to twist in the market winds.

This is a good indicator that fears about the Eurozone are going mainstream.

Comments

[Pup:]

Pot. Kettle. Black.

Jan 23 07:19 PM

[Steven Hansen:]

"increased tariffs are a negative-sum game"

balance of payments is a negative sum game. loss of jobs is a negative sum game. we need to pick our poisons.

Jan 23 08:57 PM

[Moon Kil Woong:]

LOL the Fed and Treasury shouldn't talk about the artificial devaluation of currency. Look what thay are doing to the dollar. If that's not devaluation then I don't know what is.

The sad fact is, every currency is trying to devalue as fast as possible relative to one another to shift the pain of the global recession to everyone else. That is why asides from the Yen even with the fed making as much funny money as it can the dollar isn't weakening rlatie to its peers much anymore. May the crappiest currency win. What a screwy world we live in.

Jan 23 09:24 PM

[Tradememe:]

If all other major economies are devaluing their currencies, the EU will also devalue. There should be no doubt about that. Even Trichet, the inflation hawk, is changing his tune. Perhaps that's the best solution. For as you say it's a zero-sum game. The exchange rate will remain the same and the economies of the world will have their stimulus.

Jan 24 12:03 AM

[bs_o_meter:]

I just don't understand this paranoia about import duties. It is always advantageous for the net importing countries to raise duty to balance trade. Does it make sense to have a trade deficit?

Jan 24 03:06 AM

[NobodyinPar...:]

If trade tariffs are a negative sum game then so is war. And we still expect are country to defend itself every once in awhile don't we?

Jan 24 10:31 AM

[Dave Wrixon:]

The problem is that the dollar is appreciating due to capital inflows. The inflows come both from proceeds of liquidated overseas investments and foreign borrowings all of which are being used to help stem the flow of red ink. Viable investments are being closed out to protect the interests of fat cats at home, making the US increasingly less competitive. This as we see has a negative impact on the US trade position by artificially inflating the dollar.

The true value of the total dollar on the Feds balance sheet or Government IOUs is determined by the ratio of the Government's tax base divided by its debt. Of course the more you put in circulation the less each one is worth. But also as debt increases exponentially and the tax base shrinks at an alarming rate, then the total worth also decreases alarmingly.

A collapse of the dollar is inevitable, which is what the Chinese fear, as they have a huge amount of money to the US. If they accept a big increase in the value of that debt then they have to accept a big write down on their investments. China is trying to protect its investment. The US is trying to default by stealth. However, for the value of the dollar to drop, China must stop lending. If they stop propping up the dollar then it will rapidly deflate, and the Americans will have their the competitive exchange rate they seek, and much of their debt will disappear. But their stimulus would then have to be financed according to the Zimbabwe model.

Jan 24 11:16 AM

[Robert Wein...:]

James Kwak is right on point.

As the largest manufacturer in the world and a country that depends in a large part on exports the talk of trade barriers scares me.

We pay for our life style in part by borrowing money which will someday have to be paid back regardless of what the Washington leaders think.

Taking away low cost goods and at the same time lowering our exports due to a trade war is about as dumb as it gets while trying to keep the masses happy with what the government doesn't take away from them.

Jan 24 12:10 PM

[biomedlives:]

I ask James Kwak, Robert Weinstein, and other free trade advocates if they believe our long-running trade deficit is a problem and, if they do, how they propose to fix it. I'm not a fan of protectionism, but I speculate that NAFTA and every other trade agreement the U. S. has signed in recent years has made our trade deficit worse.

If the people whose in manufacturing and software programming went oversease still had those jobs instead of lower-paying positions with poor benefits, they might not have to borrow to pay for their lifestyles.

Jan 24 01:03 PM

[Rob Viglione:]

The Chinese will not have a choice when it comes to "protecting their dollar investments" by propping up our currency. They have been able to do this through long periods of trade surpluses, in which they have accumulated USD and deferred domestic investment. The trade surpluses are shrinking and China has more internal issues to which they must apply reserves.

In absence of a conscious decision to dump US assets, we can at least expect with high certainty that the pace at which they purchase our paper will decline. This, alone, will significantly impact our currency and debt since we are in process of embarking on unprecedented deficit spending and dollar creation.


On Jan 24 11:16 AM Dave Wrixon wrote:

> The problem is that the dollar is appreciating due to capital inflows.
> The inflows come both from proceeds of liquidated overseas investments
> and foreign borrowings all of which are being used to help stem the
> flow of red ink. Viable investments are being closed out to protect
> the interests of fat cats at home, making the US increasingly less
> competitive. This as we see has a negative impact on the US trade
> position by artificially inflating the dollar.
>
> The true value of the total dollar on the Feds balance sheet or Government
> IOUs is determined by the ratio of the Government's tax base divided
> by its debt. Of course the more you put in circulation the less each
> one is worth. But also as debt increases exponentially and the tax
> base shrinks at an alarming rate, then the total worth also decreases
> alarmingly.
>
> A collapse of the dollar is inevitable, which is what the Chinese
> fear, as they have a huge amount of money to the US. If they accept
> a big increase in the value of that debt then they have to accept
> a big write down on their investments. China is trying to protect
> its investment. The US is trying to default by stealth. However,
> for the value of the dollar to drop, China must stop lending. If
> they stop propping up the dollar then it will rapidly deflate, and
> the Americans will have their the competitive exchange rate they
> seek, and much of their debt will disappear. But their stimulus would
> then have to be financed according to the Zimbabwe model.

Jan 24 01:59 PM

[Rob Viglione:]

Mass currency devaluation is NOT the best solution. The result will be inflation for consumer goods and commodities, which ultimately bears its greatest impact upon the poor and middle class. Wages will not keep pace with such rampant inflation, with living standards for most will decline precipitously.

This kind of sick monetary "stimulus" policy is the reason we now find ourselves in this mess. it is the reason for the big bubbles of our time and for the squeeze on the low and middle class. The soundness of our currency should not be degraded in these perverse social experimentations.


On Jan 24 12:03 AM Tradememe wrote:

> If all other major economies are devaluing their currencies, the
> EU will also devalue. There should be no doubt about that. Even Trichet,
> the inflation hawk, is changing his tune. Perhaps that's the best
> solution. For as you say it's a zero-sum game. The exchange rate
> will remain the same and the economies of the world will have their
> stimulus.

Jan 24 02:06 PM

[Rob Viglione:]

We lose jobs and industry overseas because of decades of bad policies, and government intervention in the economy. America was once the most competitive country in the world, but has since suffered from expensive labor laws, unions holding us all hostage, complex accounting requirements, and a hostile tax regimen. Businesses leave for a reason. This is the root cause of the decline in American production. The other side of the trade equation can be explained by rampant consumerism rotting our culture.


On Jan 24 01:03 PM biomedlives wrote:

> I ask James Kwak, Robert Weinstein, and other free trade advocates
> if they believe our long-running trade deficit is a problem and,
> if they do, how they propose to fix it. I'm not a fan of protectionism,
> but I speculate that NAFTA and every other trade agreement the U.
> S. has signed in recent years has made our trade deficit worse.
>
>
> If the people whose in manufacturing and software programming went
> oversease still had those jobs instead of lower-paying positions
> with poor benefits, they might not have to borrow to pay for their
> lifestyles.

Jan 24 02:11 PM

[Dave Wrixon:]

America's competitive edge was born of sunken investment in production capacity that was not destroyed by the bombing during wars. It is now a rust belt because the profits in the good days have been largely been squandered, and what little investment there has been has been sunk in production capacity where labor cost are cheaper.

To regain the glory years, first you need to obtain a workforce that is educated and skilled enough, but also prepared to work as hard as it competitors and for competitive rates of pay.

Once you have that and God only knows how you are ever going to achieve that then you have a level playing field on which to compete for investment capital.

Like most things in life, and something that has been a highly familiar problem in other countries, it is a chicken and egg problem that even with very skilled management will take decades to achieve. You might have what is left of Wall Street, but were they ever on your side in the first place?


On Jan 24 02:11 PM Rob Viglione wrote:

> We lose jobs and industry overseas because of decades of bad policies,
> and government intervention in the economy. America was once the
> most competitive country in the world, but has since suffered from
> expensive labor laws, unions holding us all hostage, complex accounting
> requirements, and a hostile tax regimen. Businesses leave for a reason.
> This is the root cause of the decline in American production. The
> other side of the trade equation can be explained by rampant consumerism
> rotting our culture.

Jan 24 04:34 PM

[biomedlives:]

Most jobs and industries that go to other countries do so because labor costs are much lower in those countries. Mr. Wrixon's "Competitive rates of pay" means 50 to 70% lower than current American pay scales.

On Jan 24 02:11 PM Rob Viglione wrote:

> We lose jobs and industry overseas because of decades of bad policies,
> and government intervention in the economy. America was once the
> most competitive country in the world, but has since suffered from
> expensive labor laws, unions holding us all hostage, complex accounting
> requirements, and a hostile tax regimen. Businesses leave for a reason.
> This is the root cause of the decline in American production. The
> other side of the trade equation can be explained by rampant consumerism
> rotting our culture.

Jan 25 08:19 AM

[lefty37:]

We lost a HUGE amount of jobs by our government giving tax breaks and other incentives to manufacturers to move their operations out of the US.
By the people and for the people? I don't think so!

Jan 25 10:16 AM

[Dave Wrixon:]

Yes, but much of this adjustment will be achieved through dollar depreciation.

Imported electronic goods will of course be more expensive, but then isn't that exactly what the doctor ordered?

Trust me when politicians are talking about support for a strong dollar, you can be sure it is just about to get trashed.


On Jan 25 08:19 AM biomedlives wrote:

> Most jobs and industries that go to other countries do so because
> labor costs are much lower in those countries. Mr. Wrixon's "Competitive
> rates of pay" means 50 to 70% lower than current American pay scales.
>
>
> On Jan 24 02:11 PM Rob Viglione wrote:

Jan 25 11:03 AM

[adenovir:]

We will all inflate our currencies because inflation is much more palatable politically than deflation.

Jan 25 04:14 PM

[biomedlives:]

I agree that dollar depreciation will bring about much of the adjustment. Perhaps we'll have to start manufacturing electronics and apparel again in the U. S.


On Jan 25 11:03 AM Dave Wrixon wrote:

> Yes, but much of this adjustment will be achieved through dollar
> depreciation.
>
> Imported electronic goods will of course be more expensive, but then
> isn't that exactly what the doctor ordered?
>
> Trust me when politicians are talking about support for a strong
> dollar, you can be sure it is just about to get trashed.

Jan 26 09:14 AM