WASHINGTON, Nov. 11 (UPI) -- The widening of the British trade deficit in September to 3.9 billion pounds ($6.5 billion), and the World Trade Organization's rejection of the U.S. appeal of its steel judgment highlight a grim fact of the world economy: trade imbalances are getting worse, not better.
There is no economic justification for mercantilism, the belief that only by running a trade surplus can a country grow rich. Thomas Mun's 1664 classic "English Treasure by Foreign Trade," which advocated trying to run a trade surplus with all your trading partners, thus accumulating gold reserves, was fairly comprehensively exploded by Adam Smith, and has remained out of fashion since. Nevertheless, persistent trade imbalances, where deficits are financed by inflows of hot money -- which can flow as quickly out as it came in -- from central banks of countries that run surpluses, are bound to lead to trouble in the end.
Normally, in a free floating exchange rate system, such imbalances correct themselves. However, there are a number of factors currently that prevent such automatic correction from taking effect.
In the United States, the George W. Bush administration, facing an election within a year, is desperate to keep the economy rolling forward, and to prevent job losses in states such as West Virginia and North Carolina where a clever Democrat may be able to turn economic hardship into an unexpected electoral victory.
Hence it is dependent on continued inflows of foreign investment into the Treasury bond market, to keep interest rates down and the housing market in its present state of enthusiastic boom. Further (and less forgivably) it is prepared to sacrifice the long term welfare that comes from free trade for short term political benefit in states that produce steel (thus the "anti-dumping" measures that provoked the WTO's wrath) agriculture (thus the hugely increased farm subsidy bill of 2002) and very probably textiles (expect huge political pressure to be brought on the administration to prevent the abolition of textile quotas, due on 1st January, 2005.)
A lowering of the $500 billion per annum U.S. trade deficit, probably accompanied by a weakening of the dollar, would produce an outflow of foreign money from the Treasury bond market, a sharp increase in interest rates, and almost certain electoral disaster for the Bush administration. Don't expect it before 2005 at the earliest.
In Britain, chancellor of the exchequer Gordon Brown last week boasted of the strength of the British economy, and of its greatly superior performance compared with its EU partners. Given the economic travails of France and Germany, that is not a particularly high standard to set; in any case, when trade is considered Britain, as always, fails it. British economic growth is caused primarily by excessive consumption, by the private sector and more especially by the government, that has led to an extraordinarily high level of consumer borrowing and continued and even intensifying inflation in already grotesquely overpriced housing. Since the Bank of England, unlike the Fed, pursues a policy largely independent of the government, it will inevitably begin to increase interest rates, as it attempts to mitigate the inflationary effects of the usual British habit, public and private, of spending more than they earn. This in turn will cause huge squealing among the British electorate; hence you can expect any attempt to rectify the continuing trade imbalance to be limited indeed.
In continental Europe, the main public impulse appears to be hatred of George W. Bush, and attempts to punish him for having the temerity to defend U.S. interests in Iraq without EU approval. Trade in itself is not a problem; Germany, mired in recession, continues to run a substantial trade surplus -- 14.4 billion euros ($16.5 billion) in September -- and so long as the dollar does not drop significantly further against the euro, European countries will not fear U.S. competition, but only that of the newly energetic exporters of China, India and the rest of east Asia.
However, the WTO's decision has handed the EU a weapon which it will find it hard to resist using. EU economists may be entirely incapable of devising policies that will produce economic growth in the EU itself, but they are extensively trained in the quasi-Marxist input-output analysis of Wassily Leontief, and are only too capable of determining exactly which trade sanctions, which they are now free to impose, will cause the maximum short term economic damage in states Bush needs to carry next November. The battle has moved onto terrain at which the EU bureaucracy is unsurpassed; there is surely no question that it will take the maximum advantage of this most enjoyable opportunity.
In Asia, where the surpluses are located, the problem is a different one. China runs a $100 billion per annum surplus with the U.S., but an almost equivalent deficit with the rest of east Asia. In terms of her export markets, the Chinese renminbi is undervalued, and the country is accumulating huge foreign exchange reserves -- up $17.1 billion in October alone. However, that money is being recycled through the state banking system into loans on the domestic market, partly to prop up loss-making state industries, and partly into primarily industrial real estate. Domestic Chinese loans outstanding are expected to increase by 36 percent of gross domestic product in 2003, a far higher rate than in the other countries of Asia before the "Asian crisis" of 1997. Clearly the Chinese loan bubble will have to burst sometime, but the Chinese authorities recognize that bursting the bubble will be exceptionally unpleasant for the Chinese people, who are liable to see their savings wiped out as the state banking system implodes into insolvency. Hence their desire to postpone the awful day for as long as possible.
In the rest of east Asia, particularly Taiwan, Thailand, Malaysia and South Korea, Chinese competition is providing a painful restructuring need at the lower end of their economies, as low-cost industries that were highly competitive a few years ago find themselves undercut. Hence there is no desire to revalue their currencies against the dollar, which would cause an equivalent up-valuation against the renminbi and a further loss of competitiveness. Much better simply to keep buying the T-bonds.
In short, the imbalances in world trade are unlikely to be rectified soon, for both political and economic reasons that vary from country to country. Meanwhile, with the WTO talks in Cancun having failed, and the Free Trade Area of the Americas talks in Miami next week likely to do likewise, there seems little prospect of an early resolution of the problem.
Expect at least a modest return to protectionism, and a reversal of much of the 1990s' trade-driven gains for the world economy.
