Everybody knows that our biggest source of the trade deficit is China. That’s all due to a state-managed economy where profit is not the goal, and subsidies flood the country to support the growth of CCP-connected industries that then underprice all others. But you would think that Mexico would be No. 2. It’s right next door, and it has a free trade agreement with the United States. Made in Mexico might as well be Made in America. That is surely the case for cars. Still, Mexico is not No. 2, instead, it is the European Union.
In March, our trade deficit with the EU was $18.54 billion, its biggest ever, led by Germany, Ireland, and Switzerland (thanks to pharmaceuticals to a large degree). In 2020, the deficit with the EU was $182.1 billion, our biggest ever, compared to Mexico’s at $112.7 billion, based on Census data.
“What causes trade imbalances today is not what caused them 50 years ago and it is surely not because China is more efficient at producing stuff than the U.S. is,” said Michael Pettis, finance professor at Peking University and one of our favorite authors on trade. “The imbalance is more an imbalance of income,” he says, meaning countries that save more, or whose domestic policies punish domestic consumers, lend to those countries to look elsewhere to sell. The U.S., of course, is the world’s favorite dumping ground.
Pettis is the co-author along with Barron’s columnist Matthew Klein of the 2020 book “Trade Wars are Class Wars.” They spoke Tuesday during a webinar hosted by Foreign Policy magazine.
Klein singled out Germany here, a country we like to think of as the China of Europe.
“German consumers spend less than they are earning and it’s not because they are more spend thrift, it is because their purchasing power has been shifting away from them and redirected towards the very rich and the companies they control,” said Klein. “That’s been exacerbated by the German government focusing on things like balanced budgets through tax increases on workers, spending cuts on public investment, and social welfare programs. You squeeze them so much so that import demand gets suppressed. Export growth in Germany has not been growing fast; the surplus with the U.S. is because import growth is in decline.”
Like China, this has had consequences for Germany’s neighbors and for the rest of the world. Germany doesn’t absorb demand. Germany supplies the demand, a lot of it going to the U.S.
From “Trade Wars are Class Wars”:
“Since the early 2000s, Germany businesses have been perennial savers and consistently generate a surplus worth more than 2% of GDP. The combination of sustained income from exports and lower domestic spending mechanically led to a higher national saving rate and a higher current account surplus….The danger now is that Europe and the United States will enter a trade war of their own, undermining both global prosperity and an important alliance among the world’s democracies.”
Companies get to invest in their own stock, and make stuff for the world. Their share prices rise, but only 10% of Germans own stocks so they’re not getting rich off the model.
Pettis and Klein spent a lot of time on that German model in their book. They won the 2021 Lionel Gelber Book Prize for “Trade Wars are Class Wars,” focusing on how economic policies have generated inequality both within and between states causing global tensions and political polarization.
It’s good to remember that China is not the only problem, as the authors point out.
Adding tariffs to China goods may slow exports (our March trade deficit with China was the highest it’s been since March 2015), but then what about Southeast Asia?
Vietnam and Malaysia have almost no domestic market to speak of. Vietnam, in particular, is becoming dependent on the U.S. for its exports.
In this week’s trade figures we saw that both tiny Vietnam and Malaysia hit their biggest ever monthly trade deficit with the U.S. For year-ending 2020, Vietnam added $69.6 billion to our trade deficit. Malaysia accounted for $31.6 billion. Worth noting, Vietnam’s deficit with the U.S. is bigger than the one we have with Germany. That’s because Vietnam has no consumer market. We are the consumer market for Vietnamese manufacturers.
Pettis and Klein said those surplus countries like Germany and China will continually face the ire of the United States. We see this as especially true as we power ahead to a $1 trillion deficit, likely this year, thanks in large part to massive Main Street stimulus that has propelled demand. The rest of the world did not do anything of that scale and so the demand for U.S. made goods abroad remains tepid.
The authors point out that persistent trade surpluses are usually the consequence of highly unbalanced distributions of income in favor of businesses and the rich (who invest in stocks, bonds, and real estate, not in factories). The U.S. can try to deflect those surpluses, but it becomes a question of whack-a-mole. A smaller deficit with China leads to a bigger one in Vietnam, and so it goes.
China is trying to build its domestic consumer base, but its weaker currency (coupled with its logistics and high-quality manufacturing) makes it attractive to source from there. As long as China can dump its excesses to the U.S., nothing will change. Companies there will continue to overproduce to serve this market, even as their own home market grows.
China’s overall consumer spending fell last year, while it increased here thanks to stimulus checks and generous unemployment benefits. China’s economy grew to meet American demand. The U.S. economy shrank as some workers preferred unemployment, and lockdowns in key states lasted twice as long as China’s.
For Pettis and Klein, the euro area is really the world’s biggest source of global imbalances.
How much longer with the U.S. remain the world’s consumer of last resort? Pettis hinted about restricting capital flows into the U.S. which would weaken the dollar against the euro, especially. (See CPA’s potential solution for this here.)
Pettis signed off by pulling a card from the Biden deck: economic inequalities.
“If we are going to view that as a problem, and we should, it should not be just a social issue but an economic one,” Pettis said. “We have no choice but to reverse hyper-globalization. There is only so much we are willing to give up in terms of domestic control of the economy. I think there is a retreat in globalization, and I don’t think that is a bad thing. What matters is how we do it.”