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Richmans' Trade and Taxes Blog
Geithner thinks our trade problems with China are solving themselves
In testimony before the Senate Foreign Relations Committee on March 2, U.S. Treasury Secretary Timothy Geithner explained why he thinks that market forces will balance U.S. China trade without the Obama administration having to do anything more than talk. Here are some selections:
I agree with Geithner that the U.S.-China trade balance will improve in the short-term. Federal Reserve Chairman Bernanke gets the credit. His massive buying of U.S. long-term Treasury Bonds (QE2) has made long-term U.S. Treasury Bonds such a bad investment (due to anticipated future inflation) that many investors are sending their savings out of the United States, including to China.
This has been causing a huge problem for the People's Bank of China. In order to manipulate currency values, it not only has to buy enough foreign financial assets to overcome China's trade surplus, but now it also has to buy enough to balance this Bernanke-caused inflow of private financial capital. These increased purchases of foreign financial assets contribute to China's growing inflation. (Basically, the People's Bank of China is printing the yuan that it uses to buy the dollars that it uses to buy these assets.)
But QE2 can't go on forever. It will soon cause considerable inflation in the United States, probably starting this year. Bernanke will be forced to end the program. He will be forced to cut back by growing U.S. inflation.
Geithner's mistake is a basic misunderstanding of economics. He is living in a dreamworld in which market forces eventually end mercantilism. This is indeed what classical economists throught, beginning with David Hume. Geithner hasn't yet figured out that the modern version of mercantilism, in which the mercantilist countries lend the earnings of trade back to the trade deficit countries, is largely impervious to market forces. In contrast, Bernanke's strategy for fighting mercantilism will soon be prevented by the market force of growing inflation.
Unlike Geithner, I don't expect that China will give up its mercantilist strategy. The twin goals of mercantilism are economic growth and political power. By buying our financial assets (the key step in currency manipulations), China grows its own economic and political power while shrinking ours. Why should it give up that successful strategy when it is causing Chinese power to grow and the power of their western adversaries to shrink? China will indeed slow down its mercantilism, but the slow down will be temporary, because the Bernanke-caused speed bump is just temporary.
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Atlantic Economic Journal: