Trade imbalances and foreign currency manipulation are rapidly emerging as the next “big issue” in financial markets, replacing subprime mortgages and credit default swaps.
Ten years ago few people were familiar with the intricacies of subprime mortgages, let alone their distant cousins, credit default swaps. But after these financial instruments started blowing up by the millions, rattling the global economy to the core, Americans got a hard and fast lesson in the formerly esoteric world of mortgage-backed securities.
The U.S. trade imbalance with China and criticism that China is manipulating its currency at the expense of the U.S. have in recent months begun to warrant similar attention.
The issue took center stage at the G20 meeting of the world’s largest economic powers in South Korea this week. The reason is that each of these interrelated concerns has a profound impact on U.S. – and global — labor markets.
Here’s some background: the U.S. has endured a trade imbalance with most of its trading partners for decades in an effort to promote capital markets in developing countries. This system has worked because Americans have been able to afford to pay more for cheaper goods made overseas. It’s cost the U.S. millions of jobs, but it’s helped stabilize developing economies around the globe.
But as China’s economic engine has strengthened as the U.S. struggles to recover from the worst economic downturn since the Great Depression the system has become harder to justify.
Add to this the widespread belief that China is intentionally manipulating its currency – keeping it artificially low versus the dollar — in an effort to keep its exports cheaper than its competitors in Europe and the U.S., and the result is a growing sense that something’s got to give.
With U.S. unemployment hovering stubbornly near 10%, and no relief in sight for the 14.8 million Americans looking for work, jobs have become the single most important issue as the U.S. heads into mid-term Congressional elections.
For unemployment to decline any time soon exports will have to pick up. That means demand for U.S. goods will have to also pick up. But that’s less likely to happen if U.S. goods are more expensive than Chinese goods.
“In a very direct sense, if you care about jobs you have to care about export strength,” said Cliff Waldman, an economist for the Manufacturers Alliance/MAPI, a public policy and economics research organization in Arlington, Va.
With the U.S. housing market still in disarray and consumer uncertainty (consumer spending makes up 70% of the U.S. economy) at its highest level in decades, exports will likely be key to the U.S. recovery.
“Job growth is not going to come from the consumer sector. The housing market will take years to rebuild. The financial sector is in turmoil — some strength some weakness. The U.S. really needs exports to pull it along. We can’t go on with a 70% consumer-based economy and a trade deficit,” said Waldman.
The rhetoric in Washington has heated up around the issue as members of Congress, many of them facing re-election in November, attempt to respond to their constituents’ pleas for jobs.
Some lawmakers have proposed imposing sanctions on China if it doesn’t allow its currency, the yuan, to rise substantially against the dollar. One bill approved recently by the House of Representatives would label the yuan’s current value as an export subsidy, and tax U.S. imports from China if policy makers in Beijing fail to act.
The fear is that if the U.S. takes a tough stand against China it could push the global economy beyond currency wars into even more dangerous trade wars comprised of competing tariffs and import quotas.
Bill O’Grady, chief market strategist at Confluence Investment Management, believes the timing may be right for a conversation that should have begun years ago.
“We’ve reached the point where these policies don’t work. The world is wildly unbalanced but nobody wants to engage in changes that people are afraid to make,” said O’Grady, referring to international fiscal policies that date back to the Bretton Woods agreement forged in the wake of World War II.
O’Grady said the U.S. was willing to run trade deficits as Europe and Japan rebuilt after World War II because “we were bigger than everyone else.”
“We did it willingly. We didn’t want Europe and Japan to go Communist, and it worked. We kept our trade policies open even while the other countries didn’t,” he explained.
These policies encouraged U.S. consumer spending and helped create jobs and stable governments overseas.
But it may be time for the U.S. to consider scaling back consumer spending, according to O’Grady. At the same time, developing nations like China need to become less dependant on U.S. consumers. For years the U.S. has refrained from enforcing austerity on its consumers by making imports more expensive. Meanwhile, “Americans have gotten used to cheap imports,” he said.
But jobs are a powerful incentive and Americans may now be willing to trade cheap imports for job creation through increased exports.