I ask this question as a German, who is with a degree of worry pondering the imbalances of western and southern Europe within the Euro sphere. Less competative southern countries are sharing a currency with more effective Germany and France, thereby living under a currency, which overstates their production efficiency and thus boosts unemployment. I suspect as the Euro is a sum of its parts it gave a corresponding competative advantage to Germany in recent years, as it had less purchasing power than the Mark would have retained and thus blessed Germany with an effectively depreciated currency in the world markets.

I consider this on topic here with regard to the trade balance, as i argue that the dollar has been as much overvalued externally by its incorporation of the oil producing sphere as the yuan may have been undervalued.

It would never the less be interesting to get your implicit feel for the “Pecking order”. My own starts like yours with the exchange rate — as it probably has the biggest leverage effect. This subset would include exchange rate intervention and sterilisation measures.

I would personally not put interest rates second — as they are only weakly market driven — but rather credit controls — via the MITI model.
After that, taking a shot in the dark I would place export subsidies (including myriad tax breaks, free infrastructure, cheap land in SEZ’s etc.) and import controls including NTBs and obvious biases in Government procurment policies.
I have no idea where to place capital controls — but they are clearly also important.
All these instruments are part of the arsenal of mercantilist policies that depress consumption (even though the levels are probably understated) and create chronic over investment.

Curiously, this may also be happening in higher education as you note in your latest post. I wonder what the market signals are for investing in higher education these days?
best regards JamesC

Posit a country in which the government runs loose monetary policy and channels most credit into infrastructure and investment, while simultaneously (implicitly) guaranteeing the credits and confiscating a significant part of household savings to subsidize corporate borrowing costs. That country would almost certainly run a large trade surplus. This is effectively what is happening in China. Lots of other things matter and I am sure a better economist than I could work out rough estimates of their impacts on the trade balance, although given the complexity of the measuring the primary impact and the even greater complexity of secondary impacts, I never put too much faith into these kinds of estimates.

Stoneweapon: “How do you balance the flow of credit between production and consumption without resorting to protectionism?”

That is indeed an interesting question. Assume a world of two countries and open trade. If they both run loose monetary policies, in both cases the financial system is likely to accommodate by creating credit. If one country directs most credit into production, and since production and consumption must balance, wouldn’t the financial system in the other country be forced into channeling most credit creation towards consumption.? Or vice versa?

For example, if imports and exports are not equal then credit must accumulate somewhere in the system (e.g. US treasury bonds). As credit accumulates, this is equivalent to a growing I.O.U. tally (the promise of future payback) — such promises cannot grow forever if they are realistically going to be fulfilled. Either the system gets rebalanced and the debt is paid (which is to say that the I.O.U. promise is fulfilled) or a default occurs and the promise never gets paid back. The default (broken promise) represents a retrospective revaluation of past trade to enforce a value balance.

Let us suppose for the sake of argument, that inflation in the USA, and devaluation of the US dollar, causes China to lose half the real-world value of their US Treasury bonds (an arbitrary round-number figure). What this would do is retrospectively make all of the previous exports from China to the USA roughly half the price than they seemed at the time.

Thus forcibly zeroing out the balance of trade (import vs export) for the two countries.

Policies designed to swing the balance between production and consumption can only have a short-term effect, before some external event overrides the policy. The more determined the policy makers are to keep things out of balance for a long time, the bigger the eventual correction that comes along (typically, uncomfortable for the people concerned).

What government policy can do (on a long term basis) is increase or decrease the total trade (both import and export) between their particular country and the world (which is to say, government can encourage isolationism, or globalism as it sees fit). Protectionist policies that keep some particular production inside the country are merely isolationist policies in disguise.

I would argue that it is usually better for government policy to push the balance of trade toward being more balanced rather than less balanced. Given that it is going to balance sooner or later by force of nature; better to bring it into balance sooner, and better to do it in a controlled manner.

In Australia we have a floating currency which will push the trade towards a balance automatically, and it has been of great benefit to us. If our government wants to subsidize our manufacturing industry, any effect this has on import/export balance is absorbed by our floating dollar. If China is determined to stockpile minerals, our Australian dollar floats up and makes those minerals more expensive, while automatically encouraging the Australian people to buy more foreign goods.

Just been reading this article from Caijing. It mentions an “Inflation tax” that could result from current monetary policy in China. Has anyone got the May lending figures yet? I saw a rumour reported of 500bn RMB…

I like how you put your question. I would like to see a top 10 list that we could almost agree on.

Micheal,

I am frustrated by the lack of consideration attributed to the level of impact credit markets have on trade/consumption in respect to where the impact of currency and tariffs stand.

I think too many of these other policies/factors that impact trade are more reactionary to credit flows, than being influential.

Credit seems to flow in the path of least resistance if it is not regulated towards balancing production and consumption, and the imbalance of the regulation of credit between countries intensifies the imbalance of trade.

How do you balance the flow of credit between production and consumption without resorting to protectionism?