Trade Imbalances

Are we fighting a trade war ? Perhaps. A shift of economic power ? Maybe.

The Westerners love to spend, and the Asians love to save. Both have virtues of their own. Except when it gets out of hand.

Spending. There are different forms of spending, government spending and consumer spending. Money is spent on goods and services, thereby stimulating the economy. when the economy weakens, government usually spends in the form of infrastructure, heathcare, education etc to create jobs. Just as during this current crisis, the Obama administration has pledged to spend to inflate the ecomomy and create jobs. There is a huge supply of money in the capital markets, but banks are not lending as much as before, and until they do, some of these funds will not be filtered into the rest of the economy.

There is a difference when someone spends using credit or when he spends on what he can afford. Spending on credit means using future money at this moment. It can get out of hand when proper controls are not enacted and monitored. Most banks now operate on a fractional reserve banking system. Problem arises where there is excessive leverage and credit. It becomes a monstrous bubble when people turned greedy, leveraging to an excessive and unreasonable limit, rather than what they can truly afford.

Markets will always find their way into maintaining equilibrium. In a credit bubble, deflation must take place to wash away the excesses that had piled up. This is what is happening now. I will talk about cycles in another article.

In Asia, manufacturing and exports are important sectors of the economy. China exports its goods to the rest of the world, and US is one of its biggest importer. So US is spending (mostly on credit), and China is earning and saving. It becomes a problem when the dollars earned are not spent and rotated back. So, now China holds a vast amount of US Treasuries.

US has a widening trade deficit with the rest of the world, in particular China. The US dollar has weakened considerably since year 2000. With a weakening dollar, the trade debts that it owes will shrink and hence, the trade gap tightens. The markets will always find its way back into equilibrium naturally.