Wednesday, October 24, 2012

What is up with the China bashing?

In last nights presidential debate, both Obama and Romney gave China a tongue lashing reminiscent of the Michael Fay ordeal. Why? Because China sells goods to us too cheaply. Yes, you read that right. Both Romney and Obama want China to jack up their prices. Walt-Mart, you're next.

In the candidates defense, there are some reasons why we may not want China to do this, though I do not find any of them particularly convincing.

1. Trade deficits are bad in the long run. - China is not using the dollars we send them to buy American goods (at least directly). Instead they are buying American Treasury bonds, which is a form of direct investment. America needs to pay the interest and principle on these bonds and China can use their ownership of this debt as leverage when it comes to bargaining with the U.S. over various things. At least that is what people tell me. I am not that convinced. Besides, if we used the direct investment provided by China to invest in things like infrastructure and research that will (hopefully) increase output/economic growth in the future, we should have no problem paying back our debts to China. This is especially true when you remember that the interest rate on T bills is very low compared to other forms of investment due to them being "risk-less" assets. Unfortunately the government is using most of this direct investment to fund current consumption in the form of medicare, social security, medicaid and who knows what else.

2. The dollar might lose its place as the reserve currency. - Currently the dollar is the reserve currency for most if not all of the world. This means that the U.S. can borrow at a lower rate since there are always countries ready and willing to lend to America. It also means that most of the internationally traded commodities like oil and gold are valued in dollars, which gives Americans a slight advantage when purchasing these commodities since we do not incur the transaction costs that are a part of exchanging one currency for another. It is believed that the relative stability of the U.S. dollar, the size of our economy, and the fact that the U.S. pays its debts is largely responsible for the dollars elevated status. But just like a person who borrows too much, as the U.S. deficit rises countries may start to question our ability to pay our lenders and thus may demand higher interest rates or perhaps stop lending to us altogether. That would be very bad, at least in the short term.

I believe that this criticism does have some validity. However, I do not think that our trade deficit with China is that much of a contributing factor. The U.S. certainly has a spending problem, but the deficit with China is a small part of that problem and in my opinion a straw man for the larger issue.

3. It causes job loss in the U.S. - Quick answer: that is not at all obvious. Last night Obama talked about how his tariff on tires from China saved jobs. And while they may have directly saved the jobs of some tire factory workers, it is far from clear that they saved jobs overall. That is because when the price of tires goes up, which was the point of the tariffs, people buy less tires. This means less work for tire salesmen at Sears, Tire Discounters, etc., less work for truck drives who move tires from the ports inland, and less work for the crane operators who remove the shipping containers from the ships to land. I doubt that the Obama administration went around and counted all of the people in those occupations who lost their jobs because of the tariffs, but I am sure the number was far from 0.

So why might the tariff be bad for America? Increasing the price of tires is certainly bad for consumers. There are over 200 million licensed drivers in the U.S. All of them need to buy tires at some point. When you multiply the number of tires bought by 200 million people by even pennies, you are talking about a huge increase in the dollars spent on tires, which means that those dollars cannot be spent on other goods.

Are the jobs of tire factory workers worth the jobs of the tire support workers and this huge loss in the consumer surplus of tire purchasers? In my opinion they are not. But even if you think that they are, it is important to remember that tariffs do not come without costs. Like any other decision, there are trade offs.

The bottom line: Free trade is good. If anyone tells you otherwise the burden of proof is on them. And if it is me I need it to be beyond a reasonable doubt, and then a little bit more.

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