Wednesday, January 31, 2007

The Trade Deficit

This article from The Washington Post states what many lawmakers in Washington, as well as Henry Paulson (U.S. Treasury Secretary), have been saying for quite some time: that the U.S. trade deficit with China is too large.

I think it is important to provide some context by showing you what one of my favorite economists thinks of this.

Firstly here, Greg states the possibility that some people could be overreacting.

Although this textbook problem is useful as a theoretical exercise, one should not overstate its practical relevance (as I believe Paul mistakenly did in his paper). In the example, the United States is made worse off by growth in China because our trade with China dries up, so we lose the gains from trade. This theoretical result has minimal application to the world as we see it today. World trade is booming, not shrinking.


And via Greg Mankiw, Michael Spence writes in this Wall Street Journal article:

…if China does allow its currency to revalue over time, then we will simply run a deficit with another collection of countries, and from a domestic point of view, nothing much will have changed.


I’m tempted to let China “hold our debt” as the lawmakers say. Why, because the trade deficit signifies continued U.S. economic expansion. This expansion is what continues to let people buy goods that may not come from the US. The real counter to the argument is on if China is purposefully manipulating its currency (keeping it cheap) to sell more goods, which lawmakers argue is an economic no-no.
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