Trade imbalances are still the problem

In his recent post, The capital tsunami is a bigger threat than the nuclear option, Michael Pettis argues persuasively that it is hard to imagine a scenario in which the Chinese would sell US government debt in significant quantities (the so-called nuclear option) and that the real danger is that they will continue to buy US debt to fund their trade surplus, which against all measures of sanity, is growing again.

Pettis quotes the People’s Daily to illustrate the horns of the Chinese dilemma:

“Half of China’s textile companies risk going to the wall if the yuan appreciates 5 percent against the US dollar, an industry lobby group warned. China National Textile and Apparel Council Vice-President Gao Yong attributed this knife-edge existence to the industry’s thin profit margins of around 3 to 5 percent. ”If the yuan actually appreciates 5 percent against the US dollar, over half of China’s textile companies will go bankrupt,” Gao said.

…More than 20 million people are directly employed in China’s textile industry, while a further 140 million are involved in cotton farming, according to the Ministry of Commerce. Therefore, a large upward revaluation of the yuan could cost millions of jobs."

In this context, it is unsurprising that the Chinese authorities are very reluctant to allow a significant appreciation in the value of the Yuan.

But, but, but…

It is inconceivable that the world can continue to absorb Chinese capital indefinitely. As Pettis points out:

The second largest net importer of capital until now has been the group of highly-indebted trade-deficit countries of Europe — including Spain, Greece, Portugal, and Italy. The Greek crisis has caused a sudden stop to private capital inflows, as investors worry about insolvency, and it is only official lending that has prevented defaults. These countries are unlikely soon to see a resurgence of net capital inflows. The world’s second-largest net capital importer, in other words, is about to stop importing capital very suddenly.

In other words, the world is running out of solvent debtors.

All of this would be utterly unsurprising to earlier generations of economists. As Geoffrey Crowther said in the 1940s:

If the economic relationships between nations are not, by one means or another, brought fairly close to balance, then there is no set of financial arrangements that can rescue the world from the impoverishing results of chaos.

And Keynes was preoccupied with trade balance in the last years of his life.

Just to reiterate the thesis:

The ultimate cause of the the current crisis is trade imbalances and the resultant flood of capital that has its roots in the closing of the gold window in 1971. The crisis cannot be resolved until these trade imbalances are eliminated.

The whole structure of international trade and of export industries everywhere are predicated on an unsustainable market structure, which makes it politically impossible for the major exporting nations—China, Germany, Japan—to make the necessary corrections until they are forced to, either by the insolvency of their trading partners or by the political unsustainability of the austerity and unemployment being forced upon them by a system of global trade that ignores the most important lesson of the Great Depression, namely that trade imbalances cause financial chaos.