The International Trade System Should Be Designed to Foster More Balanced Trade

Other commentators get close to the views I expressed in "Alexander Trentin Interviews Miles Kimball about Establishing an International Capital Flow Framework." In the first article above, Greg Ip interviewed Mervyn King, Fred Bergsten and Joseph Gagnon, writing this:

Protectionism can change the patterns of a country’s exports and imports, but not the overall balance.

Rather, deeper economic forces are at work. A trade surplus means a country consumes less than it produces and thus saves a lot. A deficit means the opposite. ... the persistence and magnitude of Chinese and German surpluses and U.S. deficits suggest actual policy decisions are at work.

This comes by interfering with currency markets. As Mr. King notes, a country with a weak economy and a trade deficit would expect its currency to fall to boost exports and restrain imports. That can’t happen if exchange rates can’t move, as is the case with China and Germany, though for different reasons. ...

Messrs. Bergsten and Gagnon suggest a new approach to prevent China from reverting to its old ways: When a country buys dollars to hold down its currency for competitive advantage, the U.S. should respond proportionately by purchasing that country’s currency. They also recommend the U.S. go beyond current law, which requires the U.S. to discourage currency manipulation in new trade pacts, by prohibiting it outright.

Notice that currency manipulation is often a matter of keeping an exchange rate the same when it should appreciate, rather than always being a matter of making one's currency depreciate. So currency manipulation cannot be defined by exchange rates. It needs to be defined by official purchases of foreign assets or other active policy to hold down an exchange rate.

The case of Germany is more complex:

Germany is a tougher challenge. Since adopting the euro in 1999, it hasn’t controlled its own currency. However, it did win competitive advantage over its neighbors in the currency union. Labor-market reforms restrained domestic wages. In 2007, a payroll tax cut, which made German labor more competitive, was financed with an increase in the value-added tax, which exempted exports.

I argued that Germany should in part return to having its own currency in "How the Electronic Deutsche Mark Can Save Europe." Short of that, Germany has a responsibility to manage its trade surpluses within the euro zone in other ways. As between the euro zone and the rest of the world, rules against purchase of non-euro-zone foreign assets without permission from other countries would go a long way.

I emphasize in "Alexander Trentin Interviews Miles Kimball about Establishing an International Capital Flow Framework" that monetary interest rate policy is not a problem and can be done by each currency area with only its own interests in mind since other countries can neutralize the main worrisome effects of other countries' interest rate policy with their own interest rate policy while leaving country that initially changed its interest rate policy with the stimulus or restraining effect it needs once all these interest rate movements have been scaled up appropriately. It is purchases of foreign assets that have big spillover effects for the rest of the world that cannot be neutralized without neutralizing the effect the initial purchaser of foreign assets desired.

In the second article shown above, Justin Fox discusses options for how Germany could spend more to reduce its trade surplus.

The last article above is about David Malpass, Trump's nominee for Treasury’s undersecretary for international affairs. David Malpass wants more stable exchange rates, but in many cases that would make things worse by perpetuating trade imbalances. As I mentioned above, currency manipulation often takes the form of countries' acting to keep their exchange rates the same when their currencies should move in order to better balance trade. Attacking official, unilaterally decided purchases of foreign assets is a more appropriate way to identify and combat currency manipulation.

Besides often perpetuating trade imbalances, a big problem with exchange rates that are too stable is that they make stabilization through monetary policy much more difficult. In effect, a country that maintains a fixed or nearly fixed exchange rate with some other country has used up many of its degrees of freedom stabilization policy to keep that exchange rate fixed.

If every country (or currency zone that is not too big) has full freedom in interest rate policy, while needing permission to purchase foreign assets, then each country can stabilize its own economy without artificial trade surpluses or deficits. There would still be a need to try to address the consequences different saving rates in different countries, but that is the next level up in improving the international trade architecture from the first step of banning official foreign asset purchases without permission.