The concept of comparative advantage was advanced by David Ricardo more than 200 years ago. In oversimplified terms, the notion is that if you and I do what we both do best, then trade for those things we don’t do as well, we will both be better off in the long run. Sounds simple, right?
Well it’s not. And that’s why we are flirting with a global trade war and tossing tariffs around like hand grenades.
According to the Office of the United States Trade Representative, trade in goods and services between the United States and China in 2017 was estimated to be $710.4 billion. We exported $187.5 billion to China and imported $522.9 billion. We wanted more of their stuff than they wanted of ours. The trade gap ended up being $335.4 billion in 2017.
Is that good or bad?
A trick or a treat? Some argue that it’s bad because it “should” be more fair and balanced; if we are going to buy that much stuff from China, they should buy more stuff from us. Our manufacturers, farmers, consultants and lawyers would like to derive more income from China.
What happens to the extra dollars we send to China if it isn’t used for reciprocal purchases? Some of it goes into their foreign exchange reserves where it is used to buy U.S. Government securities.
Visual Capitalist recently published a great infographic on foreign exchange reserves. It showed that China has amassed $3.1 Trillion dollars over the years. They are not the only country playing the export game to excess. Japan’s FX reserves stand at a towering $1.2 Trillion, Brazil has accumulated $358.3 Billion, tiny Switzerland has $785.7 Billion while the Saudis and Hong Kong each have in excess of $400 Billion. Clearly, you do not need to have a lot of land mass to amass a big pile of reserves!
Foreign currency reserves around the world courtesy of visualcapitalist.com.
What do these nations do with all of those foreign currency reserves? They put them into different foreign currencies. The Visual Capitalist post indicated that 63.5% of the reserves are held in U.S. dollars, 20% in Euros and 4.5% in each of Japanese Yen and British pounds; that leaves just 7.5% for all the other currencies in the world.
"Tariffs are the most obvious effort to swing the balance of trade back to what some consider to be fairer."
Although U.S. manufacturers aren’t too happy about the deficit, one big beneficiary is the U.S. Treasury. Numbers the Treasury published for July 2017 show that foreign central banks held $6,251.6 billion dollars of Treasury securities. That’s about 29% of all the securities issued by the Treasury.
This all gives rise to an interesting question: If we bought more stuff from China and they bought fewer U.S. Treasurys, who would finance our ever increasing budget deficit? If their demand for more of our products fanned the flames of inflation at the same time lower demand for our Treasurys increased interest rates, we could find ourselves in a world of hurts.
Since Ricardo advanced the notion of comparative advantage 200 years ago, global trade has seen a steady rise. This has created winners and losers as we export manufacturing jobs to countries with low-cost labor and we import everyday low prices. Now it appears that the political pendulum is starting to swing in the other direction. Offshoring and outsourcing are now starting to sound like nasty tricks rather than sweet treats.
Tariffs are the most obvious effort to swing the balance of trade back to what some consider to be fairer. Remember, though, that tariffs are taxes by another name and they may have the effect of raising the cost of living for those countries that impose them. Trick or treat? Only time will tell.
Sources:
www.cia.gov/library/publications/the-world-factbook/geos/xx.html
www.visualcapitalist.com/countries-most-foreign-currency-reserves/
http://ticdata.treasury.gov/Publish/mfh.txt
https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china
www.thestreet.com/politics/comparative-advantage-14651012
www.fiscal.treasury.gov/fsreports/rpt/treasBulletin/current.htm
