Are Americans profligate and Chinese stingy... or is government policy responsible for trade imbalances?

Many argue that China’s immense trade surpluses and the United States' massive trade deficits reflect government policies and the U.S. dollar’s special position as the world’s reserve currency, not the cultural profligacy of Americans and the stinginess of Chinese. Peking University business school professor Michael Pettis lays out this argument pretty clearly. Here’s a brief excerpt:

Let us assume, then, that a group of countries, perhaps in response to the 1997 crisis, decide that in order to protect themselves from a repeat of that disaster decide to engineer polices aimed at accumulating reserves and limiting external debt. The most obvious way would be to put into place policies that constrain consumption and boost savings (keep wages and interest rates low, limit credit availability to consumers, limit credit availability to small and medium enterprises and especially to the service sector, maintain an undervalued currency, etc.) and direct credit to the investment and manufacturing sector. As a consequence growth in production would exceed growth in consumption and the balance would represent the trade surplus. Trade surpluses, of course, have to be recycled as investment flows (or reserve accumulation) back to the country against which they are running these surpluses. This is not a choice, or even a real lending decision. It is the automatic and necessary consequence of running a trade surplus…

US consumption must grow faster than US GDP, and the choice for the Fed is whether to target a “normal” growth in consumption, and permit rising unemployment, or a “normal” growth in GDP, and so permit rising indebtedness. The Fed must use US unemployment, in other words, as a tool to prevent Asian trade policies from leading to excess US indebtedness…

Because of the dollar’s reserve status, only the US could have possibly run the deficits necessary to absorb the huge surpluses that Asian trade policies were generating. Without the dollar’s status as a reserve currency, the Asian development model that stresses expanding production while constraining consumption – which among other things results in trade surpluses and net investment abroad (which of course is the same thing) – would have either required another reserve currency, or it would have failed.

Just as Chinese policy restricted consumer credit, U.S. deregulation combined with bank greed to fuel a credit-driven consumption orgy. Kevin Phillips spells it out from the perspective of greedy banks:

The principal building blocks that the [financial] sector used to enlarge itself from 10-12% of Gross National Product around 1980 to a mind-boggling 20.6% of Gross Domestic Product in 2004 involved essentially the same combination of credit-mongering, massive sector borrowing, highly leveraged speculation, reckless, greedy pioneering of new experimental vehicles and securities (derivatives and securitization) and mega-trillion-dollar abuse of the mortgage and housing markets that became infamous as hallmarks of the 2007-2009 disaster. During Alan Greenspan’s 1987-2006 tenure as Federal Reserve Chairman, financial bubble-blowing became a Washington art and total credit market debt in the U.S. quadrupled from $11 trillion to $46 trillion.

…[T]he financial sector hyped consumer demand – from teen-ager credit cards to mortgages for the unqualified – to make credit into one of the nation’s biggest industries; nearly $15 trillion was borrowed over two decades to leverage de facto gambling at 20:1 and 30:1 ratios; banks, investment firms, mortgage lenders, insurers et al were all merged together to do almost anything they wanted; exotic securities and instruments that even investment chiefs couldn’t understand were marketed by the trillions. To achieve fat financial-sector profits, the housing and mortgage markets might as well have been merged with Las Vegas.

The principal inventors, hustlers , borrowers and culprits were the nation’s 15-20 largest and best known financial institutions – including the ones that keep making headlines by demanding more bail-out money from Washington and giving huge bonuses. These same institutions got much of the early bail-out money and as of December 2008 they accounted for over half of the bad assets written off. The reason these needed so much money is that they government had let them merge, speculate, expand and experiment on dimensions beyond all logic. That is why the complicit politicians and regulators have to talk about $100 billion here and $1 trillion there even while they pretend that it’s all under control and that the run-amok financial sector remains sound.

Posted by James on Thursday, April 09, 2009