I love talking to Alexander Trentin. Last week, Alexander called to talk about negative interest rates, but our conversation turned to trade, and to the need for international arrangements about government-generated international capital flows. Here is the essence of our conversation. Alexander's words are in italics or bold. Miles's words are in regular text.
The low savings rate in the US, the large trade deficit and the Trump victory are closely linked, says Miles Kimball. The economist calls for a new policy framework to keep capital flows in check.
For many the trade policy of Donald Trump seems to be a return to mercantilism. But what if it is a populist answer to the large capital inflows into the US which the current system does not keep in check? Miles Kimball, economics professor at University of Colorado Boulder, is afraid of the political fallout of unbalanced capital flows. He argues in an interview with «Finanz und Wirtschaft» for a new international framework to balance capital flows and trade balances.
Professor Kimball, what is your opinion on the trade policy of the Trump administration?
Trump’s advisor Peter Navarro thinks that trade deficits cause capital inflows, which is not the way it works.
But if a country is importing more than it exports, it is running a current account deficit.
Yes, but the causality is the other way round. The trade balance is caused by capital flows. The capital markets determine if capital is flowing into the US. The net amount of goods and services purchased by the US from foreign countries must be equal to the net inflow of capital into the US. The net capital inflows into the country cause the current account deficit and net imports.
Does that mean measures to stop imports like the proposed border adjustment tax will not work?
Some economists suspect that dollar appreciation would fully cancel out the effect of such a tax. But I don’t think that is the new equilibrium. I hate to say it, but the likely combination of «border adjustment» and dollar appreciation might still help the trade position of the US. The reason is that if the dollar appreciates, inflows of funds from the rest of the world determined in the capital market as euro, yen or renminbi flows would become smaller when translated into dollar values. The capital flows into the US would therefore shrink in size and the current account deficit would be reduced.
It is only a currency effect then?
In other words, even though capital flows are determined in the currency where they originate by capital market forces that wouldn’t be affected much by border adjustment plus dollar appreciation, when translated into dollar values, the capital inflow into the US could be reduced.
What kind of other measure would help to balance trade?
The saving rate of US private households is too low. We would have less net capital inflows and a more balanced current account, if the domestic saving rate were higher. An easy way to raise US national saving would be to require firms to automatically enroll their employees in 401(k) retirement plans. I wrote about this in my column «How Increasing Retirement Saving Could Give America More Balanced Trade.»
Should every country introduce such encouragements to achieve a higher saving rate?
Many of those who favor automatic enrollment emphasize only the benefits to the individual saver. But increasing the domestic saving rate also has macroeconomic benefits. But of course increasing the saving rate is only appropriate for some countries. While the US needs a higher saving rate, some countries already have very high saving rates.
Why is it so important to have balanced trade?
Politically, balanced trade is a very different animal from unbalanced trade. If trade had been more balanced, Americans would have been more accepting of arguments for free trade. The noticeable effect of the trade deficit was the loss of jobs in certain industries. Swing states which voted for Trump were the especially affected by such job losses. There are many other factors in Trump’s victory, but holding those other factors fixed, unbalanced trade resulting from strong capital inflows provided the margin of victory for him. If the US had no trade deficit, Donald Trump would not be President of the United States.
But not everybody loses from capital inflows, right?
Yes, there are winners and losers of unbalanced trade. Winners are the consumers who get cheaper goods. But losers are often not completely compensated for their losses. Countries are not one big happy family, but a composite of different people in different situations. In theory, trade deficits now lead to trade surpluses in the future. When the borrowing from other countries is paid back, trade-related jobs would be created in abundance. But when will this happen? The US current account deficit has persisted for many decades. Any reversal of the current account deficit seems to be way off in the future.
Are capital inflows coming into the US just looking for better investment opportunities?
These are often not private capital flows. Governments are pushing up their net exports by buying foreign assets. And when governments buy foreign assets unilaterally it is currency manipulation. Up until the recent past, China was a major culprit, increasing its foreign exchange reserves until 2014. Switzerland is doing the same thing, but gets away with it because it is a small country. But in relation to its GDP, Switzerland is as bad as China was in terms of buying foreign assets. My personal views on the importance of this have shifted now that I have seen the political effects on the US of China’s currency manipulation.
The Swiss National Bank can keep the exchange rate from appreciating by buying foreign assets or lowering the interest rate. Are both measures currency manipulation?
No, reducing interest rates is not currency manipulation. Buying foreign assets is a beggar-thy-neighbor policy, while lowering rates is not. If two countries buy each other’s bonds to depreciate their exchange rates, they cancel out each other’s efforts and there is no net effect. But if all countries lower their interest rates, it is a global monetary expansion and pushes up global aggregate demand.
Should currency manipulation be forbidden?
No, but we need an international capital flow framework in which such things are negotiated. Under such a framework, governments would have to get approval to buy assets in another country. This would probably not stop commodity exporters like Saudi-Arabia from buying foreign assets. But it would bring industrial countries like Switzerland under pressure when they keep their exchange rate low by currency manipulation. Of course, the international capital flow framework should not be limited to rules about direct government purchases of foreign assets. It should involve broader negotiations about other policies to keep international capital flows more nearly in balance and therefore to keep trade surpluses and trade deficits in check.
What policies could achieve such goals?
Here I have in mind policies that affecting saving, consumption and portfolio choices, such as the automatic enrollment regulations when higher saving is called for, and the perennial calls for China to institute more of a social safety net so that Chinese households will feel it is safe to save less and consume more. Capital flows are an area where international policy coordination is much more important than central bank interest rate policy, where it is fine for each central bank to focus narrowly on what is good for its own country. It is my hope that an international capital flow framework with a combination of rules about government purchases of foreign assets and coordination on policies to raise or lower the saving rate in each country can help establish and preserve an international system based on free trade and open capital markets for everyone except governments.