Questions about trade balances

[Puppycow]

A Stanford Professor writes (http://www.bloomberg.com/news/2010-07-06/china-bashing-over-yuan-needs-a-long-rest-commentary-by-ronald-mckinnon.html) that exchange rates don't really matter to trade balances, but that trade balances are actually the result of relative differences in saving rates (if I understand him correctly).

False Belief

Unfortunately, what lies behind this unnecessary political crisis is a widely held but false economic belief: the idea that the exchange rate can be used to control any country’s trade balance, which is the difference between its saving and investment rate. Instead, the problem is a saving deficiency in the U.S. -- with very large fiscal deficits and low personal saving -- coupled with surplus saving in China.

1) Is this correct?
2) If this is true, what does it say about the supply curves and demand curves we learned about in Econ 101?
3) What exactly does the term "the difference between its saving and investment rate" in the above mean? Is he saying that saving rate minus investment rate equals trade balance? IOW, Americans invest more than they save while the Chinese save more than they invest? Also, what counts as an investment as opposed to savings?

[Startz]

At a very simple level, McKinnon is necessarily correct. Here's one way to think about it.

Imagine that the economy consists of corn. Each year you grow corn, that's income. Most you eat, that's consumption. What's left over is your saving. (So income equals consumption plus saving.)

What do you do with the leftover corn? You plant it as seed for next year. That's investment. In this simple economy there's nothing else to do with it, so it has to be true that saving=investment.

Now suppose that foreign trade is allowed. If you send more corn abroad than you import, then you have a trade surplus. But, of course, if you've sent it abroad you can't plant it...because it's gone. So now we have saving=investment+trade surplus.

This equation, and it's really just an accounting identity, says that once you know saving and you know investment, then the trade surplus is mechanically known as well. Nothing else can matter.

Of course, the exchange rate might well affect saving or investment and affect the trade surplus through that route.

(By the way, McKinnon is a very distinguished economist.)

[Puppycow]

I've been thinking recently that the exchange rate does not really matter in the long run, but my reasoning was a little different:
If China pegs its exchange rate too low against the dollar, then the same adjustment as if it allowed its currency to float will be made by the effect of rising inflation in China. A yuan will be worth less, but Chinese workers will demand more of them to do the same work.
This seems to be finally happening now:
Supply Chain for iPhone Highlights Costs in China (http://www.nytimes.com/2010/07/06/technology/06iphone.html?hp)

But what it does not reveal is that manufacturing in China is about to get far more expensive. Soaring labor costs caused by worker shortages and unrest, a strengthening Chinese currency that makes exports more expensive, and inflation and rising housing costs are all threatening to sharply increase the cost of making devices like notebook computers, digital cameras and smartphones.

Desperate factory owners are already shifting production away from this country’s dominant electronics manufacturing center in Shenzhen toward lower-cost regions far west of here, even deep in China’s mountainous interior.

At the end of June, a manager at Foxconn Technology — one of Apple’s major contract manufacturers — said the company planned to reduce costs by moving hundreds of thousands of workers to other parts of China, including the impoverished Henan Province.

While the labor involved in the final assembly of an iPhone accounts for a small part of the overall cost — about 7 percent by some estimates — analysts say most companies in Apple’s supply chain — the chip makers and battery suppliers and those making plastic moldings and printed circuit boards — depend on Chinese factories to hold down prices. And those factories now seem likely to pass along their cost increases.

“Electronics companies are trying to figure out how to deal with the higher costs,” says Jenny Lai, a technology analyst at CLSA, an investment bank based in Hong Kong. “They’re already squeezed, so squeezing more costs out of the system won’t be easy.”

Also noteworthy:

GM's Chinese sales overtake US sales (http://www.steelguru.com/chinese_news/GM_sales_of_vehicle_in_China_overtake_US_for_first _time_in_H1/153909.html)

[autumn1971]

I've been thinking recently that the exchange rate does not really matter in the long run, but my reasoning was a little different:
If China pegs its exchange rate too low against the dollar, then the same adjustment as if it allowed its currency to float will be made by the effect of rising inflation in China. A yuan will be worth less, but Chinese workers will demand more of them to do the same work.
This seems to be finally happening now:
Supply Chain for iPhone Highlights Costs in China (http://www.nytimes.com/2010/07/06/technology/06iphone.html?hp)



Also noteworthy:

GM's Chinese sales overtake US sales (http://www.steelguru.com/chinese_news/GM_sales_of_vehicle_in_China_overtake_US_for_first _time_in_H1/153909.html)
Yeah, Econ 101 tells us that the inflation will happen, but in a growing economy inflation is not necessarily bad.
As for the rest of Econ 101, it is mostly attempts to explain why supply v. demand doesn't give the results that we see, or should see.
I don't mean to insult economics, but the interesting bits are where the general bits break down, with the added clusterstuff of human psychology (and those idiots actually listened to Freud).

[Puppycow]

Is America's trade deficit with China already starting to shrink?

Looks like the trade deficit in 2009 was less than any year after 2005 (http://www.census.gov/foreign-trade/balance/c5700.html#2010)

But, the recession could explain most of that.

And while US imports from China have roughly tripled since 2000, exports to China are up almost 7-fold. As a ratio, exports to imports was roughly 10:1 in 2000, but only 4:1 in 2009.

If that trend continued, the balance of trade would be roughly equal in about 15 years.