As recovery strategies in many developed countries of the world stalled in 2010, the issues of trade imbalances and currency exchange rates have drawn attention in press headlines across the globe. Developing countries have prospered dramatically from their export trade with developed countries that are now struggling to recover jobs and growth exported overseas.
Attempting to unravel the current impact of decades of off-shoring activities has now focused on international trade. Many recovery strategies are based on increasing exports and reducing imports. However, everyone cannot hope to benefit from exporting, since there have to be willing importers on the other end of the transactions. Reversing trade imbalances and reducing foreign currency reserves stockpiled in developing countries will inevitably focus on currency exchange rates, the fulcrum between competing global economies.
The era of globalization is upon us. Its consequences are all encompassing for social, economic and cultural change across the globe. Although its impacts are unmistakable, a clear definition of the term is often difficult to formulate. Globalization tends to be in the eye of the beholder from his or her unique perspective. Positive implications on the one hand may translate to negative results from the opposing view.
How were these trade imbalances created in the first place?
Some analysts would suggest that globalization began in earnest in the seventies due to relaxed trade agreements, improved communications, and the positive effects of outsourcing efforts. When outsourcing takes advantage of lower labor costs overseas, it is more commonly referred to as an off-shoring cost cutting activity. From a purely American perspective, labor-intensive textile and manufacturing industries were consequently moved off shore in mass. Capital-intensive industries like steel and aluminum fabrication followed in subsequent decades, accompanied by technology based companies as well. After the millennium crossover, service industries have been the focal point. The following chart presents the impacts on relative domestic growth measures:
The International Monetary Fund published in April 2010 its “World Economic Outlook”,1 and the diagram summarizes how “Real GDP Growth” in emerging and developing countries has diverged from the advanced economies of the world. The “red line” depicts the former, and the “blue line” represents the latter. The apparent economic impact of off-shoring activities did not become significant until a “tipping point” was reached in 1990. As demonstrated in the chart above, real GDP growth in the emerging and developing economies began to materially outpace growth in the developed countries of the world over the past two decades. The IMF forecasts this trend to continue for the next five years.
What are the long-term economic consequences of off-shoring activities?
In America, the benefits have been lower prices for imported goods, especially from China. However, the “price” has been the loss of many well-paying, middle class jobs in manufacturing and service industries. Census data reflect that average incomes for Americans have declined over the past decade.
The beneficiaries of corporate cost cutting have been the wealthy stockholders of record with very little “trickle down” noted. According to a recent study, the top one percent of earners commanded 8.9 percent of the national income in 1976, but this figure rose to 23.5 percent by 2007. During the same time span, the average hourly wage, adjusted for inflation, declined by more than seven percent. Unbridled capitalism tends to favor the wealthy without discretion.
For emerging market countries, the opposite effect has been produced. The prosperity of burgeoning middle classes in China and India has created domestic demand for better living standards, including better homes and automobiles along with better food and clothing. These demands have caused a severe run- up in commodity prices in their respective global markets. From a commercial perspective, energy and raw materials are necessary to fuel the growing industrial engines in both China and India, as well as with other developing countries that are trying to emulate their success stories. Increased imports would balance many equations, but unfavorable trade tariffs stand in the way.
How do trade imbalances and exchange rates factor into this globalization story?
To answer this question, one needs to understand how international trade is settled on a financial basis. For example, in the case of trade with China, on a daily basis the central banks of each country must settle their accounts based on currency exchange rates acceptable to both parties. China is typically due funds from the United States each day because they export more to us than they import. The trade imbalance with China was a staggering $227 billion in 2009, down from $268 billion in 2008. Our central bank pays China each day with U.S. Treasury bills, now amounting to ownership of $847 billion, nearly one third of such debt outstanding.
From purely an economic perspective, the accumulation of foreign exchange reserves enables cross-border trade to take place and should strengthen a nation’s currency value relative to its trading partners. Profits will also lure foreign investment capital to flow into the country, and if inflation and interest rates are managed properly, then these flows would also have currency strengthening impacts. If currency exchange rates are subject to market revaluation and not fixed by government decree, they usually will moderate the natural imbalances that occur when major shifts in international trade patterns materialize. The forex market reacts to the forces of capitalism and adjusts the cost structure of cross-border deals to reflect reality of all financial factors.
Chinese officials, however, have “pegged” the value of the Yuan, their national currency sometimes also referred to as the Renmenbi (“peoples’ money” in Mandarin), based on a basket of currencies including the U.S. Dollar. Natural market forces have not been allowed to strengthen the Yuan’s value. Consequently, a currency war has been developing for several decades. Reuters recently stated that, “Both the U.S. and the European Union are accusing China of intentionally keeping the value of the Chinese Yuan low to boost Chinese exports – a move that impacts jobs and competitiveness in the American and European markets.”2
With the prospect of a weakening U.S. Dollar on the horizon, global tensions will rise if natural market forces are not allowed to shape the eventual conclusion. Our global economies are “interconnected”. Any presumption that domestic policymaking can occur independent of global market forces does not acknowledge today’s reality. At present, the pressure building around the fulcrum point of currency exchange rates must be released, and government officials must find a way to do this in an orderly fashion or risk the potential for widespread currency wars.
1 World Economic Outlook Rebalancing Growth. International Monetary Fund. April 2010.
2 Simbajon, Carlo Gabriel. “Dollar vs. Yuan – Obama Administration Blinks First in Currency War with China.” All247News.com. October 16, 2010.
Bi Line: Tom Cleveland has had an extensive career in the international payments industry with over 30 years of experience in executive management, corporate governance and business development. Mr. Cleveland currently works as a writer for Forextraders.com, an online resource for the forex market.