Did Trade Liberalization Enable the Credit Crisis?

♠ Posted by Emmanuel in ,, at 1/06/2009 06:30:00 AM
This post is meant to expand on an important point made in the already overly-long post above on why a US-China trade war is a potentially welcome development. Earlier on, someone claiming to be "Pascal" (Lamy?) asked me to expand on this point. More recently, I made a similar statement which was subsequently pounced on by a blog reader. I suspect many won't agree anyway me on this, but for what it's worth...

By necessity, current account transactions are accompanied by capital account transactions. Massive US external deficits now unwinding to spectacular have thus been accompanied by "vendor financing" care of foreign creditors. True, this practice is not new. The likes of Japan, the Asian tigers and so forth long ago set the example now followed by China. What is different now is twofold. First, the scale at which it is being practiced is without precedent as China has accumulated $2.0 trillion in reserves. Second, Americans have always been spendthrifts, but it is only in recent years that they've approached the zero savings mark. Further trade liberalization gave the likes of China reason to embark on these unimaginable levels of vendor finance. Had there not been as strong an incentive to build an export-based economy (current account side), there would not have been willingness to lend so much so cheaply (capital account side).

Relatedly, household savings is not exogenously determined. Coupling abundant foreign financing and a sanguine outlook on their future finances (especially housing prices), Americans embarked on a spending spree.

Lastly, tariff reductions send price signals not only to consumers (differentially affecting their consumption based on varying price elasticities of demand) but also producers. We need to consider how much American production was outsourced to destinations like China in response to tariff reductions. Moving production overseas exacerbates the trade imbalance and necessitates further foreign financing. Insofar as there are countries willing to "game the system" by practicing vendor finance, imbalances are magnified.

I am not against trade liberalization per se. All the same, I think it's hard to dissociate further trade liberalization from the rise of global economic imbalances now imperiling the health of the world economy. It's certainly food for thought--especially for reflexive trade boosters.