With countries around the globe struggling to recover from recession, many seem to believe that the answer lies in a growth in exports. But how can this be achieved? A simple solution is to lower the exchange rate.
Under a pegged exchange rate, the currency could be devalued. Alternatively, if the country’s inflation is lower than that of other countries, merely leaving the exchange rate pegged at its current level will bring about a real devaluation (in purchasing-power parity terms).
Under a floating exchange rate, one answer would be to lower interest rates. This would involve open market operations to support the lower rate and that would increase the money supply. But with central banks’ interest rates at virtually zero, it is not possible to lower them further. In such circumstances a solution would be a deliberate policy of increasing the money supply through “quantitative easing”. For example, the USA is considering a second round of quantitative easing (known as “QE2”). This would tend to push down the exchange rate of the dollar.
But stimulating exports through devaluation or depreciation is a zero-sum game globally. If currency A depreciates against currency B, currency B necessarily appreciates against currency A. Country A’s gain in exports to Country B are an increase in imports for Country B. It is logically impossible for every currency in the world to depreciate! Yet depreciation is exactly the policy being pursued by countries such as Japan, South Korea and Taiwan, all of which have directly intervened in the currency markets to lower their exchange rates. And, in each case of course, other countries’ currencies have an equivalent appreciation against them.
Economists and politicians in the USA argue that the dollar is fundamentally over valued against the Chinese yuan (or ‘renminbi’ as it is sometimes called). They are calling on China to revalue by far more than the 2% increase since June 2010. But what if China refuses to do so? On 29 September the House of Representatives passed a bill giving the executive branch the authority to impose a wide range of tariffs on imports from China. The bill was passed with a huge majority of 348 to 79.
So is this the start of a trade war? Many in the USA argue that China is already waging such a war by giving subsidies to a wide range of exports. And that war is hotting up. China has just announced that it is imposing traiffs ranging from 50% to 104% on various poultry imports from the USA. And if it is a trade war, will there be any winners? The following articles investigate.
Global recovery’s weakness raises possibility of trade war Guardian, Larry Elliott (4/10/10)
Tension mounts as China and US trade insults over currency Independent, Stephen Foley (1/10/10)
Is the world in a trade war? Time Magazine blogs: The Curious Capitalist, Michael Schuman (29/9/10)
Trade War Is Here – and We’ve Disarmed The Huffington Post, Robert Kuttner (3/10/10)
US House Passes Anti-China Trade War Bill GlobalResearch.ca, Barry Grey (1/10/10)
Currencies the key to market’s next move BBC News, Jamie Robertson (3/10/10)
A Message for China New York Times (30/9/10)
Taking On China New York Times, Paul Krugman (30/9/10)
Krugman Makes Two Powerful Arguments Against “Taking on China” Wall Street Pit, Scott Sumner (2/10/10)
Why the U.S. can’t win a trade war with China The Globe and Mail (Canada), Carl Mortished (4/10/10)
China-Japan trade war looms CTV News (Canada), Mark MacKinnon (23/9/10)
IMF chief’s warning of currency war ‘real threat’ BBC News, interview with Dominique Strauss-Khan, head of the IMF (7/10/10)
Could disputes over currency levels lead to a depression? BBC World Service, interview with Robert Zoellick (8/10/10)
China stands firm over yuan move BBC News, Andrew Walker (9/10/10)
What to do about China’s currency? Washington Post (10/10/10)
How to stop a currency war The Economist (14/10/10)
What’s the currency war about? BBC News, Laurence Knight (23/10/10)
Nominally cheap or really dear? The Economist (4/11/10)
- Why are competitive devaluations globally a zero sum game while global trade wars are a negative sum game?
- What are the arguments for and against using tariffs as a means of stimulating recovery?
- Why has quantitative easing so far had a more discernible effect on asset prices than on the real economy?
- Do a search on “Smoot-Hawley Tariff Act” of 1930 and describe its impact on the global economy in the 1930s. Are there any parallels today?
- How is it possible for massive trade surpluses and deficits to persist and yet for individual countries’ exchange rates and overall balance of payments to be in equilibrium?
- Are global trade imbalances widening, and if so why?
- What would determine the size of the effect on the US balance of trade of an appreciation of the yuan?
Russia and Kazakhstan have been discussing the formation of a trade agreement for some time and an agreement is now in place. From July 1 2010 a customs union between these two countries will be launched. Belarus has also been in talks with the Russian government, but as yet, it will not become a member, due to disputes with Russia. Belarus was hoping that the customs union would free it from export duties on oil, but this has not been the case. The gas dispute between Russia and Belarus has continued, although a meeting is taking place to try to resolve the issue.
President Alexander Lukashenko has said that Belarus will sign the Customs Unions documents if Russia cancels petroleum products duties now and oil duties from January 2011. He said:
“As a goodwill step, we propose removing customs barriers and customs duties on petroleum products now, and we will wait until the beginning of next year regarding oil duties; but the duties must be removed from January 1.”
Although the customs union between Russia, Kazakhstan and Belarus formally began on January 1 2010, it will not work fully until these disputes have been resolved. The following articles consider this agreement and the likely impact on the countries’ negotiations to join the WTO.
Russia, Kazakhstan agree customs union minus Belarus Reuters (28/5/10)
Russia hopeful of settling Belarus gas dispute Reuters (19/6/10)
Belarus to sign customs union documents, if Russia cancel oil duties RIA Novosti, (18/6/10)
Creation of customs union should not hinder Russia’s entering WTO RIA Novosti (17/6/10)
Kazakhstan ‘moving to re-instate Soviet Union’ with customs unions with Russia Telegraph, Richard Orange (11/6/10)
Russia, Kazakhstan launch customs union without Belarus AFP (28/5/10)
- What is a customs union? How does it differ from a common market and a monetary union, as we have in Europe?
- Russia wants to maintain its tariff on gas and oil supplies. Illustrate the effects of the imposition of a tariff. Does society gain?
- What are the arguments for and against retaining protectionist measures on trade with other nations?
- Assess the likely effects of the customs union on (a) the individual members and (b) other nations. Who do you think will benefit and lose the most?
- What will be the impact of the customs union and its disputes on the accession of these countries to the WTO.
- Is it a good idea for Russia, Kazakhstan and Belarus to join the WTO? What conditions have to be met?
Trade relations between the USA and China have deteriorated recently. There are two key issues: the exchange rate and trade protectionism.
The Chinese currency, the yuan or renmimbi, since 2005 has been officially pegged to a trade-weighted basket of other currencies. In recent months, however, as the dollar has fallen relative to other major currencies, so too has the yuan. It seems as if the peg is with the dollar, not with the basket. From March to December 2009, the exchange rate index of the dollar depreciated by 16 per cent. Yet the exchange rate between the yuan and the dollar hardly changed. In other words, the yuan depreciated along with the dollar against other world currencies, such as the euro, the pound and the yen. The trade advantage that this was giving to the USA with other countries did not apply to China.
Complaints continued that cheap Chinese goods were flooding into the USA, threatening US jobs and undermining US recovery. The Chinese currency was argued to be undervalued relative to its purchasing-power-parity rate. For example, the July 2009 Big Mac index showed the yuan undervalued by 49% against the dollar (see Economics 7e, Box 25.4 for a discussion of the Big Mac index).
The USA, and other countries too, have been putting diplomatic pressure on the Chinese to revalue the yuan and to remove subsidies on their exports. At the same time various protectionist moves have been taken. For example, on December 31 2009 the US International Trade Commission voted to impose tariffs on the $2.8 billion worth of steel-pipe imports from China. The tariffs would be between 10.4% and 15.8%.
The following articles look at these trade and exchange rate issues. Are we heading for a deepening trade war between the USA and China?
Currency contortions The Economist (17/12/09)
Beijing dismisses currency pressure Financial Times, Geoff Dyer (28/12/09)
China aims for 10pc growth and won’t appreciate yuan The Australian (29/12/09)
Wen stands firm on yuan China Daily (28/12/09)
China’s premier says banks should curb lending BusinessWeek, Joe McDonald (27/12/09)
China insists will reform yuan at its own pace Forexyard, Aileen Wang and Simon Rabinovitch (31/12/09)
US slaps new duties on Chinese steel Financial Times, Alan Rappeport (30/12/09)
Chinese Steel Pipes Face Heavy U.S. Duties BusinessWeek, Daniel Whitten (31/12/09)
The US-China Trade War Is Here The Business Insider, Vincent Fernando (10/12/09)
Year dominated by weak dollar Financial Times, Anjli Raval (2/1/10)
- Explain what is meant by the ‘purchasing-power-parity (ppp) exchange rate’.
- Why is the yuan (or ‘renmimbi’) undervalued in ppp terms?
- What are the the implications of an undervalued currency for that country’s current and financial account of the balance of payments?
- What would be the implications of a revaluation of the yuan for (a) China and (b) China’s trading partners?
- Discuss Premier Wen Jiabao’s statement, “The basic stability of the renminbi is conducive to international society”.
- What forms of protectionism have been used by (a) China and (b) China’s trading partners? Who gains and who loses from such protectionism?
Back in 1993, the EU imposed tariffs on bananas imported from countries which were not former colonies of EU countries. These former colonies are in Africa, the Caribbean and the Pacific (the ACP countries). This meant that the main countries bearing the tariffs were banana producing countries in Central and South America.
“In 1996, Ecuador, Guatemala, Honduras and Mexico, together with the US, formally complained to the World Trade Organization (WTO) about the tariffs. Since then the WTO has repeatedly ruled that the EU tariffs are unfair, but little has changed thanks to continued discussions and arguments between the major players.”
Over the years the disputes between the EU and the APC countries on one side and the Latin American countries and the USA on the other have become known as the ‘banana wars’ (see Web cases 24.5 and 24.6 in Economics 7e MyEconLab). The WTO has ruled against the EU on several occasions, but to little effect as appeals have been lodged and talks have continued. At last, however, agreement has been reached – and without the WTO. This should see EU tariffs on Latin American bananas cut from 176 euros per tonne now to 114 euros per tonne over a seven-year period.
So are the banana wars over? Will EU consumers gain? And what will be the effect on Latin American and ACP banana producers? The following articles examine these questions.
Ending the longest trade dispute in history: EU initials deal on bananas with Latin American countries EU Press Release (15/12/09)
The EU-Latin America Bananas Agreement – Questions and Answers EU Press Release (15/12/09)
Lamy hails accord ending long running banana dispute WTO Press Release (15/12/09)
EU ends ‘banana wars’ with Latin America EU Observer (15/12/09)
Bananas dispute at the World Trade Organisation Reuters Factbox (15/12/09)
Banana prices to fall after longest trade dispute in EU history settled Telegraph (16/12/09)
End of banana wars brings hope for Doha Financial Times, Joshua Chaffin (16/12/09)
EU cuts import tariffs in a bid to end ‘banana wars’ (video) BBC News (16/12/09)
EU cuts import tariffs in a bid to end ‘banana wars’ BBC News (15/12/09)
Banana wars: the fruits of world trade BBC News, Nigel Cassidy (15/12/09)
EU, Latin America Proclaim End to “Banana War” Latin American Herald Tribune, Marta Hurtado (15/12/09)
Settlement should help Chiquita Business Courier of Cincinnati, Dan Monk (15/12/09)
Banana deal offers hope for global trade talks Sydney Morning Herald, Alexandra Troubnikoff (16/12/09)
Pact Ends Long Trade Fight Over Bananas New York Times, Stephen Castle (15/12/09)
Banana deal offers hope for global trade talks Sydney Morning Herald, Stephen Castle (15/12/09)
EU banana dispute ends in favor of Latin American exporters Deutsche Welle (15/12/09)
- Who has gained and who has lost from the tariffs imposed on non-ACP producers over the past 16 years?
- How might the agreement over bananas impact on the stalled Doha round talks?
- What is likely to happen to banana prices in the EU over the coming months? Use a diagram to illustrate your answer.
- Are the banana wars likely to be over now?
Large areas of land in the former Soviet Union and Eastern Europe are lying uncultivated due to export barriers and tariffs. Given the recent rapid rise in food prices, this fallow land (estimated to be around 23 million hectares) could help to reduce upward pressure on food prices.
Bread basket that is left to grow weeds Times Online (12/3/08)
||Identify three different forms of protectionism.
||Explain why the land identified in the article has remained uncultivated.
||Discuss the arguments for and against these countries reducing tariffs on food.