According to Al-Hayat newspaper (January 28, 2009), an official report issued by the American Statistics Offices showed Saudi Arabia's exports to the USA jumped to $55 billion in 2008, up from $6 billion in 1998. In the same year Saudi Arabia imported $13 billion from the USA. This is a trade deficit of $42 billion. Congress was informed that in January 2010 out of a monthly trade deficit of $37.3 billion a total of $27.5 billion was spent on importing oil. This amounted to 73.7% of trade deficits: close to three quarter of trade deficits.

It would seem that China is a convenient political scapegoat in declining American productivity and inability to compete globally. Double standards is the easiest way to determine by asking whether principles or excuses are at stake. It is not just trade that Western countries found offensive with China. Human rights, democracy and a host of other faults are equally offensive. I quote Kishore Mahbubani:

“While human rights campaigns are often portrayed as an absolute moral good to be implemented without any qualifications, in practice Western governments are prudent and selective. For example, given their powerful vested interested in secure and stable oil supplies from Saudi Arabia, Western governments have not tried to export their standards of human rights or democracy to that country for they know that any alternative to the stable rule of the Saudi government would very likely be bad for the West.”

USA’s trade deficit with the rest of the world is principally a decline in productivity over the years. However, economists have been fudging statistics to help their political masters.

Alan Greenspan, as Federal Reserve chairman, on 10th January 1995, testifying before the Senate and House Budget Committee advised that inflation rate was overestimated and this matter should be investigated. This is a crucial turning point in the history of USA.

Congress formed the Advisory Commission to Study the Consumer Price Index and appointed Michael Boskin to study the veracity’s of Alan Greenspan’s claim. The Boskin Commission quickly deduced that inflation was overstated by 1.1 percent. This has great implications and many unintended consequences.

Social Security Benefits:

The Consumer Price Index (CPI) is an important index because it affects the social security benefits of every Americans. The Bureau of Labor Statistic’s CPI is used to determine how much social benefits should be increased each year to match the inflation rate.

This is an example of indirect taxation at work if the inflation rate is understated. Deficit is reduced by passing the burden to the American public without them actually aware of it. Congress doesn’t get blamed and politicians get to keep their jobs. American ingenuity in the political arena is greatly underestimated.

Inflation-Indexed U.S. Treasury Bonds:

Inflation-Indexed U.S. Treasury Bonds are indexed to the rate of inflation. The rate of inflation is determined by the Consumer Price Index (CPI). If the government wants to pay a low interest rate on the bonds then it must ensure that inflation is low. The lower the Consumer Price Index (CPI) the lower the U.S. budget deficits.

Is inflation rate understated? To answer this question we need to study how inflation rate is calculated by the U.S. government. It is important to note that the Boskin Commission made many changes to the way inflation is calculated. The following examples should suffice to allow the reader get a grip of the mystery of inflation rate calculation.

1.       Arithmetic Vs. Geometric Calculation:
Prior to Alan Greenspan’s suggestion to Congress that inflation is overstated and the Boskin Commission inflation rate is calculated arithmetically. The difference between the two is huge. Geometric calculation always overstated inflation as compared with arithmetic calculation of inflation. If the price of a product is 100 dollars and in 10 years time it is now 200 dollars yearly inflation calculated on an arithmetic basis is 10%. On the other hand when calculated on a geometric basis it is only 7.2%. There is a discrepancy of 2.8%.

Owner’s Equivalent Rent:
Housing forms about 20% to 25% of the CPI. To calculate the Housing component of CPI the Bureau of Labor Statistics does use the house prices but an equivalent amount. This is called the owner’s equivalent rent. This data is gathered by survey. Homeowners are asked how much they are willing to pay to rent their own house. Needless to say this would understate the true cost of housing each year.

Hedonic Adjustment
This adjustment is based on quality. If the quality of a product has improved this improvement must be taken into consideration. In other words if the price of a car has increased it doesn’t mean that there is an inflation. It could mean that the quality of the car has improved: inclusion of power steering, anti-lock braking system, air-bags, etc. Computer pricing is one of the most notable culprits in this hedonistic adjustment exercise. Other items include gasoline, television sets, hospital services, microwave ovens, washing machines, textbooks, clothes dryers, air fares, apparel, etc.

One huge implication for deliberately adjusting inflation downwards is on productivity. Productivity is negatively correlated to inflation rate. Since productivity is measuring real improvement increase in inflation rates must be subtracted from increase in production. In other words the huge productivity gain by the U.S.A. was a myth. This productive myth was used by Alan Greenspan to justify the astronomical stock pricing during the early twenty-first century internet boom.

It would seem that the usual way of fighting inflation in U.S.A. by raising interest rate is not palatable and harder to swallow. However, this is just postponing the inevitable. With real productivity growth that is much lower than stated and inflation much higher than allowed we are facing a dire global economic crisis with ground zero in U.S.A. The writing was on the wall when President Nixon defaulted on U.S.A.’s debts on 15th August 1971 by announcing that they are henceforth refusing to honour their debts in gold as promised. This led to the breakdown of the Bretton Woods Agreements and slow deterioration of global economic order.

With the huge expenditure of the U.S.A. resources in military ventures abroad draining its coffers the decline of U.S.A. is inevitable. This is going to be a more dangerous world because a declining world power with an over budgeted military sector is a menace to social order.

The renminbi's exchange rate, then, is really a secondary factor in China's external account. Put another way, the global imbalance could be corrected more efficiently by addressing other, more fundamental factors. The fundamental factors underlying the US external imbalance are large fiscal deficits and low household savings, owing to excessive financial leverage. The fundamental factors on the Chinese side are high corporate and household savings, together with some distortion of resource/utility prices.

The renminbi's exchange rate is NOT a secondary factor. The above paragraph has the causal flows all wrong. Here's what it looks like to me:

The Chinese government pegs the renminbi to the dollar which practically necessitates owning US Treasury securities to do so. China certainly is not the only one that manipulates it's currency in order to more easily export to the US by owning US Treasury Securites. I can not imagine a practical way that China COULD manipulate the renminbi with respect to the dollar without owning dollar denominated assets such as US Treasury securities. This desire to exchange renminbi for interest bearing dollar denominated assets ( again not just China, many others manipulate currency values by investing in US debt ), keeps the yeilds low enabling deficit spending. The US government's desire to spend more than it takes in in taxes is the fault of US politics, however the low interest rates on Treasury Securities enables the behavior.

The effect of keeping the renminbi down is to decrease it's buying power. Since the Chinese workers are paid in renminbi, this is in effect a hidden tax on the Chinese people. Because the Chinese Government owns the accumulated Treasury Securities, the buying power once inherent in the renminbi is to the Chinese Government now in possession of the Treasury Securities. Holders of renminbi find they can not afford to buy the goods they would otherwise purchase and so save their money. If the renminbi bought more, then the choice might have been to spend the money instead of saving it.

In the US, people find imported stuff cheap and so spend more and save less. The currency manipulation creates the conditions that encourage both spending in the US and saving in China.

The US both prods China to appreciate the renminbi and also to keep buying US Treasury Securities. This is of course contradictory in the end.

China needs to let the renminbi appreciate and at the same time stop buying and even start to sell ( in an orderly fashion ) their US Security assets. China needs to use them to buy raw materials, and to invest internally. Renewable energy projects seem like just the sort of thing central planning might actually get right - Maybe Inner Mongolia could be China's solar cell. Inflation is a problem in China in part because of the renminbi's artificially low value.

And yes, if the renminbi appreciates then China will lose some export business to it's competitors, but the renminbi will also be able to purchase more from those competitors and from domestic markets.

What would China do if half the US Treasury Securities it owns were magically replaced with non interest bearing dollars as they matured? Why not start doing it now?

Whenever the word ‘China’ comes into the mind of Western economists instinctively the next associated word is ‘manipulation’. It is like a Rorschach fixation implanted at a youthful tender age that doesn’t go away even in the face of reality during adulthood.

Any intellectual discussion after that is equivalent to putting China in the dock and on trial for all perceived economic ills of the comparative country/countries in question. In any good old fashioned lynching trial character assassination is the tools of trade principally used to justify persecution and conviction in the absence of real evidence. So let us throw in China’s human rights abuses, lack of democracy, intellectual property theft, unfair legal system, etc. to cloud the issue. And don’t forget to shout Tiananmen Square at the appropriate moments when the accused tries to defend itself.

Of course no kangaroo court is complete without the ensuing witch hunt. While at it we could implicate some other emerging economies – particularly Asian ones as it is easier to identify it as an Oriental concept – at the same time.

To his credit ‘bclark76’ pointed out that many other countries also manipulated their currencies as well to sell more to USA. However, the author failed to realise that his assertion taken to its logical conclusion would mean that any country having a trade surplus with USA is manipulating its currency. In one stroke he is asserting that every country in the world is a currency manipulator. He failed to see that there will always be trade surpluses and deficits in any particular situation even as the overall global trade is balanced.

The gist of my earlier comments is USA’s real productivity has been declining over the years and the government is fudging facts and figures to assure the world otherwise. Instead of focusing on its own internal weaknesses it has taken the road of all past empires: hegemonic expansion via its super bloated military industry.

Recently, Defense Secretary Robert Gates questioned the need for the US Navy to have 11 aircraft carriers (at US$11 billion a copy) for the next 30 years when no other country has more than one. In the last decade defense spending has nearly doubled to US$549 billion excluding the cost of wars in Iraq and Afghanistan which in this year will add another US$159 billion.

So Defense Secretary Robert Gates has vowed to do things differently. How different? He is not proposing to cut the annual military budget. He is not even proposing to keep the military budget on an even keel. Instead he is still proposing budget increases of more than just the nominal inflation rate. He wants a 2 to 3 percent real growth of the military budget after inflation. And this is because USA is surviving a recession. Imagine what he wants when it is not.

To add flavour to the argument that the USA government defense budget is way out of proportion to its need, it is to be noted that the per capita spending on defense for the year 2010 of each American citizen will be more than 70% of the per capita income of each Chinese citizen.

C. Fred Bergsten before the Hearing on US-China Economic Relations Revisited, Committee on Finance, United States Senate on March 29, 2006, while acknowledging that China has a large trade surplus with USA, noted that bilateral imbalances should not be a focus of national policies because of the multilateral nature of international trade. He testified that China’s rise in trading ability of manufactured goods is accompanied by sharp decline over the past two decades in the share of the USA bilateral trade imbalance that originates in other Asian countries (especially Hong Kong, Taiwan, Korea, and Japan).

In short, even if USA were to manipulate Chinese currency to a higher level as it had done so with Japanese currency in the past, it still wouldn’t solve its inherent problem of low productivity vis-à-vis other emerging economies and its resulting unfavourable trade imbalances to it.