More misleading economic statements from uninformed people who have never taken an economics course!

What about, you say?

I’m glad you asked!

It seems like I continuously read and hear in the American press that the United States is creating a giant wealth transfer by buying oil from other countries. Those “wealth transfer” words imply to the typical citizen that somehow our U.S. money supply is leaving our country, never to return again, and somehow our country is then poorer after the transaction and the country we imported from is now richer!

That is only a half-truth! Yes, the other country becomes richer, but we grow richer also by an equal amount! Both countries always gain economically from trade!

Let’s first get a few things straight before I elaborate: I am not happy either as gas prices rise ($3.50 a gallon in the U.S. as of this writing, although down from over $4.00 recently). I am also not happy that a fairly large share of oil purchases are from countries like Saudi Arabia and Venezuela whose loyalty to our country is certainly questionable. Luckily, the U.S. produces 40% of its own oil consumed and the other 60% consumed is imported from many different countries with 85% of our imports coming from 15 countries with Canada and Mexico being the largest two.

However, when we buy from any of these countries, both countries benefit equally and there is NO transfer of wealth. When the U.S. buys oil from any other country those U.S. dollars paid on the purchase are immediately returned to the United States and are spent almost immediately in our country since the other country cannot use our dollars in their country. What is really happening is that both countries’ citizens GAIN (not lose!) equally as we are, in essence, trading one product for another for both countries to enjoy!

Let’s use an example. Let’s say the U.S. buys 1000 barrels of oil from Saudi Arabia. At today’s price per barrel of $100 that would mean the U.S. would pay Saudi Arabia $100,000 and Saudi Arabia would then, in turn, be forced to turn around and use the paper ($100,00 USD!) on say, a bunch of iPods from Apple. Yes, the Saudi’s are listening to “I Kissed a Girl” by Katy Perry with their IPods under those smart head robes they wear! Ladies and gentlemen: that is why they call it trade: the essence of the transaction is that we have traded some of our iPods for some oil to fuel our cars and heat our homes. Both of us have gained! Katy Perry is hot on the charts and the Saudi’s “got their hands in the air”, and we can now drive to 7-Eleven for a Big Gulp and stay warm in the winter.

Also, think of it this way: when an American buys a gallon of gas the money is, in substance, going to an American business such as Apple! All spending of US dollars is spent back into our economy, and all spending of Saudi dollars (actually they call their currency the “dollar” also but it doesn’t look like ours!) benefit the Saudi economy.

Yes, trade is mutually beneficial. I would rather a warm home this winter and forego another Katy Perry song!

FT.com / Asia-Pacific / China - Pressure builds over renminbi

In IB Economics, we’re currently studying the determinants of exchange rates. One important factor in determining the demand for a particular currency is the interest rates in the country whose currency is in question relative to that of other countries.

The recent cut of the federal funds rate in the US of 25 basis points to 4.5% brought the US rates closer to China’s recently increasing interest rate of 3.32%. The upward trend of Chinese rates (up 50 basis points this year) and downward trend of American rates (down 50 basis points this year) should diminish the appeal of dollar denominated financial assets and increase the demand for those in Chinese RMB. In the currency market, we should see weakening demand for dollars and strengthening demand for RMB, as US savings and government securities are relatively less appealing due to the declining returns on those investments. With further increases in Chinese rates expected (due to high inflation), the RMB should be in greater demand, as returns on Chinese investments looks to increase as rates rise. Continue Reading »

Asia Sentinel - A Falling Dollar Does Nobody Any Good

Many economists hail the decline in value of the US dollar as a boon to the American economy. It may sound counter-intuitive, but economic theory predicts that when a currency depreciates relative to other currencies, this could actually be good for the country’s economy? Why, you ask? Let’s consider an example:

In the last four months the value of a dollar in terms of euros has gone from 0.75 Euro cents to 0.69 Euro cents. For Europeans, that means that dollars are cheaper now than they were four months ago, therefore American goods are cheaper now than four months ago. Cheaper American products should mean more business for American companies as Europeans demand more of their stuff. Good for business, right? In the US, aggregate demand will shift out, unemployment should fall, and the price level should rise as more foreigners demand more American products. But what impact does the weaker dollar have on Americans? Continue Reading »

Made in China - The Atlantic Monthly

Here’s a great slide show and narrative about the manufacturing industry in the industrial city of Shenzen. After viewing the slideshow, discuss some of the questions below.

Discussion Questions:

1. What does the narrator mean when he says “Shenzhen is more or less an invented city?”
2. Why does the word “scale” come to the narrator’s mind as he explores Shenzhen? What key concept from our economics class includes the world “scale”? How does the growth of Shenzhen relate to this concept?
3. What is exported from Shenzhen to the US? What is being sent back to Shenzhen from the US? What does this suggest about the Chinese/US balance of trade? Why do you think this is happening?
4. Where do Shenzhen’s factory workers come from? Why do you think young women make up such a large percentage of factories’ workforces? Are the wages paid factory workers in Shenzhen “fair” wages? Why or why not?
5. Is manufacturing in Shenzhen labor intensive or capital intensive? What’s the difference?
6. What’s the significance of the last line about how Liam Casey, whose office overlooks the headquarters of the Shenzen communist party, has never “met anybody who was in there”. What does this say about communism in China today?

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Wu: Large yuan rise would hurt China — Shanghai Daily | 上海日报

China’s Vice Premier Wu Yi defends China’s currency controls in Washington:

The yuan’s value isn’t the cause of the deficit, Wu said yesterday at a
dinner in Washington attended by US Treasury Secretary Henry Paulson
and Federal Reserve Chairman Ben S. Bernanke.

About 85 percent of China’s surplus with the US is from foreign companies
exporting products no longer made in the United States, such as shoes,
she added.

So, America’s trade deficit is not because of a historically weak Yuan, rather because America imports shoes made in China. VP Wu should look more closely at her audience; she’s preaching to the choir with Paulson and Bernanke in attendance; and I doubt they’re swallowing what she’s dishing up. Of COURSE the trade deficit is because America imports “products no longer made in the United States”. But why do they do this? Uhm, could it be because of the historically weak Yuan? Looks like VP Wu could use a refresher in her principles of Macro course.

Now the US is threatening new trade barriers if the Chinese do not allow the Yuan to appreciate more on foreign exchange markets.

“Large scale yuan appreciation will have a negative impact on China’s
economy,” Wu said, adding that trade protection would hurt relations
between the US and China.

China’s increasing of the yuan’s flexibility may slow growth and cut into profits in Chinese firms. However, new barriers to trade with its largest trading partner will do the same. China’s liberalization of industry should now be accompanied by a similar liberalization of financial markets. A more balanced current account will allow China’s economy to begin growing at a more sustainable rate and help to allow China’s middle class access to the quality goods they demand from abroad.

Most importantly, American teachers in China will have access to more affordable breakfast cereal and quality coffee, which at current exchange rates cost more than I like to think about.

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Dani Rodrik’s weblog: Does Free Trade Bring Lower Prices?

Greg Mankiw’s Blog: Does free trade lower prices?

Here’s a very interesting discussion between two Harvard professors (a “diablog” as my IB students and I call it). Greg Mankiw (author of a widely used AP Econ textbook) takes Dani Rodrik to task on his view that countries producing the products for which they have comparative advantage, and trading in a free global market, may actually face higher prices as a result of free trade. This seems to defy what AP Econ students learn about the impact of free trade on domestic product prices.

In our text, we learned that in a particular market in which free trade exists, the world supply curve lies beyond the domestic supply curve, resulting in a lower world price, meaning domestic firms produce less output and sell it at a lower price than they would without trade. This of course would represent an industry in which the country in question is at a comparative disadvantage, and thus is a net importer of the product. Assuming that a particular country will be net importers of certain goods (those for which they have a comparative disadvantage) and a net exporter of other goods (those for which they have a comparative advantage), we may infer that the net result will be lower prices faced by consumers due to all the relatively cheap imports that trade affords. Rodrik, however, argues that in some cases, when a country is a net exporter (as the US is for agricultural products, given its huge comparative advantage in the farming industry), the foreign demand for its domestic output may in fact drive prices paid by domestic consumers up, as foreigners demand more and more of the country’s output in those markets. If the increase in price that results from exporting large quantities of output outweigh the price decreases that consumers enjoy due to cheap imports (think Walmart, folks) then perhaps free trade would result in an overall increase in the price level.

The theory brought forth in the Mankiw/Rodrik discussion goes way beyond AP Economics, but if you’re like me and enjoy pushing your understanding of economics to the edge, these articles just may be within the realm of an AP Econ student’s grasp of the subject! And if this stuff interests you as much as it does me, then you may just consider studying Econ in college! Which reminds me, for those of you who promise to major in Econ in college, I promise to have a pleasant surprise for you the day after our AP exams on the 17th! Stay tuned!

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