Wednesday, February 15, 2023

Trade Wars are Class Wars

Massive trade deficits and surpluses are often caused by financial repression. That is, some artificial mechanism is keeping wages or spending down in some country, causing exports to rise relative to imports in that country. As such, trade wars are not really conflicts between countries, but between classes within those countries. So argue the authors in the excellent book Trade Wars are Class Wars.

The concept is not new to me, as I read Pettis' previous book in 2013 (also a great read). But it was useful to catch up on the latest developments, as this more recent book was able to include what has happened in the intervening years. The book also has some great historical examples of this mechanism in action, with a particular focus on China, Germany and the United States in previous decades and centuries.

I'm not expert enough to know if what the authors are saying make sense (getting the direction of cause and effect right is difficult enough for economics experts, let alone a layman like myself). But their framework does seem to be the best explanation of the bizarre behaviour of the macroeconomy since The Great Recession.

Monetary policy in the West has had to be extremely accomodative to get inflation results that consistently undershot targets. Standard economics could not have seen this coming.

But as countries with trade surpluses have funneled their cash into US dollars as the "risk-free" asset of choice (as opposed to spending it on goods and services), they have reduced their own consumption (keeping inflation in check), and lowered interest rates such that investment levels have been above what they otherwise would be (causing all sorts of malinvestment, as asset bubbles proliferate).

As an investor, I read the book with an eye towards whether such behaviour (financial repression in surplus countries coupled with foreign cash flows into English-speaking Western government securities) is set to continue. If so, once this current covid-reopening-induced demand boom peters out, one might expect a return to extremely low interest rates as inflation once-again disappears.

But there may be growing recognition in governments around the world that this system of financial flows is not sustainable. The Chinese government appears to recognize it needs to increase consumption and reduce investment, but the problem is political; factions that benefit from the current system are unlikely to be okay with economic wealth transfers to the less well-off. In the US as well, various ideas have been floated to try to curb the trade deficit.

I'll stick to being a bottom-up investor, but I think this book is a must-read for all top-down investors.

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