The comment reproduced below was posted to Marginal Revolution (the blog of a pair of economics professors who dance mainly on opposite sides of the libertarian divide), in response to some thoughts on ‘fixing’ the trade imbalance with China.

The poster, a US Naval officer, makes a very rational, non-conspiracy-laden case for the sturdiness of the seemingly ludicrous current fiscal situation, where the USA depends on poor nations such as China to finance our deficit spending. Essentially, he frames the current account deficit and the associated dollar hegemony as a mild tax on global trade, paid to ensure security of transporting manufactured goods against the very real threat of service disruption, a service that no military besides ours is currently capable of providing (and in fact as the relative capabilities of non-state actors increases, this service will become increasingly costly to provide and difficult to match). The very first US standing military presence was created explicitly to halt piracy (after bribing them didn’t work out so well), and that role has continued more or less uninterrupted to this present day. I disagree with the commenter about how sudden the move between security regimes would have to be, but after reading I don’t disagree that it’s unlikely to change for a significant period of time. Europe doesn’t have the desire to be a military superpower on our scale, and China might have the will but would need to increase it’s military spending by at least a factor of twenty in order to rival ours… even accounting for lower labor costs (ahem), there’s much to be said for experience in these matters…

So, take this an example of why the rampant China fear (something I’ve succumbed to myself from time to time) is at least partly hype, inflated because it is a convenient tool for protectionists and xenophobes and other vested interests…

The original comment, after the jump

Perhaps being in the Navy gives me a bias, but I’ve often thought that an important element was missing from the dollar valuation/current account debate. Countries and companies that engage in international trade pay us to secure the major trade routes so that they can safely and profitably engage in commerce. They pay us informally through cheap(er) goods and by buying our bonds rather than directly with cash (tribute). If you don’t believe this, consider the issue of piracy. Piracy is very common in the littoral areas of some regions in the world, but very rare on the high seas where much of world commerce flows. Pirates don’t avoid the high seas because they fear deep water, but because they fear the U.S. Navy. If exporting countries and companies had to provide their own security by enlarging national navies or creating private ones (or paying off the pirates), the cost of imported goods would increase greatly. This would drive down international trade and increase the incentive to produce domestically. The resultant decrease in overall commerce would likely impoverish many throughout the world. Politically, it’s very hard for either the U.S. or our foreign friends to admit that this system exists. We don’t want to be an empire and they don’t want to admit to paying tribute, but there you have it. So rather than call the matter what it is, we let market forces (cost of goods and exchange rates) determine the price of the security we provide. One must admit that in many ways this represents an advance both in subtlety and overall pleasantness upon previous imperial systems. I think that foreign countries likely also pay a premium for using the dollar as the preferred international currency, just as I have to pay a premium if I want the convenience of using traveler’s checks. Even Hezbollah used dollars to pay off its supporters in Lebanon, who would have been much less happy if paid in Lebanese Pounds or in Rials. The Euro and the Yuan are touted to have the potential to overtake the dollar, but are unlikely to do so until either Europe or China is willing and able to provide the security function for trade that we do. If the relationship between the security premium and the convenience premium paid on the dollar seems unclear, consider what would likely happen if the Euro or Yuan were to overtake the dollar as the preferred currency. The value of the dollar would drop, and the U.S. standard of living would decline. American taxpayers would be less willing to subsidize foreign trade by spending on a large defense budget. Other countries would have to provide for their own trade security, or Europe or China would have to step in. This would cause a large disruption in commerce as the new security measure were built and instituted. In the meantime, everyone loses money. Given a 50 trillion dollar world economy more or less, and estimating the rest of the world accounts for 3/4 of it, our $800 billion dollar current account deficit represents about a 2% tax on the rest of the world’s GDP in exchange for security for trade and the convenience of using our currency. That’s not bad. $800 billion dollars annually also represents a very handsome return on a $440 billion dollar defense budget, or whatever portion of that is used to protect trade. The rest of the world doesn’t want to shoulder this (security) burden themselves and paying off the pirates would be more expensive. I think that the current system is likely to be more durable than some expect.

Related Posts:

• Nightlife as a measure of development (July, 2006)
• China-Congo Lovefest (September, 2007)
• HASA (June, 2008)
• No ID (June, 2006)
• franchisers over enfranchisement (January, 2006)

This entry was posted on Sunday, September 10th, 2006 at 10:04 am and is filed under economics, international hegemony, politics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.