Why we do not need to fear trade sanctions

Tensions have resulted in trade restrictions with China, but there may be a silver lining to what seems like an unfavourable economic scenario, writes David Joy.

THERE HAS BEEN much gnashing of teeth over China ‘’flexing its economic muscles’’ as it has imposed a variety of sanctions and restrictions on imports from Australia as part of broader geopolitical turbulence. Some commentators are concerned that Australia has a lot more to lose than China from a prolonged trade war.

But is a decline in exports all bad?

After all, when we as a nation export goods, we send valuable real resources overseas (and as an aside, increase carbon emissions in doing so).

The conventional economics wisdom is “exports good, imports bad”, but if we go back to first principles this is exactly the wrong way round. Exports are better seen as a cost and imports as a benefit. To use an extreme example, imagine a country which exported everything and imported nothing. It would have an awesome balance of trade but no resources (including food), so everyone would perish.

The importance of making up with China

Political tensions with China have been escalating, but there's still time for Australia to make amends and not follow in America's footsteps.

Conceptually, the only logical reason for a nation to export is that it may help gain access to imports. This is particularly relevant for developing countries which lack food and energy sovereignty. For a developed country like Australia with plentiful food, energy and other resources, plus established global trading relationships, gaining access to imports is not reliant on exports in practical terms for the foreseeable future.

Most of those importing to Australia are happy to be paid in Australian dollars (AUD) with the vast majority of Australia’s foreign liabilities being held in AUD. For decades, China has sent the U.S. (and many other countries) real resources in return for, in Warren Mosler’s words, a bank statement or spreadsheet entry, meaning treasuries which the U.S. government can produce at will, like U.S. dollars.

Hence, unless China threatens to stop exporting to us goods and services that we cannot easily access elsewhere, then we do need to worry if we use the correct economic lens and accompanying government policies.

I can hear some saying “that’s all very well, but what about the exchange rate?” Well, what about it? It certainly isn’t governed by the trade balance, that’s for sure. For every currency unit that changes hands due to international trade, there are well in excess of another hundred which are traded because of financial speculation. 2019 global trade was around $20 trillion USD (AU$26.9 trillion) or $55 billion USD (AU$74.8 billion) per day, which sounds impressively high until you realise it is dwarfed by the currency traded, which was around $6.6 trillion (AU$8.9 trillion) per day.

Even allowing for some trade-related hedging, it is clear that trade is not a key driver of currency values. Indeed, during the recent period of trade tensions with China, the Australian dollar has actually strengthened against the U.S. dollar.

MUNGO MACCALLUM: China, China, CHINA!

It may be a statement of the bleeding obvious, but a face-off with the People’s Republic of China would not be a good idea.

All this is not to underestimate the problems of those working in export-exposed sectors right now. Given a lack of assistance from the Government, they will be suffering in the short term. Policies need to be developed to deal with this issue.

When an Australian exporter is paid in Australian dollars, it is important to understand that the dollars do not “come from overseas” (unless someone has a huge stash of Aussie notes underneath their mattress). They are transferred from an Authorised Deposit-taking Institution (ADI) which is part of the Reserve Bank system — either the ADI already has the funds (of Exchange Settlement Balances) in its account at the Reserve Bank or it must borrow them (aside from the situation where the exporter and importer use the same bank). There is nothing magical about it being an export. The Government can step in and create the AUD, just as it does when the Government spends in other ways.

In this context, there would be two specific reasons for increased government spending. Firstly, to help those businesses impacted by trade sanctions imposed by another country. These payments would be temporary whilst exporters either found new foreign (or domestic) markets (and government can help with this also) or decided to shift away from that sector altogether. Secondly, the spending would have the impact of supporting economic activity more broadly so that the ripple effects of reduced export revenue are counteracted.

A job guarantee would work to nullify the negative impacts of trade volatility more broadly. It acts as an automatic stabiliser and as workers are laid off from export exposed sectors, it will take up the slack in a targeted manner to deliver fiscal help exactly where and when it is needed.

To understand all this from first principles, it is worth stealing a little from Stephanie Kelton’s bestseller, The Deficit Myth. Remembering that someone’s financial asset is someone else’s financial liability, Kelton notes that as a matter of accounting the government financial balance plus the domestic private financial balance and the foreign financial balance must sum to zero.

Morrison picks fight with China — Australia left holding the barley

Morrison, who says we are too small to matter on climate, has instead picked a fight over COVID-19 — with our biggest trade partner.

So if both the domestic private sector and the foreign sector wish to accumulate net financial assets (the latter being the case whenever there is a current account deficit, which is more likely when trade sanctions are used by other countries) the government sector must do the opposite and increase financial liabilities. Liabilities of the Government are not the same as liabilities for the rest of us since they are redeemed either by extinguishing tax liabilities or via the issuance of more liabilities. As such, there is no purely financial limitation on the Government. The limitation is real resources, in particular labour, of which there is an abundance right now.

To quote Keynes in chapter 24 of The General Theory:

‘...if nations can learn to provide themselves with full employment by their domestic policy... there need be no important economic forces calculated to set the interest of one country against that of its neighbours.’

It is in our hands to deliver full employment and we can do this irrespective of the trade policies of other countries.

It is important to note that although we do not need to fear their trade sanctions, that does not mean Australia should remain antagonistic to China, as well expressed here.

Australian governments should work to ensure full employment and not fixate on either the Budget balance or the trade balance. The introduction of a job guarantee and targeted relief for businesses impacted by trade sanctions would ensure that Australia is better insulated from geopolitical turmoil and able to negotiate with trade partners unburdened by domestic economic concerns.