With Interest Rates This Low – Is It Time To Trade?

With Interest Rates This Low - Is It Time To Trade

China is sitting on top of the glut of all gluts.  The enormous quantities of industrial capacity that has been built to propel the rapid development of China’s economy has become increasingly idle as the country faces slowdown as well as the transition over to services.  Product prices for items ranging from industrial chemicals to steel and coal have dropped as markets have worked to clear out the glut.  As governments have been faced with massive amounts of cheap Chinese goods, some of them are considering or implementing anti-dumping tariffs (such as the U.S., which in March placed punitive tariffs on some countries’ steel imports).

Tariffs are especially concerning for economists and attractive for governments currently.

As I wrote earlier this week, cheap Chinese exports are a reflection of overcapacity that developed with a slowing Chinese economy.  The “dumping” that has resulted isn’t proof of China being on the verge of being able to vanquish all its rivals.  Instead it is a reflection of the weakness of its manufacturers.

This weakness is being exported now.  Prices within foreign markets are depressed by cheap exports, with most of these markets already experiencing inflation that is worrying low.  There is little room left for central banks to respond through utilizing conventional tools, with interest rates at historic lows already.  During the 1930’s, the economies that were not able to provide a vigorous enough response to the headwinds coming from abroad (due to the gold standard in this case which placed constraints on monetary policy) the most were the nations that were most likely to impose protectionist tariffs.

To explain this even further, during the 1930’s protectionism really ran rampant.  However, not every economy was equally keen on raising trade barriers.  Doug Irwin and Barry Eichengreen published a paper a couple of years ago where they explained that the countries that had been slowest with abandoning the gold standard also had been the fast to throw tariffs up.

Countries that kept their currencies fixed and that stayed on the gold standard, were a lot more likely to place foreign trade restrictions.  While other countries devaluated and gained competitive advantage at their expense, these countries resorted to implementing protectionist policies in order to limit gold losses and strengthen their balance of payments.  Since they lacked other instruments for addressing the ever increasing slump, especially any sort of independent monetary policy, trade restrictions were used for shifting demand more towards domestic good, along with hoping to stem their declining output.

Countries these days are not as constrained as their peers from 80 years ago that were bound to gold.  However, a milder type of Depression dynamic still is playing a role.  When times are normal, cheap imports flooding in from abroad wouldn’t drag down the recipient economy, place disinflationary pressures on an economy and hurt exporters.  However, it wouldn’t be necessary for either inflation or demand to fall if the government or central bank took offsetting actions.  By providing some kind of fiscal stimulus or cutting interest rates, the government could help push other sectors into spending more to help pick the slack up.  This could result in changing trade conditions and cause a shift in balance for overall economic activity (for instance, from exporters to consumers or across exporters) instead of a slump.

However, it is hard coming by offsets right now.  Shocks coming from abroad are being underreacted to by the central banks, since they can’t cut interest rates easily and unconventional tools are utilized sparingly.  Governments mainly are in austerity mode still.  So cheap imports flooding in from broad isn’t a shift in tradition conditions that is manageable.  It is a threat instead.

Politicians being confronted with this threat will need to do the things that politicians tend to do.  With its chronically weak demand, the world is zero sum, in a very disturbing way.  If demand weakness isn’t taken seriously by governments, the pressure for clamping down on trade will be something that will be increasingly hard for them to resist.