It is rare to see two successive blog posts on the same topic but it is also rare for an economic issue to receive the attention which President Trump’s proposed tariffs on steel and aluminium have attracted. Since the last post, Gary Cohn, his chief economic adviser, has resigned in protest at the decision, swaying the political balance in the White House from supporters of free trade towards protectionists, the EU has added to its list of potential targets for retaliation to include peanut butter, Bourbon, Florida orange juice and Harley Davidson motorcycles, and President Trump has continued to threaten retaliation against the retaliation, talking of tariffs against EU car exports. There have also been comments in the newspapers looking back to the 1930s and the protectionist measures imposed by the USA as a way of helping them escape the Great Depression, which served only to make the world situation worse.

The language of the debate (if that is what it can be called) continues to be confused. On the one hand President Trump argues that the tariffs are justified by WTO rules on the grounds of national security, a legitimate reason for imposing tariffs; the argument being that steel is an important product for the defence industries. However the main exporters of steel to the USA are the EU (the largest), Canada, Mexico and South Korea – hardly countries which are likely to go to war with the USA. China does not feature among the list of the major steel exporters to the USA. Furthermore some of the steel exported is highly specialised and not even manufactured in the USA.

While talking of national security as a justification, President Trump simultaneously continues to refer to the need to reduce the US balance of payments deficit, arguing that the deficit is “BAD” and the fault of foreign countries. Not only has the deficit occurred in part because foreign producers can produce more cheaply than US ones, it has also allowed the US to consume more than it produces and, subsequently, living standards have risen. Foreign trade is not a zero-sum game – both deficit and surplus countries benefit from greater trade.

So how has a country like the USA (and the UK) been able to run such a large and persistent deficit? This is because foreign governments, banks and individuals have been willing to hold dollars and US assets rather than change them back into their own currency. In the same way that a generous parent’s continual lending allows their children to spend more than they earn, the UK current account deficit might be partially financed by a financial account surplus caused by rich foreigners and businesses placing money earned from selling to the UK in UK banks or buying property in London, UK shares or government bonds. The same applies to the US, but is reinforced by the additional benefit the USA has which is that the dollar is so widely used for international trade and as a reserve currency.


The exchange rate and the economy.

The traditional view of a fall in the value of a developed country’s currency was that it would lead to an increase in the value of their exports and a fall in the value of their imports, hence improving the balance of payments and, via the resultant increase in aggregate demand, cause an increase in employment and growth.

However the above analysis needs considerable qualification. Although a fall in the value of a currency will almost always increase the VOLUME of exports and reduce the VOLUME of imports, whether the values change in the same way will depend on the elasticities of demand for exports and imports. For a developing country whose exports are commodities with an inelastic demand, a fall in the value of the currency might worsen its balance of payments. Over time the UK’s exports have moved up-market and therefore it can be argued that they have become less price sensitive since factors such as design and quality become more important.

Secondly, the analysis assumes that firms can increase their production of exports to meet higher demand and this will depend on the state of the domestic economy, the availability of labour, raw materials and components. This is unlikely to be easy in the short term and economists talk of the “J Curve effect” whereby a devaluation initially leads to a worsening balance of payments as quantities of exports and imports do not change much, possibly because of long-term contracts or the difficulties in increasing output of export and import-substitutes and, only over time, will the balance of payments improve. While this might not apply to tourism, where people can switch their holiday destinations relatively quickly, high tech exports and imports of manufactured exports will be much slower to adjust. Firms need to take a view as to the permanence of any change in the exchange rate. In my last post, I wrote that the £:$ exchange rate fluctuated from $1.71 in July 2014, $1.32 after the Brexit vote, then to $1.21 in January, 2017, and was at $1.38 (20th January 2018) but at the time of writing (27th January 2018) it had risen to $1.42. Firms planning long-term contracts will need to take a view as to the likely long-term exchange rate and largely ignore short-term fluctuations.

We should also not forget the downside of a devaluation which is that imports become more expensive and therefore living standards fall. Not only does one’s foreign holiday cost more, but imported finished products and anything using imported components or raw materials becomes more expensive, with the increase in price depending upon how easily the supplier can pass on the increased cost to the buyer. As products become more complex and firms take advantage of globalisation, the supply chain becomes longer and there is a greater likelihood of imports being involved in some in the final product. Thus an increase in UK exports of goods is very likely to require an increase in imports needed to make our exports and some of the increased competitiveness will be lost by the higher cost of imported components and raw materials.

Recent examination of the exchange rate and UK trade in goods might suggest that the exchange rate  has a significant impact. In the last year the volume of UK goods exported rose almost 9% which would imply that the fall in sterling post Brexit has had a positive impact until one reflects that UK imports have increased by 7% during the same period, despite their increase in price. What this shows is that the exchange rate is simply one of many factors affecting the demand for imports and exports and we cannot ignore factors such as quality, income, interest rates or anything else which changes the desire to consume goods and services.

China-UK investment: key questions following Hinkley Point C delay | Business | The Guardian

Theresa May’s decision to put off approval for nuclear power station has put Chinese-British business relationship under strain

Source: China-UK investment: key questions following Hinkley Point C delay | Business | The Guardian

Essential reading for all economics students. China is an increasingly important provider of finance for the UK economy – helping to offset our rather hefty current account deficit. The article explores the diverse nature of Chinese investment, why the UK is attractive opportunity, and why money from China is still treated with caution.


Nigeria’s dollar crunch adds to fuel crisis —


Refinery woes, currency controls and militant attacks combine to prolong acute shortage

Source: Nigeria’s dollar crunch adds to fuel crisis —

Inadequate infrastructure means that, despite being Africa’s top oil exporter, Nigeria has to import fuel putting downward pressure on the value of it’s currency, the Naira (see Chart 2 below). Value-added increases when oil is refined to become something more useful, in this case fuel, so the $’s received for each barrel of oil Nigeria exports is worth less than the $’s Nigeria has to pay for the same volume of refined oil, leading to a reduction in foreign exchange reserves (see Chart 1 below).

It is difficult to see how this cycle will end. If the value of the Naira continues to fall, the price of refined oil in Naira terms will continue to rise, further depleting foreign exchange reserves and accelerating the Naira’s depreciation.

There are several solutions, central bank intervention to revalue the Naira, but they need, already dwindling, foreign exchange reserves in order to manipulate the market price for the Naira. Investment in infrastructure, a fiscal supply-side policy, to reduce the reliance on refined oil imports is an alternative, but oil accounts for 90% of Nigeria’s export revenue and, subsequently, a significant proportion of government revenue. The price of oil has collapsed and with it government revenue, a classic example of the dangers of over-reliance on a primary commodity, prone to price volatility. The fall in foreign exchange reserves, the value of the Naira and an increasing budget deficit will make lenders nervous and will lead to an increase in the yield on government borrowing, put simply, the interest rate on government bonds will have to rise to offset the greater risk, increasing government expenditure on debt repayments.

Clearly, these options are not presently viable, but the second should have been enacted when the oil price was high and export earnings plentiful, however, corruption, some $16bn in government oil receipts is unaccounted for in the last year alone, has meant that infrastructure remains undeveloped.

A further consequence of the falling value of the Naira is that despite global oil prices falling, Nigerians have to pay more for petrol at the pump. To combat rising petrol prices the Nigerian government have imposed price controls, however, this has resulted in several-hour long queues and a rise in hidden market activity. Subsequently, Nigerians either face having to pay extortionate prices or waste valuable time queueing. Ultimately, output is lost and Nigeria’s economy suffers.

Nigeria’s relatively new president has a tough task on his hands.

Chart 1

Chart 2