The term “triangular trade” is commonly used in international economics in response to concerns about bilateral deficits*. The general idea is that, even though a bilateral relationship may involve large imbalances, global flows of goods and services must balance in the long run.
In some respects, the pattern of trade between Australia, China and the United States fits the triangular trade story neatly. Australia exports lots of raw materials to China, which in turn exports a wide range of manufactures to the US, which exports high-tech goods and services to Australia. Much the same story is true, with other Asian countries such as Japan in place of China.
In the ideal version of the story, Australia would run a surplus with China, China with the US, and the US with Australia, and these (along with other bilateral balances) would wash out to leave all three countries in balance. The point of the “triangular trade” idea is that it’s a mistake to worry about bilateral balances, when trade benefits everyone.
But the Australia-China_US triangle fails to match this story in two crucial respects. First, instead of trade balance, Australia and the US have large and growing deficits, while China has a large and growing aggregate surplus. Second, the trade triangle is entangled with a triangular strategic relationship, in which Australia has to deal with the great power rivalry between the US and China.
Australian policymakers are acutely aware of this entanglement and fearful of the possibility of conflict between two such crucial trading partners. The response has been to send mixed messages, on the one hand assuring the Americans of our unquestioning willingness to follow them anywhere, on the other hand making it clear to the Chinese that under no circumstances will we be drawn into conflict with them.
By contrast, the fact that the US is massively indebted to China, and that this debt is growing by hundreds of billions of dollars each year, seems barely to have impinged on American foreign policy discussions. Strategic concerns about China have dropped off the radar screen due to more pressing concerns in Iran and Iraq, but the implicit assumption still seems to be that the US is the world’s sole hyperpower with freedom to act as it chooses in response to any aggressive action by China. In fact, any such conflict would almost certainly lead to an economic crisis and force the US government into either inflation or outright repudiation of its debt. At a minimum, this would be the end of the US dollar as a reserve currency.
The Chinese position is much harder to read, not so much because of traditional inscrutability as because communist power structures are always opaque. As creditors, they are aware of the risks involved in getting into conflict with their debtors, but it seems unlikely that, in the event of a conflict over, say, Taiwan, that they would forgo the power available to a creditor.
* Looking it up in Wikipedia, as I routinely do these days, I discover that the original exemplar is a sinister one, involving the trade in slaves, sugar and rum between Africa, the Caribbean and Europe.
John Quiggin 
The actual financial value of seignorage to the US is low in relation to its total international flow of income. The key problem here is the loss of confidence in the US Treasury/Wall Street to make good its debts in hard currency. The implication is that foreign investors would desert the Greenback currency, T-Bond and Stock Market, leading to a massive collapse in US financial values. That would certainly expose the US’s hip pocket nerve to a pretty sharp needle.
The old saying, “if you owe your bank $10,000 you have a problem. If you owe them $1,000,000 they have a problem” may go part way to explaining this conundrum. Although the PRC’s massive financial power accuring to it through its build up in foreign reserves would give it plenty of leverage with other nations who are fed up with the US’s “invade-the-world/invite the-world/insolve-the-world” policies. The PRC’s Central Bank would become a kind of de facto IMF sending in the suits to bring the rogue state to order.
I think I have made the point elsewhere that Bush is going to bankrupt the US – fiscally and militarily. Its ballooning trade deficit witht the PRC will be do to the US what it did to the UK during WWII. And Iraq is the US’s Afghanistan.
What a great deal for Australia and the USA. China sends us useful stuff and we don’t reciprocate too much.
Terje, I think John is pointing out that we may be in a spot of bother if China stops accepting our useless stuff.
JQ says “In the ideal version of the story, Australia would run a surplus with China, China with the US, and the US with Australia, and these (along with other bilateral balances) would wash out to leave all three countries in balance.”
In what sense is this version ideal? Why should Australian investment be limited by the level of domestic saving? Isn’t the purpose of international capital markets to fund investment where returns are greatest? Which at the moment in Australia means mining. Investment levels continue to be very strong across the board (not just in housing). Unless we think the private sector is making some very bad commercial decisions, then I cannot see the problem if the three countries’ bilateral balances with each other and other countries do not wash out.
Sean, the raw materials that China buys from Australia are essential for it to be able to produce the stuff that the US likes. Why would they suddenly decide not to buy from us?
John, you could drop the first three paragraphs of this post (plus the opening sentence of the fourth) at no cost. In fact it would be clearer.
More importantly, I’d be interested to know how the inflation scenario would play out, if anyone has thought it through, or can offer a link to someone who has.
Inflation could be triggered by a sharp devaulaution which raises domestic costs and in turn the CPI and wages. But this is exactly what the Chinese don’t want, since it erodes the purchasing power of their accumulated dollars over goods from Japan and Europe as well as US goods. Therefore they would act to prevent any such sharp devaluation. Alternatively inflation could be instigated by expansionary monetary policy at home in the US. But, until the exchange rate depreciated, this would leave US industry even more uncompetitive than it is now, and make the trade deficit and foreign debt even worse in the meantime. This seems a pretty crazy idea. So how is it all supposed to work? It’s all uncharted territory.
“Terje, I think John is pointing out that we may be in a spot of bother if China stops accepting our useless stuff.”
Isn’t it the other way around, we’re accepting their useless stuff? Who other than the US is going to buy all the crap (as well as non-crap) China puts out?
“this would leave US industry even more uncompetitive than it is now”
in comparison to whom?
I always thought the very idea of “triangular trade” as a phrase was NOT to look at trade between three countries. Rather to make the basic point that bilateral trade is not what should be considered. We’re actually interested in triangular, quadrilateral, quintilateral (??), 192-ie-ateral trade. All people trading with everyone. Thus (from my very limited understanding) what you’ve done here John is use triangular trade in exactly the way no one really wants you to.
Of course, when we look at those 192 country numbers the world is trading at a deficit with itself so the Grey Aliens are indeed sending something home.
And Australia mainly exports commodites, primarily unprocessed ie not much value add and pays extra for all the value adding in China and the US. Commodities materials are first to drop in value in a slump or market uncertainties. We’re not in a strong or secure position but we’ve developed consumption addictions for imported manufactures. Mark U says invest where funds are greatest but what about developing our skills and entrepreneurship to increase our returns and make them more secure in the future? We must be one of the least developed economies of all the developed nations. Thankfully we have mining resources but does this give us an excuse to rest on our laurels? (If the US did happen to nose dive, unlikely but not impossible, what’s to stop China invading Aust? They could make more efficient use of the country than us!)
“If the US did happen to nose dive, unlikely but not impossible, what’s to stop China invading Aust?”
Oh no, the Yellow Peril revived!
But seriously, the relative decline of the US (hastened by Bush, but he’s far from the sole cause) does present Australia with long-run national security challenges (although some excellent long-run economic opportunities). We may have to become the sort of sycophantic friend to China that we were to Britain and are to the US. Alternatively we might get away with a dangerous balance-of-power game between India, China and a reduced US. But I think actual invasion most unlikely – they’d all make far more money from us by keeping us as a rich quarry.
James Farrell says “Alternatively inflation could be instigated by expansionary monetary policy at home in the US. But, until the exchange rate depreciated, this would leave US industry even more uncompetitive than it is now…” But monetary policy in the US (and here, for that matter) has been very expansionary for some time. See Angry Bear 25/2/05 at http://angrybear.blogspot.com/2005/02/excessive-liquidity.html
The problem is to explain either why all this liquidity hasn’t already produced inflation or, alternatively, to find the inflation that it has produced but which hasn’t made the headlines.
An interesting sidelight on triangular (or quadrangular, or pentagonal…) trade is that apparently the figures don’t add up globally – the world as a whole is in deficit:
http://news.independent.co.uk/business/comment/article356923.ece
Are we running a deficit with Mars??
Mark U,
I was talking about the ‘useless’ stuff that Terje was referrig to – our money.
Terje offered up what is now a standard American right-wing talking point, ie. “China gives us useful stuff, in return, we give it paper (greenbacks)”.
Sure, it doesn’t work well in the Australian context, but I can only work with the material I’m given 🙂
Cheers,
Sean.
gordon,
I remember talking with a member of the League of Rights during the 80s and hearing an ernest explaination of how the amount borrowed in the world was more than the amount lent. This was apparently the result of some banking conspiracy.
The possibility that the statistics were wrong did not enter his head. It is good to see these trends persist.
In the long term the China situation will work itself out – I think the reason that the Chinese currently are storing up dollars is to protect the (low) value of the yuan. That protects the central bank from huge losses if the yuan appreciates – a vintage bubble, caused by a government. It will persist for as long as they can continue to stiff their own people.
Bring on the revolution!
No Andrew the storing up of USD assets to stop Yuan appreciation will make the losses worse when an appreciation comes. The greater the assets the worse the losses.
. . . and when Chicken Little said to the Farmer:
“The sky is falling”
the Farmer said:
“Bugger me, a talking chicken!”
No wonder it is called the dismal science.
sdfc,
That was my point – they are avoiding taking the loss now (presumably in the pursuit of stability) and are just storing up more trouble for later. While Bush’s economics are crap, particularly on the deficit question, this is hardly his fault.
how will the china situation work itself out andrew
Obviously I’ve misunderstood what you were trying to say Andrew. My mistake.
Razor
If it’s all hunky dory. How do you see this playing out?
I assume you’re not trying to argue that this is sustainable indefinitely.
Smiths,
This is only sustainable while the Chinese government can afford to keep their people in (relative) penury while the government builds up its bank account. I presume they have a political reason to do this – it is no longer an economic one.
In a way, for a dictatorship, particularly an insecure one, it is sustainable indefinately, in that there is no definate end. It will continue while the political will is there.
The longer it goes on for, though, the worse the correction will be. That amount of cash hitting even the most liquid forex market (that for the USD) would cause serious consequences. Even as an overhang it would depress prices for some time.
sdfc – I do not subscibe to is the “Chicken Little” mentality that abounds on this site of identifying a so-called problem, forecasting doom and gloom outcomes, and demanding that the governments do something about it. While we see incidents occur such as the Asian Currency Crisis, the Hedge fund collapse a few years ago and Sep 11 – what we also see is economies that are flexible enough and government policy that is flexible enough to deal with them and ameliorate the impacts.
JQ identifies that China is in surplus and hence Australia and the US are in deficit with each other and expresses concern that this is a problem. What he fails to do is demonstrate why it is a problem. From my view if it were a problem, why isn’t the USD and AUD being sold off strongly? No explanation – except maybe a plaintive cry of the markets aren’t always rational as shown by long run PPP v Exchange Rates studies demonstrating “market failure”. (Markets don’t fail – humans fail and when dealing with humans there is always going to be irrationality – try dealing with my Mother-in-Law!!). Without checking the figures it is my guess that the same situation exists for the US with both Canada and Mexico (go on – somebody tell me I’m wrong) but nobody seems to be to concerned as far as I can see.
As for the strategic concerns above, my view is that the more economically intertwined that nations become the less likely they are to go to war. If China is holding a shed load of USD denominated assets then the last thing it wants is a significant devaluation or in the worst case freezing of those assets. At the same time the continued demand for Chinese goods by the US economy leads to continued growth and economic development in China. And this, IMHO, has to be a ggod thing for the spread of knowledge and increasing democratisation of China, leading to reductions in human rights abuses etc etc etc
I don’t mind people pointing out problems as long as they can firstly identify clearly why something is a problem and secondly how it could be fixed. So far I don’t see any of that – just motherhood statements that deficits are bad and unsustainable and what about the strategic relationship!
andrew, you seem to be looking at china as if it were in a bubble,
it is locked though in a dance with the US, each dependent on the other for different things, but meanwhile…
china is building up its military strength and looking increasingly threatening to the US, so how long can they keep funding the military build up of their enemy, indefinately? i very much doubt that, especially if the chinese frustrate plans regarding iran,
and razor, your faith in the “economies that are flexible enough and government policy that is flexible enough” to deal with large problems is brave indeed,
given that there are some very good accounts available of how much for instance, the US fed and money funds are now interefering in the markets to try and prop them and how much money is being printed i think your faith is misplaced,
writing off people who express misgivings about the state of things as ‘chicken littles’ is a stupid position to take,
http://www.gata.org/SprottReportTheVisibleHand.pdf
Well Razor I would suggest that a trade deficit that has a funding requirement of $2.2B (rough calculation using last nights trade balance) per day is unsustainable and therefore bound to correct.
Labelling people concerned with this as chicken littles is let’s say just a little irrational.
smiths – that piece reads like the Da Vinci Code and has about as much credibility. I really enjoyed the bit about the miraculous recovery the day after the ’87 crash – of course it recovered – the market was over sold and there were a lot of companies and index futures going for a bargain. As for your claim about ‘printing’ money – I’m not seeing the high inflation rates that printing money has historically caused – why isn’t this happening? Perhaps the monetary and fiscal policies of the government (both US and Aussie) are being well run?
sdfc – The trade deficit is about 6% of GDP – historically high, but historical comparisons may not be as relevant given the high mobility of capital and the globalisation that is occuring. Certainly the currency markets aren’t scared by it.
Razor Said:
I don’t see the connection.
alpaca – JQ refers to strategic concerns about China. My point is that the US and Australia is actually looking after business by literally looking after business.
no, and you wont see the high inflation rates either, cos they aint that stupid,
and im not claiming that they are printing money, its a verifiable fact,
and as for the da vinci code bit, i fail to see how an article that is thoroughly refernced all the way through can be compared to a fiction book,
and your repeated use of put downs suggests and inferiority complex to me,
would you like to take your meds
Well Razor the US will stop raising its short rate soon and the Japanese will eventually start raising theirs. We’ll see what the currency markets do then.
“Looking it up in Wikipedia, as I routinely do these days, I discover that the original exemplar is a sinister one, involving the trade in slaves, sugar and rum between Africa, the Caribbean and Europe.”
This is true, but the original triangular trade is not particularly relevant to any discussion of 21st-century international trade.
The original triangular trade described how English merchants (mostly Liverpudlian) made a profit on all three legs of the Atlantic trade in manufactures, slaves and sugar.
The profits from this trade ended up in England in the hands of the merchants who organised it.
The African slave ports were run by English and other Europeans.
The Caribbean islands were mostly British possessions and were therefore not independent foreign political and economic entities, any more than Manchester was foreign to Liverpool.
“any more than Manchester was foreign to Liverpool.”
I wouldn’t try and assert that on a Saturday night in either city.
Actually, the part of the triangular trade that mattered to Britain was within the British Empire and slave fatories (i.e. depots) that it controlled, because of mercantilist policies. However that was far from the whole of the European triangular trade which also included French, Spanish, Portuguese, Dutch and Danish participants.
There was also a second, subsidiary slave-driven trade triangle: foodstuffs to the slave areas; sugar, tobacco and cotton to Europe; and then back to the North American agrarian seaboard. That’s why cod is a customary food in Jamaica.
In “Time Enough For Love”, Robert A. Heinlein remarks in passing that triangular trade routes remain profitable for longer since they take longer to saturate than simple bilateral trade possibilities.
The CAD sustainability discussion comes around every two or three weeks, probably in reaction to data releases in Australia and US.
Back on Feb 12 PrQ said in this blog
“a current account deficit is sustainable indefinitely if i
CAD/GDP=g*(Debt/GDP) where
g is the growth rate of nominal GDP, and debt is foreign obligations (including equity).
What is not sustainable is a large positive trade deficit, since this implies explosive growth in the CAD.”
According to this formula, Australia is in an unsustainable situation. I have not run the numbers for the US, but I suspect they would be too. As for China, look at PrQ’s last sentence.
How these three countries (and many others) work out of the (literal and figurative) “triangular” imbalances depends on
(a) how China copes with the inevitable problem of slackening growth rate (all low-hanging fruit picked) and moving from a managed to floating currency regime, probably a consequence of the first; and
(b) how the US copes with fiscal deficit reduction, probably requiring handing back the world sheriff’s badge to the UN.
There has been some discussion of world-wide trade deficits.
On a world-wide basis neither the current account nor the capital/financial account are in balance.
In theory the current account surplus deficit for each country should be offset exactly by the capital/financial account for each country. They aren’t.
Measurement errors exist in both.
Of the two, the trade part of the current account *should* be relatively error free. But the income (interest/dividends/trade in services) part of the current account is a notoriously difficult measurement proposition.
The financial account is also notoriously difficult to measure, particularly inwards portfolio investment. The investors are not within the jurisdiction of the recipent country authorities, and use the custodial and nominee industry.
So despite suggestions of “grey aliens” nicking off with the net imbalance, the answer is probably of the “stuff up” variety rather than a conspiracy.
However, there is a debate in the US about CAD sustainability where it is asserted that the US (in particular) deficit is overstated by lack of measurement of economic “dark matter”.
Whilst this suggestion provides some comfort to the US administration, attempts at quantifying the dark matter have fallen well short suggesting that the US CAD is sustainable. But there was some unmeasured services exports discovered in the form of US dollars circulating outside the US providing liquidity services to the rest of the world.