Will the energy shock change global trade imbalances? With Brad Setser

Episode Summary

Executive Summary: At the IMF Spring Meetings, Brad Setser argues that global trade imbalances are worsening, driven mainly by China’s massive export surge, flat import growth, and weak domestic demand. He says the energy shock will shift imbalances only temporarily, while lasting fixes require domestic policy changes, a stronger Chinese currency, and coordinated pressure from Europe, the U.S., and allies.

Main Topics: Worsening Global Trade Imbalances (Priority: 5/5): The discussion opens with a shift in concern among policymakers: global imbalances are no longer a distant issue but an urgent one, especially due to Asia's surplus and China's role. China’s Surplus and Export-Led Growth (Priority: 5/5): Setser describes China’s trade surplus as historically large, fueled by export growth far exceeding global trade and by stagnant import volumes, creating risks for China and trading partners. Energy Shock and Reallocation of Surpluses (Priority: 4/5): The transcript explains how higher oil prices redistribute dollars from importers to exporters, reducing some deficits and surpluses, but not fundamentally solving Asia’s underlying imbalance. Policy Responses in the U.S. (Priority: 4/5): The conversation covers tariffs, fiscal tightening, and tax-code reforms, with Setser arguing that broad tariffs or reduced tax incentives for offshore production could lower the U.S. trade deficit. Currency Policy and Exchange-Rate Management (Priority: 5/5): Setser emphasizes that China’s currency is an active policy tool, not merely a market outcome, and that appreciation could meaningfully reduce its surplus and rebalance trade. Europe’s Exposure and Limits (Priority: 4/5): Europe is portrayed as heavily exposed to Chinese export competition, especially in autos and machinery, but politically divided and constrained in mounting a coordinated response.

Key Arguments: Global imbalances are again a central macroeconomic concern because Asia’s surplus—especially China’s—has expanded sharply while Europe has also felt spillovers. China’s trade surplus is historically unprecedented in scale, with exports growing far faster than global trade and imports remaining nearly flat. A Chinese surplus is risky for China itself because it increases exposure to external shocks and forces China to hold large foreign assets that can lose value. The energy shock will reduce imbalances mechanically by transferring spending from oil importers to oil exporters, but because the GCC source countries are constrained, the effect is dispersed and temporary. Large oil shocks can shrink Asia’s surplus somewhat, but the Asian surplus is so large that it remains the dominant global imbalance even after price spikes. The U.S. can affect its deficit through broad fiscal tightening or a broad consumption tax-like tariff, but targeted China tariffs mainly reroute supply chains rather than reduce the overall deficit. Some U.S. trade deficit is artificially inflated by tax incentives that encourage offshore production and profit shifting, especially in pharmaceuticals. China’s exchange rate is a lever Beijing can control directly, and a stronger yuan would reduce exports and boost imports, helping rebalance trade. Europe needs a more coordinated and possibly more protectionist response, but internal divisions among member states and firms make that difficult. A joint U.S.-Europe-Japan-Korea approach would be more effective than fragmented national measures in pressuring China to change policy.

Data Points: Policy wonk concern at IMF meetings: 7 or 8 out of 10 - Setser’s estimate of how worried the average policymaker is about global imbalances. Setser’s personal alarm level on global imbalances: 10 out of 10 on social media; one notch short of full alarm overall - He says he is nearly at maximum concern, especially about China. U.S. trade deficit: 4% of GDP - Setser says this is still below the 5% threshold that would trigger full-scale alarm for him. China net exports contribution to growth over the past five years: ~6% of growth - He says net exports have made an enormous contribution to China’s growth. China net exports contribution to growth over the past two years: 1.5% of growth - Used to show continued dependence on exports. China customs surplus since the pandemic: Up $800 billion - Setser uses this to illustrate the scale of the expansion. China customs surplus: $1.2 trillion - Current approximate customs-surplus level cited in the discussion. China manufacturing surplus: 2% of GDP - He says China’s manufacturing surplus exceeds the combined Germany-Japan surplus of the 1980s. Asia oil imports from outside Asia: 30 million barrels/day - Used to calculate how oil-price shocks reallocate dollars. Europe oil imports from outside Europe: 12 million barrels/day - Part of the combined non-oil-exporter exposure to higher prices. Combined Asia and Europe oil imports: 40+ million barrels/day - The basis for the estimated dollar transfer from oil importers to exporters. Oil price shock effect: $10 increase ≈ $150 billion transfer - Estimated additional payment for oil by importers per $10 rise in oil prices. GCC trapped oil supply: ~10 million barrels/day or 10% of global supply - Explains why the GCC may not receive the full transfer from higher oil prices. Potential swing in Asian surplus with oil rising from $70 to $100: ~$400 billion - Shows that even substantial oil shocks may only partially reduce the Asian surplus. China vehicle trade shift: From importing ~1 million vehicles to exporting 8-9 million; importing ~500,000 - Illustrates a dramatic sectoral swing in autos/vehicles. U.S. budget deficit: 6% of GDP - Setser cites this as larger than the current account deficit. Broad tariff revenue estimate: ~2% of GDP - Estimated revenue from a 20% across-the-board tariff with few exemptions. Pharmaceutical trade distortion estimate: ~$200 billion - Setser says offshore tax incentives inflate U.S. pharmaceutical imports and the trade deficit by this amount. U.S. tariff peak referenced: 145% - He says the U.S. backed down because such a tariff was unsustainable for retailers and supply chains. China’s implied currency undervaluation: 20% to 30% - Setser argues this level would materially alter trade competitiveness. Taiwan current account surplus: 20% of GDP - Used to show how weak some Asian currencies are despite strong industrial positions.

Pivotal Quotes: "There is no doubt that the unbalanced external Chinese economy is a function of an unbalanced internal economy." — Brad Setser: Summarizing the link between China’s weak domestic demand and its huge trade surplus. "The core ask of the rest of the world to China is that China live a bit better, that China consume more of what it produces." — Brad Setser: Arguing that rebalancing means higher Chinese consumption, not Chinese retrenchment. "If you had the correct number or just use the trade balance then that goes up to 30 so 20 to 30 percent undervalued that would change a lot of things." — Brad Setser: On China’s currency as a key lever for reducing trade imbalances.

Implications: Global imbalances are becoming a policy flashpoint again. Expect more pressure on China to boost domestic consumption and let currencies rise, while the U.S. and Europe face growing calls for fiscal, tax, and trade-policy responses.