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Growth of int'l trade in Tonga will contribute to economic prosperity

Queanbeyan, Australia


I agree with you that the PACER Plus trade agreement is of questionable benefit for Tonga. But I do not share your concern for Tonga’s trade deficit. Over the last year, Tonga’s foreign reserves have increased about 19% to the equivalent of nearly 10 months’ imports. If the balance of trade were a problem for Tonga, its foreign reserves would be declining.

The trade deficit is not a problem because consumers need to have money before they can buy anything. Money received in Tonga from foreign remittances and aid will be spent buying additional imports. But those additional imports are not a problem because they were generated by foreign currency. The local banks and NRBT would have received foreign currency before they paid out Pa’anga to be spent in Tonga. That foreign currency is available to pay for the imports purchased using the Pa’anga that the banks issued. When the Pa’anga is used to buy the foreign currency is paid to the banks, it is taken out of circulation and is no longer available to finance any additional imports.

The banks can also issue Pa’anga into the economy as a loan. Those Pa’anga can finance additional imports in the same way as Pa’anga issued in exchange for foreign currency. But, unlike the Pa’anga from foreign sources, the Pa’anga from bank lending has not contributed to the county’s foreign reserves. When Pa’anga from bank lending is spent on imports, those imports can be paid for only by drawing down or depleting foreign reserves. But bank lending in Tonga is not excessively depleting foreign reserves.

The effect of excessive bank lending has been evident in Australia and New Zealand when they initially deregulated bank lending in their economies. The resultant increase in bank lending financed additional imports that depleted their foreign reserves, causing a financial crisis. In response, their respective governments floated their currencies. Floating the currency did not stop bank lending from increasing imports in excess of their foreign income. But it did prevent the foreign reserves from being depleted. It did this by relying on the rest of the economy and the world (through the foreign exchange market) to provide the foreign currency necessary to pay for the additional imports. As a result, these economies have had to borrow foreign currency or sell capital assets such as land and shares to foreign buyers. Private foreign debt in those economies has risen rapidly after they floated their currencies.

Bank lending and foreign debt

The economies that have adopted the floating exchange rate system generally deny that there is any relationship between bank lending and foreign debt. That denial is supported by the banks which have become extremely profitable because of the deregulation of bank lending. The denial is also fostered by the central banks and some heads of government departments that do not wish to be blamed for the disastrous outcome.

The governments in these economies are aware that the playing field for international trade is not level, and is sloped against them. But they are unaware that it is their own policies that are acting against them. Therefore, they blame other economies. They mistakenly believe that if they could persuade other counties to increase imports from them, they could reduce the growth of their foreign debt. This is a misunderstanding that has generated multiple international trade agreements such as PACER Plus.

If the money earned from any additional export income earned under such schemes were used to repay bank debt, then that would reduce net bank lending and reduce foreign debt. But reducing net bank lending would reduce the amount of money in the economy and that could cause a recession. Hence the additional export income usually circulates in the economy until it is spent on imports. Therefore, any income earned from increased exports will increase spending on imports by an equivalent amount and will not reduce foreign debt.

Monetary Independence

Besides their ineffectiveness at reducing foreign debt, these trade agreements are also ineffective at contributing to economic prosperity. This is because the floating exchange rate system has a property known as “monetary independence”. That means international transactions do not affect the amount of money in the domestic economy. The exchange rate “floats” to achieve that outcome. For example, if the country increases its exports and tries to bring more money into the country, the exchange rate must rise to make imports cheaper than local products, and thereby shift spending to imports.

Another problem of monetary independence is that it undermines those industries that supply the domestic economy. Tonga does not have monetary independence so that if it increases income from exports or tourism, more money actually flows into Tonga. When that money is spent, it circulates through the Tongan economy and contributes to the income of other businesses in the economy. Therefore, the growth of international trade in Tonga contributes to the economic prosperity of the whole economy.

But, as discussed above, in those countries that enforce “monetary independence”, an increase in exports must immediately generate an increase in imports. For imports to rise, domestic spending must shift from domestic products to imports. The additional income earned by the exporters is offset by a reduction in the income of industries that supply the local economy. Therefore, the exports do not contribute to the prosperity of the whole economy.

In addition, the reduced spending on domestic products reduces the income of domestic industries supplying the local market. That can eventually put them out of business. For example, in Australia, the growth of mineral exports has led to increased spending on imports and reduced spending on domestic products. That has destroyed many manufacturing industries supplying the local market. Recently we saw the complete demise of the Australian motor vehicle manufacturing industry.

It may be possible for Tonga to earn sufficient additional export income through PACER Plus to offset the loss of tax income to government due to the lower income from import duties. If so, PACER Plus may be of some benefit for Tonga. But for the countries that are promoting the scheme, their own policy of “monetary independence” means that the trade agreement will be of little, if any, benefit.

Best wishes,

Leigh Harkness

See also: Tonga not ready for new trade rules as PACER Plus comes into force on 13 December