[This article is Part 6 of a series. See Part 1 and Part 2 and Part 3 and Part 4 and Part 5.]
In wrapping up this series of articles on the applications of Mises’s insight into Cantillon effects in analyzing international trade, it is worth discussing the additional distortionary effect of trade finance on trade patterns, particularly in the case when government-backed trade finance is fueled by credit expansion instead of real savings. In tackling this issue, one must discuss the role of Export Credit Agencies (ECAs), i.e. of quasi-governmental institutions that act as an intermediary between governments and national exporters in offering financial support, intermediary loans, credit insurance and guarantees.
Export Credit Agencies have received a good deal of criticism over the last decades, and rightly so. First, they have been called out on their contradictory statements concerning the nature of their activities: they claim they underwrite projects the market considers too risky, while arguing that they are conservative in their investments, thus making ‘sure bets’. Given that private financial institutions would not refuse profitable investments in the first place, scholars indicate that either ECAs crowd out private trade finance, or they expose unaware taxpayers to bad loans, case in which export promotion becomes nothing more than foreign aid.
Second, export credit agencies are significantly biased in the choice of clients: by their own admission, they support trade activities that are either ‘environmentally friendly’, belong to ‘strategic’ industries, or have ‘high potential’ for export growth but are otherwise neglected by the private sector. However, once more, private financiers would not overlook high growth opportunities, unless they were not, in fact, profitable.
Third, every export credit agency around the world touts as its foremost goal the countering of foreign subsidy programs, thus ensuring a level playing field for domestic companies facing unfair competition from foreign firms. Yet, for all intents and purposes, public trade loans and export subsidies have similar effects on the market, albeit being different in their bureaucratic characteristics. Scholars thus argue that ECAs tilt the playing field in the first place—and that it is for this reason that no results of their countervailing activities are ever published. Reports of ECAs contribution to international trade that are made public purport to show only loose statistical correlations—and not the causal link—between increases in exports, and ECA loans and insurance ( Contessi and de Nicola 2012 ).
In spite of these differences, and the potential crowding out effect, private and public trade finance do seem to work together in harmony, most likely the result of the symbiosis between governments and banks. Although most mainstream economists would argue that ECAs, with all their flaws, act as ‘quasi-market’ players, in this case it is commercial banks which act as quasi-government agencies. Banks are enabled by special mandates to underwrite higher levels of trade risks than they otherwise would have been able to, and thus to profit from otherwise unprofitable ventures, eventually at the expense of taxpayers. The most appropriate examples here are Coface,Atradius, and Euler-Hermes, which are constituted both as private trade insurers and ECAs.
This cooperation notwithstanding, the more vulnerable issue does not have to do with the process in which governments choose their favorites among financial intermediaries, but with the source of the funds poured into international trade by government agencies: whether loans are requisitioned from the taxed income of the population, or from an expanded money supply purports an important distinction on the overall impact of ECA activity. The difference between the two cases is best depicted under two scenarios: 100% reserves commodity money system, and fractional reserve fiat money system.
In the first scenario, absent any government intervention in trade and trade finance, international trade flows align to the configuration of comparative advantage under the most efficient worldwide allocation of resources, while financial intermediation funds trade activities solely from the savings of the public. But if in this context we allow for government financial intervention in international trade, this intervention would be restricted under the 100% reserves commodity money standard: ECAs could only capture resources through taxation or borrowing, creating an island of calculation and allocational chaos.
International trade would then operate on a different pattern of comparative advantage than the one otherwise prevailing on the unhampered market: some exporting or importing businesses—favored by government trade promotion—would flourish at the expense of other industries, as the economy would experience unnatural business fluctuations. Nonetheless, entrepreneurs would adjust their calculations to the new market data, accounting for government activity as an increase in the scarcity of available capital, and “a lowering of the general standard of living in the present and the future” ( Rothbard 2009, 1026 ). Furthermore, as the market interest rate would not be artificially lowered—in fact, “diversion and waste of savings causes interest rates to be higher than they otherwise would, since now private uses must compete with government demands” ( Rothbard 2009, 1026 )—, entrepreneurial judgment would not be induced into malinvesting.
In the second scenario, of fractional reserve banking, government-led trade finance is being granted from an expanded money supply, by export credit agencies and commercial banks alike. Consequently, we are dealing with a much more disruptive intervention: ECAs reallocate resources to unproductive uses, wasting a part of the savings, and lowering the capital structure, but also mislead entrepreneurs into wasting savings and lowering the capital structure by reinforcing and enlarging the effects of credit expansion.
As a case in point, ECAs increase the reserves of commercial banks by providing them with financial intermediary loans that allow them to further expand bank credit, or via interest rate equalization policies, both measures having the effect of further artificially lowering the interest rate below unhampered market levels. ECA guarantees help reduce interest rate spreads between short-term and long-term by allowing banks and their clients to easily extend the maturity of their debt. In addition, because ECAs are eligible for a 0% risk weighting (Aaa or AAA rating) with respect to their debt held by private sector banks, this further undervalues the risk weighting of projects that benefit from their support.
This government safety net encourages firms to borrow and trade internationally, as state guarantees lower the trade risk perceived by entrepreneurs, as well as shift the costs of intermediating transactions from banks to domestic taxpayers. Hence, unlike the 100% reserve scenario where competition between private and public demands for savings raises the interest rate, here government injection of funds into trade finance prevents interest rates to rise, deepening malinvestments and precluding the readjustment of international trade after a crisis. These favorable terms for trade finance engage entrepreneurs and the banking system in a reckless planning of financial activity, with government intervention adding more unnatural business fluctuations to the already distorted production structure.
