Category Archive for: China [Return to Main]

Wednesday, September 29, 2010

"The Easy and Legal Way to Stop Currency Manipulation"

Daniel Gros:

A reciprocity requirement: The easy and legal way to stop currency manipulation, by Daniel Gros, Vox EU: The endless discussions about global imbalances, and China’s supposedly self-serving exchange-rate policy, have for a long time, resembled discussions about the weather; everybody talked about it, but nobody did anything. This is now changing. ...
The US political system has become so frustrated by this situation that Congress is now seriously considering whether to label the country a “currency manipulator” and impose trade sanctions which would be illegal under WTO rules and threaten to throw the global trading system into turmoil.
But there is another way. The US (and Japan) could easily prevent the Chinese Central Bank from continuing its intervention policy without breaking any international commitment. The US and Japan only need to invoke the principle of reciprocity and declare that they will limit sales of their public debt henceforth to only include official institutions from countries in which they themselves are allowed to buy and hold public debt. Instead of the “moral suasion”, tried in vain by the Japanese, the Chinese authorities would just be told that they can buy more US T-bills Japanese bonds only if they allow foreigners to buy domestic Chinese debt.
Imposing such a “reciprocity” requirement on capital flows would be perfectly legal..., there are no legal constraints on the impositions of capital controls.
This “reciprocity” measure would of course be equivalent to a very specific form of controls on capital inflows. Capital controls are always somewhat leaky, but not in this case because the Chinese Central Bank would find it difficult to hide its huge investments going through western financial institutions. No reputable financial institution would dare to become a hidden intermediary for the Chinese given that no institution bidding for hundreds of billions of T-Bills would take the risk of secretly fronting the Chinese government...
As a practical matter the introduction of the reciprocity requirement should provide a grand fathering of the existing stocks of Chinese official assets abroad (already above $2,500 billion). However, the Central Bank of China would not be able to continue its interventionist policy – and that is what counts for foreign exchange markets.
The immediate objection is, “What if the Chinese react emotionally and dump their holdings of T-Bills and US agency debt on the market? Would that not disrupt the US government debt market?” This “dumping” is not as simple as it sounds. What assets would the Chinese Central Bank buy when it sells T-Bills? There are not many choices if the Chinese Central Bank wants to dispose of thousands of billions of dollars. Either it holds cash in the form of bank deposits (this would mean a massive refinancing of the US banking system) or it buys other US assets (which would mean a refinancing of the US private sector). Moreover, the reciprocity requirement could be extended to private debt instruments as well. But this is probably not necessary as the Chinese Central Bank is unlikely to invest hundreds of billions of dollars (or euro) in private assets. Buying euro assets would of course constitute an alternative, but this does not appear too attractive at present, and would be prevented by the Europeans adopting the same reciprocity requirement.
The US might hesitate to impose a reciprocity requirement for sales of its public debt because (in contrast to Japan) it needs foreign financing for its public sector deficit. But this also constitutes the litmus test for the sincerity of the US position which cannot have it both ways, i.e. Chinese financing of its external deficit and an end to currency intervention. The choice is now up to the US, it can easily stop Chinese interventions without violating any international commitment if it is willing to rely on domestic savings to finance its own fiscal deficits.

I don't think most members of Congress would be willing to take the large risk they would attach to imposing reciprocity. But how large are the risks? Paul Krugman:

given the fact that we’re in a liquidity trap, a decision by China to buy fewer of our bonds would actually be doing us a favor — it would weaken the dollar, and help our exports.

Here's the latest: 

House Is Likely to Pressure China to Raise Renminbi: The House is expected to give the Obama administration another tool in its diplomatic pouch to pressure China to let its currency rise in value, reflecting growing concern around the country over the loss of manufacturing jobs, persistently high unemployment and a rising trade deficit.
In what is likely to be one of Congress’s last significant measures before the election, the House will vote Wednesday on a symbolic but not insignificant measure threatening China with punitive tariffs on its imports to the United States. ...
But it is unclear whether the legislation, which faces cloudy prospects in the Senate, will succeed this time in prodding a China that has become more self-confident on the world stage. ...


“The legislation will strengthen the administration’s hand in its negotiations with China, but also risks provoking a strong backlash,” said Eswar S. Prasad ... of ... Cornell and a former head of the International Monetary Fund’s China division. “Ultimately its short-term effect is likely to be more symbolic than substantive.” ...

Professor Prasad ... warned that if the Congressional proposal went forward, China could retaliate by limiting American imports or denying American manufacturers and financial institutions “the coveted prize of access to rapidly growing Chinese markets.”

A policy that is "more symbolic than substantive" is my expectation as well.

Monday, September 13, 2010

Paul Krugman: China, Japan, America

What should the US do about China's currency policy?:

China, Japan, America, by Paul Krugman, Commentary, NY Times: Last week Japan’s minister of finance declared that he and his colleagues wanted a discussion with China about the latter’s purchases of Japanese bonds, to “examine its intention” — diplomat-speak for “Stop it right now.” The news made me want to bang my head against the wall in frustration.
You see, senior American policy figures have repeatedly balked at doing anything about Chinese currency manipulation, at least in part out of fear that the Chinese would stop buying our bonds. Yet in the current environment, Chinese purchases of our bonds don’t help us — they hurt us. The Japanese understand that. Why don’t we?
Some background: If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality — namely, that China is deliberately keeping its currency artificially weak.
The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. ... And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.
So what should we be doing? U.S. officials have tried to reason with their Chinese counterparts, arguing that a stronger currency would be in China’s own interest. They’re right about that: an undervalued currency promotes inflation, erodes the real wages of Chinese workers and squanders Chinese resources. But while currency manipulation is bad for China as a whole, it’s good for politically influential Chinese companies — many of them state-owned. ...
Time and again, U.S. officials have announced progress on the currency issue; each time, it turns out that they’ve been had. ... Clearly, nothing will happen until or unless the United States shows that it’s willing to do what it normally does when another country subsidizes its exports: impose a temporary tariff that offsets the subsidy. So why has such action never been on the table?
One answer, as I’ve already suggested, is fear of what would happen if the Chinese stopped buying American bonds. But this fear is completely misplaced: in a world awash with excess savings, we don’t need China’s money...
It’s true that the dollar would fall if China decided to dump some American holdings. But this would actually help..., making our exports more competitive. Ask the Japanese, who want China to stop buying their bonds because those purchases are driving up the yen.
Aside from unjustified financial fears, there’s a more sinister cause of U.S. passivity: business fear of Chinese retaliation.
Consider a related issue: the clearly illegal subsidies China provides to its clean-energy industry. These subsidies should have led to a formal complaint from American businesses; in fact,... “multinational companies and trade associations in the clean energy business, as in many other industries, have been wary of filing trade cases, fearing Chinese officials’ reputation for retaliating ... and potentially denying market access to any company that takes sides against China.”
Similar intimidation has surely helped discourage action on the currency front. So this is a good time to remember that what’s good for multinational companies is often bad for America, especially its workers.
So here’s the question: Will U.S. policy makers let themselves be spooked by financial phantoms and bullied by business intimidation? Will they continue to do nothing in the face of policies that benefit Chinese special interests at the expense of both Chinese and American workers? Or will they finally, finally act? Stay tuned.

Thursday, September 09, 2010

Rodrik: Is Chinese Mercantilism Good or Bad for Poor Countries?

Dani Rodrik argues that China's currency policy has hurt other developing countries, but "we should not hold China responsible for taking care of its own economic interests":

Is Chinese Mercantilism Good or Bad for Poor Countries?, by Dani Rodrik, Commentary, Project Syndicate: ...Discussion of China’s currency ... is viewed largely as a US-China issue, and the interests of poor countries get scarcely a hearing... Yet a noticeable rise in the renminbi’s value may have significant implications for developing countries. Whether they stand to gain or lose from a renminbi revaluation, however, is hotly contested. ...
 Strip away the technicalities, and the debate boils down to one fundamental question: what is the best, most sustainable growth model for low-income countries? Historically, poor regions of the world have often relied on ... exporting to other parts of the world primary products and natural resources such as agricultural produce or minerals. ...
But this model suffers from two fatal weaknesses. First, it depends heavily on rapid growth in foreign demand. When such demand falters, developing countries find themselves with ...  a protracted domestic crisis. Second, it does not stimulate economic diversification. Economies hooked on this model find themselves excessively specialized in primary products that promise little productivity growth.
Indeed, the central challenge of economic development is not foreign demand, but domestic structural change. The problem for poor countries is that they are not producing the right kinds of goods. ... The real exchange rate is of paramount importance here, as it determines the competitiveness and profitability of modern tradable activities. When developing nations are forced into overvalued currencies, entrepreneurship and investment in those activities are depressed.
From this perspective, China’s currency policies not only undercut the competitiveness of African and other poor regions’ industries; they also undermine those regions’ fundamental growth engines. What poor nations get out of Chinese mercantilism is, at best, temporary growth of the wrong kind.
Lest we blame China too much, though, we should remember that there is little that prevents developing countries from replicating the essentials of the Chinese model. They, too, could have used their exchange rates more actively in order to stimulate industrialization and growth. True, all countries in the world cannot simultaneously undervalue their currencies. But poor nations could have shifted the “burden” onto rich countries, where, economic logic suggests, it ought to be placed.
Instead, too many developing countries have allowed their currencies to become overvalued... And they have made little systematic use of explicit industrial policies that could act as a substitute for undervaluation.

Given this, perhaps we should not hold China responsible for taking care of its own economic interests, even if it has aggravated in the process the costs of other countries’ misguided currency policies.

I don't think I have anything to say about this that hasn't already been said, many times, and I'm running behind at the moment, so I am am going to leave comments to you. One question might be whether or not rich nations are, in fact, obligated to pay part of the "burden" for the development of poorer countries. If so, why, and if not, why not?

Tuesday, September 07, 2010

"Being a Hegemon is a Thankless Task"

Harold James:

Recession Geopolitics: ...It is as if China’s leaders were the star pupils in one of Kindleberger’s courses. Throughout the crisis, the Chinese economy continued to grow at an amazing pace, in part as a consequence of massive fiscal stimulus. When anyone wants an example of how effective a Keynesian counter-cyclical strategy can be, internationally as well as domestically, they need look no further than China’s four-trillion-renminbi stimulus of 2008-2009.
Apart from a six-month period after the September 2008 collapse of Lehman Brothers, in which trade finance stopped and the world did look as if it was close to Great Depression circumstances, China and other emerging markets helped those export-oriented industrial economies to recover. The surprising strength of the German economy, with more vigorous growth than at any time in the past 15 years, is due to the dynamism of emerging-market – particularly Chinese – demand, not only for investment goods, engineering products, and machine tools, but also for luxury consumer products. Germany’s high-end automobile producers are now operating at full capacity.
China also followed Kindleberger’s financial lessons. For a moment, it looked as if a contagious crisis, driven by fears of government over-indebtedness, would destroy the politically fragile compromise that European countries had carefully constructed over a 50-year period. The turning point in this spring’s euro panic came when big holders of reserve currencies signaled that they saw the need for the euro as an alternative to the increasingly problematic dollar and the equally vulnerable yen. China started to buy European Union governments’ bonds, and a high-profile Chinese team even went to Greece to buy under-priced real assets.
It was not just Europe that benefited from China’s willingness to take on the mantle of “lender of last resort.” The new-found dynamism of African economies is a consequence of the Chinese drive to build up and secure sources of raw materials.

But there is a problem with Kindleberger’s argument. Kindleberger, a kind and well-meaning man, could never see that the world is never entirely grateful to the country that saves it. Being a hegemon is a thankless task. ...

Mostly just curious to see what reaction this will bring. Comments?

Friday, August 20, 2010

Does China Prove That the Washington Consensus Works?

This might provide some amusement on a Friday afternoon. Stanford's Ronald McKinnon says China proves the Washington Consensus works. It comes via John Taylor, who comments:

Does China’s remarkable economic growth, its stability during the recent financial crisis, and its immense foreign aid/investment in Africa raise doubts about free market policies and provide evidence in favor of a more interventionist approach? In a new review paper, my colleague Ronald McKinnon says “Surprisingly no.” In fact, while many tout a "third way," China has followed quite closely the 10 liberal market-oriented rules commonly called the Washington Consensus after John Williamson wrote them down 20 years ago. McKinnon convincingly shows that “The Chinese economy itself has evolved step-by-step…into one that can be reasonably described by Williamson’s 10 rules!”
Some experts worry that U.S. influence is waning relative to China, and there is cause for worry, but McKinnon argues that “U.S. influence…can be largely recouped if its government returns to a hard version of its own 'Washington Consensus'— as China has done."
McKinnon also offers a fascinating political/economic analysis and explanation for China’s rapidly growing economic involvement in Africa.

It's interesting how, after so many years of dismissing Europe and China as inferior to the dynamic US economy -- we grew faster, could handle shocks better, had a much better financial system, had lower unemployment, etc., etc. -- the right is suddenly urging us to be more like Europe (deficits, Germany, etc.) and China (as below). Here's McKinnon's argument:

Review - China in Africa: the Washington Consensus versus the Beijing Consensus, by Ronald I. McKinnon: ...The Beijing Consensus versus the Washington Consensus In promoting growth in developing countries through foreign aid and investment, does the Beijing approach conflict with “Washington” guidelines used by the World Bank, International Monetary Fund, the OECD, and the United States itself?

The Beijing Consensus is hard to write down as a precise set of rules because of its pragmatism involving “a commitment to innovation and constant experimentation” (Ramo 2004)—as per the old Chinese saying “crossing a river by feeling the stones”. It is also associated with China’s specific commercial interests in, say, investing for extracting minerals on favorable terms—which enhances sustainability on both sides. In contrast, the Washington agencies in principle are more selfless (at least since the end of the Cold War) in aiming to raise per capita incomes and welfare in the recipient countries—but run the risk that aid recipients become permanent supplicants.

John Williamson (1990) did all a great favor by writing down the rules for what he called “The Washington Consensus” for developing countries to follow to absorb aid efficiently:

  1. Fiscal policy discipline.
  2. Redirection of public spending from subsidies (“especially in discriminate subsidies” toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care, and infrastructure;
  3. Tax Reform—broadening the tax base and adopting moderate marginal tax rates:
  4. Interest rates that are market determined and positive (but moderate) in real terms;
  5. Competitive exchange rates;
  6. Trade liberalization—with particular emphasis on the elimination of quantitative restrictions; any trade protection to be provided by low and relatively uniform tariffs;
  7. Liberalization of inward foreign direct investment;
  8. Privatization of state enterprises;
  9. Deregulation—abolish regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions.
  10. Legal security for property rights.

To provide perspective on these ten rules, the year 1990, when Williamson wrote, is important. It was just after the fall of the Berlin Wall and the complete collapse of confidence in Soviet-style socialism. The rules reflect the hegemonic confidence that most people then had in liberal market-oriented capitalism—think Ronald Reagan and Margaret Thatcher. But, 20 years later, should the meteoric rise of socialist China—both in its own remarkable growth in living standards, and in the effectiveness of its foreign “aid” to developing countries, undermine our confidence in Williamson’s Washington Consensus?

Surprisingly, no. The Chinese economy itself has evolved step-by-step (feeling the stones) into one that can be reasonably described by Williamson’s 10 rules! Chinese gradualism avoided the “big bang” approach to liberal capitalism, with the financial breakdowns that were so disastrous for Russia and some smaller Eastern European economies in the early 1990s, while retaining financial control in a model textbook sense (McKinnon 1993). So let us look again at Williamson’s 10 rules to see how well they fit China today in comparison to the United States.

Continue reading "Does China Prove That the Washington Consensus Works?" »

Thursday, July 15, 2010

"Push Back"

Tim Duy responds to Ryan Avent:

Push Back, by Tim Duy: Free Exchange pushes back on my concerns about the widening trade deficit and the declines in manufacturing capacity. I appreciate that - I am well aware that I am taking an unpopular position. Not quite so sure it is "lazy," but definitely unpopular.

Regarding my disbelief that higher paid grocery clerks are the answer to declining manufacturing capacity, Avent writes:

This is a lazy and unpersuasive assessment of what's involved in service sector activity. Obviously there is much more to service employment, including work in financial, information, education, and health services, much of which is (and will increasingly be) tradable.

True enough, I oversimplified service sector jobs. Maybe. Yes and no. To begin with, it is not exactly clear that the expansion of the financial sector has yielded a good outcome, unless you believe that greater financial volatility and widening income inequality is good. More importantly, Avent is arguing that service jobs are just as tradable as manufacturing jobs, and therefore a job is a job. Refer to Alan Blinder's hypothesis back in 2007:

We economists assure folks that things will be all right in the end. Both Americans and Indians will be better off. I think that's right. The basic principles of free trade that Adam Smith and David Ricardo taught us two centuries ago remain valid today: Just like people, nations benefit by specializing in the tasks they do best and trading with other nations for the rest. There's nothing new here theoretically.

But I would argue that there's something new about the coming transition to service offshoring. Those two powerful forces mentioned earlier -- technological advancement and the rise of China and India -- suggest that this particular transition will be large, lengthy and painful.

It's also going to be large. How large? In some recent research, I estimated that 30 million to 40 million U.S. jobs are potentially offshorable. These include scientists, mathematicians and editors on the high end and telephone operators, clerks and typists on the low end. Obviously, not all of these jobs are going to India, China or elsewhere. But many will.

Avent is essentially arguing that the US has a comparative advantage in service sector jobs. Blinder views these jobs as very vulnerable to offshoring, suggesting a lack of comparative advantage. If Blinder is right, then America apparently has little left in the comparative advantage department.

Avent continues:

As far as I can tell, Mr Duy seems to want to embrace a crash programme of protectionism against China. I don't know how this is supposed to boost America's long-term economic fortunes or what evidence he can present that it will. I don't know why Mr Duy is convinced that another spurt of manufacturing capacity growth, similar to that observed in the 1990s, isn't a possibility. And I have no idea why he is so confident that a return to the manufacturing economy observed in the immediate postwar decades—a time when technologies were vastly different, when the global economy was vastly different, and when a much larger share of the world's population lived in dire poverty—is a good idea.

I will deal with the protectionism argument later. I don't view American manufacturing as incapable of rebounding. But there are no price signals to prompt that rebound. That price signal should be delivered via currency values. The dollar should adjust to spur a net increase in export and import competing industries. It is not complicated. For some reason, however, that process is not happening. Something is interfering with the adjustment. That interference prompts American firms to expect that any new innovation needs a China strategy for production, if you believe the Andy Grove hypothesis.

Also, whenever you stick your neck out and say that manufacturing might be important, you suddenly get accused of being a barbarian trying to reinvent the 1950s. Of course manufacturing technology has fundamentally changed, as well as the mix of goods produced. But in the past, that productivity growth yielded more overall output and more manufacturing employment, even if the proportion of manufacturing jobs decreased relative to overall jobs. I can even buy into that story when capacity is rising and employment is stagnant. But something very different happened this decade. Capacity stagnated as millions of jobs were lost.

Avent continues:

This is simply a very empty and disappointing view of the evolution of economic activity. Mr Duy is implying that there is only so much producing of good stuff that can go on, and America used to have most of it and now China is taking it all and America needs to fight to get it back. He's wrong. The movement of some kinds of economic activity to China is creating new opportunities in America. America's problem isn't that some jobs are leaving. It's that it's doing a poor job of preparing its workers to take advantage of the new opportunities.

If that is true, then there should be millions of jobs available to soak up the workers released from manufacturing, and wages should be soaring because we have a structural flaw in economy - the skills of the released workers do not match those needed by expanding sectors. That structural flaw should be sufficient to encourage workers to gain more education and employers to provide more on the job training. While I am sure that is true in a few sectors, in aggregate real wages and nonfarm payrolls have been stagnant for a decade. Where are these high wage paying jobs? Or even median wage paying jobs at this point? Silly me, I actually believe the unapologetic and unquestioning supporters of free trade need to answer this question. We are millions of jobs below trend, and we have lost millions of jobs in manufacturing - the manufacturing of goods that we still consume, no less. Moreover, these two trends occurred in the same decade, in concert with a third trend - the sharp rise in foreign official reserve accumulation. How can you not be even allowed to suggest that there just might be a connection?

As always, questioning the nature of trade patterns this decade means you are an ignorant protectionist. Blinder tried to get ahead of this argument:

What else is to be done? Trade protection won't work. You can't block electrons from crossing national borders. Because U.S. labor cannot compete on price, we must reemphasize the things that have kept us on top of the economic food chain for so long: technology, innovation, entrepreneurship, adaptability and the like. That means more science and engineering, more spending on R&D, keeping our capital markets big and vibrant, and not letting ourselves get locked into "sunset" industries.

What is amusing about the whole analysis is that I believe free trade works, but I also believe we don't really have free trade. In reality, foreign central banks manipulate currency levels such they accumulate massive amounts of foreign exchange reserves that effectively recycle Dollars back into the US to support consumption activities, and thus impact the dynamics of trade flows in an obviously mercantilistic fashion. This has been accomplished with the full acceptance and even cooperation of the US Treasury. It was an outcome of the strong Dollar policy, and it is why China has not been named a currency manipulator since 1994. But those central banks are immune from criticism on free trade because they interfere in the financial side of the external accounts, not the current transactions side. Indeed, one cannot even question the negative impacts of this dynamic. Avent essentially falls back on the same argument I lamented about last week:

... every right minded economist and policymaker knows unequivocally that free trade is good, and to even question that assumption makes one an ignorant heretic who has never heard of Smoot-Hawley. Therefore, the examination ends. Manufacturing's decline simply cannot be a problem if it is consequence of international trade because everyone knows international trade is good.

Another version of this argument: International trade is driven by comparative advantage. If manufacturing jobs are lost from international trade, is must be the result of a relative comparative disadvantage. The financial side of the account is irrelevant.

If you fall back on the pro-free trade argument that service sector jobs will compensate for the offshoring in manufacturing, you ignore the fact that the currency manipulation that impacted manufacturing will have the same impact on the service sector jobs if they are truly tradable. If service sector jobs are just as offshorable as manufacturing jobs, then Blinder's prescription is destined to fail unless there is a concerted, sustained effort to control the accumulation of reserves among foreign central banks.

I very much recommend Michael Pettis for an another view of what I consider to be the same problem:

...As net capital exporters try desperately to maintain or increase their capital exports, and deficit Europe sees net capital imports collapse, the only way the world can achieve balance without a sharp contraction in the capital-exporting countries is if US net capital imports surge. And at first they will surge. Foreigners, in other words, will buy more dollar assets, including USG bonds, than before.

But remember that an increase in net US imports of capital is just the flip side of an increase in the US current account deficit. This means that the US trade deficit will inexorably rise as Germany, Japan and China try to keep up their capital exports and as European capital imports drop.

I have little doubt that as the US trade deficit rises, a lot of finger-wagging analysts will excoriate US households for resuming their spendthrift ways, but of course the decline in US savings and the increase in the US trade deficit will have nothing to do with any change in consumer psychology or cultural behavior. It will be the automatic and necessary consequence of the capital tug-of-war taking place abroad.

The US, in other words, is not likely to face the “nuclear option” of a Chinese disruption of the US Treasury bond market. It is far more likely to be swamped by a tsunami of foreign capital. This tsunami will bring with it a corresponding surge in the US trade deficit and, with it, a rise in US unemployment. It will also force the US Treasury to increase the fiscal deficit as more of the jobs created by its spending leak abroad.[Emphasis added]

Therein lies the problem. A reduction in net foreign capital inflows means a welcome decline in the US trade deficit, but the US is likely to see just the opposite. Foreign capital will push desperately into US markets and as an automatic consequence the US trade deficit will surge. So the problem isn’t too little capital inflow or a sudden boycott of USG bonds. On the contrary, the US will see too much capital inflow.

All this may turn out to be very bad for the US economy, but in the past massive capital recycling has usually been very good for asset markets. Might we see a surge in the US asset markets, at least until next year when Congress starts getting tough on the trade deficit? I would be willing to bet that we do.

The patterns of capital flows and how those flows have impacted production and consumption location outcomes is a critically important issue. Even more so if the flows into the US are simply supporting consumption spending via fiscal deficits but creating relatively few jobs because that spending is quickly directed overseas, and the pace of that direction accelerates as industrial capacity contracts. Yet if you even suggest the shift in production outcomes is creating very serious and long lasting problems, your thoughts are considered "fairly poorly reasoned."

Bottom Line: When I express concerns over free trade, I am really expressing immense frustration over an international financial architecture that sustains and maintains global imbalances that yield outcomes that I believe are very difficult to justify and yet are accepted due to a blind faith in free trade. In essence, the ability to manipulate capital flows has made a mockery of the free trade crowd. I know. I used to be in that crowd, and in many ways still am. But I can no longer wrap myself in the free trade flag to justify the negative impacts of financial account manipulation. And if the US cannot seriously address financial account manipulation on a global basis - and if the Pettis article is correct, the US Treasury will fall short of what is needed even with the announced adjustment to Chinese currency policy - what choices are you left with? Either accept continued economic stagnation, or act unilaterally on the current transactions (tariffs) or financial (reciprocative devaluation or capital controls) side of the accounts. None of which are pleasant options.

Friday, June 25, 2010

Paul Krugman: The Renminbi Runaround

Paul Krugman says "China needs to stop giving us the runaround and deliver real change" in its currency policy:

The Renminbi Runaround, by Paul Krugman, Commentary, NY Times: Last weekend China announced a change in its currency policy, a move clearly intended to head off pressure from the United States and other countries at this weekend’s G-20 summit meeting. Unfortunately, the new policy doesn’t address the real issue, which is that China has been promoting its exports at the rest of the world’s expense.
In fact, far from representing a step in the right direction, the Chinese announcement was an exercise in bad faith... In short, they’re playing games.
To understand what’s going on, we need to get back to the basics of the situation. China’s exchange-rate policy is neither complicated nor unprecedented, except for its sheer scale. It’s a classic example of a government keeping the foreign-currency value of its money artificially low by ... buying foreign currency. ...
There have been all sorts of calculations purporting to show that the renminbi isn’t really undervalued, or at least not by much. But if the renminbi isn’t deeply undervalued, why has China had to buy around $1 billion a day of foreign currency to keep it from rising?
The effect of this currency undervaluation is twofold: it makes Chinese goods artificially cheap to foreigners, while making foreign goods artificially expensive to the Chinese. That is, it’s as if China were simultaneously subsidizing its exports and placing a protective tariff on its imports.
This policy is very damaging at a time when much of the world economy remains deeply depressed. In normal times, you could argue that Chinese purchases of U.S. bonds, while distorting trade, were at least supplying us with cheap credit... But right now we’re awash in cheap credit; what’s lacking is sufficient demand for goods and services to generate the jobs we need. And China, by running an artificial trade surplus, is aggravating that problem.
This does not, by the way, mean that China gains from its currency policy. The undervalued renminbi is good for politically influential export companies. But these companies hoard cash rather than passing on the benefits to their workers, hence the recent wave of strikes. Meanwhile, the weak renminbi creates inflationary pressures and diverts a huge fraction of China’s national income into the purchase of foreign assets with a very low rate of return.
So where does last week’s policy announcement fit into all this? Well, China has allowed the renminbi to rise — but barely. As of Thursday, the currency was only about half a percent higher than its typical level before the announcement. ... Chinese officials are still making statements denying that a rise in their currency will do anything to reduce trade imbalances, and ... suggest a rise of only about 2 percent ... by the end of this year. This is basically a joke.
What the Chinese have done, they claim, is to increase the “flexibility” of their exchange rate: it’s moving around more from day to day than it did in the past, sometimes up, sometimes down.
Of course, Chinese policy makers know perfectly well that although U.S. officials have indeed called for more currency flexibility, that was just a diplomatic euphemism for what America, and the world,... has the right to demand...: a much stronger renminbi. Having the currency bob up or down slightly makes no difference to the fundamentals.
So what comes next? China’s government is clearly trying to string the rest of us along, putting off action until something — it’s hard to say what — comes up.
That’s not acceptable. China needs to stop giving us the runaround and deliver real change. And if it refuses, it’s time to talk about trade sanctions.

Tuesday, June 22, 2010

Fed Watch: China, Day One

Tim Duy follows up on his post expressing skepticism about China's announcement that it intends to increase the RMB exchange rate flexibility:

China, Day One, by Tim Duy: My skepticism was valid for at least a day. Market participants quickly lost interest in the Chinese revaluation story, with stock ending down for the day:

“The announcement out of China elicited an emotional response from the market,” said Alan Gayle, senior investment strategist at RidgeWorth Investments in Richmond, Virginia, which oversees $63 billion. “A closer look at the announcement suggests China’s approach is very gradual and it is continuing at its own pace. It’s a less dramatic move when looked at more closely.”

The muted reaction was not limited to equities:

Treasuries pared losses on speculation the drop in debt in response to China’s decision to allow a more flexible yuan was too big to be sustained.

“The market is coming to the conclusion that it had overreacted to the news out of China,” said Charles Comiskey, head of Treasury trading at Bank of Nova Scotia in New York. “The policy and what it ultimately means is an open question. It’s so vague.”

The yuan "surged" to just below its existing trading range, while the parity rate was adjusted slightly in response to Monday's moves. This fostered a yuan decline:

China’s yuan declined the most since December 2008 on speculation the central bank will encourage more two-way fluctuations in the exchange rate after it pledged to expand flexibility.

The People’s Bank of China set the reference rate for yuan trading 0.43 percent stronger, the biggest gain in five years, reflecting appreciation yesterday. China’s reforms don’t necessarily mean the currency will appreciate, the official People’s Daily reported yesterday.

“There is bigger two-way fluctuation, which is quite normal,” said Lu Zhengwei, an economist at Industrial Bank Co. in Shanghai. “The reference rate shows it is now based on market demand and supply, and no longer strictly controlled.”

The yuan declined 0.2 percent to 6.8111 per dollar as of 10:17 a.m. in Shanghai, from 6.7976 yesterday, according to the China Foreign Exchange Trade system. That was the biggest loss since December 2008. It strengthened as much as 0.1 percent to 6.79 earlier today.

In any event, the today's market response to the Chinese announcement suggests that this is a considerably less dramatic event than the press would like you to believe. Of course, the press is being spoon-fed the news by Washington. From the Wall Street Journal:

President Barack Obama, badly in need of good news, got some over the weekend from the most unlikely of sources: China, which said it would allow the value of its currency to rise, thereby answering the single most fervent prayer U.S. officials utter when seeking divine intervention to help with America's big trade deficit.

...the two moves show that the U.S.-Chinese relationship has a healthier glow than it did just a few months ago, when the two nations were arguing about global warming, a visit by the Dalai Lama to the White House and American arms sales to Taiwan.

More importantly, the steps suggest a certain maturing of China's view of its role in global affairs—and a more deft touch by the Obama administration in coaxing China into playing that role responsibly.

Note the spin - China's decision represents a "maturing," aided by the "deft touch" of the Obama Administration. Now, what did China exactly do to "mature?" China has not unpegged their currency. At best, they resumed a crawling peg policy put on hiatus two years ago. At worst, they simply uttered empty words that have no real economic relevance, whose only intention was to divert attention from China at the upcoming G20 meeting, allowing for a full court press on Germany. German Chancellor Angel Merkel should take a hint and issue the following statement: "The focus of German fiscal policy will be consistent with G20 goals of promoting global growth." Of course, German policymakers believe that means fiscal austerity, but no matter. It is the words that are important. Actions less so.

The PR overload suggests the Administration is desperately in need of a "win," no matter how trivial. After all, there is a hole in the Gulf of Mexico that is leaking oil uncontrollably, creating an environmental disaster that may rival what, Chernobyl? And it is clear the Administration was late in the game realizing the magnitude of the crisis. Meanwhile, unemployment hovers around 10%, and no one expects it to be much different in six months. While likely sustainable, economic growth is anemic compared to previous recoveries from deep recessions, and appears to guarantee a substantial output gap for years to come. The Administration has no real plan to close that gap, nor do they appear particularly troubled by it. Policymakers can’t even push through a low cost jobs bill.

But these are lesser problems. The full effort of American power can instead come to bear on Chinese currency policy and walk away with a monumental commitment to allow the dollar-renminbi rate to fluctuate within its existing trading band and perhaps appreciate imperceptibly.

While China appears willing to adjust the parity rate, changes are likely to be more window dressing than anything else. The industrial base shifted from the US to China over the past twenty years, a transition aided by the Clinton Administration's commitment to a strong dollar, and it is not going to come rushing back for a for percentage points of currency value. The structural shift has happened, and it won't reverse easily. Still, the story is not over yet. With this much praise, the Administration is clearly looking for something else from China. Further support on Iran? North Korea? Time will tell.

Monday, June 21, 2010

Tim Duy: China Moves. Or Not.

Is China's announcement that it intends to increase the RMB exchange rate flexibility "more smoke than fire"?:

China Moves. Or Not., by Tim Duy: Futures markets are abuzz with excitement over the Chinese currency proclamation issued this weekend. The announcement was quickly hailed by observers worldwide as a major policy shift, yet I am inclined to side with the analysis provided by Yves Smith - the statement leaves plenty of wiggle room, and never really promises to do much of anything. At the moment, the Chinese announcement feels like more smoke than fire.

The Wall Street Journal's initial reporting was just want the Bejing and Washington wanted you to believe:

China's decision to abandon its currency peg is a victory of pragmatism over divisive politics, the result of careful diplomacy by leaders in Beijing and in Washington, each side vulnerable to powerful domestic lobbies.

In the end, both sides agreed that a more flexible exchange rate was good for China, good for the U.S. and good for the global economy. Yet timing was everything.

The implication is that hard-working policymakers on both sides of the Pacific have risked all to foster the greater good. But what exactly has changed? From the Chinese statement:

It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market

What exactly will be the basket of currencies? On what timetable? Is this really a change? And why not widen the floating bands? I see no commitments here, vague or otherwise. Of course, there are not meant to be. From the Wall Street Journal:

Yet, by returning the yuan to a managed float against a basket of currencies, Beijing won't have to cede too much in the near term when it comes to the bilateral dollar/yuan rate. The euro's weakness-the yuan is up 14% against the euro this year-should mitigate the speed of any yuan appreciation against the dollar.

Looks like China is picking a policy direction that requires little deviation from current policy. Nor do they even admit there is a need for significant change. The Chinese announcement appears to preclude the possibility of meaningful adjustments.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist.

Is "large-scale" 5%? 10%? 20%? The tone of subsequent reporting changed as journalists not sourced directly by Washington and Bejing began to realize the thinness of the Chinese announcement. From the Wall Street Journal:

China's announcement that it will let its currency appreciate puts it in a strong position going into a summit of the Group of 20 on Saturday, but does little to ease pressure from the U.S. Congress.

...But China's announcement was short on details about how much it would let the yuan appreciate. In Brazil, the central bank governor, Henrique Meirelles, said he welcomed the Chinese announcement, but wanted to see results. "It is necessary to await further developments," he said in a statement.

Is the Chinese announcement anything more than an effort to buy time ahead of next weekend's G-20 meeting? The yuan was likely to be a primary topic, but the announcement now provides cover for Chinese officials, pushing the attention on fiscal policy in Germany and Japan. A clever diplomatic trick, but will China follow through with anything more than a token rate change? They need to, as Congress will not be held at bay much longer:

In the U.S., New York Democratic Sen. Charles Schumer, who has spent a decade ramping up pressure on China over currency issues, remains skeptical that Beijing's announcement will make an appreciable difference. On Sunday, reacting to Chinese suggestions that change would be gradual, Mr. Schumer said he would move forward on legislation to penalize China for undervaluing its currency.

"Just a day after there was much hoopla about the Chinese finally changing their policy, they are already backing off," he said in a statement.

Schumer's skepticism is justified. Where is the yuan going, and how quickly will it get there? Estimates are all over the map. From Bloomberg:

The yuan’s appreciation may be limited to 1.9 percent against the dollar this year, a survey of economists showed. The currency will climb to 6.7 per dollar by Dec. 31, according to the median estimate of 14 analysts.

Later in the same article:

“We can’t exclude the possibility of yuan depreciation,” said Shen Jianguang, Mizuho Securities Asia Ltd.’s chief economist for Greater China, who said a 2.5 percent drop is possible this year if the dollar-euro rate is unchanged.

From the Wall Street Journal:

U.S. government officials expect a slow, steady increase, similar to the way China boosted the value of the yuan between 2005 and 2008.

Another opinion from the same article:

Eswar Prasad, a Cornell University economist who was formerly the IMF's top China expert, said the size of the increase during the coming month will give a hint at the "trajectory" Beijing is anticipating.

He says that in periods of economic calm, China "is comfortable with" an increase in the value of the yuan of about 10% to 15% a year.

Congress will be closely watching for any signs of foot dragging on the part of China. I am not confident they will tolerate anything less than a 15% move this year. Note too that China is not the only one buying time with this announcement. US Treasury Secretary Timothy Geithner can now release the delayed report on currency practices, which will surely not label China a manipulator. That hot potato can go back into the oven for another six months. Geithner is clearly betting the Chinese will have shown enough results between now and then to placate Congress. If not, Congress will start sharpening the knives; the tolerance for Chinese resistance will be almost negligible of this announcement is revealed to be nothing more than smoke and mirrors.

Bottom Line: On the surface, the Chinese announcement looks like just what the doctor ordered - a step toward a meaningful effort at rebalancing global activity. But the details are thin, very, very thin. Thin enough that one can reasonably look straight through the statement and conclude it is little more than an effort to keep China off the hot seat at the next G20 meeting. Time will tell if China actually intends a substantial change in currency policy. I hope this is in fact their intention, as the probability of a disastrous trade war will skyrocket if Congress believes they have been the victim of a classic bait and switch.

Update: Reality sets in quickly. From the Wall Street Journal:

China kept the yuan's exchange rate unchanged against the dollar Monday, surprising markets after announcing over the weekend it was unhitching its de facto peg.

Underscoring its vow to move gradually in liberalizing its rigid foreign-exchange regime, the central bank set the yuan's central parity rate, an official reference level for daily trading, at 6.8275 yuan to the dollar, exactly the same as Friday's central parity rate. The fixing put the yuan slightly weaker than Friday's close in over-the-counter trading of 6.8262 yuan to the dollar.

Saturday, June 19, 2010

Eichengreen: China Needs a Service-Sector Revolution

With wages increasing in China, which has effects similar to a currency appreciation, will it be possible for China make the transition to an economy where the domestic service sector expands to take up the slack created as manufactured goods become more expensive and hence more difficult to export?:

China Needs a Service-Sector Revolution, by Barry Eichengreen, Commentary, Project Syndicate: China is getting its exchange-rate adjustment whether it likes it or not. While Chinese officials continue to mull the right time to let the renminbi rise, manufacturing workers are voting with their feet – and their picket lines.
Honda has offered its transmission-factory workers in China a 24% wage increase to head off a crippling strike. Foxconn, the Taiwanese contract manufacturer for Apple and Dell, has announced wage increases of as much as 70%. Shenzhen, to head off trouble, has announced a 16% increase in the minimum wage. Beijing’s municipal authorities have preemptively boosted the city’s minimum wage by 20%.
The result will be to raise the prices of China’s exports and fuel demand for imports. The effect will be much the same as a currency appreciation. ... With exports of manufactures becoming more expensive, China will have to ... move ... toward the model of a more mature economy, in which employment is increasingly concentrated in the service sector. ...
But the bad news is that the transition now being asked of China – to shift toward services without experiencing a significant decline in economy-wide productivity growth – is unprecedented in Asia. Every high-growth, manufacturing-intensive Asian economy that has attempted it has suffered a massive slowdown. ...
Why is this? In countries that have traditionally emphasized manufacturing, the underdeveloped service sector is dominated by small enterprises – mom and pop stores. These lack the scale to be efficient...
In both Korea and Japan, large firms’ entry into the service sector is impeded by restrictive regulation, for which small producers are an influential lobby. ... Foreign firms that are carriers of innovative organizational knowledge and technology are barred from coming in. Accountants, architects, attorneys, and engineers all then jump on the bandwagon, using restrictive licensing requirements to limit supply, competition, and foreign entry.

One can well imagine Chinese shopkeepers, butchers, and health-care workers following this example. The results would be devastating. ... Employing workers in sectors where their productivity is stagnant would not be a recipe for social stability. China needs to avoid the pattern by which past neglect of the service sector creates a class of incumbents who use political means to maintain their position. Perhaps China will succeed in avoiding this fate. Here at least may be one not-so-grim advantage to not being a democracy.

Update: The People's Bank of China announces plans to enhance the RMB exchange rate flexibility.

Monday, June 14, 2010

Should China allow the Yuan to Rise?

At The Economist's Guest Network, we were asked:

Should China allow the yuan to rise? Is a stronger yuan the most important route to global rebalancing? And should addressing imbalances currently be a top global policy priority?

My response is here. There several are more here from Roach, Pettis, Bordo, Calvo, and Subramanian, and more responses may be posted later.

Friday, June 11, 2010

"Dealing With Chermany"

Paul Krugman says it's time to get tough with Germany and China:

Dealing With Chermany, by Paul Krugman: So here’s where we are: China has done nothing to change its policy of massive currency manipulation, and its exports are surging. Meanwhile, Europe is going wild for fiscal austerity. Angela Merkel says that budget cuts will make Germany more competitive — but competitive against whom, exactly?
You know the answer, don’t you? Yep: everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi. Oh, and while they rely on US demand to make up for their own contractionary policies, they’ll lecture us on how irresponsible we’re being, running those budget and current account deficits.
This is not going to work — and the United States has to take steps to protect itself.
Let’s start with China. Back in April we were told to lay off on the currency manipulation charges; the grownups would work something out with China. How’s that going, exactly?
Yes, threatening an anti-dumping duty would be a big step, and might pose some risks. But doing nothing is not an acceptable option. The economic recovery is in great danger of stalling — and if it does, the consequences will be a lot worse than a diplomatic tiff.
And it’s also important to send a message to the Germans: we are not going to let them export the consequences of their obsession with austerity.
Nicely, nicely isn’t working. Time to get tough.

Friday, May 21, 2010

Random Thoughts on China

Just a couple of thoughts before I head to the airport for the long flight home. Someone once told me that China is an interesting mix of the very old and the very new -- there's very little in the middle. And that does seem to be true. It is due to the abrupt transition that has been made, most places do not develop so rapidly and hence have middle-aged parts, not just old and new, and the pace of the transition shows. There are inevitable growing pains associated with development that is this rapid.

My casual observation both from all the government presentations on the economy I heard from various government ministers over the last two days and from walking around is that the economic development mirrors this pattern that. There is the new and efficient, and there are the old ways of doing things that are much less modern and much less efficient. There's very little in the middle. As I said on a tweet yesterday while strolling around, although growth of output has been high, it seems to me that there are still many, many people playing "small ball" economically, and hence there is still quite a bit or room for productivity to increase.

Anyway, glad I had the opportunity to come here and see what is happening first hand, particularly the ability to hear from and talk to people from the agencies in charge of economic development (though most of them were involved in one way or another with job creation and development, so I didn't hear all about all the issues they face). I am in the heart of Beijing, fairly close to the Forbidden City -- you don't see many cranes, etc. constructing new buildings since this area is already pretty densely developed -- so I may not have gotten a very good sense of the old-new balance (even so, there is lots of construction in evidence, mostly old buildings being gutted or raised to make room for something else). All in all, it's a pretty interesting place. I saw no signs of anything but full spreed ahead,

Looks like the next conference is Budapest in June. That will be interesting too. If someone had told me that starting a blog would lead to world travel on other people's dimes, I would have laughed. But it has. And all I can say is huh. Cool. Didn't expect that.

I am not looking forward to getting to the airport 2 hours early, my 12 hour flight, 6 hour layover in SF, and then the 1 hour flight to Eugene (and on the way here, one plane was delayed an extra three hours). But clicking my heels together and wishing I was back in Kansas (OK, Oregon) won't get it done, so I guess I don't have much choice. So I'd better get going -- maybe I can connect at the airport. If not, and I'm pretty much out of the international data plan I got before coming, no more internet until SF. I hope I don't get tremors from the withdrawal (I have two posts that I set before I left to publish later tonight).

Apologies for writing so little the last several days. The opportunity cost was giving up the chance to use the few free hours I had to see (a little bit of) Bejing, and I decided MU/P was higher for sight-seeing than for most anything else. But Tim Duy did a pretty good job picking up the slack, so I owe him a thanks.

Tuesday, May 18, 2010

On the Road Again

I am traveling to China today (Beijing) to talk at a conference about US fiscal policy during the crisis, and have no idea about my ability to connect here once I arrive. I assume it won't be a problem, but just in case -- and because I won't have as much time as usual -- I have things set to post automatically until I get back.

Update: Finally here. Here are the slides for my presentation today.

Google is different here, but if I log onto the VPN at school I can get to the regular version. Sometimes my blog won't come up if I'm not logged in to the VPN, but not always, so not sure what's up. Blogs hosted by Google on blogger seem to be missing, and other blogs on TypePad don't always load either (though they do show up on Google unlike the blogs on blogger). With VPN though, no troubles. Anyone know the current state of blog access here?

Sunday, May 02, 2010

"The 'Real' Causes of China’s Trade Surplus"

Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti argue, based upon their forthcoming AER article, that although China has accumulated nearly two and a half trillion in reserves in the last two decades, "it is wrong, and even dangerous, to blame this on a manipulation of the exchange rate." They argue that the existence of credit market imperfections leading to the need for high levels of internal savings provides a better explanation:

The “real” causes of China’s trade surplus, by Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti, Vox EU: Over the last two decades, China has run large trade surpluses. Its foreign reserves swelled from $21 billion in 1992 (5% of its annual GDP) to $2.4 trillion in June 2009 (close to 50% of its GDP). The effect of this gigantic build up of reserves has been a source of growing public attention in the context of the debate on global imbalances. This debate has gained momentum during the global crisis. Lobbyists and politicians voice the popular concern that by swamping western markets with its products, China contributes to the failure of domestic firms and job losses. The call for protectionism is mounting.

Did China engineer a trade surplus?

A common argument, especially in the US, is that the culprit of global imbalances is the exchange rate manipulation carried out by the Chinese authorities, who peg the renminbi to the dollar at a low value. According to Fred Bergsten, head of the Peterson Institute for International Economics, the renminbi is undervalued by at least 25% to 40%. This "hostile" policy raises calls for robust retaliation.

While economists have so far opposed any measure that might ignite a vicious cycle of trade retaliations and protectionism, even their front is cracking. Krugman (2010) advocated using the threat of a 25% import surcharge to force China to revalue. Last month, 130 lawmakers signed a letter asking the US Treasury to increase tariffs on Chinese-made imports. On 12 April 2010, Barack Obama openly criticized the Chinese exchange-rate policy in front of Hu Jintao, arguing that currencies should "roughly" track the market so that no country has an advantage in trade. Meanwhile, Senator Charles Schumer called for high tariffs against Chinese imports in order to force Beijing to revalue its currency.

The exchange rate manipulation premise

The manipulation thesis rests on the simple postulate that the imbalance itself is evidence of a misalignment of the exchange rate. Letting market forces determine the exchange rate would restore trade balance.

This argument has weak foundations. What matters is the real exchange rate, not the nominal one. While the Chinese surplus has persisted for almost two decades, the real exchange rate has remained as flat as a pancake (see McKinnon 2006, Figure 3). A misaligned real exchange rate should feed domestic inflation, e.g., by increasing the demand of non-traded goods and stimulating domestic wage pressure. Yet, until very recently it does not appear as if China has experienced any major inflationary pressure – between 1997 and 2007 the inflation rate was on average about the same as in the US. Moreover, wages have grown slower than output per worker (see Banister 2007).

In a recent article on this site, Helmut Reisen (2010) shows that a large part of the alleged undervaluation of the renminbi can be attributed to the Balassa-Samuelson effect (i.e., the fact that non-traded goods do not follow the law of one price and are relatively cheap in developing countries). He concludes that "the undervaluation in 2008 of the renminbi was only 12% against the regression-fitted value for China's income level." This is by no means a large number: “Both India and South Africa (which had a current-account deficit) were more undervalued in 2008.” In summary, while it is reasonable to expect some appreciation of the real exchange rate in the years to come (through either inflation or adjustments in the nominal exchange rate), the government manipulation of the nominal exchange rate is unlikely to be the primary cause of the two-decades-long imbalance.

A “real” explanation: Growing like China

What, then, can account for the Chinese surplus? We believe that the answer lies in real (i.e., structural) factors rather than in nominal rigidities. Let us look at the imbalance from an asset flow perspective: 

Continue reading ""The 'Real' Causes of China’s Trade Surplus"" »

Friday, April 23, 2010

Will Chinese Revaluation Create American Jobs?

An argument that revaluation of the renminbi/renembi won't have much effect on jobs in the US:

Will Chinese revaluation create American jobs?, by Simon J Evenett and Joseph Francois, Vox EU: Many in the US are pushing China to revalue the renminbi. Will that create US jobs? Traditional Keynesian analysis associates higher exports and lower imports with more jobs, but today’s world is more complex. Chinese parts and components feed into US firms’ global competitiveness. This column says a dearer renembi would boost the competitiveness of US exports to China but reduce US competitiveness everywhere else. A revaluation may be the right policy for other reasons, but its impact on US jobs is far from clear.

Undervaluation of China’s exchange rate is central to the debate on the right global policy mix in the aftermath of the economic crisis. Estimates of the undervaluation vary (from zero to 40%, Cheung, Chinn, and Fuji 2010) along with the reasons for focusing on the renembi:

  • The IMF expresses concern about persistent capital account imbalances and asymmetries between surplus and deficit countries, with concern that imbalances contributed to past global financial instability and could so in future. The IMF also calls an exchange rate appreciation “essential” for China’s domestic macroeconomic situation (IMF 2010).
  • Senior Brazilian and Indian officials call upon their Chinese counterparts to revalue the renminbi to mitigate competitiveness concerns.
  • In the US, some call for revaluation as a means of redressing the bilateral imbalance with China and quickly creating US jobs.

In this column, we focus on the last issue; that is, whether it is realistic to expect a US jobs bonus to follow a Chinese revaluation. ...

With extensive global supply chains and outsourcing, a modest Chinese revaluation will ... raise costs for US firms and thus harm US competitiveness everywhere except in the Chinese market. This cost-raising effect mutes the current account improvement and, by our estimates, may result in 424,000 jobs losses in the US.

Findings such as these call for a rethink of aggressive foreign trade policy towards China, not just by the US but all those nations that supply and source parts and components to and from China as part of global supply chains.

And, rebuttal:

Estimating the effect of renminbi appreciation on US jobs: A comment on Francois' China result, by William R. Cline, Vox EU: Would appreciation of the renminbi actually destroy US jobs? This column discusses recent estimates that find that making intermediate inputs from China more expensive would hurt US global competitiveness. It argues that the direct effect of an improvement in the US trade balance would create far more jobs than might be lost to more expensive intermediate inputs.

In a recent study, Francois (2010) estimates that if China appreciated the renminbi by 10%, the US trade balance would rise by $100 billion but the number of US jobs would decline by 430,000. He uses a computable general equilibrium (CGE) model to make this calculation. He allows for below-full capacity and sticky wages so that it is possible for a change in the external balance to affect the level of employment. The paradoxical negative sign on employment as a consequence of the currency correction stems from the model specification that emphasizes induced losses of jobs throughout the economy that result as a consequence of the increase in costs of intermediate inputs imported from China and used in the US economy. Francois argues that the gain of employment in exports and import substitutes would be too small to offset the loss of jobs in the general economy; hence the net loss of 430,000 jobs. This column examines whether these results make sense. ...

This exercise suggests that something appears to have gone wrong in the Francois calculations. A reasonable approximation of his two opposing effects suggests that the 10% RMB appreciation would create 320,000 jobs from the US trade balance improvement and eliminate only 32,000 jobs from the induced effect of higher intermediate input costs to US manufacturing. ...

Even if the effect on US jobs is small, we should still care about the effect of China's currency policy on other developing countries. That's where China's currency policy is likely have the greatest effect in terms of shifting the location of manufacturing employment.

The effect of the policy on global imbalances and the potential impact on financial stability is also of concern. However, given the IMF's behavior toward countries that needed help in the past, it's hard to be critical of the desire to establish a reserve fund as insurance against having to turn to the IMF for help. That's why giving countries such as China a larger role in determining IMF policies could help with currency alignment problems. With a credible change in IMF policy, countries could get the help they need when troubles arise at a smaller cost than it takes to build up large reserve balances.

Thursday, April 22, 2010

Eichengreen: Why China is Right on the Renminbi

Barry Eichengreen says that China's exchange rate policy is "exactly right":

Why China is Right on the Renminbi, by Barry Eichengreen, Commentary, Project Syndicate: After a period of high tension between the United States and China, culminating earlier this month in rumblings of an all-out trade war, it is now evident that ... China is finally prepared to let the renminbi resume its slow but steady upward march. ...
Some observers, including those most fearful of a trade war, will be relieved. Others, who see a substantially undervalued renminbi as a significant factor in US unemployment, will be disappointed by gradual adjustment. They would have preferred a sharp revaluation of perhaps 20%...
Still others dismiss the change in Chinese exchange-rate policy as beside the point. For them, the Chinese current-account surplus and its mirror image, the US current-account deficit, are the central problem. ... The US is running external deficits because of a national savings shortfall, which once reflected spendthrift households but now is the fault of a feckless government.
There is no reason, they conclude, why a change in the renminbi-dollar exchange rate should have a first-order impact on savings or investment in China, much less in the US. There is no reason, therefore, why it should have a first-order impact on the bilateral current-account balance, or, for that matter, on unemployment, which depends on the same saving and investment behavior.
In fact, both sets of critics have it wrong. China was right to wait in adjusting its exchange rate, and it is now right to move gradually rather than discontinuously. ...
China successfully navigated the crisis, avoiding a significant slowdown, by ramping up public spending. But, as a result, it now has no further scope for increasing public consumption or investment.
To be sure, building a social safety net, developing financial markets, and strengthening corporate governance to encourage state enterprises to pay out more of what they earn would encourage Chinese households to consume. But such reforms take years to complete. In the meantime, the rate of spending growth in China will not change dramatically.
As a result, Chinese policymakers have been waiting to see whether the recovery in the US is real. If it is, China’s exports will grow more rapidly. And if its exports grow more rapidly, they can allow the renminbi to rise. ...
Evidence that the US recovery will be sustained is mounting. As always, there is no guarantee. ... Because the increase in US spending on Chinese exports will be gradual, it also is appropriate for the adjustment in the renminbi-dollar exchange rate to be gradual. ...

Chinese officials have been on the receiving end of a lot of gratuitous advice. They have been wise to disregard it. In managing their exchange rate, they have gotten it exactly right.

Wednesday, April 21, 2010

"Brazil and India add to China Pressure"

Interesting development on China's currency policy:

Brazil and India add to China pressure, by Geoff Dyer, Financial Times: China is facing growing pressure from other developing countries to begin appreciating its currency, providing unexpected allies for the US in the diplomatic tussle over Beijing’s exchange rate policy. ...
Indian and Brazilian central bank presidents have made the most forceful statements yet by their countries about the case for a stronger Chinese currency.
While most of the public pressure on China has come from the US, the comments underline that a number of developing economies feel that China’s dollar peg has imposed costs on their economies. ...
Lee Hsien Loong, prime minister of Singapore, added his country’s voice to the debate last week, saying it was “in China’s own interests” with the financial crisis over to have a more flexible exchange rate.
Some in China have fended off US pressure for a stronger currency, describing it as a distraction from the real causes of the financial crisis. However, criticism from developing countries is not so easy to bat away. ...
The increase in criticism of China comes at a time of relative calm between Beijing and Washington over the issue, with many US officials and analysts assuming China has already decided to abandon its peg with the dollar over coming months. ...

I've been interested in how the crisis would affect the strategy of developing economies, in particular if we would see an increase in the number of countries abandoning Western-style development strategies that are, at their heart, market-based in favor of more centrally directed development such as in China.

However, part of China's development strategy includes its currency policy, and if both developed and developing countries begin to view these policies as coming at the expense of other nations, at the expense of developing nations in particular, there may be less willingness to pursue similar strategies (e.g. due to fear of retaliation in the form of trade restrictions imposed by nations that believe they are being harmed by the policy).

Tuesday, April 06, 2010

"Evaluating the Renminbi Manipulation"

Following up on the Joe Stiglitz post below this one, Martin Wolf has a different view. Unlike Stiglitz, he thinks that sanctions against China in retaliation for its currency policy are needed if China doesn't change its ways:

Evaluating the renminbi manipulation, by Martin Wolf, Commentary, Financial Times: The incumbent superpower has blinked in its confrontation with the rising one: the US Treasury has decided to postpone a report due by April 15 on whether China is an exchange-rate manipulator. ...

Is China a currency manipulator? Yes. ...China has controlled the appreciation of both nominal and real exchange rates. This surely is currency manipulation. It is also protectionist, being equivalent to a uniform tariff and export subsidy. Premier Wen Jiabao has protested against “depreciating one’s own currency, and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism”. The Chinese pot is calling the US kettle black.

Yet some economists deny this, offering four counter-arguments: first, while the intervention is huge, the distortion is small; second, the impact on the global balance of payments is modest; third, global “imbalances” do not matter; and, finally, the problem, albeit real, is being resolved. Let us consider each of these points in turn. ...[explains why he believes each point is wrong]...

I conclude that the renminbi is undervalued, that this is dangerous for the durability of global recovery and that China’s actions have not, so far, provided a durable solution. I conclude, too, that rebalancing is a necessary condition for sustainable recovery, changes in competitiveness are a necessary condition for rebalancing, real renminbi appreciation is necessary for changes in competitiveness, and a rise in the currency is necessary for real appreciation, given the Chinese desire to curb inflation.

The US was right to give talking a chance. But talk must lead to action. 

Also, please see this update from Paul Krugman:

Immaculate Transfer Strikes Again, by Paul Krugman: Oh, dear. Via Mark Thoma, I see that Joe Stiglitz has fallen victim to the doctrine of immaculate transfer...

[As Krugman explains here, Steven Roach - who is also mentioned by Martin Wolf - is another recent victim.]

Stiglitz: No Time for a Trade War

Joseph Stiglitz warns against unilateral sanctions against China in retaliation for its currency policy:

No Time for a Trade War, by Joseph E. Stiglitz, Commentary. Project Syndicate: The battle with the United States over China’s exchange rate continues. When the Great Recession began, many worried that protectionism would rear its ugly head. ... But ... protectionism was contained, partly due to the World Trade Organization.
Continuing economic weakness ... risks a new round of protectionism. In America, for example, more than one in six workers who would like a full-time job can’t find one.
These were among the risks associated with America’s insufficient stimulus, which was designed to placate members of Congress as much as it was to revive the economy. With soaring deficits, a second stimulus appears unlikely, and, with monetary policy at its limits and inflation hawks being barely kept at bay, there is little hope of help from that department, either. So protectionism is taking pride of place.
The US Treasury has been charged by Congress to assess whether China is a “currency manipulator.” ...[T]he very concept of “currency manipulation” itself is flawed: all governments take actions that directly or indirectly affect the exchange rate. Reckless budget deficits can lead to a weak currency; so can low interest rates. Until the recent crisis in Greece, the US benefited from a weak dollar/euro exchange rate. Should Europeans have accused the US of “manipulating” the exchange rate to expand exports at its expense?
Although US politicians focus on the bilateral trade deficit with China – which is persistently large – what matters is the multilateral balance. ... Many factors other than exchange rates affect a country’s trade balance.  A key determinant is national savings. America’s multilateral trade deficit will not be significantly narrowed until America saves significantly more...
Adjustment in the exchange rate is likely simply to shift to where America buys its textiles and apparel – from Bangladesh or Sri Lanka, rather than China. Meanwhile, an increase in the exchange rate is likely to contribute to inequality in China, as its poor farmers face increasing competition from America’s highly subsidized farms. This is the real trade distortion in the global economy – one in which millions of poor people in developing countries are hurt as America helps some of the world’s richest farmers.
During the 1997-1998 Asian financial crisis, the renminbi’s stability played an important role in stabilizing the region. So, too, the renminbi’s stability has helped the region maintain strong growth, from which the world as a whole benefits. ...
But exchange rates do affect the pattern of growth, and it is in China’s own interest to restructure and move away from high dependence on export-led growth. China recognizes that its currency needs to appreciate over the long run, and politicizing the speed at which it does so has been counterproductive. ...
Since China’s multilateral surplus is the economic issue..., the US should seek a multilateral, rules-based solution. Imposing unilateral duties after unilaterally labeling China a “currency manipulator” would undermine the multilateral system, with little payoff. China might respond by imposing duties on those American products effectively directly or indirectly subsidized by America’s massive bailouts of its banks and car companies.
No one wins from a trade war. So America should be wary of igniting one in the midst of an uncertain global recovery – as popular as it might be with politicians whose constituents are justly concerned about high unemployment, and as easy as it is to look for blame elsewhere. Unfortunately, this global crisis was made in America, and America must look inward...

Thursday, March 25, 2010

China Says It Will Not Adjust Exchange Rate

China's not budging:

China Says It Will Not Adjust Policy on the Exchange Rate, by Sewell Chan, NY Times: Despite mounting pressure in Congress for the Obama administration to declare China a currency manipulator, the Chinese government is giving no indication that it will change its exchange rate policy.
After meeting with officials at the Treasury and Commerce Departments on Wednesday, China’s deputy commerce minister, Zhong Shan, told reporters, “The Chinese government will not succumb to foreign pressures to adjust our exchange rate.”
Mr. Zhong reiterated a statement this month by the Chinese premier, Wen Jiabao, who said he did not believe the currency, the renminbi, was undervalued. ...
Mr. Zhong said that “the basic stability of the renminbi” was generally beneficial, because “a great surge in the value of the renminbi would hurt the economies of developing countries, especially the least-developed countries.” ...
China’s position has raised the ire of members of both parties in Congress, who say that the exchange-rate problem is holding back job growth in the United States. Two senators, Lindsey Graham, Republican of South Carolina, and Charles E. Schumer, Democrat of New York, have introduced legislation that would effectively compel the Treasury to cite the Chinese currency for “misalignment.” The Treasury has not found China to be manipulating its currency since 1994...
With unemployment near 10 percent in the United States, Congress has seemingly run out of patience with that argument.
“We’re fed up,” Mr. Graham said on Tuesday. “China’s mercantilist policies are hurting the rest of the world, not just America. It helped create the global recession that we’re in. The Chinese want to be treated as a developing country, but they’re a global giant, the leading exporter in the world.”
The Senate bill would let the Commerce Department retaliate against currency misalignment by imposing duties or tariffs. “The only thing that will make China move is tough legislation,” Mr. Schumer said.
The two senators pointed to a new study by the Economic Policy Institute, a labor-backed research organization, saying the growing trade deficit between China and the United States resulted in the elimination or displacement of 2.4 million American jobs between 2001 and 2008. ...

Krugman on this topic: Taking On China, Chinese New Year, World Out of Balance, The Chinese Disconnect, More.

Monday, March 15, 2010

Paul Krugman: Taking on China

Paul Krugman says it's time to take a stand against China's currency policy:

Taking on China, by Paul Krugman, Commentary, NY Times: Tensions are rising over Chinese economic policy, and rightly so: China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done. ...
Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. ... This is the most distortionary exchange rate policy any major nation has ever followed.
And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.
So how should we respond? First of all, the U.S. Treasury Department must stop fudging and obfuscating.
Twice a year, by law, Treasury must issue a report identifying nations that “manipulate the rate of exchange between their currency and the United States dollar...” ... Treasury has been ... unwilling to take action on the renminbi... Instead, it has spent the past six or seven years pretending not to see the obvious.
Will the next report, due April 15, continue this tradition? Stay tuned.
If Treasury does find Chinese currency manipulation,... we have to get past a common misunderstanding ... that the Chinese have us over a barrel because we don’t dare provoke China into dumping its dollar assets.
What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed... Long-term rates might rise slightly, but ... the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.
It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies... But that would be a good thing ... since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.
So we have no reason to fear China. But what should we do?
Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years ... and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. ... And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”
But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

Tuesday, January 12, 2010

Rodrik: Will China Rule the World?

Dani Rodrik:

Will China Rule the World?, by Dani Rodrik, Commentary, Project Syndicate: Thirty years ago, China had a tiny footprint on the global economy and little influence outside its borders... Today, the country is a remarkable economic power: the world’s manufacturing workshop, its foremost financier, a leading investor across the globe from Africa to Latin America, and, increasingly, a major source of research and development. ...
All of which raises the question of whether China will eventually replace the US as the world’s hegemon, the global economy’s rule setter and enforcer. In a fascinating new book, revealingly titled When China Rules the World,... Martin Jacques is unequivocal: if you think China will be integrated smoothly into a liberal, capitalist, and democratic world system,... you are in for a big surprise. Not only is China the next economic superpower, but the world order that it will construct will look very different from what we have had under American leadership.
Americans and Europeans blithely assume that China will become more like them as its economy develops and its population gets richer. This is a mirage, Jacques says. The Chinese and their government are wedded to a different conception of society and polity: community-based rather than individualist, state-centric rather than liberal, authoritarian rather than democratic. China has 2,000 years of history as a distinct civilization from which to draw strength. It will not simply fold under Western values and institutions.
A world order centered on China will reflect Chinese values rather than Western ones, Jacques argues. ... Before any of this comes to pass, however, China will have to continue its rapid economic growth and maintain its social cohesion and political unity. None of this is guaranteed. ... China’s stability hinges critically on its government’s ability to deliver steady economic gains to the vast majority of the population. China is the only country ... where anything less than 8% growth ... is believed to be dangerous because it would unleash social unrest. ...
The authoritarian nature of the political regime is at the core of this fragility. ... The trouble is that ... China’s growth currently relies on an undervalued currency and a huge trade surplus. This is unsustainable, and sooner or later it will precipitate a major confrontation with the US (and Europe). There are no easy ways out of this dilemma. China will likely have to settle for lower growth.
If China surmounts these hurdles and does eventually become the world’s predominant economic power, globalization will, indeed, take on Chinese characteristics. Democracy and human rights will then likely lose their luster as global norms. That is the bad news.

The good news is that a Chinese global order will display greater respect for national sovereignty and more tolerance for national diversity. There will be greater room for experimentation with different economic models.

Update: More on China -- Google is considering shutting down, its search engine services in China, due to "attacks and the surveillance" on Google's email accounts (in particular, those held by human rights activists in China) and "attempts over the past year to further limit free speech on the web."

Friday, January 01, 2010

Paul Krugman: Chinese New Year

Paul Krugman urges China to reconsider its currency policy:

Chinese New Year, Paul Krugman, Commentary, NY Times: ...China has become a major financial and trade power. But it doesn’t act like other big economies. Instead, it follows a mercantilist policy, keeping its trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory.
Here’s how it works: Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged ... at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses.
Under normal circumstances, the inflow of dollars from those surpluses would push up the value of China’s currency... But China’s government restricts capital inflows,... buys up dollars and parks them abroad, adding to a $2 trillion-plus hoard of foreign exchange reserves. ...
In the past, China’s accumulation of foreign reserves, many of which were invested in American bonds, was arguably doing us a favor by keeping interest rates low — although what we did with those low interest rates was mainly to inflate a housing bubble. But right now the world is awash in cheap money... Short-term interest rates are close to zero... China’s bond purchases make little or no difference.
Meanwhile, that trade surplus drains much-needed demand away from a depressed world economy. My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs.
The Chinese refuse to acknowledge the problem. Recently Wen Jiabao, the prime minister, dismissed foreign complaints: “On one hand, you are asking for the yuan to appreciate, and on the other hand, you are taking all kinds of protectionist measures.” Indeed: other countries are taking (modest) protectionist measures precisely because China refuses to let its currency rise. And more such measures are entirely appropriate.
Or are they? I usually hear two reasons for not confronting China over its policies. Neither holds water.
First, there’s the claim that we can’t confront the Chinese because they would wreak havoc with the U.S. economy by dumping their hoard of dollars. This is all wrong, and not just because ... the Chinese would inflict large losses on themselves. The larger point is ... China has little or no financial leverage.
Again, right now the world is awash in cheap money. So if China were to start selling dollars, there’s no reason to think it would significantly raise U.S. interest rates. It would probably weaken the dollar against other currencies — but that would be good, not bad, for U.S. competitiveness and employment. ...
Second, there’s the claim that protectionism is always a bad thing... If that’s what you believe, however, you learned Econ 101 from the wrong people — because when unemployment is high..., the usual rules don’t apply.
Let me quote from a classic paper by the late Paul Samuelson...: “With employment less than full ... all the debunked mercantilistic arguments” — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He then went on argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.
The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.

Friday, December 11, 2009

Rodrik: Making Room for China

Dani Rodrik says that if China wants to pursue industrial policy, as he believes it should, its membership in the WTO leaves it little choice but to keep its currency undervalued:

Making Room for China, by Dani Rodrik, Commentary, Project Syndicate: China’s undervalued currency and huge trade surplus pose great risks to the world economy. They threaten a major protectionist backlash in the United States and Europe; and they undermine the recovery in developing and emerging markets. Left unchecked, they will generate growing acrimony between China and other countries. But the solution is not nearly as simple as some pundits make it out to be.
Listen to what comes out of Washington and Brussels, or read the financial press, and you would think you were witnessing a straightforward morality play. It is in China’s own interests, these officials and commentators say, to let the renminbi appreciate. ...
This story casts China’s policymakers in the role of evil and misguided currency manipulators, who, inexplicably, choose to harm not only the rest of the world, but their own society as well. In fact, an appreciating renminbi would likely deal a serious blow to China’s growth, which essentially relies on a simple, time-tested recipe: encourage industrialization. Currency undervaluation is currently the Chinese government’s main instrument for subsidizing manufacturing and other tradable sectors...
Before it joined the World Trade Organization in 2001, China had a wider range of policy instruments for achieving this end. It could promote its industries through high tariffs, explicit subsidies, domestic content requirements on foreign firms, investment incentives, and many other forms of industrial policy. But WTO membership has made it difficult, if not impossible, to resort to these traditional forms of industrial support. ... Currency undervaluation has become a substitute. ...
The trouble with currency undervaluation is that, unlike conventional industrial policy, it spills over into the trade balance. ... Indeed, China’s current-account imbalance ... began its inexorable rise in 2001 – precisely when the country joined the WTO.
Given that WTO rules tie China’s hands on industrial policy, how much of a growth penalty would the Chinese economy suffer if the renminbi were to appreciate? My estimates, crude as they are, suggest a steep trade-off. An appreciation of 25% – roughly the extent by which the renminbi currently is undervalued – would reduce China’s growth by somewhat more than two percentage points. This is a significant effect... [I]t would be a tragedy if the most potent poverty-reduction engine the world has ever known were to experience a notable slowdown. ...
So we are left, it seems, with two equally unappetizing options. China can maintain its currency practices, but at the risk of large global macroeconomic imbalances and a major political backlash in the US and elsewhere. Or it can let its currency appreciate, at the risk of inducing a growth slowdown and political and social unrest at home. It is not clear that advocates of this option have fully comprehended its potentially severe adverse consequences.
There is, of course, a third path, but it would require re-writing the WTO’s rules. If China were allowed a free hand with industrial policies, it could promote manufactures directly while allowing the renminbi to appreciate. This way the increased demand for its industrial output would come from domestic rather than foreign consumers. It is not a pretty solution, but it is the only one. ...

One of the arguments for maintaining an undervalued currency given above is that "it would be a tragedy if the most potent poverty-reduction engine the world has ever known were to experience a notable slowdown." I don't find the poverty reduction argument very compelling. I am all for reducing poverty, but if China's policy reduces poverty within its borders at the expense of other developing countries with poverty problems that are just as bad or worse, how does that justify maintaining an undervalued currency? As Rodrik notes, China's currency policy serves to "undermine the recovery in developing and emerging markets." And it also takes jobs from those countries during normal times. Are China's poor somehow more deserving than the poor in other countries?

Sunday, November 29, 2009

"Dangers of an Overheated China"

Tyler Cowen:

Dangers of an Overheated China, by Tyler Cowen, Commentary, NY Times: ...Several hundred million Chinese peasants have moved from the countryside to the cities over the last 30 years... To help make this work, the Chinese government has subsidized its exporters by pegging the renminbi at an unnaturally low rate to the dollar...; additional subsidies have included direct credit allocation and preferential treatment for coastal enterprises.
These aren’t the recommended policies you would find in a basic economics text, but it’s hard to argue with success. ... Those same subsidies, however, have spurred excess capacity... China has been building factories and production capacity in virtually every sector of its economy... Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. ...
Regional officials have an incentive to prop up local enterprises and production statistics... Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.
Put all of this together and there is a very real possibility of trouble. ... What will the consequences be ... if and when the Chinese economic miracle encounters a major stumble? A lot of Chinese business ventures will stop being profitable, and layoffs and unrest will most likely rise. The Chinese government may crack down further on dissent. The Chinese public may wonder whether its future lies with capitalism after all, and foreign investors in China will become more nervous.
In economic terms, the prices of Chinese exports will probably fall, as overextended businesses compete to justify their capital investments... American businesses will find it harder to compete with Chinese companies, and there will be deflationary pressures in both countries. And ... the Chinese ... may have less to lend to the United States government. ... The United States will face higher borrowing costs, and its fiscal position may very quickly become unsustainable.
That’s not so much a prediction as a very possible contingency, and we should be prepared for it. For now, we should avoid two big mistakes. The first would be to assume that just because borrowing costs are now low, we can postpone fiscal responsibility and keep running up the tab — with the aid of Chinese lending, of course. The history of financial crises shows that turning points can come swiftly...
The second mistake would be to demand too many concessions from the Chinese. What we see in the numbers today are a growing China... Yet there’s a real chance that, soon enough, Chinese economic weakness will be a bigger problem than was Chinese economic strength.

Wednesday, November 18, 2009

links for 2009-11-18

Tuesday, November 17, 2009

"China and the American Jobs Machine"

Robert Reich says China won't be abandoning its currency policy anytime soon:

China and the American Jobs Machine, by Robert Reich, Commentary, WSJ: President Barack Obama says he wants to "rebalance" the economic relationship between China and the U.S. as part of his plan to restart the American jobs machine. "We cannot go back," he said in September, "to an era where the Chinese . . . just are selling everything to us, we're taking out a bunch of credit-card debt or home equity loans, but we're not selling anything to them." He hopes that hundreds of millions of Chinese consumers will make up for the inability of American consumers to return to debt-binge spending.
This is wishful thinking. True, the Chinese market is huge and growing fast. ... But in fact China is heading in the opposite direction of "rebalancing." Its productive capacity keeps soaring, but Chinese consumers are taking home a shrinking proportion of the total economy. Last year, personal consumption in China amounted to only 35% of the Chinese economy; 10 years ago consumption was almost 50%. Capital investment, by contrast, rose to 44% from 35% over the decade. ...
Chinese companies are plowing their rising profits back into more productive capacity—additional factories, more equipment, new technologies. China's massive $600 billion stimulus package has been directed at further enlarging China's productive capacity... So where will this productive capacity go if not to Chinese consumers? Net exports to other nations, especially the U.S. and Europe. ...
The Chinese government also wants to create more jobs in China, and it will continue to rely on exports. Each year, tens of millions of poor Chinese pour into large cities from the countryside in pursuit of better-paying work. If they don't find it, China risks riots and other upheaval. Massive disorder is one of the greatest risks facing China's governing elite. That elite would much rather create export jobs, even at the cost of subsidizing foreign buyers, than allow the yuan to rise and thereby risk job shortages at home.
To this extent, China's export policy is really a social policy, designed to maintain order. Despite the Obama administration's entreaties, China will continue to peg the yuan to the dollar... This is costly to China, of course, but for the purposes of industrial and social policy, China figures the cost is worth it. ...

While China's currency policy is certainly a worthy topic for discussion, lately we are spending a lot of time pointing our fingers at others and blaming them for our problems rather than engaging in the more difficult task of getting our own house in order. I'm not saying that we should ignore things that unfairly disadvantage us, whatever those might be, just that a continued focus on external factors provides a convenient excuse to avoid going through the difficult changes needed to reform our own economy, an excuse that can be exploited by powerful interest groups opposed to needed change (though Reich at least touches on the US side of the equation in a part I left out).

Yes, China needs to change its currency policy, and the fact that it won't or can't change will probably lead to further economic imbalances, perhaps to dangerous levels, and cause increased political tension in the future. But I hope we don't allow the financial industry and others wishing to deflect blame for the crisis and avoid stricter regulation to use the controversy over China's currency policy to divert our attention elsewhere and alter the narrative about how we got into this mess.

Monday, November 16, 2009

Paul Krugman: World Out of Balance

Paul Krugman reiterates that China's currency policy must change:

World Out of Balance, by Paul Krugman, Commentary, NY Times: International travel by world leaders is mainly about making symbolic gestures. Nobody expects President Obama to come back from China with major new agreements, on economic policy or anything else.
But let’s hope that when the cameras aren’t rolling Mr. Obama and his hosts engage in some frank talk about currency policy. For the problem of international trade imbalances is about to get substantially worse. And there’s a potentially ugly confrontation looming unless China mends its ways. ...
Despite huge trade surpluses and the desire of many investors to buy into this fast-growing economy — forces that should have strengthened the renminbi, China’s currency — Chinese authorities have kept that currency persistently weak. They’ve done this mainly by trading renminbi for dollars, which they have accumulated in vast quantities.
And in recent months China has carried out what amounts to a beggar-thy-neighbor devaluation, keeping the yuan-dollar exchange rate fixed even as the dollar has fallen sharply against other major currencies. This has given Chinese exporters a growing competitive advantage over their rivals, especially producers in other developing countries.
What makes China’s currency policy especially problematic is the depressed state of the world economy. ... China’s weak-currency policy exacerbates the problem, in effect siphoning much-needed demand away from the rest of the world into the pockets of artificially competitive Chinese exporters.
But why do I say that this problem is about to get much worse? Because for the past year the true scale of the China problem has been masked by temporary factors. ...
That, at any rate, is the argument made in a new paper by Richard Baldwin and Daria Taglioni of the Graduate Institute, Geneva. As they note, trade imbalances, both China’s surplus and America’s deficit, have recently been much smaller than they were a few years ago. But, they argue, “these global imbalance improvements are mostly illusory — the transitory side effect of the greatest trade collapse the world has ever seen.”
Indeed, the 2008-9 plunge in world trade was one for the record books. What it mainly reflected was the fact that modern trade is dominated by sales of durable manufactured goods — and in the face of severe financial crisis and its attendant uncertainty, both consumers and corporations postponed purchases of anything that wasn’t needed immediately. How did this reduce the U.S. trade deficit? Imports of goods like automobiles collapsed; so did some U.S. exports; but because we came into the crisis importing much more than we exported, the net effect was a smaller trade gap.
But with the financial crisis abating, this process is going into reverse. Last week’s U.S. trade report showed a sharp increase in the trade deficit between August and September. And there will be many more reports along those lines.
So picture this: month after month of headlines juxtaposing soaring U.S. trade deficits and Chinese trade surpluses with the suffering of unemployed American workers. If I were the Chinese government, I’d be really worried about that prospect.
Unfortunately, the Chinese don’t seem to get it: rather than face up to the need to change their currency policy, they’ve taken to lecturing the United States, telling us to raise interest rates and curb fiscal deficits — that is, to make our unemployment problem even worse.
And I’m not sure the Obama administration gets it, either. The administration’s statements on Chinese currency policy seem pro forma, lacking any sense of urgency.
That needs to change. I don’t begrudge Mr. Obama the banquets and the photo ops; they’re part of his job. But behind the scenes he better be warning the Chinese that they’re playing a dangerous game.

Saturday, November 07, 2009

"Why the Renminbi has to Rise to Address Imbalances"

Martin Feldstein joins those arguing that China must let the value of the renminbi rise:

Why the renminbi has to rise to address imbalances, by Martin Feldstein, Commentary, Financial Times: Global leaders have agreed reducing global imbalances is a priority. ...[T]hat agreement means the US must raise its national saving to be less dependent on foreign funds. China must lift domestic spending to maintain high employment without producing so many exports.
Some progress is happening on both fronts. The US household savings rate has risen, driven by the need for US households to rebuild wealth. Corporate retained earnings have also begun to rise. But increasing private saving is not enough ... if federal deficits remain high. The Obama administration must agree a budget that will reduce deficits in the years ahead.
China has succeeded in raising its domestic spending through fiscal incentives and an explosive growth of credit. ... Chinese government spending has also increased domestic demand via major rises in infrastructure investment and building low income housing.
But while these two shifts are necessary to reduce global imbalances, they are not enough..., exchange rates must also adjust.
The dollar must decline relative to other currencies to make US products more attractive to foreign buyers and to cause Americans to substitute US goods and services for imports. ... That is why the recent decline in the dollar relative to the euro, the yen and other currencies is ... natural and desirable...
Unfortunately, the Chinese government has not allowed the renminbi to appreciate. ... With the dollar falling relative to other major currencies, the fixed exchange rate of the renminbi relative to the dollar has caused the Chinese currency to fall relative to the euro, yen and other currencies. The trade-weighted value of the renminbi has therefore been declining, making Chinese exports more attractive and foreign goods more expensive in China.
The result has been an increase in China’s exports from $276bn in the second quarter of the current year to $325bn in the third quarter. This helps lift GDP and jobs in China but prevents reducing global imbalances.
China’s policy of keeping the renminbi weak means that the US dollar must decline more rapidly against the euro, yen and other currencies to achieve the same overall trade-weighted fall of the dollar. China’s weak renminbi policy therefore not only prevents remedying China’s large current account surplus but also reduces Europe’s exports. ...

Although China has agreed to take steps to reduce global imbalances and its trade surplus, it is reluctant to let its currency rise. ... Fortunately, the Chinese economy is expanding rapidly and its growth is becoming less dependent on exports. When it has the confidence to allow the renminbi to rise, we will be on the path to reduced global imbalances.

[Traveling: Scheduled to post at preset time.]

Tuesday, November 03, 2009

"Death by Renminbi"

Thomas Palley says China's currency policy must change:

Death by Renminbi, by Thomas I. Palley, Commentary, Project Syndicate: Over the last several weeks, the dollar's depreciation against the euro and yen has grabbed global attention. In a normal world, the dollar's weakening would be welcome, as it would help the United States come to grips with its unsustainable trade deficit.

But, in a world where China links its currency to the dollar at an undervalued parity, the dollar's depreciation risks major global economic damage that will further complicate recovery from the current worldwide recession.

A realignment of the dollar is long overdue. Its overvaluation began with the Mexican peso crisis of 1994, and was officially enshrined by the "strong dollar" policy... That policy produced short-term consumption gains for America,... but it has inflicted major long-term damage ... and contributed to the current crisis.

The overvalued dollar caused the U.S. economy to hemorrhage spending on imports, jobs via off-shoring, and investment to countries with undervalued currencies.

In today's era of globalization, marked by flexible and mobile production networks, exchange rates affect more than exports and imports. They also affect the location of production and investment.

China has been a major beneficiary of America's strong-dollar policy, to which it wedded its own "weak renminbi" policy. As a result, China's trade surplus with the U.S. rose... The undervalued renminbi has also made China a major recipient of foreign direct investment, even leading the world in 2002 ― a staggering achievement for a developing country.

The scale of recent U.S. trade deficits was always unsustainable...
But China retains its undervalued exchange rate policy... When combined with China's rapid growth in manufacturing capacity, this pattern promises to create a new round of global imbalances.

China's policy creates adversarial currency competition with the rest of the world. ... Furthermore, the problem is not only America's. China's currency policy gives it a competitive advantage relative to other countries, allowing it to displace their exports to the U.S. ... Yet a mix of political factors has led to stunning refusal by policymakers to confront China.

On the U.S. side, a lingering Cold War mentality, combined with the presumption of U.S. economic superiority, has meant that economic issues are still deemed subservient to geo-political concerns. That explains the neglect of U.S.-China economic relations, a neglect that is now dangerous to the U.S., given its weakened economic condition.

With regard to the rest of the world, many find it easy to blame the U.S., often owing to resentment at its perceived arrogance. Moreover, there is an old mentality among Southern countries that they can do no wrong in their relationships with the North...

Finally, all countries likely have been shortsighted, imagining that silence will gain them commercial favors from China. But that silence merely allows China to exploit the community of nations.

The world economy has paid dearly for complicity with and silence about the economic policies of the last 15 years... It will pay still more if policymakers remain passive about China's destructive currency policy.

Our problems are not China's fault.

Thursday, October 29, 2009

"China to Investigate US Car Subsidies"

China sends a message:

China to investigate US car subsidies, by Sarah O’Connor: China is preparing to launch a trade investigation into whether US carmakers are being unfairly subsidised by the US government...
The move comes at a time of heightened trade tensions between the two countries after the US imposed duties on Chinese tires last month. Many warned this would prompt Beijing to retaliate.
Few vehicles are actually exported from the US to China, but the move would have symbolic power by turning the tables on Washington. ... The investigation could lead to import duties. ...
China has already told the US that it has received a petition for an investigation, which ... would formally launch on Wednesday. Before that, the two countries will negotiate. Top US government officials are already in China for trade talks this week, and Barack Obama, US president, is due to visit the country next month.
China had notified the US it had received anti-dumping and countervailing duty petitions on cars, a spokeswoman for the United States Trade Representative said.
World Trade Organization rules require China to invite the US to consult on the countervailing duty petition before initiating any investigation... The countries expect to consult over coming days.  ...
China has received an anti-dumping petition as well, which asks for investigation into whether US car exports are being sold at unfairly low pries. ...

Saturday, October 24, 2009

South-South Trade Tensions

Brian Hoyt of the World Bank's Crisis Talk blog says increasing trade tensions between the emerging markets of the Global South may prove to be problematic:

South-South Trade Tensions, by Brian Hoyt: John Authers argues that the newsworthy economic story of late isn't dollar weakness; rather, it is the weak renminbi:
Many, if not most, hopes for global recovery are pinned on China buying goods from countries such as Brazil. Commodity prices, a key driver of equities and forex rates, also move in response to the new orders received by China's manufacturers.
This currency regime makes it far harder for such countries to sell to China. So it is no wonder that currencies are back at the top of the agenda.
...China has been building stronger trade relations with the Global South for quite some time. It is now South Africa's top export destination. But many of these partnerships are built around China purchasing commodities, and selling manufactured goods. With a weakening currency, China is likely to purchase fewer non-commodity goods from its trading partners. This may lead to growing trade tensions, particularly with countries who are not endowed with commodities.
Much attention has been paid to the importance of the economic relationship between China and the United States, or "Chimerica" (See this week's Economist cover story. Or Paul Krugman). Rising trade tensions between the two economic powers could spell doom for the global economy.
Yet, one should not discount the importance of emerging market trade relations, and the possible tensions that may arise. Today's Wall St Journal reports of Indian grievances toward China's trade practices:
Trade friction is growing between India and China. India leads all members of the World Trade Organization in antidumping cases against China. India has banned imports of Chinese toys, milk and chocolate, citing safety concerns...
Heavy industries minister Vilasrao Deshmukh recently told reporters, "We don't want India to be turned into a dumping ground". Yet, India's actions have had little effect on the growing trade imbalance between the two countries:
Alas, trade tensions are not only worrisome between the West and the East. They may prove problematic between the emerging markets of the Global South.

Friday, October 23, 2009

Paul Krugman: The Chinese Disconnect

"China is stealing other peoples’ jobs":

The Chinese Disconnect, by Paul Krugman, Commentary, NY Times: Senior monetary officials usually talk in code. So when Ben Bernanke ... spoke recently about Asia, international imbalances and the financial crisis, he didn’t specifically criticize China’s outrageous currency policy.
But he didn’t have to: everyone got the subtext. China’s bad behavior is posing a growing threat to the rest of the world economy. The only question now is what the world — and, in particular, the United States — will do about it.
Some background: The value of China’s currency, unlike, say, the value of the British pound, isn’t determined by supply and demand. Instead, Chinese authorities enforced that target by buying or selling their currency in the foreign exchange market — a policy made possible by restrictions on the ability of private investors to move their money either into or out of the country.
There’s nothing necessarily wrong with such a policy, especially in a still poor country whose financial system might all too easily be destabilized by volatile flows of hot money. ... The crucial question, however, is whether the target value of the yuan is reasonable. ...
Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.
Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.
But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.
And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.
So what are we going to do?
U.S. officials have been extremely cautious about confronting the China problem, to such an extent that last week the Treasury Department, while expressing “concerns,” certified in a required report to Congress that China is not — repeat not — manipulating its currency. They’re kidding, right?
The thing is, right now this caution makes little sense. Suppose the Chinese were to do what Wall Street and Washington seem to fear and start selling some of their dollar hoard. Under current conditions, this would actually help the U.S. economy by making our exports more competitive.
In fact, some countries, most notably Switzerland, have been trying to support their economies by selling their own currencies on the foreign exchange market. The United States, mainly for diplomatic reasons, can’t do this; but if the Chinese decide to do it on our behalf, we should send them a thank-you note.
The point is that with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can’t be tolerated. Something must be done about China’s currency.

Monday, October 19, 2009

"Fed Chief Cites Trade Imbalances’ Role in Crisis"

Ben Bernanke:

Fed Chief Cites Trade Imbalances’ Role in Crisis, by Edmund Andrews, NY Times: Ben S. Bernanke, the chairman of the Federal Reserve, said on Monday that global trade imbalances played a central role in the global economic crisis and warned that the both the United States and fast-growing Asian nations needed to do more to prevent them from recurring.
“We were smug,” Mr. Bernanke said of the United States, saying the American financial regulatory system was “inadequate” at managing the immense inflows of cheap money from China and other countries that had huge trade surpluses.
Though the Fed chairman acknowledged that trade imbalances have declined sharply as a result of the crisis, mainly because trade itself plunged, he warned that American foreign indebtedness will aggravate the imbalances once again unless the United States reduces its soaring federal budget deficit.
“The United States must increase its national saving rate,” he said. “The most effective way to accomplish this goal is by establishing a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time.” ...
By the same token, he said, Asian countries needed to rely less on exports and more on their consumption at home for their economic growth. One way to increase Asian household consumption, he said, would be for countries like China to increase social insurance programs and reduced the uncertainty that currently hangs over many consumers. ...
With the Asian economy expanding at an annualized rate of 9 percent in the second quarter of this year, and China’s economy expanding at rates of more than 10 percent, Mr. Bernanke said, “Asia appears to be leading the global recovery.”
But the Fed chairman warned that the United States-led crisis was fueled in large part by huge inflows of cheap money to the United States from countries like China that were trying to recycle dollars from their huge trade surpluses.
The Fed chairman noted that global trade and financial imbalances have narrowed considerably since the crisis began... But he cautioned that the imbalances could widen out again as economic growth revives. While the United States has to tighten its belt by saving more and consuming less, China and other Asian countries need to increase their consumer spending in order to promote faster domestic economic growth.
Mr. Bernanke avoided what was in many ways the elephant in the room: the value of the United States dollar. The dollar has dropped sharply in recent weeks against the euro and the Japanese yen, which has helped increase American exports by making them cheaper in some foreign markets. But the dollar has not budged in more than a year against China’s renmimbi...

There were three important factors in the crisis, global imbalances (Bernanke's savings glut), low interest rate policy by the Fed, and the failure of markets and regulators to provide the checks and balances necessary to prevent the crisis from occurring. The global imbalances combined with the Fed's low interest rate policy led to the massive build up of global liquidity looking for a safe, high return home, and the market and regulatory failures allowed the extra liquidity and the false promise of high, safe returns to concentrate risk in the mortgage markets.

Bernanke focuses on two of these causes of the crisis, global imbalances and regulatory problems (market failures get less attention), but he does not focus on the Fed's role in the crisis at all. So let me say that I hope the Fed is more willing to consider popping bubbles as they inflate than it has been in the past. But that is not the main point I want to make.

The crisis, according to Bernanke, occurred when the excess global liquidity overwhelmed financial markets -- it was too much for either regulators and markets to handle. Think of a hurricane hitting a city that is so strong and powerful that it overwhelms levees and other flood/damage control mechanisms. That's essentially Bernanke's explanation, the shock was too big for the mechanisms we had in place to control the damage. One solution to the hurricane problem is to hope that such large shocks don't happen again and simply rebuild the same defenses as before, and another response is to recognize that such shocks will occur every so often and to build the stronger defensive measures needed to get ready.

Bernanke acknowledges that the defenses, i.e. the regulation of financial markets, need to be strengthened, but he seems to place a lot of emphasis on reducing the size of future shocks (reduce the budget deficit, have Asian countries consume more to reduce imbalances, etc.). I think that is fine, we should reduce the danger as much as we can, but we need to accept that global imbalances are possible, that a shock of this magnitude could and probably will happen again at some point in the future, and we need to make sure that markets don't fail like they did this time (i.e. we need to fix the bad incentives in these markets). But more importantly, we need to strengthen our regulatory defenses in anticipation of the next big shock. If it's fair to blame the government for not having levees, etc. ready for Katrina, if we insist that the defenses need to be strengthened going forward, then the same argument can be made in financial markets. Despite our best efforts to reduce the chances that a large shock will occur through deficit reduction and higher domestic saving rates, we should expect that global imbalances will rear their head again at some point, and the system cannot be overwhelmed again like it was this time.

For that reason, I'm a bit disappointed in Bernanke's willingness to point fingers at external causes and say other countries must change their consumption habits, or to blame budget deficits, at a time when financial regulation is coming onto the legislative agenda (though he didn't say anything about the exchange rate). Those are important problems and I don't mean to dismiss them, but right now financial regulation is being considered by congress, and it's essential that we get the regulations in place that can withstand the next big shock. Blaming external forces for the crisis will make it easier for opponents of regulation to blame China and other countries, and that gives legislators an excuse to give in to pressure (e.g. campaign contributions) from the financial industry to go soft on regulatory changes.

Update: Paul Krugman comments on Bernanke's remarks: America’s Chinese disease (not quite what you think).

Saturday, October 10, 2009

"Global Imbalances and the Financial Crisis: Products of Common Causes"

Maurice Obstfeld and Kenneth Rogoff attempt to sort out the role that global imbalances played in the financial crisis. This is the introduction to their paper:

Global Imbalances and the Financial Crisis: Products of Common Causes, by Maurice Obstfeld and Kenneth Rogoff, October 2009 (Conference Draft): In my view … it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s. --Ben S. Bernanke1
Introduction Until the outbreak of financial crisis in August 2007, the mid-2000s was a period of strong economic performance throughout the world. Economic growth was generally robust; inflation generally low; international trade and especially financial flows expanded; and the emerging and developing world experienced widespread progress and a notable absence of crises.
This apparently favorable equilibrium was underpinned, however, by three trends that appeared increasingly unsustainable as time went by. First, real estate values were rising at a high rate in many countries, including the world’s largest economy, the United States. Second, a number of countries were simultaneously running high and rising current account deficits, including the world’s largest economy, the United States. Third, leverage had built up to extraordinary levels in many sectors across the globe, notably among consumers in the United States and Europe and financial entities in many countries. Indeed, we ourselves began pointing to the potential risks of the “global imbalances” in a series of papers beginning in 2001.2 As we will argue, the global imbalances did not cause the leverage and housing bubbles, but they were a critically important codeterminant.
In addition to being the world’s largest economy, the United States had the world’s highest rate of private homeownership and the world’s deepest, most dynamic financial markets. And those markets, having been progressively deregulated since the 1970s, were confronted by a particularly fragmented and ineffective system of government prudential oversight. This mix of ingredients, as we now know, was deadly.
Controversy remains about the precise connection between global imbalances and the global financial meltdown. Some commentators argue that external imbalances had little or nothing to do with the crisis, which instead was the result of financial regulatory failures and policy errors, mainly on the part of the U.S. Others put forward various mechanisms through which global imbalances are claimed to have played a prime role in causing the financial collapse. Former U.S. Treasury Secretary Henry Paulson argued, for example, that the high savings of China, oil exporters, and other surplus countries depressed global real interest rates, leading investors to scramble for yield and underprice risk.3
We too believe that the global imbalances and the financial crisis are intimately connected, but we take a more nuanced stance on the nature of the connections. In our view, both of these phenomena have their origins primarily in economic policies followed in a number of countries in the 2000s (including the United States) and in distortions that influenced the transmission of these policies through financial markets. The United States’ ability to finance macroeconomic imbalances through easy foreign borrowing allowed it to postpone tough policy choices (something that was of course true in many other deficit countries as well). Not only was the U.S. able to borrow in dollars at nominal interest rates kept low by a loose monetary policy. Also, until around the autumn of 2008, exchange-rate and other asset-price movements kept U.S. net foreign liabilities growing at a rate far below the cumulative U.S. current account deficit. On the lending side, China’s ability to sterilize the immense reserve purchases it placed in U.S. markets allowed it to maintain an undervalued currency and postpone rebalancing its own economy. Had seemingly easy postponement options not been available, the subsequent crisis might well have been mitigated, if not contained.4
We certainly do not agree with the many commentators and scholars who argued that the global imbalances were an essentially benign phenomenon, a natural and inevitable corollary of backward financial development in emerging markets. These commentators, including Cooper (2007) and Dooley, Folkerts-Landau, and Garber (2005), as well as Caballero, Farhi, and Gourinchas (2008) and Mendoza, Quadrini, and Rios-Rull (2007), advanced frameworks in which the global imbalances were essentially a “win-win” phenomenon, with developing countries’ residents (including governments) enjoying safety and liquidity for their savings, while rich countries (especially the dollarissuing United States) benefited from easier borrowing terms. The fundamental flaw in these analyses, of course, was the assumption that advanced-country capital markets, especially those of the United States, were fundamentally perfect, and so able to take on ever-increasing leverage risklessly. In our 2001 paper we ourselves underscored this point, identifying the rapid evolution of financial markets as posing new, untested hazards that might be triggered by a rapid change in the underlying equilibrium.5
Bini Smaghi’s (2008) assessment thus seems exactly right to us:
[E]xternal imbalances are often a reflection, and even a prediction, of internal imbalances. [E]conomic policies … should not ignore external imbalances and just assume that they will sort themselves out.6
In this paper we describe our view of how the global imbalances of the 2000s both reflected and magnified the ultimate causal factors behind the recent financial crisis. At the end, we identify policy lessons learned. In effect, the global imbalances posed stress tests for weaknesses in the United States, British, and other advanced-country financial and political systems – tests that those countries did not pass. ...

See also: Why are we in a recession? The Financial Crisis is the Symptom not the Disease! [open link]. The paper argues that the huge increase in the labor supply available to developed countries is the primary force behind our current troubles. Here are parts of the introduction and conclusion:

The impact of globalization is a sharp increase in the developed world’s labor supply. Labor in developing countries – countries with vast pool of grossly underemployed people – can now compete with labor in the developed world without having to relocate in ways not possible earlier. ... [W]e argue that this huge and rapid increase in developed world’s labor supply, triggered by geo-political events and technological innovations, is the major underlying force that is affecting world events today.2 The inability of existing financial and legal institutions in the US and abroad to cope with the events set off by this force is the reason for the current great recession: The inability of emerging economies to absorb savings through domestic investment and consumption caused by inadequate national financial markets and difficulties in enforcing financial contracts through the legal system; the currency controls motivated by immediate national objectives; the inability of the US economy to adjust to the perverse incentives caused by huge moneys inflow leading to a break down of checks and balances at various financial institutions, set the stage for the great recession. The financial crisis was the first symptom. ...

10 The Way Forward The common wisdom is that cheap money and lax supervision of financial institutions led to this financial crisis, and solving that crisis will take us out of the recession. In our view, the financial crisis is just the symptom. The fundamental cause of the crisis is the huge labor supply shock the world has experienced, not the glut in liquidity in money supply.

Recovery will only occur when structural imbalances in global capital flows are corrected, in part through higher saving in developed nations and in part through greater capital flows into developing nations. ...

It may be tempting for those in power to close the door to outsourcing of manufacturing and other activities. While that may provide some immediate relief, it will accentuate other problems...

When millions of World War II soldiers returned home that increased the US labor force of about 60 million workers by almost 25% within a very short period of time. At that time the Department of labor, which certainly had no cause to accentuate the negative, predicted that 12 to 15 million workers would be unemployed.28 That did not happen! We managed that problem well leading to prosperity instead of doom, thanks in no small part to the GI Bill and other governmental fiscal intervention. We can manage this one as well. For that to happen, the first step is to recognize the problem for what it is. A solution may well require actions similar in scope to the GI Bill and require a national debate.

While there is plenty of blame to go around for mistakes, the macro forces triggered by the labor shock is like a tidal wave that needed to wash ashore no matter what. History might have taken an entirely different path with better risk management controls in place in the US but then again, financial innovation might just have found a different way of getting highly leveraged deals done off-shore or through creative accounting.29 The root cause of the excess liquidity in the global financial system must be addressed, otherwise we are just squeezing the proverbial balloon only to see it bulge out somewhere else. However, this does not negate the need for the development of improved risk management in the broadest sense in order to ensure financial stability and prosperity going forward.

China and India will continue to need to bring tens of millions of rural laborers into the productive workforce in the coming decades and the world economy must find a sustainable way of dealing with this influx. Clearly China’s export led growth strategy of the past cannot continue indefinitely and domestic consumption must be allowed to grow as a share of GDP. At the same time, Western economies must adjust to a new equilibrium in which commodities are scarcer and households will face stiffer competition for jobs.

Tuesday, September 22, 2009

"On the G20 Agenda"

Tim Duy:

On the G20 Agenda, by Tim Duy: Simon Johnson at the Baseline Scenario has a nice piece bemoaning the US pursuit of a rebalancing agenda at the upcoming G20 meeting. I largely agree with Johnson's tone. Something that sounds nice, but that to which no parties, particularly China and the US, can make a credible commitment. It is, however, keeping some poor staffer at the US Treasury busy 24-7. Johnson's third point, however, misses some important points:
Where is the evidence that this kind of “imbalance” had even a tangential effect on the build up of vulnerabilities that led to the global financial crisis of 2008-09? I understand the theoretical argument that current account imbalances could play a role in a US-based/dollar crisis, but remember: interest rates were low 2002-2006 because of Alan Greenspan (who controlled short-term dollar interest rates); the international capital flows that sought out crazy investments came from Western Europe, which was not a significant net exporter of capital (i.e., a balanced current account is consistent with destabilizing gross flows of capital); and the crisis, when it came, was associated with appreciation – not depreciation – of the dollar.
I believe Johnson underestimates just how close we came to a destabilizing collapse of the Dollar in 2008. That avoidance of that near collapse was well documented by Brad Setser in his legendary "quiet bailout" series:
...The US had a large external deficit going into the subprime crisis. That means it has a constant need for external financing. Foreigners need to more than just hold their existing claims on the US, they need to add to them. The US responded to the subprime crisis with policies — a fiscal stimulus, monetary easing — designed to support domestic US demand, not to assure ongoing demand for US financial assets. And for a complex set of reasons – ongoing growth in China, energy-intensive growth in the Gulf, limited expansion of supply and perhaps monetary easing in the US — the price of oil has shot up even as the US has slowed. Higher oil prices are likely to push the US trade deficit and the US need for financing up — not down – at least in nominal terms.
So far that hasn’t been a serious problem. Central bank reserve growth has been very strong, most because a couple of big countries are adding to their reserves at an incredible rate. The New York Fed data tells us that a lot of that growth has been channeled into safe US assets. But there are also growing signs that rapid reserve growth is causing some countries — including some big countries — trouble.
Later analysis can be found here. Had it not been for the supporting role that China and other central banks played in financing the US current account deficit, we would have seen a full blown currency crisis, well before the financial crisis of September 2008.
As an aside, the intervention to support the Dollar was also the key event that allowed the US recession to evolve in the pattern envisions by domestic-focused economists, as opposed to those seeped in the traditions of international finance. Brad Delong has a fantastic piece on this issue, including the key assumption failed the internationalists:
Before dinner one evening I was lectured by a prominent Washington-area international finance economist about all the reasons that the 1986-1990 U.S. experience was likely to be a bad guide to the future…
...The Japanese government was willing to buy very large amounts of dollar-denominated assets in the late 1980s to keep the decline in the value of the dollar "orderly." In so doing, it inflated its domestic credit base and touched off its own property bubble. No foreign government is going to risk this again just because the U.S. would rather that the decline in the dollar was slow and orderly.
I have no doubt that the willingness of central banks to flood the global economy with month in an effort to hold currency pegs contributed greatly to the great commodity price bubble that ultimately sent US real consumption into a tail spin well before the events in the fall of 2008.
As to the G20 proposal itself - easier said than done. Back on the real side of the economy, I believe the US economy is very structurally misaligned, to a disturbing degree. We simply do not make many of the products we want to buy, and have the capacity to make many products - like expensive housing - that no one wants to buy. Moreover, these structural misalignments have been building for at least 15 years, at least partly the consequence of the US strong Dollar policy that gave license for wholesale currency manipulation to support mercantilistic policy objectives. Reversing 15 years of policy in which deep structural shifts occurred will not happen overnight.
Nor do I think the Chinese are interested in making that transition happen. Thomas Freidman has a point here:
China now understands that. It no longer believes it can pollute its way to prosperity because it would choke to death. That is the most important shift in the world in the last 18 months. China has decided that clean-tech is going to be the next great global industry and is now creating a massive domestic market for solar and wind, which will give it a great export platform….So, if you like importing oil from Saudi Arabia, you’re going to love importing solar panels from China.
This restructuring, not so much the financial restructuring, is what I suspect the Administration really wants to address.
Good luck with that.

Sunday, August 02, 2009

Global Rebalancing

Free Exchange says "many of the things you know about China are wrong":

Many things that you know about China are wrong, Free Exchange: If you think you understand the dynamics underlying global imbalances and the role China plays in generating them, have a good look at this piece, from this week's print edition. It challenges many of the ideas that pass for conventional wisdom on the subject. For instance, it is a commonplace that China depresses domestic demand to boost its exports. But in fact:

China’s current-account surplus will fall to under 6% of GDP this year and 4% in 2010, down from a peak of 11% in 2007. Exports amounted to 35% of GDP in 2007; this year, reckons Mr Cavey, that ratio will drop to 24.5%. ...

In fact, the popular perception that China has always relied on export-led growth is rather misleading. Its current-account surplus did soar from 2005 onwards but until then was rather modest. And over the past ten years net exports accounted, on average, for only one-tenth of its growth.

The problem is that too little of domestic demand growth goes to consumption. Rather, investment accounts for a rising proportion of Chinese output. But this isn't because consumption is growing slowly, as is widely believed:

It is often argued that China runs a current-account surplus because its consumer spending has been sluggish. On the contrary, China has the world’s fastest-growing consumer market, increasing by 8% a year in real terms in the past decade. ... Even so, China’s consumer spending has grown more slowly than the overall economy. As a result consumption as a share of GDP has fallen and is extremely low by international standards: only 35%, compared with 50-60% in most other Asian economies and 70% in America.

Investment has just grown  ... too fast for consumption to keep pace. It's also assumed that China has pursued export-led growth because it must create jobs for its many people. And yet:

The more important reason why consumption has fallen is that the share of national income going to households (as wages and investment income) has fallen, while the share of profits has risen. Workers’ share of the cake has dwindled because China’s rapid growth has generated surprisingly few jobs. Growth has been capital-intensive, focusing on heavy industries such as steel rather than more labour-intensive services. Profits (the return to capital) have outpaced wage income.

Capital-intensive production has been encouraged... The government has also favoured manufacturing over services...

It's ironic; by favouring capital-intensive manufacturing exportables, the government has missed out on opportunities to grow more labour-intensive retail and service sectors which could employ more workers. It often seems as though economists believe that simply by allowing its currency to appreciate, China can begin to break down many of the world's structural imbalances. Certainly, that would help. But it also appears ... China will have to pursue serious internal reforms—strengthening its financial sector, improving its social safety net, and removing burdensome regulations designed to generate massive investment in manufacturing industries. In other words, rebalancing isn't as easy as it looks.

[Traveling all day today, so I probably won't be able to do much. Update: So nice to get to the airport and find out your flight is canceled. It's going to be a long day. Update: Now I'll be happy to leave the airport in Ithaca. First flight canceled, second delayed. All night in the Philadelphia airport, if I can get there. So much fun.]

Friday, July 24, 2009

"All Stimulus Roads Lead to China"

Should emerging countries, China in particular, intentionally spend more on imports from the U.S.?:

All stimulus roads lead to China, by Barry Eichengreen, Commentary, Project Syndicate: Now that the “green shoots” of recovery have withered, the debate over fiscal stimulus is back with a vengeance. ... It is possible to argue the economics both ways, but the politics all point in one direction. The US Congress lacks the stomach for another stimulus package. ... A second stimulus simply is not in the cards.

If there is going to be more aggregate demand, it can come from only one place. That place is not Europe or Japan, where debts are even higher than in the US – and the demographic preconditions for servicing them less favorable. Rather, it is emerging markets like China.

The problem is that China has already done a lot to stimulate domestic demand... As a result, its stock market is frothy, and it is experiencing an alarming property boom. ... Understandably, Chinese officials worry about bubble trouble.

The obvious way to square this circle is to spend more on imports. China can purchase more industrial machinery, transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending toward imports of capital equipment would avoid overheating China’s own markets, boost the economy’s productive capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just when such support is needed most.

This strategy is not without risks. Allowing the renminbi to appreciate as a way of encouraging imports may also discourage exports, the traditional motor of Chinese growth. And lowering administrative barriers to imports might redirect more spending toward foreign goods than the authorities intend. But these are risks worth taking if China is serious about assuming a global leadership role.

The question is what China will get in return. And the answer brings us back, full circle, to ... US fiscal policy. China is worried that its more than $1tn investment in US Treasury securities will not hold its value. It wants reassurance that the US will stand behind its debts. It therefore wants to see a credible program for balancing the US budget once the recession ends.

And, tough talk notwithstanding, the Obama administration has yet to offer a credible roadmap for fiscal consolidation. ... We live in a multipolar world where neither the US nor China is large enough to exercise global economic leadership on its own. ... Only by working together can the two countries lead the world economy out of its current doldrums.

I don't think we should count on this happening.

Friday, June 26, 2009

"China Crosses the Rubicon"

According to this analysis, China's economic interests are having a big impact on its strategic plans. It also makes it sound as thought Russia and China could be be headed for conflict over border regions. I'm not sure if this will generate much discussion or not, but I'm curious what you think about this:

China Crosses the Rubicon, by Wen Liao, Commentary, Project Syndicate: For two decades, Chinese diplomacy has been guided by the concept of the country's "peaceful rise." Today, however, China needs a new strategic doctrine, because the most remarkable aspect of Sri Lanka's recent victory over the Tamil Tigers is ... the fact that China provided ... both the military supplies and diplomatic cover ... needed to prosecute the war. ...

So, not only has China become central to every aspect of the global financial and economic system, it has now demonstrated its strategic effectiveness in a region traditionally outside its orbit. ... What will this change mean in practice in the world's hot spots like North Korea, Pakistan, and Central Asia?

Continue reading ""China Crosses the Rubicon"" »

Thursday, June 18, 2009

A Lasting Recovery?

Olivier Blanchard argues that global imbalances must be resolved in order to put the world economy on a sustainable path to recovery:

What is needed for a lasting recovery, by Olivier Blanchard, Commentary, Financial Times: In 2007, worried about the growing size of current account imbalances, the IMF organised multilateral consultations to see what should be done about it. There was wide agreement that the solution was conceptually straightforward. To caricature: get US consumers to spend less. Get Chinese consumers to spend more. This would be good for the US, good for China, and good for the world. ...

It was an impressive piece of global macroeconomic planning. But, at least until the crisis, not much happened. ... And, since the beginning of the crisis, dealing with global imbalances has gone down the priority list. ... As the crisis evolves, however,... the issue of global imbalances is likely to return to the fore. Again, a central role will have to be played by the US and by China.

Continue reading "A Lasting Recovery?" »

Monday, May 25, 2009

Global Imbalances and Future Crises

I've been trying to figure out how much danger there is of a sudden unwinding of global imbalances that could extend and potentially deepen the recession. I've been worried there is a chance this could happen, but Barry Eichengreen explains that there are "two hopes for avoiding this disastrous outcome":

Fix global imbalances to avert future crises, by Barry Eichengreen, Commentary, Project Syndicate: Future history books, depending on where they are written, will take one of two approaches to assigning blame for the world’s current financial and economic crisis.

One approach will blame lax regulation, accommodating monetary policy, and inadequate savings in the US. The other, already being pushed by former and current US officials like Alan Greenspan and Ben Bernanke, will blame the immense pool of liquidity generated by high-savings countries in East Asia and the Middle East. All that liquidity, they will argue, had to go somewhere. Its logical destination was the country with the deepest financial markets, the US, where it raised asset prices to unsustainable heights.

Note the one thing on which members of both camps agree: the global savings imbalance – low savings in the US and high savings in Chinaand other emerging markets – played a key role in the crisis... Preventing future crises similar to this one therefore requires resolving the problem of global imbalances. ...

Whether there is a permanent reduction in global imbalances will depend mainly on decisions taken outside the US, specifically in countries like China. One’s forecast of those decisions hinges, in turn, on why these other countries came to run such large surpluses in the first place.

One view is that their surpluses were a corollary of the policies favouring export-led growth that worked so well for so long. China’s leaders are understandably reluctant to abandon a tried-and-true model. They can’t restructure their economy instantaneously. ... They need time to build a social safety net capable of encouraging Chinese households to reduce their precautionary saving. If this view is correct, we can expect to see global imbalances re-emerge once the recession is over and to unwind only slowly thereafter.

The other view is that China contributed to global imbalances not through its merchandise exports, but through its capital exports. What China lacked was not demand for consumption goods, but a supply of high-quality financial assets. It found these in the US, mainly in the form  of Treasury and other government-backed securities, in turn pushing other investors into more speculative investments.

Recent events have not enhanced the stature of the US as a supplier of high-quality assets. And China, for its part, will continue to develop its financial markets and its capacity to generate high-quality financial assets internally. But doing so will take time. Meanwhile, the US still has the most liquid financial markets in the world. This interpretation again implies the re-emergence of global imbalances once the recession ends, and their very gradual unwinding thereafter.

One development that could change this forecast is if China comes to view investing in US financial assets as a money-losing proposition. US budget deficits as far as the eye can see might excite fear of losses on US Treasury bonds. A de facto policy of inflating away the debt might stoke such fears further. At that point, China would pull the plug, the dollar would crash, and the Fed would be forced to raise interest rates, plunging the US back into recession.

There are two hopes for avoiding this disastrous outcome. One is relying on Chinese goodwill to stabilise the US and world economies. The other is for the Obama administration and the Fed to provide details about how they will eliminate the budget deficit and avoid inflation once the recession ends. The second option is clearly preferable. After all, it is always better to control one’s own fate.

Friday, May 15, 2009

Paul Krugman: Empire of Carbon

Paul Krugman says that if we want to save the planet from global warming, China's participation will be required:

Empire of Carbon, by Paul Krugman, Commentary, NY Times: I have seen the future, and it won’t work.

These should be hopeful times for environmentalists. Junk science no longer rules in Washington. President Obama has spoken forcefully about the need to take action on climate change; the people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system... And once America acts, we can expect much of the world to follow our lead.

But that still leaves the problem of China, where I have been for most of the last week. Like every visitor to China, I was awed by the scale of the country’s development. Even the annoying aspects — much of my time was spent viewing the Great Wall of Traffic — are byproducts of the nation’s economic success.

But China cannot continue along its current path because the planet can’t handle the strain.

The scientific consensus on ... global warming has become much more pessimistic over the last few years. ... Why? Because the rate at which greenhouse gas emissions are rising is matching or exceeding the worst-case scenarios. And the growth of emissions from China ... is one main reason for this new pessimism.

China’s emissions, which come largely from its coal-burning electricity plants, doubled between 1996 and 2006. ... And the trend seems set to continue: In January, China announced that it plans to continue its reliance on coal... That’s a decision that, all by itself, will swamp any emission reductions elsewhere.

So what is to be done about the China problem?

Nothing, say the Chinese. Each time I raised the issue..., I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels. After all, they declared, the West faced no similar constraints during its development; while China may be the world’s largest source of carbon-dioxide emissions, its per-capita emissions are still far below American levels; and anyway, the great bulk of the global warming that has already happened is due not to China but to the past carbon emissions of today’s wealthy nations.

And they’re right. It is unfair to expect China to live within constraints that we didn’t have to face when our own economy was on its way up. But that unfairness doesn’t change ... that letting China match the West’s past profligacy would doom the Earth as we know it.

Historical injustice aside, the ... climate-change consequences of Chinese production have to be taken into account somewhere. And anyway, the problem with China is not so much what it produces as how it produces it. ...

The good news is that the very inefficiency of China’s energy use offers huge scope for improvement. Given the right policies, China could continue to grow rapidly without increasing its carbon emissions. But first it has to realize that policy changes are necessary.

There are hints ... that the country’s policy makers are starting to realize that their current position is unsustainable. But I suspect that they don’t realize how quickly the whole game is about to change.

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

It’s time to save the planet. And like it or not, China will have to do its part.

Wednesday, April 01, 2009

Asia and the "Bond Bubble"

Yu Qiao says Asian countries are worried about their large investment in dollar denominated US assets and would like one of those one-sided, heads we win, tails the taxpayers loses deals that everyone else seems to be getting:

Asia is the victim if the bond bubble bursts, by Yu Qiao, Commentary, Financial Times: ...Most of Mr Obama’s stimulus spending is devoted to social programmes rather than growth promotion, which may exacerbate America’s over-consumption problem and delay sustainable recovery. On top of this, the unprecedented fiscal stimulus, with the Federal Reserve’s move to inject money into credit markets, contains self-destructive seeds. ... In the long term, America may seek to resolve its economic mess by devaluing the dollar at best and a default at worst. ... It is the foreign holders of US obligations denominated in dollars that would end up paying.

Analysts have warned of the dangers of the US Treasury bond bubble that developed in late 2008. ... If this bubble burst, east Asians would be victims..., the consequences would devastate Asians’ hard-earned wealth and terminate economic globalisation.

No other international monetary system offers a viable alternative. However, we can make the main reserve currency power more accountable by creating an instrument to help manage the global crisis.

The basic idea is to turn Asian savings, China’s in particular, into real business investments rather than let them be used to support US over-consumption... [E]quity claims on sound corporations and infrastructure projects are at less risk from a currency default. But Asians do not want to bear the risk of this investment because of market turbulence and a lack of knowledge of cultural, legal and regulatory issues in US businesses. However if a guarantee scheme were created, Asian savers could be willing to invest directly in capital-hungry US industries.

First, Asian countries could negotiate with the US government to create a crisis relief facility. The CRF would be used alongside US federal efforts to stabilise the banking system and to invest in capital-intensive infrastructure projects such as a high-speed railway from Boston to Washington DC.

Second, Asians could pool a proportion of their holdings of Treasury bonds under the CRF umbrella to convert sovereign debt into equity investment. Any CRF funds, earmarked for industrial commitment, would still be owned and managed by their respective countries. In return, Asians would hold minor equity shares that would, like preferred stock, be convertible .

Third, the US government would act as the guarantor, providing a sovereign guarantee scheme to assure the investment principal of the CRF against possible default of targeted companies or projects. Fourth, the Fed would set up a special account with the US government to supply liquidity that the CRF requires to swap sovereign debt into industrial investment in the US.

The CRF would lessen Asians’ concern about implicit default of sovereign debts caused by a collapsing dollar. It would cost little and help the US by channelling funds to business investment. Conventional Keynesian policies – fiscal and monetary expansion on a national basis – cannot solve the problem but will make it worse.

If China and other Asian countries were to fix their under-consumption problem, that would help too (though not right now, if the cheap foreign loans dry up that will make recovery harder).

Wednesday, March 18, 2009

"China Toys With Biting Hand Feeding Its Surplus"

John Berry:

China Toys With Biting Hand Feeding Its Surplus, by John M. Berry, Bloomberg: If Chinese Premier Wen Jiabao is so worried about the safety of China’s investment in U.S. Treasury securities, he can order the money be moved elsewhere.

Of course, that likely would drive down the value of the dollar, push up U.S. interest rates and cause huge losses in China’s $700 billion portfolio of Treasuries.

The reality is that Wen and China are stuck. They have no viable alternative so long as China continues to accumulate large amounts of foreign currencies as a result of its big trade surplus. ... [C]ontinuation of a big trade surplus is ... critical to China -- something Wen conveniently forgets. ...

There will still be a large deficit to be financed, and China and the U.S. will still be intertwined both economically and financially. Wen must know that.

What he doesn’t seem to accept is that anything he and other senior Chinese officials do to raise questions about U.S. creditworthiness or the value of the dollar could come back to haunt them.

Tuesday, February 24, 2009

Did China Help to Create the Financial Crisis?

Was bad advice to developing countries partly responsible for the financial crisis? According to this, the answer is yes:

How China helped create the macroeconomic backdrop for financial crisis, by Moritz Schularick, Economist's Forum: Over the past decade, China and other emerging markets accumulated foreign currency reserves to insure against the economic and political vagaries of financial globalisation. They were wise to do so. Countries with larger reserves are weathering the storm relatively better than those who have bought less insurance.

Although purchasing insurance policy might have been sensible from the perspective of each country, collectively these currency interventions prepared the ground for the global crisis. Emerging markets, most notably China, helped to create the macroeconomic backdrop for the current financial crisis by subsidising interest rates and consumption in the US. ...

[After] the Asian crisis... Emerging markets heeded Martin Feldstein’s advice and took out an insurance policy against the vagaries of financial globalisation. By running current account surpluses, intervening in foreign exchange markets and building up currency reserves, Asian and other emerging economies were sustaining export led growth and buying insurance against future financial instability.

These policies turned developing markets into net capital exporters to the developed world, mainly to the US. ... Yet the accumulation of large war chests of foreign reserves through currency intervention carried negative externalities.

The arrangement opened a Pandora’s Box of financial distortions that eventually came to haunt the global economy. The glut of savings from emerging markets has been a key factor in the decline in US and global real-long term interest rates, despite the parallel decline in US savings.

Lower interest rates in turn have enabled American households to increase consumption levels and worsened the imbalance between savings and investment. And because foreign savings were predominantly channeled through government (or central bank) hands into safe assets such as treasuries, private investors turned elsewhere to look for higher yields. This ... unleashed the ingenuity of financial engineers who developed new financial products for the low interest rate world, such as securitised debt instruments.

This is not to say that reserve accumulation was the only cause for the current crisis. Yet the core issue remained the Chinese willingness to fund America’s consumption and borrowing habit. Without this support, interest rates in the US would almost certainly have been substantially higher, acting as a circuit breaker for the developing debt-consumption bubble.

Beijing and others cannot be blamed for reckless lending into the housing bubble or leverage in western financial institutions, but it is clear that a vast amount of capital was flowing from a developing country ... to one of the richest economies in the world. ...

From the perspective of emerging markets, the academic debate as to whether reserve levels have grown excessive has been answered almost overnight in the current crisis.  It is clear to policy makers from Buenos Aires to Budapest and Beijing that one can’t have too many reserves in a world of volatile capital flows. ... Have we therefore come to a crossroads for financial globalisation...? After the dust has settled, members of the economics profession will have to think hard about what the right policy advice ... should be. ...

The liquidity coming into the US from Asia and other sources such as the oil producing countries was a factor in the crisis, as were low interest rates under Greenspan, but the availability of large amounts of liquidity on easy terms in and of itself is not enough for problems to develop. How the liquidity is used is the important factor, and if the proper regulatory safeguards are absent, the liquidity may not be used very wisely (as we now know all too well).

With the proper regulatory apparatus in place, or with financial instruments that truly disperse and reduce risk as promised, the reserve balance insurance polices pursued by developing countries do not have to lead to a financial crisis. Distortions are one thing, a crisis is something else and the mere existence of distortions does not lead, by necessity, to a meltdown of the financial system. I am not arguing that no distortions existed, but the crisis was not a necessary consequence of those distortions. The article notes that "Beijing and others cannot be blamed for reckless lending into the housing bubble or leverage in western financial institutions," and I agree. With the proper regulatory framework in place, the crisis need not have happened, and I can't see how the absence of effective regulatory safeguards is the fault of the polices pursued by countries anxious to protect themselves from a repeat of the Asian crisis.

Friday, February 06, 2009

"Is China Immune to Crisis?"

Ken Rogoff is worried about "the sustainability of China's growth paradigm":

Is China Immune to Crisis?, by Kenneth Rogoff, Commentary, Project Syndicate: Addressing the annual World Economic Forum in Davos, Switzerland, Chinese Premier Wen Jiabao explained his government's plans to counter the global economic meltdown with public spending and loans.

He all but guaranteed that China's annual growth would remain above 8 percent in 2009. ... But does the Chinese government really have the tools needed to keep its economy so resilient? Perhaps, but it is far from obvious. ...

With roughly $2 trillion in foreign-exchange reserves, the Chinese do have deep pockets... Many leading Chinese researchers are convinced that that the government will do whatever it takes to keep growth above 8 percent. But there is a catch. ...

Simply put, it is far from clear that marginal infrastructure projects are worth building, given that China is already investing more than 45 percent of its income, much of it in infrastructure. ... In fact, China's success so far has come from maintaining a balance between government and private sector expansion. Sharply raising the government's already outsized profile in the economy will upset this delicate balance leading to slower growth in the future.

It would be preferable for China to find a way to substitute Chinese for U.S. private consumption demand, but the system seems unable to move quickly in this direction.

If government investment has to be the main vehicle, then it would be far better to build desperately needed schools and hospitals than "'bridges to nowhere," as Japan famously did when it went down a similar path in the 1990s.

Unfortunately, China's local officials need to excel in the country's "growth tournament" to get promoted. Schools and hospitals simply do not generate the kind of fast tax revenue and GDP growth needed to outperform political rivals.

Even prior to the onset of the global recession, there were strong reasons to doubt the sustainability of China's growth paradigm. The environmental degradation is obvious even to casual observers.

And economists have started to calculate that if China were to continue its prodigious growth rate, it would soon occupy far too large a share of the global economy to maintain its recent export trajectory. ...

One way or the other, the financial crisis is likely to slow medium-term Chinese growth significantly. But will its leaders succeed in stabilizing the situation in the near term?

I hope so, but I would be more convinced by a plan tilted more toward domestic private consumption, health, and education than to one based on the same growth strategy of the past 30 years.

Monday, December 22, 2008

What Decoupling?

A proposal to rebalance consumption and investment in China:

The China Growth Fantasy, by Yasheng Huang, Commentary, WSJ: Remember the hype about "decoupling"? Not so long ago, Western analysts -- in particular investment-bank economists -- were peddling the idea that China had become ... able not only to drive its own growth independent of the United States but also to power the global economy forward.

To the extent that these Wall Street economists are still employed, few would make that argument now. The economic numbers emerging out of China are sobering. ... Clearly China is not bucking global trends.

So how did all the decoupling theorists get it so wrong? ...

Continue reading "What Decoupling?" »

Friday, September 12, 2008

"The Economics of Kapital and the Capital of Economics"

Michael Perelman is giving a talk to give in China in a few months, and is hoping to get (helpful and constructive) feedback on this initial draft:

The Economics of Kapital and the Capital of Economics

Introduction I want to talk about two capitals ‑‑ capital as it appears in economic theory and Das Kapital of Karl Marx. A careful consideration of these two capitals serves as a warning of what might be in store for any country that allows itself to follow the logic of markets.

Each of these two capitals presents a different sort of difficulty. Economics, the basic theory of capitalism, paradoxically never bothered to develop a serious theory of capital. In contrast, Marx's idea of capital as a social relation is so rich that it defies being compressed into a simple theory.

For this reason, many parts of Marx have rarely been integrated into their modern analysis of his work; these parts stand as incredibly brilliant observations, each of which are like a kaleidoscope. Turn them a bit and they will generate many new observations, each of which could merit a book of its own.

The three observations selected here represent both a chronological sequence and a progression in the sophistication of the challenges that they present.

Continue reading ""The Economics of Kapital and the Capital of Economics"" »

Friday, September 05, 2008

"A Chinese Conspiracy Theory"

Andrew Leonard at Salon sums up recent commentary on Chinese investments in U.S. bonds that is going sour, and provides some of his own:

A Chinese conspiracy theory, Andrew Leonard: Hardly a day goes by without Dean Baker finding something to get angry about in the pages of the New York Times or Washington Post, but on Friday morning the co-director of the Center for Economic and Policy Research delivered a double-dose of dyspeptic sputtering.

"Is China's Central Bank Run By Morons?" asks Baker, responding to a Times piece detailing the woes of the People's Bank of China, which has found itself stuck with a gargantuan pile of U.S. bonds that are turning out to be a pretty bad investment.

Baker can't understand how anyone could have been stupid enough, back in 2001 or 2002, not to foresee that the then mighty dollar would inevitably decline, given the size of the U.S. trade deficit. If the Times' Keith Bradsher was reporting accurately, argues Baker, when he quoted an expert in Chinese financial affairs as saying that many bank officials "resented the institution's losses," then the Times misjudged the importance of the story.

If the people who run China's central bank are really this ignorant, that should have been the headline of the article, which should have been on the front page.

I think Baker is overstating the case to declare that "Apart from buying bonds from Zimbabwe, it's hard to imagine how [the Chinese] could have made a worse investment." After all, if the Chinese hadn't been bailing out the U.S. financial system, where would the U.S. have gotten the money to pay for all the Chinese-made goods whose export has fueled China's economic rise?

To me, the most interesting tidbit in Bradsher's story was a reference to a conspiracy theory currently all the rage in China.

From the Times:

[The expert] said the officials blamed the United States and believed the controversial assertions set forth in the book "Currency War," a Chinese best seller published a year ago. The book suggests that the United States deliberately lured China into buying its securities knowing that they would later plunge in value.

"A lot of policy makers in China, at least midlevel policy makers, believe this," Mr. Shih said.

That nugget reminded me of a line from a long, if not particularly interesting or insightful essay about Chinese-U.S. relations by Treasury Secretary Hank Paulson in the current Foreign Affairs.

Despite the two countries' long history of interaction, they frequently display a stunning ability to misunderstand each other.

Seriously; the officials at the People's Bank of China probably aren't morons, but they do betray a breathtaking misunderstanding of the quality of recent government in the United States if they think we could intentionally pull off that kind of massive grifter's scam on China. We're not worthy.

Another line from Paulson's essay is apropos here:

Exploiting popular anxieties about globalization, economic nationalists in China are questioning the benefits of China's integration into the international economic system.

That sentence also holds true if one substitutes the words "United States" for "China." Both nations boast sizable factions who believe the other side is taking advantage of them. I don't normally find myself in Paulson's camp, but I've got to agree with him on this one -- the U.S. and China are not playing a zero-sum game. China's bankrolling of U.S. debt has been critical to the stability of the U.S. economy and the U.S. appetite for Chinese goods has translated into increased prosperity for hundreds of millions of Chinese.

That's not necessarily a bad thing.

Brad Setser comments here.