James Galbraith: Clueless in China

James Galbraith expresses sympathy for Ben Bernanke on behalf of all economists:

Clueless in China, by James K Galbraith, Commentary, The Guardian: Speaking as I rarely feel entitled to do, on behalf of all my fellow professional economists, I felt true, true sympathy last week for Ben Bernanke, as he trailed after Henry Paulson in China.

Paulson's China policy is easily understood. In the United States government the Treasury represents the interests of Wall Street, as Joe Stiglitz has written eloquently... An alumnus of Goldman Sachs, Secretary Paulson is ideally suited to his job.

And what Wall Street wants from China is what Wall Street always wants: the freedom to speculate (excuse me, invest) in currency, corporate stocks and bonds, and real estate. Wall Street loves risk, uncertainty and volatility. The Chinese don't. This is a conflict. It is not in any sense a complicated question.

Paulson made a power play, based on a threat: open up or we'll shoot ... based on a bluff. Since the bluff was transparent, the Chinese called it. And when they did, the US side folded. The Chinese then completed the hand by giving back a few symbolic concessions, so that Paulson's team would not have to admit ... that the trip had accomplished nothing at all....

Bernanke is an economist..., he is at heart an academic. In other words, he has standards, and a certain amount of professional dignity to maintain.

And last week he had the sorry job of putting economic lipstick on Paulson's pig. More than that: Bernanke had to argue that it was in China's economic interests to go along with Paulson's plan. Worst of all, he had to talk past the Chinese officials, who somehow seemed to feel that they have a better understanding of their own interests. It must have been dreadfully embarrassing.

Bernanke gave it a good college try, with an impressively wonkish speech... On no evidence at all, he argued that a higher RMB would help China maintain its economic growth. The trouble with this that current policy has given China world-beating economic growth for three decades. Bernanke knows this (and said so), so he couldn't press this argument very far.

Next, having credited Chinese growth partly to its high savings, Bernanke made his second argument: China should now bring its savings rate down. This he said should be achieved by improving China's social safety net, so that Chinese families would feel less need to squirrel away funds to cover health care and old age. Apart from the direct benefits, Bernanke argued that this would reduce China's trade surplus by increasing Chinese household consumption.

Finally, as the US delegation left town, Paulson rather gratuitously promised to try to increase private savings rates in the United States, which Paulson wants to do, of course, by cutting Social Security and Medicaid.

So here's the Bernanke-Paulson position in brief summary:

1) China's currency strategy has helped produce rapid growth for 30 years; therefore it should be abandoned.

2) China's high savings rates have been a key to this success; therefore they should be reduced.

3) China, a country emerging from communism, should spend more on public health and social security, so that ordinary Chinese can save less. (This is actually a good point, as far as it goes.)

4) The United States, a capitalist country, should spend less on social security and public health, so that ordinary Americans will be forced to save more.

5) Somehow, all this will reduce the deficit in the US-China balance of trade, a goal whose importance everyone agrees on but that no one can actually explain.

Adam Smith wrote it; I only quote it:

Such as they were, however, those arguments convinced the people to whom they were addressed. They were addressed by merchants to parliaments and to the councils of princes, to nobles and to country gentlemen, by those who were supposed to understand trade to those who were conscious to themselves that they knew nothing about the matter ... Those arguments therefore produced the wished-for effect ... The attention of government was turned from guarding against the exportation of gold and silver to watch over the balance of trade... From one fruitless care it was turned away to another care much more intricate, much more embarrassing, and just equally fruitless.

I've been thinking about the proper role of the Fed chair in this situation, i.e. the extent to which Bernanke should speak out on matters such as this. I don't have the answer (your thoughts?). The Fed chair is partly a political appointment that brings the Executive branch's interests to Fed policy table, but the Fed has a larger responsibility to protect the overall public interest, not the interests of any particular sector (as the Fed has argued many times when speaking out against targeting asset-price bubbles).

On that basis one thing is clear, the Fed chair should not take public positions that undermine the credibility of the Fed as protector of the larger public interest rather than the interests of Wall Street of any other group. I think there is already some belief that the Fed has moved in this direction with its adoption of inflation targeting (which some view as holding down wages to benefit business), and other actions haven't helped to insulate the Fed from criticism for taking political positions, e.g. Greenspan's remarks on taxes and deficits.

I think Bernanke's position can be justified on an economic basis, i.e. there is theoretical support for the position that the policies he advocates for China will raise economic well-being generally. And though the speech wasn't directed at the implications for U.S. monetary policy, there is a connection to U.S. monetary policy and it did give advice on China's monetary policy, so in that sense it is within the Fed's purview.

But as the Galbraith commentary above makes clear, I'm not sure it passes the political test of not appearing to represent a narrower set of interests. Given the importance of Fed credibility, from my perspective an abundance of caution is in order when the Fed chair speaks, and I would prefer that the Fed limit itself to comments that relate directly to the conduct of U.S. monetary policy.