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Thursday, June 02, 2011

Quick International Finance Note #1

Tim Duy:

Quick International Finance Note #1, by Tim Duy: Brad DeLong directs us to Ryan Avent, whose conclusion I agree with:

If Congress called into question the safety of the one safe asset for which markets have an almost unlimited appetite, all hell would break loose.

Washington is making the recovery harder than need be. My only quibble is with this characterization:

When debt issues came up during my trip to China, officials had a consistent message: China is a patient investor. It wants America to take steps toward fiscal sustainability, but it's happy to have this happen over a 5- to 10-year period.

This characterization maintains the myth that China is doing the US a favor by being an “investor” in the US economy. As Michael Pettis explains, China would not want to be the recipient of their own gift:

But what about the benefits to the US of reserve currency status? A lot of analysts argue that the predominance of the dollar gives the US two important advantages. It reduces the cost of imports to American consumers and it lowers US government borrowing costs.

But both arguments are seriously flawed, I think. Americans already over-consume, and so it is hard to argue that they benefit in the aggregate from lower consumption costs, especially when it comes at the expense of employment. And anyway if cheaper consumption is such a gift, it is hard to explain why attempts by the US to return the gift to countries whose consumption costs are artificially high – demanding for example that these countries revalue their currencies and so reduce costs for their own consumers – are always so indignantly rejected.

DeLong summarized this issue nicely last October in a takedown of John Cochrane:

When Cochrane writes….does he genuinely not understand that China's investment in the United States does not reflect a belief on the part of China's savers that the U.S. offers high rates of return? Does he genuinely not understand that this is a government-run foreign-exchange intervention program--the largest one in history?... that an economics professor is pretending that China's dollar asset-purchase policy is "a tragic investment decision, not a currency-manipulation effort" makes me want to hide my head in shame.

China did not deliberately “invest” in the US. That “investment” is a byproduct of an economic development strategy. They are investing in themselves, with the expected returns outweighing the expected losses to be suffered on the byproduct of their strategy, a portfolio of US assets. And when they rattle the saber of that portfolio, note any action on their part would make them the victim of self-inflicted wounds. That portfolio is like a noose around the necks of both nations.

    Posted by on Thursday, June 2, 2011 at 12:24 AM in Economics, Fed Watch, International Finance | Permalink  Comments (6)


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