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Martin Feldstein is right

by Brad Setser
May 24, 2006

Felstein has argued that more “competitive” dollar would contribute to reducing the US trade deficit, and at least help to slow the rise in the US current account deficit.  I agree – though I would think the case for Asian and Gulf appreciation is stronger than the case for Euro appreciation.   Dollar depreciation alone isn't enough to bring the US trade deficit down (and slow the increase in the US current account deficit, which is set to rise because of growing net interest payments even if the trade deficit stabilizes), but it is a part of the process.

But that is not what this post is about.  Feldstein also has argued that the US data understate central bank financing of the United States.   Throw in financing from the oil states' investment authorities as well.   And the more I look at the data, the stronger Feldstein’s argument that the US data understate official inflows looks. 

For one, recorded inflows of around $220b seem low relative to global reserve accumulation (after adjusting for valuation changes, and including all Saudi foreign assets) of around $660-670b.     There is no doubt that central banks bought more euros and pounds and yen in 2005 than they did in 2004.   Recorded purchases of euros, yen, pounds and the like in the IMF’s COFER data totalled $150 billion, and since the IMF does not have data on the current composition of China and others who added, by my estimates, $300b to their reserves (on a valuation adjusted basis), that total is no doubt low.    Add in another $80b in non-dollar purchases from that set of countries.   That makes $230b, out of around $580b in (valuation-adjusted) reserve  growth — leaving $350b for the dollar.   I won't go through all the details for how I calculated this, but it is based on a fairly detailed analysis — and includes an implicit guess about changes in the portfolio of those countries who don't report their currency composition of their reserves to the IMF.

However, the IMF COFER data exlude reserves China shifted to its state banks (and a smaller currency swap), Taiwan's reserves and the increase in the Saudi-Monetary authorities non-reserve foreign assets.  Add those in and global reserves grew by about $660-70b by my estimates.  So even if the world’s central banks bought $250b of euros, pounds and yen in 2005 – that still leaves a bit over $400b for the dollar.   

$220b shows up in the US data, maybe $90b will show up in the BIS data showing central bank dollar deposits …  and so on.   But there is still a gap of around $100b.    Maybe more.  

And the $660-70b total leaves out the Norwegian oil funds, and the oil money parked in the Kuwait investment authority, Abu Dhabi’s investment authority and so on.    Add in at least another $50b there.    A good chuck of that went into dollars.    So I strongly suspect the US data understates official financing by at least $100b, maybe more.    And that sets aside the question of what the world’s banks are doing with all the dollars that central banks have placed on deposit – some no doubt are lent out to folks who lend to the US (though some are lent out to folks who buy Brazil’s dollar bonds as well). 

Another way of getting at the same result:  There is a huge gap between the Gulf oil exporters current account surplus and recorded inflows into the US – which likely implies that a lot of purchases went through London.   The IMF's WEO data shows that Middle Eastern reserves (i think this data includes all Saudi assets) increased by $107b in 2005, and there were official outflows (Think Kuwait investment authority and the like) of anoter $92b.  Call it $200b.  Recorded US inflows from the Gulf were only a bit over $10b.   That's a big, big gap.   Not all the $200b went to the US, but more than $10b did.   The US data may understate official inflows from the Gulf by as much as $100b. 

If attempts to show that the gap between known central bank flows of dollars (and known Gulf purchases of dollars) and their overall reserve increase (the Gulf’s current account surplus) are not convincing, just look at the following graph.

I plotted the increase in global reserves against (net) debt inflows to the US – that is foreign purchases of US debt net of US purchases of foreign debt – and recorded official inflows to the US.    It turns out that official inflows tracked global reserve growth until 2004 – which makes sense, because all Japanese flows show up in the official US data – but not in 2005.     There is a much closer match between overall reserve growth and net foreign purchases of US debt.


Maybe that is not determinative, but it is certainly suggestive.  It certainly seems like the US data misses some official flows.

In the part of the Treasury's Foreign Exchange report that no one reads, the Treasury argued — based on the official data — that private demand for US assets picked up in 2005.  They are right.  But they insist a bit too much.    Private flows provided, in my view, maybe $400b of the total net flows the US needed in 2005 – far more than the $250b or so they provided according to the US data in 2004.  And I suspect that the US data somewhat understated central bank flows in 2004 as well.   Total dollar reserve accumulation, according to the BIS, was closer to $500b — and most of that came back to the US, one way or another.

$400b in net private flows from foreign investors to the US in 2005 is more than the $250b (if you believe the official data) or $150b (if you believe me/ the BIS and think offshore dollar deposits from central banks indirectly helped finance the US) in private financing for the US in 2004.  But $400b is not enough to cover a $800b deficit.    The US still needed $400b from its friends in the governments of China, Russia and the Middle East.

And all the available data suggests it will need far more in 2006.


  • Posted by Dave Chiang

    Hi Brad,

    In economic theory, Martin Feldstein is right. The theory sounds nice on an academic paper, but in reality, a lower dollar will not address the structural challenges the US is facing. There is simply very little “real wealth” producing, industrial capacity left in the United States. American Industry has squandered its technological edge by outsourcing manufacturing to overseas competitors. A lower dollar will not re-create the US manufacturing industry, and will not turn America into a nation of savers. And while a middle class in China is growing, Engineering salaries in China are only 5% of comparable US salaries. Besides, what consumers goods do Americans produce in the US that are attractive to Chinese consumers?


  • Posted by Guest

    How would “Gulf” appreciation work? The Gulf has one product, oil, which it sells in dollars. It seems rather beside the point what the local currency is worth. Now a barrel of oil costs xxx Gulf currency. If the Gulf currency appreciates, a barrel would cost 2 * xxx Gulf currency. But presumably the price in Usd would remain the same…. I guess it would cost Michael Jackson some, and maybe there are some tourist dollars going to parts of the Gulf, but otherwise would Gulf currency appreciation really have any impact?

  • Posted by Dave Chiang

    Reply to Guest

    Actually Saudi Arabia SABIC is one of the world’s largest producer of petrochemicals, fertilizers, textile fibers, and plastics. Taking a cue from the Japanese and Chinese, the Middle East oil nations have Industrial policies to diversify away from raw material exports of energy into higher-valued added manufactured products. The economic linkages between the Middle East oil states and the Far East are rapidly evolving as well. Perhaps one day in the not too distant future, Saudi Arabia will begin accepting Euros, yen, and yuan for their exports. That would eliminate a pillar of support for US Dollar hegemony that has massively distorted the imbalance global economy.


  • Posted by Lord

    China will find it has been paid more for its output than it is actually worth. That will be a crushing blow.

  • Posted by Guest

    David Chiang understands that China is facing enormous problems, he is just not allowed to say it. They imprison people in China for speaking their minds.

  • Posted by bsetser

    Guest. The middle east has two big exports — petroleum, and petroleum derivatives (D.Chiang is right about SABIC, but fertizers and plastics are all made chemically from hydrocarbons). Exchange rate appreciation wouldn’t have an impact on exports. What it would have an impact on is imports. European vacations become more affordable for more people. European goods become more affordable. And so on. There is no reason why the Gulf countries are paying what they are now paying (more than in 2000) for European goods.

    How does that help the US. Europe sells to the Middle East, the US sells to Europe. And more middle east demand for eurozone exports would bid up the euro, and at some point, US goods might even become competitive in the middle east and Russia — no doubt US goods sell as a “political discount” but that discount presumably is not infinite.

    Emirates buys Boeings …

  • Posted by Nathan

    Dave Chiang,

    I know you are big China proponent, but industrial production in the US hasn’t peaked, plateaued or for that matter declined. I would paste a graph for you, but I am unable, so let’s look at some numbers. Based on data from the FRB, with 2002 as a base year index here’s some data:

    1950: 16.31
    1960: 23.67
    1970: 38.06
    1980: 51.74
    1990: 66.63
    2000: 104.28
    2005: 113.40

    You may be confusing employment growth, with output growth, which is a common misappropriation. The US has been shifting from an industrial economy, to an information and service oriented economy, just as it made the transition from an agricultural based on economy to an industrial based economy. The same transition which China is making right now.

    So yes indeed, a lower dollar may change some of the transfer pricing that multinationals use, which may have some effect on the trade deficit, in addition to making American exports more competitive (for instance, a sharp increase in the Yen relative to dollar would Japanese exports for autos in particular to US, for that reason, the Japanese auto companies have created a “natural” hedge by building plants in the US).


  • Posted by Charlie

    Dave Chiang,
    You make the same argument as the chinese government. One thing that puzzles me about this argument. If a depreciating dollar will have no effect, why does the chinese government spend so much money keeping the dollar from depreciating? The having to buy oil in dollars argument is illogical since a stronger yuan relative to the dollar will make oil less expensive to the chinese.

  • Posted by Dave Chiang

    To Guest,

    Several months ago, I posted in a pubic internet forum that I owned a fair amount of Exxon/Mobil stock which I had started purchasing a decade ago, and that it was TS for those who choose to run a 3/4ton 4×4 w/ $3.00 a gal gaz. Don’t like the situation? Then get on the other side of the fence

    The profanity laced, rabid replies, has me seriously questioning the overall mental balance of the average person residing in this country at the moment

    Show-off and brag all the way up, scapegoat foreigners and whine all the way down.


  • Posted by Dave Chiang

    Reply to Charlie,

    The United States is not the only export market for the Chinese. In fact, the Europe and Southeast Asia are equally important trading partners to the Chinese. Why would the Chinese want to significantly appreciate their currency and voluntarily lose global economic competitiveness? Already the Chinese economy is losing labor intensive employment to Vietnam, India, and Pakistan in textile manufacturing. If the Bush Administration wants a Chinese currency revaluation, the US Dollar needs to depreciate against all major currencies in the world, not just the Chinese yuan.


  • Posted by Charlie

    David Chiang,
    OK, so why do they focus on the USD if the value of the USD doesn’t matter? Why not depreciate against Vietnam, India, and Pakistan? It would be more effective and far less expensive.

  • Posted by Dave Chiang

    To Charlie,

    Since critical commodities especially oil are priced only in US Dollars, the global monetary system is fundamentally based on US Dollar hegemony. Other nations across Asia and Latin America must also obtain US dollars to purchase these critical commodities. With the US Dollar at the central core of the global monetary system, almost every economy in the world with the possible exception of North Korea is forced into monetary linkages with the US currency. The Euro is just a derivative of the US Dollar. Given that 70% of global trade transactions are denominated in US Dollars, the Chinese are not at liberty to decouple their currency from the US dollar without catastrophic economic consequences. Simply stated, the Chinese will not be bullied by the Neo-con Bush Administration into a currency revaluation that would be tantamount to economic suicide.


  • Posted by Charlie

    Dave Chiang,
    Your arguments don’t hold water. You’ve reverted back to the argument about commodities being priced in dollars. If the Yuan appreciated relative to USD, commodities would be less expensive to the chinese. If anything, with rising commodity prices in USD, an appreciating Yuan would be more stabilizing, not less stabilizing. There are a lot of countries that don’t hold massive USD reserves and aren’t pegged to USD that haven’t experienced the destabilization you say would occur. Also, how is the Euro a derivative of the US dollar? Can you explain this in more detail?

  • Posted by alex

    Dave Chiang: American Industry has squandered its technological edge by outsourcing manufacturing to overseas competitors.

    I agree that it’s been, and continues to be, a big mistake. However, I’m not convinced that all is lost yet.

    what consumers goods do Americans produce in the US that are attractive to Chinese consumers?

    Why are you obsessed with consumer goods? What about industrial and agricultural goods?

    The profanity laced, rabid replies …

    Irrelevant, since the replies here are civil.

    the US Dollar needs to depreciate against all major currencies in the world, not just the Chinese yuan

    Impossible so long as China continues to buy lots of dollars. Chinese policy not only keeps the yuan down, but the dollar up as well.

    Why would the Chinese want to significantly appreciate their currency and voluntarily lose global economic competitiveness?

    So you think that China is competitive only because of their currency manipulation. Hmmm.

    Since critical commodities especially oil are priced only in US Dollars …

    As Charlie mentioned, that’s all the more reason to let the yuan appreciate against the dollar.

    the Chinese will not be bullied by the Neo-con Bush Administration into a currency revaluation that would be tantamount to economic suicide

    While I’m no fan of the Bush administration, their response to Chinese currency manipulation has been laughably weak. They started a war based on imaginary WMD’s, but do little about real economic warfare being waged against the US.

  • Posted by John123

    Brad–excellent analysis of the disparity between real and reported dollar flows. Ignoring the dollar holdings of the central banks of Asia, where are the OPEC exporters stashing their dollar holdings?

    Sooner or later, the OPEC countries may want to invest these dollars in something other than U.S. t-bills. This brings up what happened in the late 1970s and early 1980s when Citibank and others “recycled” these petrodollars in high risk developing countries who for the most part forfeited the loans.

    As to David Chiang’s take on a devaluation of the dollar having no effect on the U.S. trade deficit with China, why does he then so strongly oppose a devaluation of the Yuan because he says it will be a disaster for China?

    No, I think simple price demand elasticity indicates that both Chinese and U.S. consumers will react to sharply changed prices. Feldstein is right: a devalued dollar will both aid U.S. exports and diminish U.S. imports, ceterius paribus. It would cheapen U.S. goods in China and increase competition with Chinese producers. It will put an end to China’s export-led development if the Yuan appreciates substantially.

    But it will never happen since the Chinese Government–like Japan’s will not allow it.

  • Posted by Dave Chiang

    “Strong Dollar” policy by Treasury Secretary Robert Rubin

    To Charlie,

    China is primarily an industrial exporter. Plain and simple, a revaluation of the Chinese yuan would damage China’s global economic competitiveness.

    The strong dollar policy instituted by former Treasury Secretary Robert Rubin and slavishly followed by successors destroyed the American Industrial base. That economic policy was supported by the major Wall Street financial institutions in a deliberate attempt to outsource US production and destroy the US labor movement. It succeeded.

    The strong dollar policy was the policy of the Wall Street-Treasury complex. China as a sovereign nation retains the right to their national monetary policies. It is beyond contempt that the Bush Administration and economic lackey Martin Feldstein would attempt to dictate the monetary policy of the Central Bank of China. Imagine the uproar if the Chinese attempted to dictate the monetary policy of the US Federal Reserve. The authority of the Bush Administration may extend to Baghdad Iraq but not to Beijing China. Period.


  • Posted by Joshua

    If the Chinese government ever decided to stir up anti-Chinese sentiment in the U.S, it could do a lot worse than hire Dave Chiang. His hatred of America and Americans is so utterly profound that he would be the natural choice.

    As an aside, his attack on the “neo-con Bush administration” is particularly risible given not only his own government’s utterly wicked human rights record but also the ongoing brutal rape of the great nation of Tibet.

    U.S. State Department Report on Human Rights Practices in China (2004)

  • Posted by Joseph Wang

    Dave Chiang: This isn’t a China versus the United States issue. If you look at views on what China should do with the RMB, it doesn’t fall on national lines. (Personally, I think a strong currency is a good thing.) Treasury has been trying to convince China that appreciating the RMB is a good thing, but the United States is not in a position to force China to do anything.

    Also, if you look at the policies that are coming out of Beijing, they aren’t for a fixed currency. Right now the PBC and banking regulators in Beijing seems to have been convinced that for a gradual float of the RMB, and they are taking up policies that are very friendly to Wall Street. There are people in China who are alarmed by this (the Neo-Leftists in the National People’s Congress) but the situation is hardly US versus China.

  • Posted by wcw

    Dave, may I respectfully suggest you start to keep your own blog, then to take your often-long, usually tangential responses to Mr. Setser there and post only the link in comments here?

    I for one would be extremely appreciative, and likely would click through now and then.

  • Posted by Joseph Wang

    Joshua: Careful about identifying people with groups. There are 1.3 billion Chinese and 350 million Americans each with slightly different ideas about how the world is supposed to work.

    Also, I don’t think the logic applies that because of fact X, you have no right to complain about Y. Just because the government of Ebonia does something doesn’t mean that one shouldn’t take the observations of Ebonians seriously.

  • Posted by Dave Chiang

    Reply to Joshua,

    What do Chinese human rights have to do with China’s monetary policy? Why don’t you debate the topic on Chinese monetary policy rather than tangential issues. And by the way, Tibet is a part of China that is recognized by even the US government.

    As a sovereign nation, China retains the right to their national monetary policies. The Bush Administration has absolutely no right to dictate the monetary or currency policies of the Central Bank of China. If the Nush Administration want a weaker currency, they can authorize the US Treasury to exchange US Dollars for Chinese yuan at a rate of 1 US Dollar for 4 Chinese yuan.


  • Posted by bsetser

    john 123 — where are OPEC countries stashing their oil windfall. The honest answer is that we don’t know. It doesn’t show up in the US, except indirectly, as flows from london. and there is no way of even guessing whether the overall distribution of flows from london between different US assets is any way indicative of the OPEC countries preferences, since it is intermingled with flows from a broad range of sources. I suspect that they are buying a range of US securities, sort of like China. but i don’t know. Russia was until recently holding mostly t-bills and short-term instruments (russian flows are showing up in the US data), but there policy seems to be changing. the q1 data showed a net outflow from Russia, which harldly makes sense. i suspect that they shifted into longer-term instruments held by London custodians. but that is just a guess.

    Agree with J. Wang’s comments above. And i know data issues aren’t the most exciting things to discuss, but I am interested in any critique of my analysis here.

  • Posted by Charlie

    David Chiang,
    It sounds like you’re saying that depreciating the USD relative to the Yuan won’t have any effect on China, but appreciating the Yuan relative to USD will have a devastating effect on China. Don’t you realize the two are synonomous with each other?

    Regardless of your opinions. Actions speak much louder than words. I doubt China would risk 10% of it’s GDP keeping the USD proppped unless they thought it would make a difference. You’re chinese government approved reply about commodities being priced in dollars forcing the chinese governement to purchase USD just doesn’t hold water. Particularly since they don’t actually hold much USD. They recycle the USD back into the US via fixed income investments. The only argument that makes sense is they are propping the USD so they can be more competitive in exports.

  • Posted by OldVet

    Comrade Chiang is making some good points (Oh Lord, I promise to repent tomorrow.)

    If US politicians took financial and other actions that were strictly aimed to benefit the US economy, we would not be in such a mess today. We have elected and appointed cowards to run Treasury and trade policy, who are lackeys of the corporate elites in the US who pay the election piper’s tune. Corporations decided to ship factories to Mexico, China, and software production to India. Corporate America made investments overseas and wants their balance sheets to look strong. Therefore corporate America told US politicians to have a “strong dollar” policy, and they did.

    We can decide to raise the price of Chinese goods, or Japanese goods, and then do it through tariffs. We have no business telling China to use common sense from our point of view, since common sense from Beijing’s point of view is more factories and more peasants employed who won’t overthrow the Chinese politicians and generals. Very simple.

    I’ve been around the world a time or two, and we can expect no cooperation from anybody when it is adverse to their own interests, or their perception of their interests. It’s a complete misunderstanding of international trade relations to think that America has “friends” – we have transactional cooperators, and maybe a favor from time to time, but most governments focus on keeping their politicians in power and their own citizens satisfied. I spent 10 years overseas with the US diplomatic service promoting US business and economic interests, some time ago, and things haven’t changed. What has changed is we have morons in elected and appointed positions of trust in the US, who are not hardnosed enough to make tough decisions that will benefit Americans, other than American corporations’ executives. And we’ve pandered to keeping failed US politicians in power and our generals fully in business with wars. That can change only with a change in what Americans accept from their own elected politicans, appointees, and other employees.

    I’m no fan of the commie governments in China or Viet Nam or George Bush either. But when you have the power to solve your own financial-imbalance problems, and you refuse to do so, who’s to blame? If we don’t change US actions, we don’t get the solutions we need. China and Japan’s governments will pursue their own interests until those interests change because of whatever we do ourselves.

  • Posted by Joseph Wang

    Charlie: The only argument that makes sense is they are propping the USD so they can be more competitive in exports.

    It’s not the only argument that makes sense, since if this were the case, they wouldn’t be devaluing at all. Keep in mind that the Chinese government held to the peg from 1993 to 2006 even through periods (like 1998) when a devaluation looked tempting.

    The argument that makes more sense to me is that the Chinese government is of the opinion that any drastic changes in economic policy is bad, and so it wants a “creeping appreciation” which gives time for people to adjust to a floating currency. It also doesn’t want its pre-existing stock of
    dollar reserves to go down.

    Keep also in mind that what triggered the imbalances was US fiscal and monetary policy post-2001, and this was something China had no control or influence over. If you had gone back to 1999, and mentioned what has happened since then, I don’t think many people would have believed you.

  • Posted by Guest

    Dr. Brad Setser:

    In the past I read your argument that China not only intervenes in the US Treasury market but also agency securities. Do you have any hard evidence in regards to this argument?

  • Posted by EthanJ

    Why do Gulf exporters (and the Russians) keep parking their money in the US? 5% inflation is going to wipe out any returns they might hope to get. And it’s only going to get worse – as long as the dollar is prevented from depreciating by the Chinese (and other) central bank, US inflation will have to remain substantially ahead of the rest of the world. That’s a large continuing penalty to pay for the privelege of investing in “safe” US assets.

    Maybe the Treasury should rethink TIPS?

  • Posted by ReformerRay

    Mr. Chiang is right to insist that the U. S. government has no business telling China how to operate its currency. It is a soverign nation. It can do what it likes with its currency. It can also do what it likes with all the dollars we have sent them.

    OleVet is right that we should not expect to have “friends” among our trading partners. It is a dog-eat-dog world out there. The U. S. must realize that it is no longer top dog in the economic world and that the U. S. had better pay some attention to retaining as much assets as possible in their own country.

  • Posted by DOR

    “David Chiang understands that China is facing enormous problems, he is just not allowed to say it. They imprison people in China for speaking their minds.” Written by Guest on 2006-05-24 14:28:22

    “If the Chinese government ever decided to stir up anti-Chinese sentiment in the U.S, it could do a lot worse than hire Dave Chiang. His hatred of America and Americans is so utterly profound that he would be the natural choice.” Written by Joshua on 2006-05-24 16:39:55

    “Comrade Chiang . . .” Written by OldVet on 2006-05-24 17:14:49

    I am sick and tired of the thinly veiled insults aimed at a serious and quite competent participant in these discussions.

    Pointing to Dave Chiang’s policy positions and insinuating – or blatantly stating – that the only reason he holds such views because of his ethnic Chinese surname; that anyone with an ethnic Chinese surname must be employed or intimidated by the Chinese government; or that those who have views that do not agree with one’s own hate America is a disgrace.

    Doing so under the veil of “guest” only makes the bigotry worse.

    Did I miss Dave’s declaration that he is a citizen of the People’s Republic of China? I ask this because so many people here seem to assume he is.

    Brad, may I suggest that you initiate a registration system. It might help clear out some of the school yard name calling and return this fine forum to a mature level of discussion.


  • Posted by Guest

    If you read what Mr. Chiang says — and he is right, there is no way the United States can compete with China unless the dollar devalues an absurd amount — the US has one set of remedies. They come down to protectionism — at least until the IMF member countries come up with a regime, as originally advocated by Lord Keynes at Bretton Woods, to prevent imbalances in countries’ international accounts.

    Until that time, the only thing the US can do is impose extraordinary tariffs, which as I understand it any WTO member can do to redress its current accounts under emergency conditions. If the US does not face an emergency, I don’t know what you call its trade account situation.

    Although protectionism is a dirty word among economists, think of all the very obvious benefits such action would have around the world. We would shut down the Asian game of export led growth which is unsustainable anyway. By doing that we would also reduce demand for oil and the price of oil, which would rein in the power of certain countries that are drunk on the power they now have through high oil prices.

    Four other measures would strengthen the US if they were also performed in concert with the emergency tariffs. We should balance our budget, which would not be that hard if the Bush tax cuts were repealed and the US quit Iraq. We should impose a US oil import quota (gasoline taxes take forever to reduce consumption even though I am economist by training and understand why economists love the gas tax “solution”… if you want to reduce consumption, do it!) and institute rationing with tradable white market coupons. Third, we should legalize recreational drugs, since illegal drug imports represent a large cash outflow that increases the current account deficit (reported or not) while providing financing for criminals and terrorists around the world. And lastly, we would need a policy that promotes energy efficiency while transitioning us to renewable energy. The necessary R&D and new product development, if performed domestically (again, under a somewhat protectionist regime) could help revitalize American science, engineering, and manufacturing.

    Let the Chinese retaliate: as Mr. Chiang says, they don’t buy anything from us anyway. Under the current regime they are waging a brutal trade war against the United States and winning it, so I don’t understand why fear of a trade war is trotted out as a reason to back off protectionist measures. Can anyone please explain that one to me?

    I know, I am dreaming, and the distance between what I am proposing and what either party is willing to do right now is vast. On the other hand, since we will probably do nothing, the dollar might well crash at some point because even the most judciously managed devaluation could easily spiral out of control in a world where a run on the dollar is a mouse click away for so many economic agents. At that point, at least some of the measures I have discussed, will be seen as inevitable.

    Written by Guest

  • Posted by OldVet

    Hey DOR, you don’t have even the slightest sense of humor. I addressed “Comrade Chiang” in support of the thrust of his views, for about the third or fourth time recently, with a term of true affection for his willingness to take and defend unpopular stands.

    Since we need somebody with hardnosed views on trade policy, I’d suggest we put Comrade Chiang in charge of US trade policy and Treasury policy today. He’d do a much more pragmatic job than the buffoons we have today who pander to a small group of corporate elitists.

    We could put you in charge of Guantanamo.

  • Posted by Charlie

    Keep in mind that the Chinese government held to the peg from 1993 to 2006 even through periods (like 1998) when a devaluation looked tempting.

    If you look at a chart of Yuan vs USD, what China did was massively devalue the Yuan and then peg to the USD at a massively devalued rate. The exchange rate of Yuan to USD prior to the Yuan pegging would have resulted in far fewer than 8 Yuan to the USD. I don’t buy the argument of pegging to keep things stable. Maybe it makes export prices to the US stable, but it certainly doesn’t make commodity import prices or exports to other countries stable. China is blatantly trying to subsidize their export industry and come up with lame arguments that are full of holes to try to deny what their actual agenda is. They can’t publicly state that they are trying to dump exports at a price where other countries can’t possible complete. Dave Chiang reads asian press and press and believes the chinese side of the story. I’m merely poking holes in his and your arguments that in my opinion are ludicrous upon close examination.

  • Posted by DOR


    You’re right. I shouldn’t have lumped you in with the anonymous name callers. However, in my defense it is considered to be extremely uncool for a non-Chinese to call a Chinese “comrade”, particularly in a policy discussion.


    The official Rmb:US$ exchange rate prior to January 1, 1994, was about 50% stronger than after that date. However, there were two exchange rates, one for international transactions and one for domestic ones. As a result of a whole lot of leakage from one to the other, the “devaluation” was actually much, much smaller than 50%, and affected primarily in-bound tourism.

    About 90% of China’s trade is denominated in US dollars, including all those commodities and manufactured components. The alternative to fixing the exchange rate is inflation targeting. Since China had zero experience with inflation targeting, and extremely poor data; and since the experience of inflation targetters around the world is less than wonderful, the fixed system seems better.


  • Posted by Derkar


    I can’t grasp your perseverance to prove the Chinese approach to be wrong. Let’s put the whole discussion in the developmental perspective. Clearly, China is now driven by the pro-development agenda and does whatever it takes to become a modernized economy, which is still a long way off. The outward strategies China has rightly adopted require its currency to be set at such a value vis-à-vis the greenback as to not hurt export industries. These industries provide vital employment to millions of the Chinese and are instrumental in securing political and social stability in the country. The latter is something the US must care about strongly, because instable China will make it extremely difficult for American exporters to tap its huge market potential. Let’s keep that in mind.
    On the other hand, the dollar is depreciating against other major currencies and by pegging to the depreciating currency China is actually importing inflation, which, if unchecked, can put in jeopardy the Chinese competitiveness (though the basket feature of the exchange rate regime in China probably mitigates negative exchange rate pass-through effects).

  • Posted by HK

    Brad–As I repeatedly argued, that the dollar should depreciate 20-30% in effective terms is without doubt. The most important point is how the burden of appreciation be distributed among important currencies, i.e., euro, yen, won, renminbi, riyal, ruble, pound, Canadian dollar, Mexican peso, etc. Most economists would argue that the currencies of China and oil producers should appreciate more than 30% since they have soaring current account surplus with dollar-pegged system, while, being more or less floating, other currencies should probably appreciate less than 20%.

    However, the actual situation is exactly the opposite; the Chinese and oil producers’ currencies continue to be pegged to the dollar, while other currencies are appreciating against the dollar. This situation is unlikely to change, until and unless the US resorts to some strong measures like protectionism. This is an unfortunate reality. Any IMF quota increase for China, Saudi Arabia, or Russia would have to wait until they recognise international responsibility.

  • Posted by Derkar

    It should not come as a surprise to us. As Jeffrey Frankel of Harvard puts it, “rigid pegs to the dollar are dangerous when the dollar appreciates”. Since the dollar is under downward pressure, dollar-pegging countries gain in terms of competitiveness in the markets of appreciating currencies (the euro and the yen).

  • Posted by LP

    What I don’t understand is why America is so against protectionism at all. It would be glorious, if framed correctly, to the American people: strengthening US manufacturing and technology innovation (tech, which is already quite strong), balancing current accounts, and acting in defense of China/Asia’s utter inaction in revaluing their currencies, which is an indirect attack on the dollar.

    Dr. Setser et al., why hasn’t America become protectionist much sooner, and will it attempt to be so in the future?

  • Posted by Derkar

    Protectionist sentiment is already on rise in the US. As C. Fred Bergsten of the Institute for International Economics states: “The US has already restricted imports from China in six sectors and the House already passed the English bill, making it much easier to raise barriers against trade from China.”
    But there is also an understanding that too much protectionism is trade-distorting and it is American consumers who are going to be badly hurt as a result of it. Besides, in case the US adopts pervasive controls on imports from China, this will inevitably trigger Chinese retaliation. And given the huge shares these countries have in international trade, an ensuing trade war between them would be severely shocking for the world economy.

  • Posted by John123

    I concur with Derker, LP and Guest’s endorsement of protectionist measures to end the U.S. trade deficit since dollar devaluation seems unlikely. Direct trade measures are government policy no more nor no less than Central Banks intervention to peg currencies.

    Under the former GATT and now WTO, a country facing persistent balance of payments deficit can legally impose temporary quotas or import tariffs to reduce imports. U.S. law allows the President to do so unilaterally without Congressional approval, and in fact, President Richard Nixon did so around 1973 when there was another U.S. dollar emergency when he imposed an import surcharge of about 25-30%. The emphasis is on temporary surcharges that hopefully would lead the dollar downwards, and then could be abolished.

    President Bush is unlikely now, given his poll numbers, if ever, to do anything like this even if his new Treasury Secretary insisted. The large domestic retailers and most “domestic” manufacturers” -virtually the entire span of consumer brand name companies from Walmart to GE -would take a tremendous financial hit. Many export dependent foreign exporters that are now on already shaky financial grounds with large excess capacity would probably go under. Conversely, real U.S. goods producers would benefit, and eventually U.S. manufacturing employment rise.