So these enormous surpluses are probably an embarrassment, as would having a diplomatic discussion about them. The topic is more of an internal US political one: if you want to respond to angry workers in Ohio, why not blame the cheap RMB. A rhetorical tool.

Probably one of the more constructive ideas would be if China, in say 3 to 4 years after another 100 million jobs have been created or moved into proper market territory, and productivity gains from technological modernization, better infrastructure etc have made the coast a solid middle income (but still with third world consumption levels) would introduce a minimum wage, some form of social security and rationalize the rural sector, internal distribution and the remainder of the SOE portfolio. At last there is now a civil code complete with Book on property rights, so there is progress and some day, those surpluses will decline. Now, and that would be the day that China could afford to become a little more assertive diplomatically. Howzzat?

Zou is saying that by sacrificing consumption now, mercantilism leads to higher consumption by the mercantilist country in the long-run.

By the way, if you found the paper online, please post the link.

Howard

There is nothing in that paper that suggests that Zou thinks that mercantilism is a good policy for China, and if his paper is right then its clear that China *isn’t* following a mercantilist policy since Zou argues that mercantilist policies will lead to high consumption while China has low consumption.

Trouble is that there are dozens of agencies, each with some idea of what currency policy should be, and they all have enough political pull so that they can influence the decision.

Richman: It also requires that credit availability be limited to those Chinese who are not on the government’s favored list.

Which runs against government policy regarding the banks, which is to get them to loan more money to consumers and non-SOE’s (not that they need much of a push).

Richman: Here’s a simple way you can check things out: Ask your Chinese friends if they can borrow from a Chinese bank, and if so how much interest they would have to pay.

Ummmm….. Yes.

http://www.ccb.com/portal/en/home/index.html

Click on personal loans for how to get a mortgage and/or car loan. The interest rate for a 30 year mortgage at 80% loan to value appears to be 5%. If you click on corporate, you see CCB’s products aimed at small and medium business.

ICBC has a similar website

http://www.icbc.com.cn/e_index.jsp

Check out its “happy home” and “happy business” loans.

And you can also look at a few other Chinese banks. They are clearly trying to get people to borrow money from them. Also if you look at the annual reports for these banks, they have a large fraction of their loans from consumers. CCB which used to be one of the old state-owned banks has about 20% loan to consumers, and the fraction for the joint stock commercial banks, which never did loan to the SOE’s, is much higher.

The Chinese government rejected a financial model based on the Japanese Keirsatsu or South Korean Chaebol in the early 1990’s. The main model that the Chinese government used to model its banking system was the United States, which leads to the curious fact the difference between China-2008 and US-1990 is in some ways smaller than US-2008 and US-1990 since there were a *lot* of changes in the US banking system in the late 1990’s that China didn’t pick up.

Richman: Here’s the reference: Heng-Fu Zou, “Dynamic Analysis of the Viner Model of Mercantilism, in Journal of International Money and Finance, Volume 16 pages 637-651.

I’ll take a look at that. But just because a Chinese professor wrote something, doesn’t make it official policy.

The only people who need to be involved in China’s mercantilist strategy are those at China’s Central Bank. It’s really a very simple strategy. It involves borrowing or printing yuan and using them to buy dollars. It also requires that credit availability be limited to those Chinese who are not on the government’s favored list.

Here’s a simple way you can check things out: Ask your Chinese friends if they can borrow from a Chinese bank, and if so how much interest they would have to pay.

Here’s the reference: Heng-Fu Zou, “Dynamic Analysis of the Viner Model of Mercantilism, in Journal of International Money and Finance, Volume 16 pages 637-651.

Howard

Reading the Chinese academic and official literature and listening to what Chinese academics and officials are discussing, I simply do not think that this is the case. First of all, lots of people have lots of different ideas on what to do, so I don’t see anything in terms of a coherent strategy on really anything. Second, whenever Japan gets mentioned, it’s *always* in the context of “Japan really messed up their economy good, what can we learn from their mistakes.” I’ve never heard anyone in China say anything good about way the Japanese have run their economy, and pointing out that Japan did something is the easiest way of getting China to do the opposite.

(And yes, I do get the sense that a lot of this is nationalism. The Japanese are the last people in the world that China wants to copy or say good things about. If you want to have China do industrial policy or protectionism, say that you got the idea from South Korea. Let’s copy the Japanese is the last thing you want to say to an audience of Chinese.)

Also can you point me to the paper, I can’t find any papers published in 1997 on his website, and none of the papers seem obviously to do with currency policy.

http://econ.gsm.pku.edu.cn/Hzou/index.htm

I’m a stickler for reading original papers and sources since I’ve found that citations get it wrong.

One other factoid. Most economic growth in China hasn’t come from exports. Exports may be important for employment, but if growth drops because of reduced exports there is a lot of room for Keynesian expansion.

Richman: You are definitely correct that the economics problems of the Vietnam era had many causes. But I am also correct that the main cause of the inflation was Arthur Burns loose money supply. This was proved when Paul Volcker ended the inflation by tightening money supply.

However, even if Burns been replaced by Volcker in 1972, Volcker simply could not have done in 1972 what he did in 1980, because the institutions weren’t there (Regulation Q and lack of money market funds to give an example). This is my point about China is that a lot of the discussion assumes that China could have changed currency policy faster than it has, and I don’t think it can.

I should also point out that the legislation in 1980 that decontrolled interest rates also led to the savings and loan crisis.

Richman: Just because China had balanced trade with the world in 2003 doesn’t mean that they weren’t intentionally producing trade surpluses with the United States.

China had balanced trade with the world from 1978 to 2003. The policies that caused the massive reserve build up after 2003 were formulated between 1990 and 1993, and so it’s implausible to me that they were designed with the intention of promoting exports, and as a matter of fact between 1998 and 2001 they had the effect of hurting Chinese exports.

Richman: Chinese dollar reserve accumululations have mirrored their trade surpluses with the United States since 2001.

Yup that’s accounting for you. The *really* interesting thing is that in the last six months, dollar accumulations have increased massively while the trade surplus has not.

Richman: Whether exchange rates are fixed or floating does not matter in the least. The yen floats, yet the Japanese government controls the rate through their dollar purchases. The key is the Chinese government’s dollar purchases, not whether the rate is fixed.

Once you’ve committed to a fixed exchange rate then the amount of dollar purchases comes from that. China has been trying to get off a fixed exchange rate as quickly as possible. It’s one of those things that seems a lot easier than it looks.

Let me give you an example of why it is difficult. You have an Excel spreadsheet that calculates something. If you wrote it in 1998, you probably put in a fixed CNY/USD exchange rate. You now have to go through that spreadsheet and rewrite it so that it has a cell for the current exchange rate.

Now a bank has probably tens of thousands of those spreadsheets, so you have to go through each one and fix it to use floating exchange rates. Just doing that could take months, and that’s only one of a hundred things that you have to do to move from fixed to floating.

The bottom line is that in the conversations I’ve had with people from the PRC and in the papers I’ve read, no one has ever said “Let’s run these huge trade surpluses since they are good for China.” The tone of the conversation has always been “How do we get ourselves out of the mess that we are in right now and avoid messing up our economy as badly as the Japanese did with theirs?”

I don’t think you are correct when you wrote that China was not following a strategy. Their strategy was invented by the Japanese. Economists call it “monetary mercantilism.” Peking University economics professor Heng Fu Zou explained how it works in a 1997 paper.

You are definitely correct that the economics problems of the Vietnam era had many causes. But I am also correct that the main cause of the inflation was Arthur Burns loose money supply. This was proved when Paul Volcker ended the inflation by tightening money supply.

Just because China had balanced trade with the world in 2003 doesn’t mean that they weren’t intentionally producing trade surpluses with the United States. They were getting a lot of direct investment in 2003. In general, such investment would cause trade deficits. Chinese dollar reserve accumululations have mirrored their trade surpluses with the United States since 2001.

As far as China buying autoparts from Mexico, I don’t think that is completely true. Last time I looked, Detroit automobilies still consisted mostly of parts made in the United States and Canada.

Whether exchange rates are fixed or floating does not matter in the least. The yen floats, yet the Japanese government controls the rate through their dollar purchases. The key is the Chinese government’s dollar purchases, not whether the rate is fixed.

Howard Richman
http://www.trade-wars.blogspot.com

Suppose in January 2001, you got a committee of Western politicians, labor union leaders, business executives, and economists together and asked this question. Do you think that China should adopt a fixed or floating exchange rate for the next ten years? I’ll bet that 90% of them would have said fixed exchange, and that all of them would have argued that it would have been dangerously irresponsible for China to consider floating exchange rates.

In January 2001, the main concern was that China would devalue its currency to boost trade and a fixed exchange rate was intended to prevent that. No one in 2001 that I know of predicted or even imagined that the US dollar would drop as it has, and so the idea that China adopted a system of fixed exchange rates to promote exports is flawed because that policy was adopted long before the current situation occurred.

For most of the 1990’s, the exchange rate was set so that China was running an overall trade surplus, and no one was complaining. And personally, I think China has been moving off the peg as fast as it can.

I don’t think it is. In fact, I don’t think that the Chinese government really has anything that could be called a “trade strategy.” Things happen. The government reacts.

During WTO negotiations, China was extraordinarily flexible on a lot of issues, and there are lots of people in the Chinese government who think that a zero balance of payments is a good thing. There are people who disagree. This is makes decision making slow and rather ad-hoc.

One thing that is important to point out is that until 2003, China had a zero balance of trade. It imported large amounts of raw materials from resource rich countries and exported finished products to the developed world. This system broke down with the strain of the Iraq War.

Richman: Mexico is not following that strategy. If their exports would go up with the United States, the peso would go up in value and they would import more U.S. products.

Suppose China opens up to auto part imports. China gets those parts from Mexico. US plants get shut down. That doesn’t affect US-Mexico trade at all.

Richman: Arthur Burns was increasing money supply far faster than the economy was growing. He was causing the inflation that occurred.

Economic events tend to be multi-causal and can often be looked at in certain ways. For example, what was putting a drag on the growth in the US economy. Vietnam.

Also Burns had some limits in what he could do that are strikingly reminicient to some of the constraints that China is under. He couldn’t revalue the US dollar because that was pegged under Bretton Woods. He couldn’t really influence monetary policy because the US had fixed interest rate. He couldn’t influence fiscal policy because that was in the hands of Congress. So he really couldn’t do anything even if he wanted to, and since he was working under wrong economic theories, he didn’t want to change them.

One interesting thing is to read about Arthur Burns and his economic beliefs. It’s almost like reading something written in Medieval times since the economic theories he was using were so archaic (the Philip Curve, price controls, demand push inflation). But I have sympathy for him. What I worry about is the incorrect and disastrous thing that I believe that people will be laughing at thirty years from now.