Can the debate over trade – or globalization – be separated from the debate over exchange rates?
I am often struck by how frequently debates over trade – and, more broadly, globalization – don’t bother to mention what strikes me as the most salient fact about contemporary globalization, namely that it has been marked by an enormous amount of government intervention in the foreign exchange market and a huge surge in the sale of US financial assets to emerging market governments.
Rather than trading US made goods for goods made in the emerging world, the US has – over the last say thirty years – financed the growth in its imports from the emerging world by selling US financial assets. That has to have had an impact on the composition of output in the US - -and the distribution of gains on globalization. It has favored those who generate financial assets (and import goods) over those who produce goods, for example.
And it seems increasingly difficult, at least to me, to maintain this pattern is entirely the product of the operation of free markets. Not so long as key governments are intervening so heavily in the foreign exchange market – and hoarding most of the oil windfall.
Take the most extreme example: China.
If 2000, China exported around $250 billion worth of goods, and its government bought about $15 billion of foreign exchange in the market. In 2008, China is on track to export about $1400 billion worth of goods, and its government is on track – at least judging from the April data — to buy about $900 billion of foreign exchange in the market.
Yet the popular discussion of trade and globalization rarely also mentions the enormous rise in government intervention in the markets – and the surge in the sale of US financial assets to emerging market governments.
Take a look at Eduardo Porter’s argument for responding to the pressures associated with globalization by expanding the scope of America’s social safety net. Or look at Tyler Cowen’s passionate defense of globalization.
Neither mentioned Chinese intervention in the foreign exchange market. Both also left out any mention of how rising oil prices have dramatically increased the foreign assets of the not-so-democratic governments of the world’s oil-exporting economies.
They aren’t alone: most discussions of the difficulties of selling trade to the American public don’t mention the unprecedented rise in government intervention in the foreign exchange market. And for that matter, most discussions of the difficulties explaining the benefits of sovereign wealth funds to the American public don’t mention that many sovereign funds are a by produce of one-sided government intervention in the foreign exchange market.
To flesh out my intuition, I went back and looked at US goods trade with the emerging world – setting Mexico* aside – since 1978.
* Mexico is part of NAFTA along with Canada, and splitting the two seemed a bit strange. Moreover, Mexico has allowed its currency to float more freely than most emerging economies.
It is striking that the US doesn’t export much more, relative to the size of its economy, to the emerging world now than it did in 1980 – or, for that matter, in 1997. It just so happens that US exports to the emerging world (excluding Mexico) were 2.6% of US GDP in 1980, in 1997 and in 2007 (they are a bit higher in 2008). US imports from the emerging world by contrast fell from 3.9% of US GDP in 1980 (when oil was high) to 3.7% of US GDP in 1997 and then rose to 6.2% of US GDP in 2007.
It is also striking that the US now imports a lot more from the emerging world than it exports. Paul Krugam is right. US imports from the emerging world are no longer small, and they have been growing rapidly.
So how has the US balanced the rise in its imports of goods from the emerging world?
By selling debt to the emerging world, and recently by selling debt to the governments of the emerging world. My estimates of the growth of the emerging world’s dollar reserves (which require making an assumption about the currency composition of the countries that do not report data to the IMF; see the notes at the bottom) suggest that the growth in the sale of US financial assets to the emerging world has exceeded the growth in US imports from the emerging world.
Why does this all matter? Well, economically, I suspect that the US debate over globalization would be quite different if US exports to the emerging world had grown together with US imports. The winners from globalization woud not be as obviously tied to the financial sector. The shift from central bank reserves to of sovereign wealth funds won’t change the distribution of winners either: the financial sector expects to take a far bigger cut on the sale of US financial assets to sovereign funds than it gets from the sale of US debt to central banks; and bigger feeds managing money for sovereign funds than for managing the funds of more cost-conscious central banks.
No one has argued that the main benefit of globalization is that it allows America’s bankers to sell US debt – and increasingly shares of American companies – to governments in the emerging world. But that is a fairly accurate description of current trade and financial flows.
Incidentally, Broda and Romalis’ analysis of the distributional consequences of US trade with the emerging world not only predates the rise in food and energy prices, but it also doesn’t look at the distributional impact of rising US exports of financial assets to the emerging world. That strikes me as an important oversight: Dani Rodrik has argued that trade tends to increase the price of things that are exported even as it reduces the price of imports more than it reduces the overall price level. And it is pretty clear that the US is currently “exporting” a lot of financial assets to the emerging world.
A quick point of clarification: the rise in US imports from the emerging world over the past several years hasn’t been driven primarily by the rise in the price of oil. Stripping OPEC out of the data doesn’t change the picture much. At least not yet. The data ends in 2007 — a year when oil averaged $70. It will average much much more in 2008. US imports from OPEC are set to soar.
*I added Mexico to this graph as well; trade with Mexico isn’t the central story of the past ten years.
And one aside. US imports to Europe, Japan and the NAFTA countries have increased significantly since say 1980. US exports to Europe, Japan and the NAFTA countries, by contrast, haven’t increased that much relative to US GDP. The two periods when US exports to the advanced economies fell relative to GDP – the early 80s and the early part of this decade – both followed periods of dollar strength. Exchange rates do matter.
However, most of the rise in US imports from Europe, Japan and the NAFTA countries came before 2000. The increase in US imports since say 2000 has all come from the emerging world. That is an important change.
Imports (of goods) from the emerging world have gone up significantly relative to US GDP. Exports (of goods) to the emerging world haven’t gone up. Exports of financial assets have.
A major surge in US exports to the emerging world – one that matched the surge in US imports from the emerging world over the past few years — could change this pattern.
DeLong is hopeful. I wish I could be as optimistic.
Chinese policy making seems frozen, with policy makers unable to decide whether to raise rates (to tame inflation) or cut rates (to curb speculative inflows); or to decide whether to allow the RMB to rise (to curb inflation) or to hold the line (to support exports). Chinese policy makers currently seem to agree on little other than the need to tighten controls on lending and capital inflows. The appreciation of other Asian currencies has stopped. I don’t currently see the kind of consensus globally needed to really address an imbalance as large as the one that has been allowed to build up.
* Two general technical notes.
One: I opted to look at goods trade because I found a longer time series that included more countries. Most US service exports go to the advanced economies, so my sense is that including services wouldn’t change the basic story much. I also believe that tax arbitrage tends to increase the stated US deficit in goods trade with Europe while increasing the US income surplus — as US and European firms use transfer pricing to shift profits to low-tax European jurisdictions. As a result, I suspect the “true” US trade deficit with Europe is smaller than the data indicates.
Two: My estimates for the sale of US financial assets to emerging market governments are based on my work estimating dollar reserve growth rather than the US data. The US data — especially the US data prior to the forthcoming revisions (which will incorporate the survey data) — tends to understate official purchases of US assets. My estimates hinge on two key assumptions: those countries that do not report data to the IMF have a fairly high dollar share of their reserves (around 70%), and the increase in dollar reserves predominantly finances the purchase of US assets, not dollar-denominated debt issued by residents of other countries. I also added in my estimates of the new inflows into the dollar assets of the Gulf’s sovereign funds. Here I make the opposite assumption, namely that the Gulf sovereign funds have a more diversified portfolio than the emerging market central banks who report data to the IMF.
The continued focus on the China yuan (is US inflation not high enough) is a questionable idea that somehow the Chinese are saving too much money - that they should become rampant consumers like their bankrupted American peers. The high Chinese savings rate, is not an issue that is structurally more problematic than the average Joe6pack in the US just being fiscally irresponsible with their money. It is apples to oranges, and this is an issue that really should be addressed as an US domestic issue. Another area where I think Paulson is a bit off in his pointed criticism of China’s economy being opaque to foreign investment. It is interesting that some 70 billion in FDI is making it into China on a yearly basis (not including the 40 billion in hot money), yet the Chinese rules are somehow opaque.
http://www.allroadsleadtochina.com/index.php/2008/06/11/paulson-remarks-on-4th-round-of-us-china-strategic-economic-dialogue/#more-778
One has to separate the notion of globalization and the notion of a specific economic policy such as low tariffs.
Also, I’m not exactly sure what there is to “debate” about globalization. Debating globalization is like “debating whether the sky should be blue or not.” The driving force behind globalization is communications technology, and barring some massive catastrophe, it’s going to continue.
Also discussing China and India in connection with globalization rather incorrect since both China and India started their economic booms before massive tariff reductions occurred.
My belief is that foreign trade helped China and India, but I don’t think that it was the primary reason for Chinese economic growth. China would be poorer without global markets, but it still would have grown quite markedly. By contrast, Mexico hasn’t undergone particularly spectacular growth due to NAFTA.
Mexico needs to get competitive, period. A lot of manufacturing that initially moved from the US to Mexico after the signing of NAFTA has since moved east to China. Hopefully Calderon can do what 80 years of PRI have not.
Once Sarkozy takes control of the EU presidency and a new president is in the oval office, we’ll probably see some very hard line negotiations on the manipulated Yuan.
DC,
I hate to be churlish, but Dr. Setser is correctly worrying about the distortions in the global economy brought about by official reserve purchases, not the savings of ordinary people. Is there any evidence that Dr. Setser is wrong and that these massive reserve inflows are not official inflows?
Dr. Setser,
This is a brilliant piece of work even by your (immensely high standards). You are right that something will have to be done to help move the Emerging Market Countries (slowly so as not to meltdown the global economy) off of their addiction to reserve purchases to support their export sector.
This is not going to be pleasant as it will probably entail something on the order of an offsetting license tax on EM imports equal to those countries Reserve buildups, but I do not see anything else that would avert global economic catastrophe.
Brad,
Do you have any comments on the confession of Robert Cassidy re negotiations on China’s entry into the WTO?
http://www.fpif.org/fpiftxt/5274
Cassidy was Clinton’s point man in the negotiations. According to Cassidy:
Frankly, I am quite amazed on how little play his remarks have received. From what I can tell, better to ignore his remarks entirely rather than to open a good discussion on trade and on how globalization has been structured.
I have been making these points for a number of years now.
At some point, the elephant in the room will be so large that avoidance will be impossible.
Stormy: Frankly, I am quite amazed on how little play his remarks have received.
One reason is because people who work for multi-national corporations and financial institutions are not going to be too upset
that multi-national corporations and financial institutions benefit from a given policy, and there are a lot of people that work for MNC’s and financial institutions.
One point that needs to be made is that there have been no major new trade agreements in the last ten years, yet world trade has increased dramatically during this time. I think the lesson from this is that what is driving globalization aren’t trade agreements but rather technology, and unless someone wants to uninvent the internet, it really doesn’t make that much of a different if people sign new trade agreements or not.
Also my personal sense is that the increase in economic disparity is not directly a result of trade but rather due to the increasingly knowledge intensive nature of the economy. If you have a Ph.D. in physics, the possibilities are limitless, since multi-nationals are going to be tripping over each other trying to get you.
If you aren’t in the fortunate few that have access to this sort of education, then things will be very bad, and I think the discussion of the next decade rather than the last is what to do about this.
China is tackling its trade imbalance now. It enacted a Scandinavian style labor law this year. By this law alone, it jacked up the exporters’ labor cost by more than 40%. The processing traders got the message already and a lot of them are packing and leaving. IMHO, the China trade surplus should be stabilized to about 250b USD this year, slightly less than 2007.
My intuitions is, even after the China trade surplus is reduced to, say, 1% GDP eventually, the US trade deficit will still remain a GIGANTIC problem. Any betters?
A very informative post. Those who talk about ‘the value of the dollar’ need to learn to distinguish between its value against European currencies and its value against mercantilistic currency manipulators. The financial services industry has a dog in this fight, so I would expect them to try to fog the issues to maintain the status quo. Maybe that’s why Paulson is one of those who talk about the value of the dollar as being a single magnitude.
Is there any evidence that Dr. Setser is wrong and that these massive reserve inflows are not official inflows? - Beau Butts
The massive reserves inflows of “hot money” are most certainly NOT official inflows, but speculative investors who are overseas ethnic Chinese betting on the continued revaluation of the Chinese yuan versus the US Dollar. So far its been a one way winning bet. I will even personally admit to partially contributing to the excessive 18% money supply growth in the Chinese economy with US Dollar wire money transfers to relatives. Most overseas Chinese have close relatives or families in China that facilitates capital inflows or flight depending upon current global economic conditions. With several hundred thousand people crossing the Hong Kong-Shenzhen border daily, the China PBoC is really powerless to do anything significant about the “hot money” issue. While the Intel Chip Fab in Dalian or the Airbus A320 assembly factory in Tianjin may get the news headlines, fundamentally China relies on the overseas Chinese community for trade, investment, technology, and managerial expertise. The vast bulk of FDI into China is from Hong Kong, Taiwan, and Southeast Asia Chinese.
As far as trade policy goes, it seems to me that the law of competitive advantage is right and that lowering trade barriers has generated a vast amount of wealth. The question of what happens to that wealth is another issue that competitive advantage theory is quite silent about.
Prophets: Mexico needs to get competitive, period. A lot of manufacturing that initially moved from the US to Mexico after the signing of NAFTA has since moved east to China.
One reason that China has done well is that its actually spent a huge amount of wealth on social infrastructure. Roads and schools. It might seem to be a simple thing to set up a sweatshop for example, but it isn’t. It’s hard to set up a factory line for example when people can’t read.
don: The financial services industry has a dog in this fight, so I would expect them to try to fog the issues to maintain the status quo.
Shocking. Industry makes arguments that are in its self-interest.
Anyway, what is different between now and the 1980’s and 1990’s is that I can’t think of an obvious group that would be interested in rolling back trade agreements.
Most businesses today are either multi-national or want to be. People who work for these businesses aren’t going to be advocating a rollback. Organized labor is divided between groups that either are benefiting from trade (longshoremen and teamsters) are else groups that don’t want to rock the boat and lose whatever benefits they have.
Brad,
Wow! I am extremely impressed! You hit the nail on the head.
The only thing missing from your analysis is a solution. Our program is summarized in Chapter 10 of our 2008 book, which can be read online at http://www.idealtaxes.com. (I’ve offered to send you a free review copy if you e-mail me your snail-mail address.)
Basically, we advocate that the Unted States require balanced free trade from the mercantilist governments while encouraging domestic US savings to make up for the diminishing inflow of foreign savings.
Howard Richman
http://www.trade-wars.blogspot.com
Rising energy prices will act as an structural impediment that will slow trans-Pacific globalization. Increasingly, US importers of heavy steel industrial products are switching to Mexican suppliers. That’s Ok. The Chinese will do just fine serving their own growing domestic and Southeast Asian markets. The Asian region is rapidly transforming into a regional trade bloc facilitated by kinship economic ties of the overseas Chinese communities.
Let’s take the hypothetical example that the US government imposes a 40% trade protectionist tariff on the Apple iPhone. Does everyone think it’s that easy for the entire electronics infrastructure built in China to be relocated back into the United States? What that would really do is destroy the profitability of US multinational corporations that have invested billions of dollars in production facilities in China. Apple iPhone sales would plunge along with the entire US stock market. The Chinese government could legally apply tariffs through the WTO for duties to be applied on US exports to China on everything from GE wind turbines to GM train locomotives. Now let’s be honest, a full blown trade war between the US and China isn’t remotely possible given the US multinational K-Street lobby clout in Washington. Boeing maybe the biggest US Defense contractor but a China joint venture completes final conversion assembly of every Boeing freighter aircraft for UPS, DHL, Federal Express, and US postal service. The Chinese economy is too interwoven into the US Economy through US multinational corporations.
Don: I agree with what you’re saying. Just talking about “strong dollar” is overly simplistic. We need to distinguish between the dollar’s strength vs. Europe and its strength vs. the currency manipulators. Ironically, weakening the dollar vs. the currency manipulators would likely strengthen it vs. Europe!
Don,
Whoops! What I wrote doesn’t make sense in the short-run. I was talking about the longer run.
Weakening the dollar versus the currency manipulators could let producers know that they can safely invest in the US without fear that the currency manipulators will make their investments unprofitable. The boom in investment in US production that would result would eventually strengthen the dollar vs. Europe.
Howard
Howard Richman,
The strong Euro hasn’t destroyed Germany’s exports to the world. In fact, Germany retains the title of world export champion over both the US and China. The Chinese yuan has already revalued a huge 20% but that still hasn’t satisfied the China basher pundits. If a weak devalued currency is a factor in trade performance, then how come the US still isn’t competitive with Germany? Is the US inflation rate still not high enough for Brad Setser with $4 per gallon gasoline and $3 loafs of bread?
don: Those who talk about ‘the value of the dollar’ need to learn to distinguish between its value against European currencies and its value against mercantilistic currency manipulators.
You really can’t. If the CNY/USD, EUR/USD, and CNY/EUR values are consistent, currency traders will do massive trades in order to make them consistent.
Richman: The boom in investment in US production that would result would eventually strengthen the dollar vs. Europe.
If you weaken the dollar then you make it much cheaper and easier for China to buy US based corporations, which I though you believed was a bad thing.
Twofish: ‘You really can’t. If the CNY/USD, EUR/USD, and CNY/EUR values are [not] consistent, currency traders will do massive trades in order to make them consistent.’
Yes, you can. The yen is at all-time lows versus the euro. The dollar is overvalued versus the yen and undervalued versus the euro. Just because cross-trades are consistent with this structural imbalance, does not mean it doesn’t exist. The dollar can certainly rise against the euro and fall against the yen and yuan. The cross trades would just need to conform to the new order. Another way of saying the same thing is that the euro is overvalued and the yen and yuan are undervalued.
If unemployment becomes a big problem, we may see a natural constituency for political pressure against currency manipulators.
Twofish,
The skill premium cannot be not the major cause of inequality because the returns on skilled labor are so grossly disproportionate across various skills that there must be some other explanation. For example, pay for engineers and other skilled professionals has nosedived while at the same time the incomes of professionals in the financial sector with the same or less education and skills have soared. The common thread is the one that Dr. Setser identified: people able to engage to take advantage of importing goods (via offshoring) and/or exporting financial products (packaging and selling U.S. debt overseas) have prospered while everyone else has taken a major hit.
DC,
Dr. Setser and I are talking about currency flows from China to the United States, not flows into China. Go back and read Dr. Setser’s original post and my comment. His point still stands: EM inflows into the U.S. have seriously distorted the global ecnomy in dangerous ways and those problems need to be worked out. Hopefully the EM will end this madness before the major convertible currency countries have to do it for them but I fear that may not happen.
Beau Butts,
Let’s make this perfectly clear, every one of those US dollars from Chinese exports invested in US Treasury bonds was printed originally by the US Federal Reserve. The Chinese export “real wealth” industrial products to the US in exchange for fiat US Dollars printed in unlimited quantity by the Federal Reserve. Certainly the China PBoC doesn’t have the legal monetary authority to print US Dollars. Federal Reserve monetary printing is fully responsible for the excess US Dollar liquidity that has swamped the entire world. The US Dollar is devaluating versus a global basket of currencies as a direct result. What is required to rectify the financial situation is a multi-currency regime for strategic oil resources. It is intellectual dishonesty to blame the Chinese for the disfunctional reserve currency status of the US Dollar.
Twofish et al,
The wealth has been generated for those at the top.
Globalization has been structured to leverage cheap labor, cheap taxes–along with subsidies–and few if any environmental regulations.
Taxes for foreign firms inside China were either half that of indigenous firms or no taxation for ten years. That does not violate WTO guidelines by the way. Only recently has that playing field been altered.
Labor–we know how that one works. Again, this does not violate the central WTO principle.
Environmental regulations: While foreign firms inside China may plead not directly guilty, they do use the energy and infrastructure built with little regard for the environment. Again, this does not violate the central WTO principle.
Central WTO principle: Foreign firms cannot be at a disadvantage with indigenous firms in the host country.
China has taken that principle, and by disadvantaging their own firms, made China a honey pot for outsourcing and giant export machine.
Then there is the currency peg–now much looser.
The U.S. fritters with tweaking the edges of the problem: tax rebates, interest rates….
Time to get serious to see if we can get trade in balance.
By the way, several years ago, I spoke to a retired senior US State Dept official who was a friend of the family. I asked him if high-level US government officials in the Clinton Administration were concerned about the US trade deficit. His response was that the US government can print as many US dollars that Japan and China would like. Under the reserve currency status of the US Dollar which has been largely abused, the rest of the world exports products essentially for “free” during the last couple decades, in exchange for fiat US Dollars that can only be printed by the Federal Reserve.
Stormy: Globalization has been structured to leverage cheap labor, cheap taxes–along with subsidies–and few if any environmental regulations.
Sure, and in the process its managed to generate a huge amount of wealth. The wealth tends to be concentrated in the hands of the people that make the decisions (as it always does), but they are willing to share just enough so that they don’t end up with angry people taking their stuff.
If it was merely the rich taking from the poor, the system would have fallen apart by now. The reason it hasn’t is that it *isn’t* the rich taking from the poor. It involves making the pie bigger and the rich taking a bigger piece. Since the poor are better off than they were before, they don’t complain.
This is why it is much harder than it seems to motivate the poor to revolt against the system. They are getting something out of it. Also if it is the rich taking from the poor, then the answer is pretty simple, shoot the rich and take the money back.
However, if it is the rich generating wealth and then taking most of it, then shooting the rich won’t work, because if the shoot the rich, the wealth generation falls apart. That’s basically what happened in Zimbabwe.
The comparison between exports of goods and services and exports of financial assets is quite interesting and relevant, but a little weird. The former generates gross GDP / national income at the same order of magnitude. The latter generates spread income for Wall Street, but at a much lower order of magnitude.
Well I personally believe the sh!ts will soon hit the fan. I think you can use GE stock as a good proxy for what is happening to the US financial system and the economy as a whole. GE is tanking, and the US economy and banking system is going down with it.
Florida REOs sell for a 60% discount from peak, Phoenix and Las Vegas REOs go for a 50% discount from peak, and most California REOs are going for at least a 40% discount from peak. Worse still, there is no end in sight to the housing price declines.
That means that this latest batch of Wall Street downgrades won’t be the last. We’re no farther along than the 3rd inning in this little game. Already impaired with $400 billion in toxic waste securities,
Is the Fed balance sheet big enough to absorb another $500 Billion Option ARM Crisis coming soon?
LOL
Twofish,
Well, at least you are not shy about class warfare! I guess the food riots don’t count–and the increasing concentration of wealth in the hands of a few.
As far as wealth being created….the U.S. looks like a giant debtor nation to me. Wonder how that happened?
As far as it collapsing, certainly looks that way to me. Give it a couple more years…if that. Looking around the world, I see mostly mess.
Beau: For example, pay for engineers and other skilled professionals has nosedived while at the same time the incomes of professionals in the financial sector with the same or less education and skills have soared.
If you have high-level skills you can move from sector to sector and go into whatever sector is willing to bid the most for your services. If you don’t have these skills, you are stuck.
Beau: The common thread is the one that Dr. Setser identified: people able to engage to take advantage of importing goods (via offshoring) and/or exporting financial products (packaging and selling U.S. debt overseas) have prospered while everyone else has taken a major hit.
First of all, the number of people taking advantage of globalization isn’t a small number.
Second, over the last ten years people have been cushioned from wage loss first by the stock market, and then by real estate. If you look at total wealth, the situation is not nearly as bad, and this explains why there really hasn’t been a major political backlash thus far.
Also the problem with a lot of these studies is that they aren’t longitudinal. It’s possible for the median income to go down while the incomes of most people go up. To correct for this you need take into account immigrants coming in, and then people retiring.
don: If unemployment becomes a big problem, we may see a natural constituency for political pressure against currency manipulators.
Much harder than it sounds….
1) In the 1980’s, you could get support for protectionism from American corporations. All those American corporations are now global corporations with customers and plant throughout the world. If you have a CEO from Switzerland, he isn’t going to be particularly moved if you talk about helping the American worker.
2) In the 1980’s, people were much more likely to be in support of non-market restructuring of the economy. The problem that you run into if you don’t want to fundamentally restructure the economy is that then you run into the problem that you are bashing evil multi-national corporations while at the same time begging them for employment. This doesn’t work.
It the push is strong enough, someone will come up with a new message and a new ideology, but it has to be something different from the concepts of the 1980’s and 1990’s. All those fights are settled.
JKH — I agree with your point. The fee income is going to be fairly small — though some of the fee income will be proportional to the accumulated stock not just the flow. The bigger distributional impact likely comes from the impact of flows of this magnitude on asset prices.
Stormy: Well, at least you are not shy about class warfare!
I’m not. Marx was wrong about a great many things, but he was right that the class struggle is one of the major motivating factors in history. What he didn’t realize is that the ruling classes would understand enough about class struggle to keep themselves in power.
It really doesn’t take that much money to buy the loyalty of someone that is poor to begin with.
Stormy: I guess the food riots don’t count
When prices change, someone gets angry and someone gets happy. The happy people don’t riot. Rising food prices are awful for the urban poor, but they are wonderful for your typical poor peasant farmer in India or China.
Stormy: the U.S. looks like a giant debtor nation to me. Wonder how that happened?
I know a lot of rich people that are in debt, and a lot of poor people who aren’t.
Part of it is human psychology. Most people born in the US have never been poor, whereas most people in China have. Poor people that become rich tend to save a lot more than rich people that become richer. You compare the spending habits of someone that was born in the 1930’s with someone born in the 1960’s.
Stormy: As far as it collapsing, certainly looks that way to me. Give it a couple more years…if that. Looking around the world, I see mostly mess.
Things always look like a mess. But one good thing about a sense of history, is that things today look much less messy after you see a really, really, really big mess.
Twofish -
You make some good points. I think U.S. pressure was instrumental in forcing Japan to abandon its currency peg, but it’s hard to see where the pressure will come from to stop the new currency mercantilists. Maybe we will follow Europe’s example if, as I suspect, they become the first to apply such pressure. It may take the form of industry-specific measures, though, which would be the worst of all possible worlds.
I agree with Howard. In my view,the old mercantilism (collect gold to support an army) was seriously wounded by Adam Smith and the concrete example of the American revolution. (Napoleon’s citizen army was probably the coup de grace.) The new one may have started with the example of England’s industrial revolution. Asian economies may have taken a more recent cue from Japan’s experience.
What are emerging markets?
By that I mean are we talking about countries or the multinationals that do business in those countries?
Certainly some countries have sovereign entities like Saudi Arabia, but most do business through multinational corporations most of which are located or based in the G7. Export profits from those emerging market countries falls mainly to the multinationals who can then use tax arbitrage in any number of other countries.
As you say : Follow the Money !
Peter -
“My intuitions is, even after the China trade surplus is reduced to, say, 1% GDP eventually, the US trade deficit will still remain a GIGANTIC problem. Any betters?”
If I had to bet, I would say in the very long run the U.S. is in great position. If I recall correctly, it has 70% of the world’s arable land (weighted by climate growing time). A major consequence of the world’s growth is just starting to emerge - much higher food demand. It wouldn’t surprise me to see the relative price of food soar over manufactured output, and the U.S. current account move to apparent permanent surplus.
test
“It wouldn’t surprise me to see the relative price of food soar over manufactured output, and the U.S. current account move to apparent permanent surplus.”
From agriculture to industry and back… Might as well give EVERY one 40 acres and a mule, for how else could the multitude of former industrial/service laborers support themselves with no jobs in the city and gas prices at prohibitive levels (no tractors)…
Dave Chang: You wrote: “The strong Euro hasn’t destroyed Germany’s exports to the world.” You are correct. European companies have been cutting their profit margins in order to preserve their market shares as much as possible. With lower profits, they are probably investing less. If the euro stays strong they will eventually start losing market share.
Twofish: You wrote: “If you weaken the dollar then you make it much cheaper and easier for China to buy US based corporations, which I thought you believed was a bad thing.” You are correct that, other things being equal, American assets would be less expensive to the Chinese government. However, at the same time, the weaker dollar would lead to increased purchase of American products by China’s residents, leaving fewer dollars for the Chinese government to spend on US assets.
Don: I really appreciate your comments. Our analyses of the current situation are very similar. I hate to be the one to break the bad news to you, but the Unted States government, under President Bush, has just begun to do exactly what you feared. You wrote: “(I)ndustry-specific measures .. would be the worst of all possible worlds.”
At the end of May, the Bush administration adopted just such an industry specific measure, a killer-tariff against Chinese steel pipe exports. Here’s what I editorialized about it in my June 5 blog entry:
Perhaps because President Bush ran on a steel-protectionist platform in 1980, the Bush administation decided to act this time. President Bush, after all, likes to keep his promises.
There are four trade positions:
1. Free Trade - belief that no tariffs should be imposed to give one industry an advantage over another industry. For free trade to be beneficial it must be balanced.
2. Protectionism - belief that those industries that are on the government’s favored list should be protected, even though that protection might hurt industries that are not on the government’s favored list. Protectionism only hurts a country when trade is balanced, otherwise it can protect an industry without hurting other industries.
3. Mercantilism - a system that allows a government to manipulate trade in order to produce trade surpluses. Favored industries are protected without hurting other industries. Mercantilism is a system of protectionism that steals industries from trading partners when those trading partners tolerate trade imbalances.
4. Balanced Trade - a system that opposes mercantilism by assuring that trade is balanced. It can be practiced without providing any preference to one industry over another.
Under the Bush Administration’s leadership, the Republican Party gives lip service to free trade ignores mercantilism and practices protectionism for those favored industries that have political influence.
Howard Richman
http://www.trade-wars.blogspot.com
Richman: However, at the same time, the weaker dollar would lead to increased purchase of American products by China’s residents, leaving fewer dollars for the Chinese government to spend on US assets.
That presumes that most of Chinese wealth is generated from trade with the US, which it is not. When people in the US think about China, the first thing that comes to mind is trade, which obscures the fact that most of the economic growth in China (and India for that matter) is internally generated.
Richman: There are four trade positions.
There are probably four hundred. If you have someone that believes that that the government shouldn’t protect specific industries, but should set the currency in order to maintain either trade deficits or surplus. Or you have someone that believes that the government should protect specific industries but shouldn’t set overall currency levels.
One big problem in political thinking and why ideologies are a bad thing is that they force you to combine ideas in certain ways, whereas in order to deal with new situation, you need to combine ideas in new and different ways.
don: it’s hard to see where the pressure will come from to stop the new currency mercantilists.
It’s not. However if your concern is China’s currency policy, you don’t need political pressure, since it is clearly unsustainable, and there is going to have to be a revaluation in the next year, or else things are going to seriously break.
The problem with using political pressure in trade issues is that you end up having to form coalitions with people with very different motives. For example, if you impose trade sanctions on China for currency valuation, you are going to be on the same side of the table as people who want to impose trade sanctions for one of a hundred other reasons (China oil investments in Darfur). That makes it very hard to impose pressure, because if China suddenly decides to compromise on your issue, the people on your coalition will want to impose trade sanctions anyway because it didn’t compromise on their issue.
And if you get what you want then the fights really start. For example, ask yourself, why does Paulson *really* want China to revalue the RMB, and if you look at what interests Paulson represents (i.e. Wall Street investment bankers), the answer is pretty obvious, and that is that if China lifts capital controls and strengthens is the RMB, there will be lots of money to be made helping China structure deals to buy US companies.
In order to keep yourself in good shape, you have to know what the motives are of the people around you and how the see the world, and this can be difficult sometimes because people see the world in very different ways.
The big objection that I have to a lot of what you are saying is that it just gets the motives of the Chinese political and economic elite to be wrong.
The main goal of the Chinese political and economic elite is to make China a rich and powerful country by whatever means necessary. The secondary goal is to keep the Communist Party in power by whatever means necessary.
No one in Beijing is shy about admitting this, but there is a something of a consensus that what you call merchantilist policies don’t help in this effort, and to be honest I think focusing on Chinese behavior which the US has only the limited ability to influence removes attention from things that the US can fix.
Don: Asian economies may have taken a more recent cue from Japan’s experience.
Yes they have but in a negative way. In the case of China, Japan and Russia’s experiences in the 1980’s are widely considered examples of what *NOT* to do. The situations which are considered positive examples are the United States, Singapore, Hong Kong, Cuba, and Taiwan.
2fish –
I am a bit less convinced than you are that Beijing’s policy consensus excludes merchantilism. Beijing has failed miserably to rebalance China’s growth away from exports — or to adopt policies that would reduce its need to intervene in the fx market. Current levels of reserve accumulation speak for themselves. As does the ongoing rapid growth in China’s exports to Europe.
There are many things the US can and should do on its own. But with China’s surplus now $370b, or about 1/2 the US deficit, and with a realistic estimate of the size of the annual Chinese purchases of US financial assets now in the $600b range, it also true that Chinese policy choices have an impact on the United STates ability to reduce its external deficit/ dependence on central banks for financing. By definition, if one country runs an external surplus, another has to run a deficit — and China’s surplus is now 1/2 the size of the US deficit and thus a meaningful part of the global total. Chinese financial flows make it cheap to borrow, and in effect induce more borrowing in the rest of the world. if the US — all other things being equal — decides to borrow less, then global interest rates have to fall until the US decides to borrow, someone else borrows more or China saves less (and/ or invests more at home). the same applies to the rMB/ dollar — the uS cannot devalue against the RMB w/o Chinese cooperation, b/c China is the one doing the intervention.
the US could take policy steps to restrain demand even as China maintains its existing set of policies. What would the effect be? Well, a smaller fiscal deficit and less demand at the current stage in the cycle might lead to slower US growth and a weaker US dollar. There would be some spillover into less US demand for Chinese goods, and thus some fall in China’s surplus. but the $ peg (or close to it) would imply that China’s exchange rate would also depreciate, pushing up China’s exports to the rest of the world. And barring a change in Chinese domestic policies (taking the brakes off) China’s large savings surplus would remain and world rates would have to fall until it is absorbed globally.
I would be much happier if I thought the US could solve its all its problems entirely through its own actions — I like the notion that the US controls its own destiny. But if US policies are driving the US deficit, one would expect high interest rates globally — with the high rates depressing investment globally and pulling savings into the deficit country. that isn’t what we see.
the policy steps the US could take on its own are those recommended by Mr. Richman — border controls (or import certificates) of various kinds, and the like. Or the us could adopt a very restrictive macroeconomic policy.
I would rather see adjustment driven by a different policy mix in both the deficit and surplus countries that didn’t involve such a draconian shift in US policy at the border. But I stand by the notion that the surplus countries are a necessary part of the solution — adjustment driven entirely by a contraction in the deficit country isn’t pleasant.
The China PBoC is revaluating their currency as fast as they can without significantly impacting the macroeconomic stability of the economy. The China yuan should be only revaluated in tandem with the rising productivity rate in order to minimize impact on industrial production and employment. It is not the Chinese government responsibility or the “mandate from heaven” to bailout the inbalanced US economy. Now, you know who calls the shots in the US, the money printers at the Federal Reserve and their crony capitalist partners at Goldman Sachs.
Brad,
I agree with you that restraining overall US demand in order to solve the trade deficits has many undesirable side effects, including slower US growth. The further problem is that it doesn’t work. The 2001-2002 recession barely caused a blip in our trade deficits and the current slowdown is not doing much more.
I also agree with you that it is best to enlist Chinese cooperation in solving the problem. As Teddy Roosevelt once remarked, the United States should talk softly but carry a big stick. Import Certificates (tied to exports) could be the big stick that would not have to be used.
Here is how we put it in our May 26 commentary, “How to recapture the Republican Advantage on Trade”:
President Bush and Senator McCain should announce tomorrow that the mercantilist governments had better start reducing their trade surpluses with us on their own, or we will impose Import Certificates, an idea initially recommended by Warren Buffett and elaborated in our book Trading Away Our Future. If the mercantilist countries do not comply, Import Certificates, tied to exports, would gradually force trade into balance.
Faced with import certificates, China would remove its 30 percent tariff on Michigan auto parts, its 30 percent tariff on Harley Davidson motorcycles, and its 40 percent tariff on Bucyrus mining equipment. Our manufacturing companies would hire back laid-off workers and begin building new highly-efficient factories to meet growing world demand.
If the Republicans were to insist on balanced trade, then our mercantilist trading partners would have to import from us in order to continue to export to us. The result would be a prosperous U.S. economy led by new highly-efficient U.S. factories, and the Republican Party would start winning elections again
This commentary can be read at: http://www.enterstageright.com/archive/articles/0508/0508republicantrade.htm
Howard Richman
In the 1980’s, the Japanese government actually paid for a US technical study on building a “bullet train” line between San Francisco, Los Angeles, and San Diego. Japan’s government even offered to finance the $10 billion US project at low 1-2% interest rates using Japanese Bullet train technology. For the cost of 1 month of the Iraqi war, California could have a high-speed bullet train system saving billions of gallons of fuel between the cities. But under the existing Neo-conservative US ideology, the only acceptable government spending is for military warfare.
One may also recall the American Patriots screaming bloody murder about giving away the nation by letting the Japanese in. They were not called Neo-Cons at that time, but their ideology was one in the same. Now with Fox News 24/7, the Neo-Con stupidity is pretty much nationwide. California and the rest of the United States could have an excellent mass transportation system, but protectionism stopped it. The Soviet mentality of the Washington Consensus Elite crowd is truely amazing. We are in the mess we are now because of conservative american “soviet” thinking.
DC — on a broad trade weighted basis, the nominal RMB is appreciating by much less than it did in 2005, or much of the 1990s. the rmb is i think down v the euro for the year. Europe is China’s largest trading partner. the pace of rmb appreciation v the dollar slowed in april as well. And the biggest threat to Chinese macro stability isn’t a stronger currency it is high levels of inflation — inflation that stems in part from China’s policy of resisting currency appreciation. I rather doubt that China is moving as fast as it can.
David Chang,
I disagree with your assessment when you wrote: “The China PBoC is revaluating their currency as fast as they can without significantly impacting the macroeconomic stability of the economy.” They are currently facing inflation which would be reduced were they to revalue faster. Not only would oil prices be reduced, but also the increased imports and reduced exports would restrain Aggregate Demand.
I only partly agree when you wrote: “The China yuan should be only revaluated in tandem with the rising productivity rate in order to minimize impact on industrial production and employment.” Revaluating in conjunction with increased productivity does nothing to reduce the trade surpluses. I agree that a faster reevaluation could cause loss of jobs in industrial employment. But there is no need whatsoever for the Chinese economy to suffer unemployment. Instead of lending dollars to the US Treasury at negative interest rates (after inflation), the PBofC could make credit available for home mortgages so that any lost industrial jobs lost could be replaced by increased construction jobs.
Moreover, ending mercantilism would be a very good move if the Chinese government’s goal is to grow mutually with the United States. The trouble with mercantilism is that it eventually impoverishes one’s trading partners, ruining the market for exports. If trade were balanced, both the United States and China would grow together into the distant future. A world economy based upon balanced trade is sustainable. Mercantilism is not.
Howard
bsetser: I would be much happier if I thought the US could solve its all its problems entirely through its own actions — I like the notion that the US controls its own destiny.
But if US policies are driving the US deficit, one would expect high interest rates globally.
The main policy that caused all of this mess was the decision in 2001 to drastically cut income taxes and the decision in 2003 to invade Iraq. Had neither of these decisions been made, the US budget would have remained in balance and CNY/USD exchange rate would have remained stable.
Neither were Chinese decisions, and I find it bizarre to blame China for the economic consequences of decisions that were made in the US. Ultimately, the trillion dollars that Iraq war has cost must be paid for, and if it doesn’t come through taxes, and it doesn’t come through overseas borrowing, then it will come through higher prices of imported goods.
bsetser: I stand by the notion that the surplus countries are a necessary part of the solution — adjustment driven entirely by a contraction in the deficit country isn’t pleasant.
“Structural adjustment” to use an IMF term is extremely unpleasant which is why everyone wants to have such massive currency reserves so that they aren’t ever forced to do it.
The logic of fixed exchange rates is precisely to force deficit countries to undergo painful adjustments. There’s something very ironic here that economists who were completely deaf to the pain of the third world in the 1990’s when they were forced to undergo painful “austerity programs” are talking about “currency manipulation” when a system of fixed exchange rates works exactly in the way that is was supposed to work.
The US because of its extreme power is not going to be forced to go through what Latin America is going through, but what really bothers me is that people are not looking at the consequences of current actions. Suppose China revalues the RMB by 20% tomorrow, all of the economic problems of the US will be resolved, right?
No, not right. First of all, increasing the value of the RMB will increase prices in the United States in a way that will pay for Iraq and so the net drag on the US economy will be the same. It will be better disguised, but the Iraq war will still have to be paid. Second, revaluing the RMB will make US assets incredibly cheap for Chinese buyers, and this will have consequences. Third, if you ask for help, and get it, that doesn’t change the amount of power the US has or its lack thereof. If China and the Saudis do what the US politely asks it to do, they are still doing it because they are being asked politely. Next time, they might not.
Credit needs to go where credit is due. The Iraq War will probably go down as one of the most stupid and self-destructive things that any great power has ever done to itself.
One important rule of politics is never believe your own propaganda. Politicians lie. If a politician has to tell voters that it is all China’s fault that they are out of work, and don’t blame him because he is totally helpless, that’s something I’ve learn to expect. If you read every political speech since Pericles they basically have the same sorts of lies. You are good. They are evil. I’m one of you. Give me power, and I’ll fight for you against them.
But if that politician starts believing what he says, then you really start running into problems.
Richman: the PBofC could make credit available for home mortgages so that any lost industrial jobs lost could be replaced by increased construction jobs
Which is what the government has done. The trouble with making easy credit available for home mortgages is that it inevitably leads to a housing bubble and non-performing loans, and the Chinese government trying very hard not to get into that situation.
You can also do fiscal stimulus. But if there is endemic corruption and mismanagement in a political system, then throwing money at it might not be such a good idea.
One thing I don’t believe in is economic utopia. Any non-trivial economic and political decision is going to have bad consequences, and any non-trivial economic and political decision is going to involve careful balancing between a lot of different factors.
I very strongly distrust anyone that says “do this and the world will be perfect.”
Richman: The 2001-2002 recession barely caused a blip in our trade deficits and the current slowdown is not doing much more.
That’s because the 2001-2002 coincided with massive tax cuts creating a large capital deficit. Capital deficit -> current deficit.
Richman: As Teddy Roosevelt once remarked, the United States should talk softly but carry a big stick.
The United States really doesn’t have much of a big stick to use. If you want someone’s help in fixing your problems, threatening them is hardly a good thing to do.
Richman: Import Certificates (tied to exports) could be the big stick that would not have to be used.
Except at that point the US would have to pull out of WTO and the world trade system, and I don’t think that there is the political consensus to do anything like that. Every multinational would hire every lobbyist they can to kill that idea, and they would.
Also, never make a threat in a negotiation unless you are willing and able to act on it, and import certificates are just not a credible threat for the US to make.
Actually, I like industry specific measures in the context of trade negotiations since it placates a specific group of people in exchange for not oppose general trade liberalization.
Twofish:
You wrote that if the US enacted Import Certificates, we would have to pull out of the WTO. While it is true that Warren Buffett’s version of Import Certificates (see http://www.money.cnn.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm ) as incorporated into Senators Dorgan and Feingold’s “Balanced Trade Restoration Act of 2006″ (see http://www.theorator.com/bills109/s3899.html ) might be seen as contradicting WTO Rules (though Dorgan and Feingold argue that it does not), we have put together a much more limited Import Certificate plan that does not contradict WTO Rules.
By the way, I would not object to the United States pulling out of the WTO. I think that the whole idea of achieving free trade through international regulation is flawed. Just as money finds its way into politics, no matter what the campaign finance laws, governments will find loopholes to exploit, no matter what the system of international trade regulations.
I would prefer a new world trade system based upon balanced trade. Countries that practice protectionism within a system of balanced trade are hurting the industries that they are not protecting.
Howard Richman
Richman: We have put together a much more limited Import Certificate plan that does not contradict WTO Rules.
Whether or not it violates WTO rules or not ultimately depends on the WTO dispute adjudication process. If your import certificate plan hurts an industry, they are going to argue like hell that it violates WTO rules and if you want to win, your lawyers are going to have to be better than their lawyers.
Richman: I would prefer a new world trade system based upon balanced trade. Countries that practice protectionism within a system of balanced trade are hurting the industries that they are not protecting.
This is going to sound harsh, but wishing for something doesn’t make it possible. I’d prefer to live in Marx’s world Communist society. I’d also prefer it if I could sprout wings and fly and walk on water.
Reality doesn’t care that much about what you or I prefer, and I’ve found it more useful to start with what is politically and economically possible rather than what is desirable.
Richman: Just as money finds its way into politics, no matter what the campaign finance laws, governments will find loopholes to exploit, no matter what the system of international trade regulations.
True. Your point being????
2fish — I share your assessment that the iraq war was an immensely misguided policy choice. I also am not a fan of the post 01 tax policy.
But I am not convinced that those two decisions are an explanation for the US deficit. what is the mechanism? There is one obvious one — namely, a war + tax cuts = big fiscal deficits. that fiscal deficit has to be financed by more domestic savings, less domestic investment or more borrowing from abroad. the mechanism that brings this about is higher us rates. that either reduces investment (or increases us savings) or pulls in more money from the rest of the world.
Absent a rise in rates, the mechanism that produces the rise in foreign financing from a bigger fiscal deficit is hard to see.
Moreover, when the US reduced its deficit (it fell from 04 through 07, and is set to be very big again in 08), a rise in household borrowing (and residential investment) offset the fall in government borrowing. I don’t see how that was a product of US policy. I do see how it was a byproduct of Asian currency intervention (which held their currencies down, pushed exports up and indirectly produced a large rise in Chinese savings v investment as china restrained domestic demand growth to avoid overheating in the face of the strong stimulus from booming exports) and high savings in the oil exporting economies. Again, if excessive us borrowing was putting pressure on global savings, rates should rise. if US borrowing was a response to a surplus of savings outside the us, rates should be low — and rates were low. this is in effect the dooley et al argument: the mechanism through which Asian export led growth produces a deficit in the us is by depressing us real rates.
finally, i fully accept the argument that emerging economies wanted to increase their reserves after 97. part of that was a desire to avoid the imf. part of it was a desire to insulate themselves against markets that proved more volatile than expected, and failed to provide stable financing (don’t blame the imf alone, countries turned to the imf when market financing disappeared). but that cannot explain the scale of the current reserve buildup; china has way more than it needs to avoid the imf and it is still adding at an accelerating pace. if avoiding the imf is the goal, a country should stop intervening once it has enough. countries now have WAY more than enough. hence i consider this argument a red herring. china wants to avoid allowing its currency to appreciate. it has sacrificed other objectives, icnluding domestic financial stability, to this objective.
Coincidentally, while bsetzer was posting on his blog, Howard, Jesse, and I posted on our trade-war blog an article relating oil prices, trade deficits, and falling exchange rates, which deals with nearly all the issues raised in the preceding blogs. I recommend it to you: trade-wars.blogspo.blog.com. I’ve read all the above with great interest.
bsetser: that fiscal deficit has to be financed by more domestic savings, less domestic investment or more borrowing from abroad
Or devalue the currency which is part of what is going on.
I do agree that the currency peg has had the effect of increasing the current account deficit. Where I disagree is that the peg was intended to have this as a effect. My point is that the policy of pegging the RMB to the dollar was established in 1993, and if you accept the existence of the peg as a given fact, then anything that happens afterwards is a result of US policies.
The only decision that the PRC can make is whether or not to break the peg, and then how fast to let the RMB rise. My argument is that people that argue that the RMB can rise instantly vastly understatement the difficulties and risks of messing with currency policies, and also underestimate the difficulty it is to get a bureaucracy to adopt a new currency policy. It wasn’t obvious to anyone until about 2003 that the peg was failing, and once you start discussing whether or not to break the peg, it’s going to take about two years to finish making the decision.
bsetser: Moreover, when the US reduced its deficit (it fell from 04 through 07, and is set to be very big again in 08), a rise in household borrowing (and residential investment) offset the fall in government borrowing. I don’t see how that was a product of US policy.
Between 04 and 07 Greenspan had a policy of drastically decreasing interest rates in order to avert a recession. Greenspan had the option of keep the Federal Funds rate high which would have removed pressure from the USD/RMB exchange rate. It would have also sent the US economy into a nasty recession which would have been politically unacceptable. So the Fed made a decision to cut overnight rates. This caused the USD to drop against all currencies. However because of the peg, this created a massive deficit with China. At the time, this was the least bad option for everyone since China had the savings that they could use to sterilize the inflow.
But again, the driver here was US policy. Greenspan could have refused to cut the Federal Funds rate which would have attracted overseas investment, and there is no external reason why Greenspan could have chosen not to cut Federal Funds in order to keep the value of the dollar constant. There are plenty of internal reasons. People hate losing their jobs in an election year.
bsetser: Again, if excessive us borrowing was putting pressure on global savings, rates should rise.
Except that Greenspan was cutting short term Federal funds so that rates wouldn’t rise. Cutting short term interest rates (which the fed has total control over), prevents long term rates from rising.
bsetser: that cannot explain the scale of the current reserve buildup;
Once you start a policy, there is enough bureaucratic interia so that it is very difficult to say *stop* we’ve had enough. This is one of the things that you have keep in mind before you issue an order, because there can be enough interia to keep things moving even after they are very harmful.
This why the Chinese government moves slowly. Once you push things in a certain direction, its hard to say *stop* even if it turns into a disaster.
bsetser: china wants to avoid allowing its currency to appreciate. it has sacrificed other objectives, icnluding domestic financial stability, to this objective
China wants full employment and low inflation just like everyone else. If China didn’t want the RMB to appreciate then it would have kept the peg, but instead it is 20% off of its highs. US pressure doesn’t have much to do with this since China has in the past ignored US pressure when it feels that it isn’t conducive to its national interest.
The problem with a lot of analysis is that is underestimates how complex social and economic systems are. I don’t think anyone in 2001, would have been able to predict that the world would look like what it does today and to have what happens be the intentional result of decision assumes a degree of fortune telling that simply does not exist. There are just too many moving parts.
People make decisions based on short term constraints and these interact with the decisions that other people make to produce totally unexpected results. I don’t think there was a single Chinese decision maker that would have expected or wanted reserves to get to be as large as they are.
This is why I think it is vitally important to think about what happens next. Suppose China does exactly what the US wants (say do a maxi-reval of 20% tomorrow). There will be some bad side-effect of that decision that no one quite appreciates today. No idea what it is. No one knows the full consequences of any economic decision, not the Fed, not the Politburo, not either the Presidents of the US or China, not the banks. There are just too many moving parts, and the best that you can do is to make sure that any decision or non-decision you make isn’t suicidal.
However even avoiding suicide and a lot of argument, and this sort of argument makes things slow when it comes time to decide whether or not to do a maxi-reval or whether to take some other policy. The Chinese government moves slowly not because it has some grand plan or likes the status quo. On the contrary, it moves slowly because it frankly has no idea what the consequences of its actions are and it is divided between people who think that it will be a big disaster if they do X, and others who think that it will also be a big disaster if they do not-X.
2fish
“I do agree that the currency peg has had the effect of increasing the current account deficit. Where I disagree is that the peg was intended to have this as a effect. My point is that the policy of pegging the RMB to the dollar was established in 1993, and if you accept the existence of the peg as a given fact, then anything that happens afterwards is a result of US policies.”
I strongly disagree. China could have changed its policy at any point in time. and the US is under no obligation to manage its currency for the benefit of other countries that unilaterally choose to peg to the $. China is responsible for the consequences of pegging to the dollar at an unchanged rate as its circumstances changed and as the US economy changed.
I also think you are overstating the complexity of some things. The impact of exchange rates on trade, for example. The rmb depreciates v the euro. A simple theory would say the that the impact would be a larger Chinese surplus with europe. that simple prediction has been born out. when the rmb moved from a trend appreciation (b/c of $ appreciation) to a trend depreciation (b/c of $ depreciation), a simple theory would say that the result would be a larger trade surplus globally. low and behold, that is what happened. parsimony doesn’t mean a model is wrong. a simple exchange rates impact trade flows model seems to work pretty well here.
finally, the us was raising rates in 04 and 05. the cuts didn’t start til late 07. and short-rates (which the fed clearly controls) rose above long-rates (which china may control, through its massive purchases). you could argue that the fed shoudl have tightened more, but it was tightening then — and chinese/ other purchases at the longend of the curve undid some of the expected effect.
again, if excesses in the us are the sole cause of the big us deficit (and a fall in investment v savings globally), the us deficit should be putting pressure on rates both in the us and globally. didn’t happen. frankly, i had hoped china wouldn’t finance w’s war and tax cuts so their costs would more visible.
Massive OPEC oil surpluses in the 70’s seem to have been routed through U.S. banks to developing countries, mostly guaranteed by the local governments. Then came the “LDC debt crisis,” with some bailouts of banks and some defaults.
In the latest episode, the Asian trade surpluses seem to have been routed through investment banks to home buyers. Then comes the “housing crisis” with its attendant bailouts and defaults. The new oil surpluses and Asian trade surpluses combined should make for a real Lulu brewing somewhere. I wish I knew where. U.S. farmland? I certainly hope it will not be U.S. government debt.
Don,
I agree with your analysis. Once you figure out where, do let me know. I also hope it won’t be U.S. government debt, but I suspect that that will be part of it. I hadn’t thought of US farmland. Hmmmm….
Howard
Don,
I have been very impressed that you have been thinking through some of these issues along the same lines that we have. Do you have any published papers or commentaries that you could e-mail me. I can be e-mailed at director@phaa.org.
Howard
Howard-
Thanks, but I have published nothing in this area.
As Brad says, “….if excessive US borrowing was putting pressure on global savings, rates should rise. If US borrowing was a response to a surplus of savings outside the us, rates should be low….”
But, by similar logic, as I explain at http://reservedplace.blogspot.com/2008/05/enigma-inside-conundrum.html, if central bank intervention was driving US interest rates, government bonds should have been relatively expensive and spread product relatively cheap. In fact, before the financial crisis, spreads were tight. My conclusion is that US demand to borrow has been as responsible for the US current account deficit as foreign central bank supply of savings.
bsetser: I strongly disagree. China could have changed its policy at any point in time,
No it couldn’t. Changing from a system of pegged exchange rates to an system of floating exchange rates is one of the most complex, difficult, and dangerous things that a nation can do with its economy. People have had their hands full dealing with the slow unpeg, and any depeg that was faster than what has happened would have caused huge amounts of economic disruption.
One thing that makes depegging difficult is that it is an all or nothing irrevocable decision. Once you’ve depegged, then it is effectively impossible to move back. There are dozens of examples of botched depegs that have devastated an economy. The examples of successfully depegs in economic history are quiet small, and they have always taken years to undertake.
bsetser: US is under no obligation to manage its currency for the benefit of other countries that unilaterally choose to peg to the $. China is responsible for the consequences of pegging to the dollar at an unchanged rate as its circumstances changed and as the US economy changed.
Who is resposible for what is something in international finance is something is quite unclear right now. If the US view is that international monetary policy should be designed so that what every is good for the US is good, and to hell with the rest of the world, and the US can do whatever it pleases and is not responsible for the consequences then sure, the US isn’t responsible.
However, the post-WWII major efforts that have been made to create an international framework for monetary policy have relied on fixed currency exchange rates to prevent nations from doing precisely what Greenspan did in 2001-2004. Both Bretton Woods I and the Washington Consensus mandated a system of fixed exchange rates precisely so that nations would have to “bite the bullet” and undertake actions that would hurt its domestic economy rather than to run presistent deficits.
The US is really the only country that is able to break these rules because the dollar is used as a reserve currency and because of its huge economic and political power. Any other country that tried what the US did between 2001 and 2004 would have quickly run into a massive currency crisis.
Here is an experiment. Replace the nations involved in your statement, US->Mexico and China->US, and imagine arguing it in front of the IMF in 1995.
The system of fixed exchange rates that China adopted in 1993 was one aspect of the Washington Consensus that it did adopt (and influence from Hong Kong was pretty crucial), and it was willing to uphold the peg through the Asian crisis of 1998.
bsetser: again, if excesses in the us are the sole cause of the big us deficit (and a fall in investment v savings globally), the us deficit should be putting pressure on rates both in the us and globally. didn’t happen.
That’s because the peg and high Chinese savings rates meant that US excesses are being financed by Chinese savers. I don’t disagree that this is happening. Where I do very strongly disagree about is how this situation came about, and the decisions that lead to this situation were made mostly in Washington and not in Beijing. As you yourself have pointed out, most of the costs of the current situation are going to be borne by Chinese rather than Americans, and that strongly suggests that the critical decisions are being made in Washington rather than Beijing.
bsetser: frankly, i had hoped china wouldn’t finance w’s war and tax cuts so their costs would more visible.
Wars and tax cuts are something else that are hard to undo. Once you’ve committed yourself to fighting a war cutting taxes then it takes some rather extreme pressure to undo those.
Also any efforts to make the cost of a policy obvious runs into the fact that you are dealing with politicians whose job it is to hide the costs of any policy. This is in some ways a good thing since it makes politicians very interested in pro-growth policies since it is much easier to hide things in a growing economy than in a stagnant one.
bsetser: US is under no obligation to manage its currency for the benefit of other countries that unilaterally choose to peg to the $.
I’m curious what you think the responsibility is of economists and international organizations that were encouraging third world nations to peg their currencies to the dollar.
This statement points out the fatal flaw of Bretton Woods I and Bretton Woods II. Under a Bretton Woods system then nation that ends up serving as the reserve currency *does* have an obligation to manage its currency for the benefit of nations that peg to it. The trouble with that as we found out in the early 1970’s and in the early-2000’s, is that the US simply can’t and won’t cause a recession in its domestic economy for the good of the rest of the world.
2fish — the US advocated pegs briefly in the early 1990s as a tool of macroeconomic stabilization in high inflation economies. They were not meant to last forever. By the late 1990s, the US was advocating more exchange rate flexibility. Out of a desire not to undermine HK’s currency board or Argentina (then under pressure), the argument was usually presented as an argument in favor of corner solutions — i.e. dollarization or currency boards could work, as could flexible currencies, but pegs by countries that wanted monetary autonomy wouldn’t. I was at the treasury at the time and this was part of my brief, so i know the exact policy very well. The US was biased toward flexibility, and encouraged many countries to move off the dollar. i believe that the US was prepared to support both an Argentine and Turkish move off the dollar in 00 for example, but neither wanted to move.
it turns out that a low fewer Emerging markets than we thought adopted the kind of policies the US advocated; most decided to peg an undervalued level rather than float. That really was their choice — not one pushed by the US.
bsetser: the US advocated pegs briefly in the early 1990s as a tool of macroeconomic stabilization in high inflation economies. They were not meant to last forever.
The problem is that getting off a peg is really quite difficult. The second you start moving off of a peg, then you get this positive feedback cycle that causes massive capital flows. Looking at Argentina and Turkey (and China now), it wasn’t so much that they didn’t want to get off the peg, it was that they couldn’t easily move off of their pegs without a lot of turmoil.
I agree with Twofish on virtually everything, only it is put better than I could do.
Excellent commentary!
Brad, this is really one of the better economics blogs I’ve come across (and t my age, a blog is pretty unconventional, so it may not mean very much). But so many posts makes it hard to follow the discussion(I found out that there are some regulars but also many casuals and the casuals are labor intensive). When I started I tend to agree that the introduction was excellent (still do), but the discussion is pretty hard to follow. Any way to systematize this for old folks?