Krugman laid a big egg a couple weeks ago, to such an extent that I cannot fail to respond. The analysis is wrong and the policy prescriptions are just horrendous.
But enough of my bald assertions, let’s go straight to the tape:
China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery.
Fine, I don’t have a problem with this, I trust Paul’s judgment.
The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.
Significant and powerful, by focusing on the costs to the Chinese government of maintaining the current exchange rate. So far, Krugman’s aim is dead on.
Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.
Ok, this is obviously an issue. However, notice how the pejorative language begins to pop in. ‘Unwarranted’ trade surplus, you say? Do tell! Is that an international economics faux pas? By which standard is this deemed as unwarranted?
It is unfortunate, is it not, that the relevant interest rates are already near zero. That sounds a lot like poor economic management to me. And so I wonder why, precisely, the trade surplus is ‘unwarranted’ while the interest rates just are where they are, as if by magic. Of course, this is another failing of the Bush Administration, along with all the debt they kindly incurred on our behalf. I think Paul should have gotten a dig in here, but in any case I do not like this use of language at all.
But let’s move right on to the policy prescriptions:
So how should we respond?
Watch him go in entirely the wrong direction from here.
Treasury must issue a report identifying nations that “manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” The law’s intent is clear: the report should be a factual determination, not a policy statement. In practice, however, Treasury has been both unwilling to take action on the renminbi and unwilling to do what the law requires, namely explain to Congress why it isn’t taking action.
Oh, Snap! As the kids said back when I was still a resident of the good-old USA. A Treasury finding of manipulation! Those Mandarins in Beijing will be shaking in their boots when that one comes out!!
Of course, one needs to conveniently forget how another government organization under the Federal government identifies the biggest human rights violators every year, in a report that is greatly affected by political concerns. Just one example of how serious or significant ‘government reports’ are.
An angry denunciation will be properly viewed as nothing more than a political complaint. If the argument is that Treasury needs to do this prior to other defensive actions, then that would be different. But Krugman does not seem to assert that the report is a required precursor to the actions he will now advocate:
In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
Oh great, let’s start a global trade war on par with any ever seen before.
Remember the trade agreements China signed in order to join the WTO? Well apparently the rules have changed without your permission! How’s about that for supporting law and international agreements! Think for just a second how that looks from the Chinese perspective. One small bump in the road and all those ‘binding’ agreements are cast aside, ditched on an old abandoned highway.
We need to think in terms of mutuality. Think about what the Chinese need and want before talking about how to induce the Chinese to work with us.
In order to tackle this problem, (and I do agree this is a problem, the Yuan is fundamentally overvalued), everyone should first stop talking about ‘currency manipulation’. This term is highly pejorative for a policy that China has followed for over a decade, without complaint until about 2005 (Paul says 2003 but he is deep in economic circles). Indeed, China’s currency was a stabilizing force back in 1997 during the Asian financial crisis.
Now, this policy, a policy a large number of countries follow, is suddenly manipulation.
The disconnect in this piece is all the more obvious when you realize that Paul touches directly on Chinese concerns:
It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.
And yet, despite having China ‘over a barrel’, we must start a trade war to correct the improper pegging of the dollar. I think this internal inconsistency (at multiple levels) should be fairly apparent by now.
What does China need and want? Krugman points to one major aspect: they don’t want the dollar to fall too far. China is long dollars, and they want their investment to pay off. That they are long dollars tells us much about both their trust in US economic management as it does about the folly that was the Bush Administration. That trust will not be rebuilt in a day, and will not be fostered by Krugman’s quite radical policy prescription.
You can’t blame the Chinese for going to bat for their export industry. It is the export industry that helped China work again, helped the government create jobs, helped numerous areas to develop rapidly. Out of all the mass of China’s economy, the export industry stands out both in size and in national coverage. You can certainly expect China to consistently support the export industry as much as possible.
If you read the preceding carefully you noticed the interesting phrasing ‘helped the government create jobs’. In China, the government is responsible for everything. I am not saying that in a negative or positive way, it is just a fact of life. The government is effectively responsible for making sure the people have jobs. Read the Constitution and you will understand.
The export industry has created jobs for millions of people, and therefore is deserving of special protections.
What Krugman should do is focus on mutuality to find solutions.
Krugman says that this is a lose-lose. He says the Western recovery is being artificially depressed by China’s policies.
This is a big economic game, and the US has made the rules. If China’s policy is win-lose, then China should go ahead and take their gains from this round of the game. That is just how it works, and getting upset about it is highly destabilizing. Bush’s economic mismanagement has led to losses, as they were destined to, and so the losses must be realized. The US is a horribly wasteful country and must change fundamentally. Isn’t that what the IMF tells developing countries?
If China’s policy is lose-lose, then make the case directly. China’s export industry obviously needs markets in which to sell, and so compromise can be reached because of fundamental mutuality.
Another issue of major importance to China is the inflation rate, a significant source of destabilization. I believe that the persistent and quite serious inflation of the past years is due to restrictive international investment policies on external investments. Paul says the exchange rate is maintained by outflows of capital, and I contend that even more open market operations would be necessary to stem the inflation pressures domestically.
A wave of Chinese money is eager to invest in the US, at this time of historically low price levels, and China’s policies (and perhaps other factors) prevent that to some extent. In my mind, one can expect the kind of buy-in the US received from Japan back in the late 80s, only supersized, as only the Chinese can do. Indeed, I believe that there is an enormous amount of hot money floating around China which would be better invested overseas. When the rich are looking to garlic to make money (as well as the insanely overheated real estate market) you know there is a lack of good opportunities.
My economic analysis might be totally off, but that’s not important. What matters is that we agree to work through the problem logically, without unnecessary, aggressive, rhetoric. There has been entirely too much of that in past years.
And a trade war is what we all need least.