Krugman vs. Krugman

I don't get Krugman's logic here:

Things are different for a country that shares a currency with other countries. Ireland can raise employment by cutting wages of Irish workers relative to German workers. But America, with its floating dollar, gains nothing — nothing at all — from overall wage cuts. All we get is a magnified real debt burden.

If that's the case, then why worry about China's currency peg, as he has done for years now? Either their peg helps boost American employment (at the zero lower bound), or it's of no concern for employment. Or Krugman is wrong.

This Is What Adjustment Looks Like (An Ongoing Series)

Increasing inflation in China causes a real exchange rate appreciation. Michael Pettis:

[T]he month-on-month increase in prices suggests that inflation is running at just under 13% annually, although month-on-month numbers are always suspect because they don’t correct for seasonality and one or two big numbers can have a disproportionate effect. Still, although the CPI inflation number was below market expectations it is nonetheless well above the PBoC’s comfort level, which is officially 4%. In December the year-on-year rise in prices was 4.6%.

This stubbornly high inflation number, coupled with good growth numbers and a surge in exports will, I suspect, give Beijing the sense that it has room to tighten, so I expect that we will continue to see measures such as interest-rate and minimum-reserve-requirement hikes to slow down economic growth. In keeping with this on Friday the PBoC announced yet another 50-basis-point hike in minimum reserves (making it the fifth hike in five months).

But will these measures bite? My guess is that they will at first, but that when they do they will be quickly reversed. Any real attempt to reduce the sources of overheating will cause economic growth to slow too quickly, and Beijing will change its mind, especially if, as I expect, inflation peaks soon and starts to decline.

Let’s face it – most Chinese growth is the result of overheated investment, and removing the sources of overheating without eliminating growth is going to prove impossible. I have been making the same argument for at least two or three years, and so far we have seen how Beijing veers between stomping on the gas when the economy slows precipitously and stomping on the brakes when it then grows too quickly. I don’t believe anything has changed.

More at the link.

This Is What Adjustment Looks Like

The real exchange rate -- including domestic inflation -- is still the appropriate measure:

The [Chinese] central bank has been pumping out currency at an ever-accelerating pace over the past decade to limit the renminbi’s appreciation against the dollar. That strategy has helped preserve a competitive advantage of Chinese exporters by keeping their prices relatively low on global markets — while also protecting the jobs of tens of millions of Chinese workers in export factories.

Now, though, that cheap currency policy seems to be reaching its limits. The extra renminbi are feeding inflation. That is starting to undermine exporters’ price competitiveness — just as a stronger renminbi would do if Beijing was not intervening to begin with. ...

Inflation in China is not just the result of China’s currency market intervention, although Mr. Hu and other economists describe it as the biggest single cause. Another cause is aggressive lending by Chinese banks, despite repeated demands by regulators to slow things down.

Meanwhile, David Leonhardt tries to play down currency concerns in advance of Hu Jintao's visit to the U.S.:

For the United States, the No. 1 problem with China’s economy is probably intellectual property theft. Technology companies, for example, continue to notice Chinese government agencies downloading software updates for programs they have never bought, at least not legally.

No wonder China has become the world’s second-largest market for computer hardware sales — but is only the eighth-largest for software sales.

Next on the list, say people who work in China or do business there, is the myriad protectionist barriers China has put up. These barriers make this country’s recent efforts at “buy American” protectionism look minor league. In some cases, Beijing has insisted that products sold in China must not only be made there but be conceived and designed there. The policy goes by the name “indigenous innovation. ...


The most relevant comparison of two currencies is one that is adjusted for inflation in the two countries. When inflation is higher in one country, as in China today, it means that country’s products are becoming more expensive — and imports into the country become relatively cheaper. In effect, the real price of Chinese-made goods is rising faster than the exchange rate suggests.

Without taking inflation into account, the renminbi has risen 3 percent against the dollar since last summer, when China began letting it rise. Once inflation is accounted for, the real increase has been about 5 percent. At that pace, the renminbi could erase its artificial undervaluation — as some economists estimate it — in less than two years.

Developing.

China's Current Account Surplus and the Yuan

"If you think U.S. President George W. Bush's administration had a tough time dealing with China, the next occupant of the White House may have it worse." So claims yesterday's International Herald Tribune.

The article offers a clear explanation for the mechanism through which pegging the yuan to the dollar reinforces the savings - investment gap that underlies China's current account surplus.

It also hints at the dilemma the Chinese monetary authorities now face. Pegging the yuan requires continual purchases of foreign assets, which in turn expands the money supply, which in turn generates inflation. Stemming inflation requires higher interest rates, which may well pull in additional capital flows, thereby forcing the central bank to accumulate still more foreign exchange reserves, additional monetary expansion, and more inflation. In short, the desire to keep domestic prices stable is not easily reconciled with the desire to maintain the pegged exchange rate.

One obvious solution to this dilemma is to allow the yuan to float. No sign that this is likely to happen any time soon.

The Soaring Euro: Imitation is the Sincerest Form of Flattery

American exchange rate policy during the last 40 years has leaned heavily on a simple strategy: unwilling to use US monetary policy to influence the dollar's external value, it has sought to induce other governments to alter their policies. The logic, of course, is simple. All bilateral exchange rates are a function of the interaction between two monetary policies, and thus the exchange rate can be influenced via changes in either policy. During the 1960s and early 1970s, the US pressured (or, as one of my current [German exchange] students put it in class, coerced) Germany to accumulate and hold dollars to shore up the Bretton Woods System. During the 1980s, the US pressured Japan and, to a lesser extent Germany, to realign the mark-yen-dollar triangle. Currently, the US pressures the Chinese to revalue.

The EU seems to be embracing this policy as if they had invented it themselves. Sarkozy, during his recent visit to the States, scolded Congress and demanded the US take steps to stem the dollar's slide or face a trade war. An EU delegation is headed to China to pressure (coerce?) the Chinese to revalue the yuan. All of this on the heels of the ECB's decision that it prefers to keep interest rates steady, thereby refusing to use interest rates to stem the euro's rise.

EU tactics seem a direct consequence of monetary union. Fifteen years ago the French would have screamed at the Germans and then probably devalued the franc. Now, it does no good to scream at the Germans (althought Sarkozy did try that first, I guess old habits die hard), and the French can't devalue. Nor can they directly control ECB monetary policy. The only way to influence the euro's external value, therefore, is to pressure other governments to adjust their policies.

I had always considered American policy a consequence of American structural power and isolationism. The EU's embrace of this strategy makes me wonder if American policy isn't also a product of institutions, especially the independence of the Federal Reserve.

Puzzling Commentary on the Dollar's Decline

Stephen S. Roach, chairman of Morgan Stanley Asia, wrote yesterday on the dollar's depreciation . "The dollar, relative to the currencies of most of America’s trading partners, is off about 20 percent from its early 2002 peak. Recently it has hit new lows against the euro and a high-flying Canadian currency." (Maybe we need to stop calling it the looney and start calling it the "goose").

I have always had a lot of respect for Roach's commentary, but two things about this particular article struck me as a bit odd:

1. Roach calls the dollar depreciation " the functional equivalent of a tax hike on consumers." Except, it isn't functionally equivalent to a tax increase. A tax increase would generate revenue that the government could spend on services (or investment). Why not instead simply call it what it really is, a reduction in real income. The fall won't be 20 percent, but it will be real.

2. Roach then asserts that a Chinese revaluation constitutes a tax increase: "{Pressuring China to revalue] would...be an egregious policy blunder ... but it would also amount to Washington taxing one of America’s major foreign lenders." Except, this isn't a tax either--if a devaluation reduces US income, doesn't a revaluation raise China's income?

I guess he is trying to say that a revaluation would reduce the yuan-denominated return on the dollar-denominated assets China currently holds. But again, that's not a tax, it's a reduction of income and a loss of wealth (the yuan value of the 1 trillion + China currently holds would also fall). But, that loss would be offset by the income gains from improved terms of trade. Hence, goods and foreign assets will cost less in real terms in the future. Moreover, I suspect that as the dollar falls the rate of return needed to attract foreign capital rises; hence, an initial negative wealth shock may well be at least partially offset by cheaper assets and higher returns.

How that all of this nets out--increased real value of wages, salary, and interest income minus the reduced nominal interest income and the wealth shock of current dollar-denominated asset holdings--is more complicated than I can figure out, but I doubt it is negative.

More broadly, I wish Roach had taken advantage of his opportunity to explain in clear and direct terms what is happening to the dollar, why it is happening, and what the consequences will be. The piece he did write does more to confuse than clarify.

More Protectionism

"This year's [really poorly conceived trade bills] are calibrated to attract broader [congressional] support by softening the threat and involving international bodies. In years past, the leading currency bill threatened across-the-board 27.5 percent tariffs on all Chinese goods. The new bills would permit sanctions, but only after significant consultation between the two countries.

"It's a much more conciliatory batch of bills than their predecessors," said Gary C. Hufbauer, a trade expert at the Peter G. Peterson Institute for International Economics in Washington. "It's not slamming the hammer. It's kind of turning the screw." (But who is getting screwed here, Dr. Hufbauer?)

Some analysts expect that this fall, as the election season heats up, one of these bills will gain approval, possibly by the two-thirds majority required to override a presidential veto." (Super-majority support for protectionism is always good news.)

Maybe this reaction by 1,028 economists to the current round of congressional stupidity is OTT, but on the other hand, maybe not (Hat Tip to Greg Mankiw).

Passing the Buck, I Mean Renminbi

The IMF this week announced new guidelines for how it will evaluate exchange rate policies.

"Rato said the new rule "gives clear guidance to our members on how they should run their exchange rate policies, on what is acceptable to the international community and what is not."

Treasury Secretary Henry Paulson said in a statement that it would send "a strong message that the IMF will put exchange rate surveillance back at the core of its duties and rigorously implement its rules on exchange rate surveillance going forward."

Unclear, however, is what the IMF can do to encourage changes for those governments whose policies the "international community" find unacceptable. Strikes me that the Bush administration found a nice way to deflect pressure from Congress--they can now say, "the IMF has authority on these issues." And, they can say, "the IMF failed to find that China is manipulating its currency."

To wit, Paulson testified in front of Congress this week:

Mr. Paulson asked Congress to support the International Monetary Fund and the World Bank, as the IMF works on a package of institutional reforms and the bank replenishes its trust fund for poor countries. "The [international financial institutions] are indispensable to promoting the U.S.'s global economic interests, which cannot be effectively pursued through bilateral means alone," he said.

Mr. Paulson said reforms adopted by the IMF last week to its economic surveillance policies elevated the importance of exchange rate policies. "A multilateral approach places exchange rate issues in a broader, less politically charged context where the win-win aspects of reform can be more persuasively emphasized," he said.

China seems less sanguine. "The People’s Bank of China, the central bank, said in a statement on its website that the IMF “should carry out its duties based on mutual understanding and respect”, especially for the views of developing countries" and urged the IMF not to cave to American pressure on exchange rate issues.

Currency Conundrums

Here's a good political economy puzzle...

A bipartisan congressional bloc yesterday unveiled the latest effort to encourage change in China's exchange rate. "U.S. Senators Max Baucus (D-Mont.), Chuck Grassley (R-Iowa), Charles Schumer (D-N.Y.), and Lindsey Graham (R-S.C.) today introduced major legislation to deal with foreign currency concerns threatening the U.S. economy. The Currency Exchange Rate Oversight Reform Act of 2007 establishes a new approach to examining world currencies, requiring new consultations with offending nations and imposing new consequences for inaction. When currencies are so undervalued that they become fundamentally misaligned with the U.S. dollar, they can put American manufacturers and wage-earners at a significant disadvantage in the global economy. The bill unveiled today is the result of the four Senators’2006 commitment to draft new, vigorous, and WTO-consistent legislation to address currency misalignments."

Simultaneously (and not coincidentally so), the Treasury released its Semiannual Report in which it again declined the opportunity to label China a "currency manipulator."


The puzzle: How do we explain the fact that the two dominant policymaking branches of the US government have diametrically opposed China Currency policies?

Bashing China, Again

A case in point (re Evolution and Protectionism)

"In a rare three-panel subcommittee hearing Wednesday, House lawmakers discussed policy options that might address so-called currency manipulation by China and other countries. The event served as an opportunity for lawmakers on both sides of the aisle to express frustration with China’s undervalued currency and, to a lesser extent, the weakness of Japan’s yen.

Democrats made clear that they intend to push legislation aimed at China, although details are still unclear.

These lawmakers and other critics in the business and labor communities blame cheap imports for China’s skyrocketing trade surplus with the United States and the loss of U.S. manufacturing jobs."

The NYT also has a great piece on the effort to craft a "new trade policy." How much education would it take to transform these legislators into free traders? The one thing they actually could do to balance the current account they refuse to discuss--balance the budget.

Trade Politics by Any Other Name Would Still Smell as ...

As we shift our attention to exchange rates and trade imbalances, it will be helpful to bear in mind that from the perspective of many (most?) American legislators, exchange rate policy is just another term for "Trade Policy." One illustration of this appeared in the Detroit News today.

"Accusing China of "cheating," Democratic U.S. Sen. Debbie Stabenow of Michigan Wednesday introduced legislation to make it easier for U.S. manufacturers to prove they're being injured by currency manipulation and impose sanctions on guilty foreign competitors.

"Countries like China are cheating, artificially lowering their prices… China and Japan together comprise the top offenders as it relates to currency manipulation," charged Stabenow, who introduced the bill with U.S. Sen. Jim Bunning, R-Ky. Both sit on the Finance Committee that handles trade.

"This practices creates an unfair subsidy for goods in those countries," said Stabenow, who claimed that China can sell an auto part actually valued at $100 for only $60 in the United States "because of the discount they get as the result of currency manipulation."

The House is looking at an identical bill at a time when the Democratic takeover of Congress is casting a huge spotlight on President Bush's trade policies, especially with regard to China. Many lawmakers from manufacturing states blame the loss of 3 million jobs to unfair trading practices by global competitors."

I will spend the six weeks following spring break trying to convince you that this may not be the best way to think about exchange rates and trade imbalances.