Archive for the Category International economics

 
 

A bigger China shock?

I have a new piece at The Hill.  Here’s an excerpt:

The biggest puzzle is what the Trump administration is trying to achieve with its trade war. Is it a move to pressure the Chinese to open up their economy, thus reducing barriers to U.S. trade and investment? Maybe, but it was precisely the opening of the Chinese economy that first created the “China shock.”

Indeed, China was no threat at all to U.S. firms when its economy was closed under the leadership of Chairman Mao. An even more open China would create an even bigger shock, resulting in even more economic dislocation in the Rust Belt. Presumably, Ohio manufacturing workers who supported candidate Trump were not hoping China would buy more Hollywood films and computer software, so that America could buy more auto parts from China.

Read the whole thing.

PS.  A recent NBER paper by Zhi Wang, Shang-Jin Wei, Xinding Yu, and Kunfu Zhu reversed the finding of the famous Autor, Dorn and Hanson paper on the “China shock”.  Here is the abstract:

The United States imports intermediate inputs from China, helping downstream US firms to expand employment. Using a cross-regional reduced-form specification but differing from the existing literature, this paper (a) incorporates a supply chain perspective, (b) uses intermediate input imports rather than total imports in computing the downstream exposure, and (c) uses exporter-specific information to allocate imported inputs across US sectors. We find robust evidence that the total impact of trading with China is a positive boost to local employment and real wages. The most important factor is employment stimulation outside the manufacturing sector through the downstream channel. This overturns the received wisdom from the reduced-form literature and provides statistical support for a key mechanism hypothesized in general equilibrium spatial models.

I don’t “believe” either result.  The science of economics has not advanced to the point where it’s possible to have a high level of confidence in these sorts of empirical studies.

PPS.  Off topic, this made me smile:

Trump has moaned to donors that Powell didn’t turn out to be the cheap-money Fed guy he wanted. The president repeated the effort this week in an interview with Reuters, adding the ridiculous claim that the euro is manipulated and the more credible notion that China is massaging the yuan. (The European Central Bank rarely intervenes directly in currency markets; when the ECB does, it’s usually with the Fed.)

Where to begin:

1. Trump had a choice between Yellen and Powell.  I suggested Yellen, as she had done a very good job.  Trump’s advisors said he shouldn’t pick Yellen because she’s not a Republican.  So Trump picked Powell, even though he was slightly more hawkish than Yellen.  Trump is tribal and assumes everyone else in the world is just as corrupt as he is.  He thought Powell would be “better” because he’d want to help a Republican president.  And now Trump is shocked to find out that Powell is not his lapdog.  (Actually it’s too soon to know for sure, as Trump also wrongly assumes that higher interest rates mean tighter money.  But we can cut him some slack, as lots of other people make the same mistake.)

2. I also smiled at the notion that the ECB doesn’t intervene in the currency market.  Of course they have a 100% monopoly on the entire supply side of the euro currency market.  Yes, I understand the reporter meant “foreign exchange market” when he said “currency”.  But even that’s a bit misleading, as ECB policy does affect the forex value of the euro, and there have been ECB actions in recent years that were clearly aimed at depreciating the euro.  Ditto for the Fed and the Chinese central bank.  Still, the reporter is correct in claiming that Trump has no grounds to complain about ECB policy; I wish he had made the same point about China.

PPPS.  Another day, another two convictions of close Trump advisors.  In one case it was for for a crime that Trump ordered him to commit.  Trump’s now as deeply enmeshed in scandal as Nixon was back in 1974.  The good news for Trump is that none of this matters.  Trump’s support is in the low 40s and it will not decline at all.  There was no Nixon cult—his supporters abandoned him in droves.  But the Trump cult would support him if he murdered someone in the middle of Times Square, at least that’s what Trump himself claims.  As long as those 40% of voters stick with Trump, frightened GOP Congressmen will do the same.  Trump is safe.

Still, it will be fun watching the scandal play out—lots more to come!

Screen Shot 2018-08-21 at 6.53.56 PMPPPPS.  Focus on the blue line, as the yellow line partly reflected the worsening economy.

Reveal, depress, destroy: Three types of contagion

The term ‘contagion’ is used quite a bit in the financial press, but what does it actually mean?  There are at least three very different types of contagion, each with its own policy implications:

1.  An economic crisis in one country might reveal a weakness that was not previously apparent to the international investment community.  Thus in the late 1990s, the gradual rise of China and the strengthening US dollar was slowly weakening the position of export-oriented nations in Southeast Asia, which had fixed their currencies to the US dollar and also accumulated dollar-denominated debts.  When Thailand got into trouble in mid-1997, investors looked around and noticed similarities in places like Malaysia and Indonesia.  It wasn’t so much that Thailand directly caused problems in those countries (in the way a US recession might directly cause problems for Canada); rather it revealed weaknesses that were already there.

2.  A financial crisis in a big country might depress the global Wicksellian equilibrium real interest rate.  For example, the US housing bust and banking crisis of 2007-08 triggered a global recession.  By itself, this doesn’t necessarily cause problems in other countries.  But if the foreign country is already at the zero bound (Japan), or if the foreign central bank is too slow to cut interest rates (ECB), then a lower global equilibrium interest rate might lead to tighter money in other countries.  Here I would say that the US triggered the Great Recession, but the Fed, ECB and BOJ jointly caused the Great Recession.

Similarly, under an international gold standard, the hoarding of gold in one country can depress nominal spending in other countries.  Indeed gold hoarding by the US and France was a principal cause of the Great Depression.

3.  A financial crisis in one country can affect other nations if they are linked via a fixed exchange rate regime or a single currency.  Consider Greece, which comprises less than 2% of eurozone GDP.  Fears that Greece might have to leave the eurozone caused significant stress in other Mediterranean nations.  If one country were to exit, investors might expect this to lead to an eventual breakup of the entire eurozone.  That would trigger a banking crisis, and would also lead major debtor nations such as Italy to default on their huge public debts.  This is why a small country like Greece could have such a big impact on eurozone asset markets; investors feared that a Grexit would destroy the eurozone.

So far, Turkey looks like it fits the “reveal” template best.  The greater the extent to which Turkey is viewed as a special case reflecting local conditions, the smaller the contagion effect.  If Turkey becomes seen as emblematic of much of the developing world, then contagion is more likely.

Maybe it’s my jet lag . . .

and my cold . . . but I just don’t get this Conor Sen Bloomberg article:

Trump Wants the Fed to Roll Back the U.S. Economy

Higher interest rates could revive manufacturing and exports. That will hurt consumers and workers.

I’m only at the subtitle, but already lost.  How do higher interest rates boost manufacturing and exports?  And if they did, why would that hurt workers?

One of the main ways the Fed has won its credibility on inflation has been setting interest rates higher, sometimes much higher, than the inflation rate. This was most extreme in 1984, when short-term interest rates spent much of the year over 10 percent while consumer price inflation (stripping out food and energy) finished the year under 5 percent.  When investors and savers can get a “free lunch” by earning a high inflation-adjusted return in Treasuries, they’re incentivized to do so rather than invest in new production or consuming goods and services, both of which would put upward pressure on inflation.

This is reasoning from a price change.  Real rates were high in the mid-1980s precisely because growth was strong.  And buying Treasuries is not an alternative to producing consumer and investment goods.  That’s mixing up financial investment with physical investment.  For instance, suppose America had a massive corporate investment boom financed by corporate bonds.  Then you’d see lots of bond buying and lots of physical investment at the same time.  They are not alternatives.  A better argument would have been that Reagan’s fiscal deficits crowded out private investment.

But this has broader distortionary effects in the economy. On a global level, if investors can earn a high real interest rate on U.S. assets, they’re going to do so, which all else equal will drive the dollar higher in foreign exchange markets than it otherwise would be. The dollar being artificially higher will make U.S. exports less competitive in global markets, leading to larger trade deficits.

Distortionary?  Artificial?  Sorry, but Volcker and Greenspan were targeting inflation at about 4% from 1982-90.  There was nothing “artificial” about the resulting interest rates, they were simply the result of market forces.  The Fed does not set the real interest rate over an extended period of time.  Again, the fiscal deficits might have played a role (although even that factor was probably less important than widely believed at the time.)

In other words, the Fed established its credibility on inflation over the past few decades by setting real interest rates at a high level, which helped to orient the economy around financial activities, consumption and imports rather than production, labor and exports.

These are not either/or scenarios.  Consumption is not an alternative to production, labor etc.  Consumption is an alternative to investment.  Indeed consumption often booms during periods of high employment, such as the late 1960s and the late 1990s.  The same is true of financial activities.  And production is an alternative to leisure, not an alternative to consumption.  And real interest rates have not in fact been high over the “past few decades”.  They were high in the 1980s and have been low since 2001.

Trump wants a different model. It’s what his tariff threats seek to accomplish: making the U.S. economy more production-oriented rather than consumption-oriented. And he wants monetary policy to help do the same thing. If the Fed stops increasing interest rates over the next few quarters, then we’ll never get those high real interest rates in this economic cycle that we’ve gotten in past cycles. This should put downward pressure on the dollar, making U.S. exports more competitive, but at the cost of cheaper imports for U.S. consumers.

Where to begin?  How does downward pressure on the dollar lead to cheaper imports for U.S. consumers?  How does Trump’s tariff model lead to a more “production-oriented” economy?  Are low tariff countries like Singapore, Switzerland and Germany not production-oriented?  And how can monetary policy make the US more production-oriented? Isn’t money neutral in the long run? Where’s the long run aggregate supply curve in this model?

Update:  Several commenters suggested I misinterpreted the phrase “at the cost of cheaper imports”.  Perhaps it was meant to imply that imports would get more expensive.  I.e., “at the cost of more expensive imports for consumers”.

In the long run, if trade and monetary policy leads the U.S. economy to be somewhat less consumption-oriented and more investment-oriented, that’s something we can handle.

How could monetary policy have any long run impact on the share of GDP going to investment?  Is Sen arguing that monetary policy has a long run impact on real interest rates?

I guess in Bloomberg world, high interest rates lead to more manufacturing and exports, which hurts workers.  Low interest rates lead to more production, which helps workers.  But consumers must pay the “cost” of cheaper imports from the weaker dollar.

Am I missing something?

HT: Ramesh Ponnuru

Things that smart people don’t know

It would be interesting to make a list of things that smart people don’t know.  Unfortunately, I don’t have enough paper or barrels of ink.  One of my favorites is trade, where smart people think China is an outlier.  Actually, only tiny Belgium has more balanced trade than China:

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Why don’t smart people know this?  Because they don’t bother looking at the data.

Another misconception is that trade deficits are bad.  This article at National Interest caught my eye:

Trump is right to push on trade. A simple return to anything resembling a balanced international trading system would result in massive gains for the United States. What presidential advisors Peter Navarro and Wilbur Ross call the deficit drag depresses the American economy by about 3 percent overall. That is to say, if international trade were balanced, the American economy would be 3 percent larger than it is now.

I had to read this twice, to make sure my eyes weren’t deceiving me.  The Navarro/Ross argument is based on this equation:

GDP = C + I + G + (X-M)

They assume that if X-M is negative 3% of GDP, then this causes GDP to fall by 3%.  Actually it has no effect, because the negative caused by subtracting M (imports) is exactly balanced by a positive to C + I (consumption and investment).  Every time you buy an imported car, consumption rises by the amount of the purchase.  Every time someone buys an imported truck, investment rises by the amount of the purchase.  If you switch from imports to domestic cars, the labor to produce those domestic cars doesn’t just magically appear on the scene, it gets diverted from some other type of production.  Can reducing the trade deficit boost total aggregate demand? No, for standard monetary offset reasons.  But even if I’m wrong, higher AD has no long run impact on employment, for standard “natural rate” reasons.

Yup, this is all just EC101. And yes, Trump’s top economic officials do not know this stuff.  It reminds me of when freshmen in economics get lost trying to write an answer to an essay question:  “Demand goes up so price rises.  The higher price causes demand to fall.  The fall in demand then lowers the price, which causes demand to increase . . .”  Eventually they give up and stop writing, hoping for the curve to allow them to pass the course.

Irving Kristol, who was a supply-sider, founded The National Interest back in 1985.  Perhaps it’s fortunate he passed away in 2009, and did not have to see what happened to his neoconservative journal.  The article was titled:

Trump Is Right: The U.S. Can’t Lose a Trade War

BTW, Trump supporters who care about trade deficits (do they even exist?) might be interested in knowing that Trump’s policies are making the US trade deficit larger.  Or maybe they don’t care.  In fairness, it’s not growing as fast as the budget deficit, which is now rising rapidly. During an expansion.

PS.  The comment section after my previous post reminded me of an old joke.  A guy tells his friend that he has an uncle who insists that there’s an alien from Alpha Centauri who wears a sport coat with pink polka dots, and that lives in a tiny teapot on his fireplace mantle.  The friend responds, “Oh come on, how likely is it that someone from Alpha Centauri would rear pink polka dots.”

Commenters thought the best way to respond to Trump’s latest outrage was to discuss the merits of breastfeeding.

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Trade shocks and demand shocks

Paul Krugman has an excellent piece on the potential effects of an all out trade war.  Likely Krugman, I think it unlikely that we actually go that far.  My view is that before that happened, Trump would become frightened by a sharp fall in stocks and negotiate some sort of face saving deal where he could claim “victory”.  (But when thinking about the stock market as a warning device, beware of the “circularity problem”.  The stock market won’t warn Trump if it thinks he would heed their warning.)

Here I’d like to add one additional downside to a trade war, the way trade policy can (and has) interacted with monetary policy.  A trade war might be even worse than Krugman estimates, if it leads to tighter monetary policy and falling NGDP.

You might think that Krugman has already factored falling NGDP into his estimate that a trade war could reduce RGDP by 2 to 3 percent.  But unless I’m mistaken, he’s using a general equilibrium approach that abstracts from demand shocks.  In other words, Krugman is showing that even in a world where the central bank stabilizes AD, a trade war could reduce RGDP by 2 to 3 percent by making the economy less efficient.  But what if the central bank does not stabilize AD? In that case you might get an ordinary recession, piled on top of the adverse supply shock produced by a trade war.  A recession slows the process of worker re-allocation into non-tradable sectors.

I can see two possible channels by which a trade war could reduce aggregate demand:

1.  Imagine the central bank is targeting interest rates.  If a trade war occurs, it’s likely that investment demand would fall, reducing the global equilibrium (i.e. “natural”) rate of interest.  If the central bank does not reduce the policy rate as quickly as the natural rate is falling, that would lead to (effectively) tighter money and falling NGDP.  (Think of this as a channel that operates if I’m wrong about monetary offset, and the Keynesians are right.)

2.  Imagine the central bank is targeting inflation.  If inflation is kept at 2% while RGDP growth is falling, then NGDP growth will also slow.  (Here the problem can occur even if monetary offset is operative, as long as they target inflation, not NGDP.)

Keep in mind that slower NGDP growth is always a problem, even if there are other problems at the same time.  Careful readers might recall that this is exactly what went wrong in 2008.  The Fed adopted IOR to prevent its liquidity injections aimed at rescuing banking from spilling out into more aggregate demand, out of fear of inflation.  They thought the banking crisis was “the real problem” when in fact there were two real problems, banking distress and falling NGDP.  The falling NGDP led directly to higher unemployment, and also as a side effect made the other “real problem”, i.e. banking distress, even worse.

In my research on the Great Depression I found that the biggest problem caused by Smoot-Hawley was not that it reduced the efficiency of the US economy (the direct effects were modest), or even the retaliation from abroad.  Rather the biggest problem was that Smoot-Hawley led to lower aggregate demand.  This occurred either because of a fall in the Wicksellian equilibrium rate (very bad news under a gold standard), or because it reduced the likelihood of international monetary cooperation, or both.

BTW, this is no surprise:

Fears of a looming trade war between the U.S. and China are paradoxically helping to increase the value of the U.S. dollar in global currency markets, analysts say, potentially undercutting a Trump administration policy goal.

This is what happens when you have a president who hires crackpot economists who don’t even know that the current account deficit is a saving/investment issue, not an import/export issue.

HT:  Tyler Cowen