It’s China’s world, we just live in it (Krugman, round two)

One day after striking back at Ryan Avent, Paul Krugman posted another essay on the Chinese yuan, and this one’s actually very thoughtful.  In the end I still don’t agree, but I think he makes his case much more effectively.  We seem to mostly differ on how we interpret two issues:

1.  Nominal GDP determination (or AD if you prefer that terminology) in the US, and in particular what should be held constant when thinking about policy options.

2.  The disparity between East Asian and American savings rates, and who’s to blame.

Let me start with where we agree.  Krugman says: 

Let me start with a proposition: the right way to think about China’s exchange rate is, initially, not to think about the exchange rate. Instead, you should focus on China’s currency intervention, in which the government buys foreign assets and sells domestic assets, on a massive scale.

I strongly agree.  Let me first talk about an easier case, and then come around to China later.  The right way to think about Japanese CA surpluses is not to think about the yen, but rather to think about the fact that the Japanese save more than they invest.  In my previous post I discussed how we kept pressuring the Japanese to appreciate the yen, to “solve” their CA surplus problem.  They did keep appreciating the yen, but for a while they were able to keep running CA surpluses because the Balassa-Samuelson effect kept kicking in.  That is, they had fast productivity growth in export industries, which allowed them to appreciate the yen in real terms and keep running surpluses.  After the early 1990s growth slowed sharply.  Without the B-S effect, the only way to offset the effect of a higher yen was deflation, which meant that although the nominal yen kept appreciating, the real exchange rate for the yen leveled off.  Deflation was my fear for China in late 2008 and 2009, but I agree that that danger is now past.  The B-S effect would allow China to appreciate the real yuan, and even maintain a large CA surplus.  Indeed I predict they will allow some appreciation later this year.

But here is my first important point, the Japanese case shows that it is possible to be pessimistic about the effects of currency appreciation for reasons that have nothing to do with what Krugman calls “elasticity pessimism.”  Recall my earlier post on supply and demand, I said something like “never reason from a price change.”  Never start an argument “if the price increases . . . , or if the interest rate increases . . . , or if the exchange rate increases . . .”  Always start with the underlying force causing the price change.  And I am pretty sure that if Krugman read this and understood my argument, he would agree with me.  That’s why he started off by saying the issue isn’t the yuan, it’s the Chinese government’s massive purchases of foreign exchange.  And conversely I would agree with him that if the Chinese government stopped buying hundreds of billions in foreign bonds, the real value of the yuan would rise and the Chinese CA deficit would get smaller.  So what about my reference to 40 years of a rising yen failing to solve the Japanese CA deficit.  Was it a red herring?  No, it wasn’t intended as being an application of elasticity pessimism (although I could understand people reading it that way) it was meant to show that the underlying issue is Japanese saving exceeding Japanese investment, and that artificially changing the nominal value of the yen won’t make the imbalance go away.  Krugman’s best argument would be that Japan’s imbalance reflects private decisions by the public, whereas China’s reflects a deliberate mercantilist policy by the government.  I’ll address that issue, but first I’d like to deal with one other problem, high unemployment in the US. 

Here Krugman’s explanation of the liquidity trap and monetary policy ineffectiveness is slightly more nuanced than in the previous post:

In normal times, you could argue that this policy provides benefits to the rest of the world, by reducing borrowing costs (although given what we did with those capital inflows, maybe not). But these aren’t normal times. We’re currently living in a world in which both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment; so it’s a paradox of thrift world, in which anyone who tries to save more reduces demand, reduces employment, and – because investment responds to excess capacity – ends up actually reducing investment. By exporting savings to the rest of the world, via an artificial current account surplus, China is making all of us poorer.

OK, “unable or unwilling” is better than “unable.”  But I’d prefer simply “unwilling.”  Still, I get his point.  We don’t live in a perfect world, and we don’t have the more expansionary monetary policy that Krugman and I would both prefer.  So what’s wrong with going after China as a sort of second best policy?  Here’s why it rubs me the wrong way.  First we are told that we must make all sorts of interventions in our financial system, and bail out GM and AIG, because otherwise we’ll have a depression.  Or we need to run up trillion dollar deficits.  When I suggest the real problem is not (mostly) subprime loans, but rather bad monetary policy that caused NGDP to fall at the fastest rate since 1938, people constantly throw up their hands and say “there’s nothing we can do about those stubborn central bankers.” So we have to adopt suboptimal financial system bailouts, auto bailouts, and massive deficits that will hurt our efficiency down the road, all because monetary policy isn’t doing its job.  It like when you are at the zero bound all the laws of economics go out the window.  We can justify all sorts of bailouts because we have to worry about declines in velocity (even though a forward-looking monetary policy can deal with falling velocity.)  And we have to have big deficits because we’re told Bernanke won’t consider a 3% inflation target.  And now we are being told we must risk a trade war.  All because in the General Theory Keynes showed that in a liquidity trap mercantilist policies might actually “work” as beggar-thy-neighbor policies. 

My response is that there are a million different shocks that could cause NGDP to fall.  One is a financial crisis, another is trade.  But we simply have to stop treating the symptoms of the problem and attack the root cause.  It is the central bank’s job to keep NGDP growth at a slow but steady rate.  If they don’t do their job I just don’t see how we can keep fixing the problem with all these second best policies, whether they are fiscal stimulus, bank bailouts, or threats of protectionism.  As someone once said, “the problem with second best policies is that they are usually implemented by third best economists and achieve fourth best results.”  If the central bank is doing its job, then Chinese policies that look mercantilist to the average voter or average politician, will be nothing more than a source of low cost capital for the US economy.  And if they don’t do their job . . . well then one way or another we are in deep trouble, and don’t expect bank bailouts and trillion dollar deficits and trade wars with China to stop unemployment from rising to 10%.  It’s like putting a band-aid on a deep knife wound.

So that’s the backdrop to my analysis of China’s trade policies, it’s not our problem, it’s their decision.  But even so, is there any possible justification for their weak yuan policy, or is it just naked mercantilism?  The honest answer is that I don’t know.  I don’t doubt that export growth is one motivation for their policy, but I also think China’s critics are too quick to dismiss how their policies fit into a broader East Asian pattern of high saving rates.

Suppose China’s government began a new policy.  They announced their government would spend $500 billion each year adding to their foreign reserves, but would no longer peg the yuan.  Would that satisfy China’s critics?  Probably not, as Krugman noted the real issue is the Chinese accumulation of dollars, not the exchange rate per se.  If you are buying foreign reserves at a massive rate it is quite possible to lift exchange controls and let the currency float, and yet still end up with what most people would regard as an overvalued currency.  So the real question is whether China is justified in holding large and increasing quantities of foreign reserves.

I’d like to point out that there are many commonalities between China and 5 other East Asian economies; Japan, Taiwan, HK, Singapore and South Korea.  One of those similarities is that they all have huge stocks of foreign reserves.  In per capita terms China’s CA surplus is by far the smallest of any of the six East Asian powerhouse exporters.  The most recent data I could find in The Economist shows China’s CA surplus as $284.4 billion whereas the other five economies combine for a $286.7 billion surplus.  So if Krugman is right, those five economies actually are doing more damage to the world economy than China, which has 7 times the population and a modestly larger (PPP) GDP than other other five economies.

Krugman might respond that the other five economies are fairly wealthy, and have very low birthrates, so it makes sense for them to save a lot.  Their surpluses reflect the natural forces of their economy.  China is a developing country, and like South Korea in the 1970s and 1980s might be better off running deficits, and borrowing against future income.  There are many ways in which the government could use those funds to address domestic challenges.  Instead they accumulate massive stocks of foreign exchange, which help neither us nor the Chinese people.  I think that would be a respectable argument, but there are other considerations as well.  China faces a looming demographic nightmare that Korea did not face in the 1970s.  It is likely that in a few decades China will be much richer than today.  The hundreds of millions of Chinese that will then be retiring will expect to be provided with decent pensions.  Yet the Chinese social security system is woefully underfunded.  You can make a strong argument that the Chinese government should be setting aside a lot of money right now, in light of the fiscal challenges that they will face in the future.

I would add that there seems to be a big difference between East Asian and Western attitudes toward saving.  I think that there is a lot to be said for the high saving models developed by places like Singapore.  Even though I am a libertarian, I’d much prefer the sort of high forced saving/low tax economy of Singapore to the low saving/high tax economy that we have in the West.  Our fiscal situation reminds me of those guys who live week to week.  Who say “I should be able to swing that vacation to South Beach as long as my transmission doesn’t blow out on me.”  Yes, we should be able to just barely afford national health care as long as it doesn’t turn out to be much more expensive than expected, like Medicare turned out to be much more expensive than expected.  And if things really get bad we can always add a VAT.  Of course the Europeans already have a VAT, maybe they’re hoping some loose change will turn up under the cushions.  Seriously, in about 20 years, when the West is struggling to deal with ever-increasing debts, I predict that the Singapore high saving/low tax model will look clearly superior to the Western model.  So while there are many things I don’t like about the Chinese government, I am not willing to condemn them for setting aside a big pot of foreign exchange reserves.  It’s their choice.

But let’s say I am wrong, suppose CA surpluses really do cause unemployment in the US.  Should we put high tariffs on China, or on the gang of 5 smaller East Asian economies that collectively do even more damage?  After all, those five countries are much richer and thus would suffer less in utilitarian terms from a US tariff. Krugman likes to mention that China’s surplus is one of the largest in world history, as a share of world GDP.  But that’s only because China itself is very large.  Suppose China split up and each province became a separate country (oops, there goes my check from the PRC.)  Would we ignore their smaller surpluses the way we ignore Korea and Taiwan’s surpluses?  I predict we would, and yet the geographic entity called “China” would still have the same impact on the world economy.  So why single out China for punishment?

Here is an analogy.  The average Chinese citizen emits about 1/4th the greenhouse gases that the average American emits.  So they are much more responsible stewards of the environment than we are.  Yet China has more than 4 times the US population, so their total emissions are slightly higher that US levels.  Yet it would obviously be absurd for the US to put tariffs on Chinese goods because their total emissions were slightly higher–after all, our wasteful lifestyles are 4 times more carbon-intensive than theirs are. 

Oh wait, I seem to recall that Krugman also recommended that China be singled out for a carbon tariff.

Do you see a pattern here?  China is a very, very, big country.  We all read about its 1.4 billion population, but I don’t know if that has really sunk in.  It’s roughly the population of North and South America, and Western Europe, combined.  The policies China adopts will have a bigger effect than the same policies pursued in smaller countries.  We need to get used to the fact that we are living next to an elephant.  That shouldn’t be so hard; the Canadians have been doing that for decades.  I recently saw this line in someone’s blog:

It’s China’s world, we just live in it.

We haven’t quite reached that point, but we’re getting close.  I get very frustrated when I read Western commentators talk about China as if they are addressing a naughty schoolboy.  It’s not that they aren’t naughty at times, the problem is that there seems to be no awareness that it not “our world” anymore.  These Asian countries shouldn’t be treated as children.  We used to treat Japan the same way.  The Economist recently pointed out that in 18 of the last 20 centuries more than half the world’s GDP was in Asia.  And in a few more decades they will regain a majority of world GDP.  Each year the world economy will look a little more like the typical Asian economy.  Maybe it’s time we stopped lecturing them about saving too much, and ask ourselves whether we are saving too little.

PS.  I just noticed that Krugman has another post, where he continues to claim that most of the world is in a liquidity trap.  I strongly disagree with his view that the ECB is “trapped.”  Yes, rates in Europe are pretty low, but they could be lower.  The ECB is not refraining from a more expansionary policy because they aren’t able to, but rather because they don’t want to.  Now you could argue that even if they cut rates to zero they would still be suffering suboptimal levels of AD.  But the point is that they have interest rates exactly where they want them, they aren’t “trapped.”  I agree that it is possible that Japan and the US and the UK might all want to do more, but even that isn’t certain.  I recall that during the financial crisis the BOJ had a big debate about cutting rates by 0.25%, and compromised with a 0.20% cut.  It’s funny how Krugman and I look at the same picture and see different factors as being essential.  We both agree the major central banks are too reluctant to take unconventional steps, that they could in fact take.  I take that as implying they aren’t trapped, Krugman focuses on the fact that conventional policies alone might not get the job done in countries where rates are pretty low.  I focus on the fact that the ECB explicitly decided not to make rates even lower, and the US explicitly decided to pay interest on ERs.  Refraining from paying interest in ERs would not be “unconventional,” rather the paying of interest was unconventional, and a contractionary unconventional policy

Regarding the ECB, it is clear from their behavior during the crisis of late 2008 that interest rate bounds weren’t the problem, they did exactly what they wanted to do, which was to cut their target nominal rate at an agonizingly low speed.

HT:  Dilip


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54 Responses to “It’s China’s world, we just live in it (Krugman, round two)”

  1. Gravatar of Bill Woolsey Bill Woolsey
    17. March 2010 at 08:58

    Scott:

    Great post!

  2. Gravatar of Dr. Liberty Dr. Liberty
    17. March 2010 at 09:06

    Sumner: “Its like when you are at the zero bound all the laws of economics go out the window.”

    Krugman: “For the moment “” or more likely for the next several years “” we’re living in a world in which none of what you learned in Econ 101 applies.”

    According to Krugman, they do.

  3. Gravatar of Doc Merlin Doc Merlin
    17. March 2010 at 09:21

    In terms of the state accumulating foreign currency assets/debt/etc you may want to add Norway to your list.

  4. Gravatar of marko marko
    17. March 2010 at 11:31

    Russia and Saudi Arabia should be there also.

  5. Gravatar of JTapp JTapp
    17. March 2010 at 12:21

    “Australia isn’t in a liquidity trap…I guess.”
    What in the world is Krugman looking at? He is basically assuming a can opener and saying monetary policy is ineffective everywhere, hence the “whole advanced world” is in a liquidity trap.
    He wouldn’t pass any of my sophomore level macroeconomics classes.

  6. Gravatar of BPO BPO
    17. March 2010 at 12:44

    “We haven’t quite reached that point, but we’re getting close.”

    Really, Scott? How close?

    “I get very frustrated when I read Western commentators talk about China as if they are addressing a naughty schoolboy.”

    I get very frustrated when I read repeated apologia from Western commentators who feel they have to defend the Chinese at literally every turn. When the U.S. creates bad waves around the world, even if not organized or nefarious, you’re the first man on the scene to point fingers. When the Chinese do so, you’re the first man on the scene to explain that, gosh, they’re just behaving according to societal norms.

    And if it’s China’s world, and they are operating – for whatever reason – to the ultimate detriment of much of the West, exercising an amount of control that by your own definitions will entail China dictating terms politically, economically and eventually militarily to the rest of the planet in a way the U.S. could never have dreamed, why, exactly, do you seem so anxious for that to come to pass? Is it really just so you can be proven “right,” and receive the recognition you desire for “seeing it coming” ahead of time?

    And come on, you’re telling me the Chinese are better stewards of the earth simply because on a per capita basis they don’t yet have access to the wasteful lifestyles available in the United States? You’re telling me that the rampant and horrific environmental degradation in China – aside from global warming itself – just, what, doesn’t count on their “Better Stewards of the Earth” scorecard because their greenhouse gas emissions on a per capita basis are lower? Are you _serious_ with this stuff?

    (And this doesn’t begin to get into the folly of arguing in a vaccum that China’s reserves are being accumulated to pay for their demographic time bomb – or whether they could even be used to do so if China wanted to in the first place.)

    I like your work, Scott, but when it comes to virtually anything you argue about China I feel like I’m reading one of the emails from my brilliant astrophycisist friend who positively oozes wisdom and intelligence, until he starts talking about FEMA concentration camps and how America staged the 9/11 attacks.

  7. Gravatar of StatsGuy StatsGuy
    17. March 2010 at 12:47

    At the risk of being labeled a Krugman apologist (and since I think I’m the only non-libertarian, non-Republican-leaning person here):

    1) Krugman has been consistent about what he means by liquidity trap for the past 6 months (prior to that he was very unclear), arguing repeatedly that the _political_ window for Fed action has contracted (largely due to initial failures to achieve results). Yet it seems like we keep harping on that point here.

    2) Can someone please detail the difference between state enforced savings coupled with administrative action to reduce consumption (e.g. administrative credit restrictions, exchange controls) and an undervalued currency, and Mercantilism?

    In the past, mercantilism has been focused on accumulation of gold, which is really a measure of debt, but one which was less dependent on the good faith of the debtor. The actual impact on trade/production is quite similar.

  8. Gravatar of Nathan Nathan
    17. March 2010 at 13:50

    Scott- You say that the accumulation of foreign exchange reserves is not really the root cause in the case of Japan or China, but rather the root cause is the savings/investment imbalance. I’m not sure I understand the mechanism behind that. It seems to me that when a government decides to purchase a large amount of foreign exchange reserves by creating domestic currency assets (bank reserves, government debt, etc.) it is causing a savings/investment imbalance in the domestic economy – because it is taking domestic savings and turning them into foreign investments. What if the government chose instead to invest (or simply spend) the money at home? Wouldn’t that reduce the imbalance? What am I missing?

  9. Gravatar of FuManchu FuManchu
    17. March 2010 at 13:56

    Scott, another interesting statistic: China’s current account deficit with Japan, Korea, and Taiwan exceed its current account surplus with the United States. The US should be pressuring its allies in the region rather than China itself to equalize the surpluses.

    Email me (the one I registered with) if you want to see some of the data I gather from China Customs.

  10. Gravatar of Dilip Dilip
    17. March 2010 at 16:23

    Michael Pettis:
    http://mpettis.com/2010/03/how-will-an-rmb-revaluation-affect-china-the-us-and-the-world/

  11. Gravatar of Assorted Links « It Don't Mean Much, These Seats are Cheap. Assorted Links « It Don't Mean Much, These Seats are Cheap.
    17. March 2010 at 16:31

    […] Sumner on China, round two. […]

  12. Gravatar of Rafael Rafael
    17. March 2010 at 17:54

    Scott,

    I think you have forgotten the intertemporal aspect (remember the transfer problem) of such FX issues.

    There´s a post by a brazilian blogger that explains this effect (google translator gives a hand):

    http://translate.google.com/translate?js=y&prev=_t&hl=en&ie=UTF-8&layout=1&eotf=1&u=http%3A%2F%2Fmaovisivel.blogspot.com%2F2010%2F01%2Fmais-uma-escorregada-do-professor.html&sl=pt&tl=en

    this one is useful too (really good post):

    http://translate.google.com/translate?js=y&prev=_t&hl=en&ie=UTF-8&layout=1&eotf=1&u=http%3A%2F%2Fmaovisivel.blogspot.com%2F2008%2F03%2Fum-modelo-para-discusso.html&sl=pt&tl=en

    Cheers

  13. Gravatar of FT Alphaville » Further reading FT Alphaville » Further reading
    18. March 2010 at 00:07

    […] Revaluation: ‘It’s China’s world, we’re just living in it’. […]

  14. Gravatar of stillgoingnative » anti- anti-china tariffs stillgoingnative » anti- anti-china tariffs
    18. March 2010 at 00:50

    […] appreciation will not materially affect the U.S. trade deficit, and it will have questionable near-term impacts on imbalances. As Chinese gain more purchasing power, they will likely do things like leave the lights on after […]

  15. Gravatar of JMcL JMcL
    18. March 2010 at 02:38

    Could not agree more with BPO’s contribution. Congratulations to a great post.

    Sure, we are using more than our fair share of resources in the west but I think that many there are starting to realize where this will take us. Not so in emerging Asia. To argue the Chinese case based on per capita averages when there is such an extreme wealth and income disparity within the borders of China just does not do it. It is nobody’s but China’s own fault that they have a population of 1.4bn. The attitude that it is now China’s turn to develop, pollute and exploit natural resources just leaves everybody in this world without hope. Maybe criticism about China would be less shrill if it were less arrogant and nationalistic and if it acted less selfishly and more responsibly wrt changing the world such that it becomes a better place to live in – or at least good enough for another couple of generations. However, since wealth and prosperity are so deeply ingrained in Chinese culture, I have little hope that their “apres moi le deluge” attitude will change before it is too late.

  16. Gravatar of Bon Bon
    18. March 2010 at 04:48

    I would also like you to look at the Micheal Pettis link above posted by Dilip. In particular, you argue that China could be justified in holding large reserves in order to pay for future health care of the elderly. But Pettis says that it is impossible for China to use these reserves for anything other than defending the currency, because doing so would put a hole in one side of their balance sheet.

  17. Gravatar of scott sumner scott sumner
    18. March 2010 at 05:40

    Bill, Thanks.

    Dr. Liberty, Yes, I know Krugman thinks that. But he’s wrong.

    Doc Merlin and Marko, Yes it’s absurd to single out China

    JTapp, Yes, and he also ignores the fact that small counties can devalue if they wish. His argument is very weak.

    BPO, You said;

    “I get very frustrated when I read repeated apologia from Western commentators who feel they have to defend the Chinese at literally every turn. When the U.S. creates bad waves around the world, even if not organized or nefarious, you’re the first man on the scene to point fingers. When the Chinese do so, you’re the first man on the scene to explain that, gosh, they’re just behaving according to societal norms.”

    This relfects the issues being discussed right now. A few points:

    1. I don’t agree with the Noam Chomsky view of foreign policy. I believe the US has a net positive effect on developing countries. But that’s not my blog’s focus.

    2. I have frequently argued that the US often gets blamed for international interventions solely because we are large, which is the same point I am making about China. (No one pays attention when France invades an African country w/o UN approval.) You haven’t read that, because I don’t typically discuss foreign policy in my blog.

    3. I think the Chinese government is far worse than the US government. They have a one child policies, they don’t allow rural people to legally move to the cities, they don’t give farmers property rights, etc, etc. Corruption in China is much worse than in America. Some of these I have mentioned in previous posts on China.

    4. But, this blog is mostly about the Fed. That’s why I focus my criticism on the US. It was Fed policy not Bank of China policy that drove NGDP much lower between mid-2008 and mid-2009. That’s the primary subject of the blog.

    5. I am trying to influence public policy. When Krugman recommends a very bad policy toward China, I will address that issue even if it makes me look like an apologist for the commies in Beijing. BTW, I also oppose our trade embargo on Cuba, and none of the people who know me well would mistake me for a Castro apologist.

    6. I am also a contrarian, and I find the Western press to be absurdly biased against China. The coverage of Vietnam is far more favorable, even though both countries are quasi-communist countries transitioning to capitalism.

    You said;

    “by your own definitions will entail China dictating terms politically, economically and eventually militarily to the rest of the planet in a way the U.S. could never have dreamed, why, exactly, do you seem so anxious for that to come to pass? Is it really just so you can be proven “right,” and receive the recognition you desire for “seeing it coming” ahead of time?”

    I have never once said China will militarily dominate the planet. I don’t think they ever will, nor would I support them if they did. I am a believer in Fukuyama’s end of history idea, and think that eventually China will be a peaceful democracy that lives in peace with its neighbors, like a bigger version of Holland.

    You said;

    “And come on, you’re telling me the Chinese are better stewards of the earth simply because on a per capita basis they don’t yet have access to the wasteful lifestyles available in the United States? You’re telling me that the rampant and horrific environmental degradation in China – aside from global warming itself – just, what, doesn’t count on their “Better Stewards of the Earth” scorecard because their greenhouse gas emissions on a per capita basis are lower? Are you _serious_ with this stuff?”

    There are local and global environmental issues. The other issues are local, and will be dealt with as China gets richer. Many US cities like Pittsburgh and Chicago used to have very dirty air. As we got richer we cleaned up our air. On my recent trips to Beijing I have already notice that the air is cleaner than in the 1990s. Air and water pollution can be cleaned up with development, the global warming problem is potentially more far-reaching. There is no argument for putting tariffs on Chinese goods because some of their cities have smog, that wouldn’t make any sense and I doubt even Krugman would support that idea. I was focusing on global environmental issues.

    You said:

    “I like your work, Scott, but when it comes to virtually anything you argue about China I feel like I’m reading one of the emails from my brilliant astrophycisist friend who positively oozes wisdom and intelligence, until he starts talking about FEMA concentration camps and how America staged the 9/11 attacks.”

    That’s absurd, everyone knows 9/11 was not a US government conspiracy, it was planned by a group of invisible 12 foot aliens from the Planet Venus. :)

    I’m glad you like my other posts. I was about to tell you to skip the China posts, but then I recalled what makes me an effective blogger against Krugman. I force myself to read a lot of left-wing nonsense that I find annoying. Thus I get inside their heads, and I know how they think and why they think the way they do. I take Krugman very seriously. I think it is easier to criticize someone like Krugman if you don’t regard him as a fool. He is a very smart guy. (No offense to my readers who do regard him as a fool, but I really think it is important to listen to the other side, and consider their arguments.)

    more to come . . .

  18. Gravatar of scott sumner scott sumner
    18. March 2010 at 06:19

    Statsguy, Krugman keeps calling for another massive fiscal stimulus, even though the political window on that is just as closed as monetary stimulus, even more so. Were we to have a double dip, the next move would be monetary, not fiscal.

    I think of mercantilism as tariffs and quotas. And the impact of an undervalued exchange rate is much different from tariffs. Import tariffs reduce both exports and imports, whereas an undervalued exchange rate reduces current imports and raises future imports. That’s very different.

    And please don’t leave this blog. Even though you feel lonely at times, your input from a non-right-wing perspective is very valuable. (Not to lump everyone else together, I know we have Republicans, libertarians and other varieties of commenters who are non-left wing.) Then there is “Don the Libertarian Democrat,” who favors fiscal and monetary stimulus.

    Nathan, You are right. I thought I said the exchange rate wasn’t the key problem, it was the S/I imbalance. But I agree that a government accumulation of forex reserves is saving. I think I made that point when I suggested that the Chinese government might, and I emphasize “might,” be justified in wanting to save right now.

    Perhaps my wording was sloppy, but I agree with you.

    Fu manchu, Thanks, I had read that these countries often are the origin of much of what we buy from China. So you might have $400 in Dell computer components made in Taiwan, then sent to China for assembly. Say the Chinese add $50 VA in assembly, and then ship the $450 computer to the US. Now China gets credits with the entire export to the US, even though it’s really a Taiwan computer. This biases bi-lateral deficits. Krugman would respond that he uses global imbalances, but many Americans do focus too much on the bilateral imbalance.

    Thanks Dilip, I partly agree and partly disagree with Pettis, but it’s such a long post I may not have time to comment. Maybe I’ll do a brief comment next time.

    rafael, I don’t think the intertemporal issues affect my argument. Do you see how they could cause a problem?

    JMcL, You said;

    “Sure, we are using more than our fair share of resources in the west but I think that many there are starting to realize where this will take us. Not so in emerging Asia.”

    Tom Friedman keeps complaining China is ahead of us in green tech. I know China is way ahead of us in solar panels. Believe me, the Chinese are very aware about their enviromental problems. The fast growing middle class in the cities doesn’t like breathing dirty air. When I visited a national park only official park buses were allow in, and they were super-clean (electric I think), everyone else had to walk. At the same time, overall they are much dirtier than America, as is true of all middle income countries (visit Mexico City sometime.)

    You said;

    “It is nobody’s but China’s own fault that they have a population of 1.4bn.”

    You and I probably have very different values. I consider people a plus, not a minus. China’s one-child policy discourages population growth. I oppose the policy, but their current government’s policies are much more anti-population growth than ours. In any case, if you divided up China into thirty countries, it would have exactly the same impact on the planet, but people wouldn’t criticize China any longer, just as you never read criticism about Taiwan and Vietnam and Korea causing global warming. It is being punished because of where some meaningless dotted lines are drawn on a map–national boundaries.

    You said;

    “Maybe criticism about China would be less shrill if it were less arrogant and nationalistic”

    I agree they are too nationalistic. That’s a problem that big countries tend to have. Russia’s another example, but in deference to BPO I won’t mention any others.

    You said;

    “I have little hope that their “apres moi le deluge” attitude will change before it is too late.”

    They will.

    The trade-off between the environment and wealth is very different when you are poor. The US was highly polluting when we were a developing country, and it was very rational (even in retrospect) for us to have behaved that way. We need to accept the fact that we live on the same planet with billions of Chinese and Indians who’s interests are not the same as ours. But they are getting richer very fast.

    Bon, I read the post yesterday and it’s pretty long so I won’t read it again right now. It is obviously possible to use the reserves for other things, so his argument must be more subtle. Reserves are an asset with real value. They could use the bonds to buy lots of foreign stuff to help develop their countries. Any balance sheet problems can be dealt with–they are a communist dictatorship after all, and they can make balance sheets do whatever they want them to do.

  19. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    18. March 2010 at 06:43

    1. There is much stronger criticism of Krugman/ECB available. ECB is actually in the process of tightening. Previously they were auctioning unlimited 1% one year liquidity, so their de facto policy rate was one year rate of one percent. They changed the format of the auction couple of months ago so that the actual price of one year liquidity is the weighted average of future policy rates, and now they are in the process of ending one year liquidity auctions. This process is equivalent to a conventional 75-50 bps tightening.

    2. ECB is also paying 0.25 on reserves. Why single out Fed for the interest on reserves criticism?

  20. Gravatar of Steve Steve
    18. March 2010 at 07:10

    Dear Scott,

    I liked your post about economics, but your China posts seem to be less about economics and more about spreading your opinion about China, winning an argument etc.

    Why don’t you focus on the economic side of it, and explain more why Krugman is wrong, why Japan policy did not change anything etc. THAT is interesting. I love your blog because you up to now were not one of those trying to be polemic or trying to win an argument, but wrote a lot of interesting and accessible stuff about economics.

    Steve

  21. Gravatar of The Problem With China’s Currency Peg | Reaction Radio The Problem With China’s Currency Peg | Reaction Radio
    18. March 2010 at 07:41

    […] reading Scott Sumner’s take on the China currency peg dilemma, I see that both he and Paul Krugman hit on the fundamental […]

  22. Gravatar of The Problem With China’s Currency Peg | Stocks and Dollars The Problem With China’s Currency Peg | Stocks and Dollars
    18. March 2010 at 08:53

    […] reading Scott Sumner’s take on the China currency peg dilemma, I see that both he and Paul Krugman hit on the fundamental […]

  23. Gravatar of The Problem With China’s Currency Peg | Top Equity News The Problem With China’s Currency Peg | Top Equity News
    18. March 2010 at 09:28

    […] reading Scott Sumner’s take on the China currency peg dilemma, I see that both he and Paul Krugman hit on the fundamental […]

  24. Gravatar of The Problem With China’s Currency Peg | Manufacturer China The Problem With China’s Currency Peg | Manufacturer China
    18. March 2010 at 09:43

    […] reading Scott Sumner’s take on the China currency peg dilemma, I see that both he and Paul Krugman hit on the fundamental […]

  25. Gravatar of Gregor Bush Gregor Bush
    18. March 2010 at 10:38

    Scott,
    In a previous post you made the point that not only was Krugman wrong about monetary policy being ineffective at the ZLB but also that he’s completely mistaken about the effects of his proposed tariffs on aggregate demand.

    Krugman’s view seems to be that of Keynes cica 1936, that any negative supply shock (high wage policies, tariffs, labour market restrictions) will boost AD because of its positive impact on inflation expectations (How convenient that left-wing policies that have been debunked by economists suddenly become ‘sound economic policy’ at the ZLB. No wonder Krugman always want to argue that we’re in a liquidity trap!). Your recounting of market reaction to the progress and passage of Smoot-Hawley showed how the opposite was true: that shocks that tend to lower expectations of future GDP will also tend to dampen aggregate demand in the current period. I think you should have reiterated this point in your recent post.

    If the Krugman tariff is enacted, look for a 2000 point decline in the Dow, a widening of credit spreads and for the US and global economic recoveries to be cut off at the knees. The negative effects on US producers from a weaker US and global economy will exceed by great lengths any advantage from a stronger CNY.

  26. Gravatar of Rafael Rafael
    18. March 2010 at 10:51

    “I don’t think the intertemporal issues affect my argument. Do you see how they could cause a problem?”

    Scott, I´ll try to explain what´s the problem based on the discussion I read in a brazilian blog (economists in Brazil are struggling daily in the newspapers about currency misalignments), with the disclaimer that those arguments were not coined by myself:

    First, the assertion that an increase in the savings rate would have the effect of the exchange rate in the short term is a well-known result. An increase in the saving rate Brazilian changes the composition of global demand and has the immediate effect on a reduction in demand for non-tradable goods. So in the short term as there is no change in productive capacity, the increase in the savings rate has the effect of engendering a fall in the relative price of non-tradable goods, ie, a real depreciation of the exchange rate (increase the competitiveness of exports).One can argue that the effect would not be noticeable, which is an empirical question in which I disagree but, until now, we can agree to disagree.

    If we explore the connection between the short and long-term external balance, we’ll se that what matters is the dynamics of accumulation of assets. A lasting increase in the savings rate that is not accompanied by an increase of similar magnitude in the rate of investment results in a cumulative improvement in net external position of the country (ie, will reduce debt or will accumulate more foreign assets, for example, international reserves and portfolio investment abroad or FDI).

    The accumulation of net foreign assets of course has the effect – unambiguously – to improve the income account of the balance of payments during both the transition and the long term. With an income of foreign assets greater (or less debt service), we have expanded our purchasing power of tradable goods, that is, we may have a lower trade balance, and thus the price mechanism implies an exchange rate more appreciated in the long term.

    In short, if the exchange rate is misaligned today, public policies that increase the savings rate reduce the misalignment of two effects: the short run, depreciate the real exchange rate, and in the long run, appreciate it.

    Hope it´s clear now why the long run matters.

    Cheers

  27. Gravatar of On China’s currency peg and potential policy actions « naked capitalism On China’s currency peg and potential policy actions « naked capitalism
    18. March 2010 at 13:22

    […] reading Scott Sumner’s take on the China currency peg dilemma, I see that both he and Paul Krugman hit on the fundamental […]

  28. Gravatar of JMcL JMcL
    18. March 2010 at 19:18

    Dear Scott,

    At the risk of digressing from the original topic, let me just add a couple of thoughts to your debate of my opinion futher up:

    Yes, it is my firm opinion that there are too many humans on this planet and that those who are advocating continuous growth for the sake of economic progress are irresponsible and selfish theoreticians.

    Imagine what will happen when with growing affluence more and more Chinese can afford to have meat or fish for every meal, more Chinese couples can treat their wedding dinner guests to a bowl of shark’s fin, more and more people in this world can afford a car or other mean of individual transport… etc. Surely, these are not just Chinese problems but China is currently the place where economic growth and growing affluence makes the most broad-based impact on these issues.

    It is unsustainable. Economic output cannot grow indefinitely. And no, I do not agree with your view that China (or humans in general) will eventually change before it is too late. Humans only make sudden and radical changes when there is an immediate threat that leaves them no choice or the luxury to procrastinate. Environmental problems are creeping up on us much too slowly for there to be the sudden reckoning that is needed to get everybody focused or else… You may know the story of Easter Island. If not, I recommend you look it up. It is a micro example of what is happending to the world.

    As for your view that population growth is positive: I have lived in one of the Asian powerhouse exporters you mentioned in your essay for the last 15 years and have been regularly visiting Asia long before. I have seen it develop, the populations grow… and people change. On average, they have become much more wealthy and many people even made it from rags to riches. As a casual visitor you are blown away by snapshots of the status quo of development and the glitz you see at the surface. However, what you only realise after you have been exposed to it over a longer period of time is that these societies have lost a lot of their former instincts and soul… all in the interest of economic growth and materialism. Who wonders why in surveys about who are the happiest people in Asia places like Hong Kong and Singapore are regularly at the bottom of the list while the less developed countries are at the top? I am sure the outcome would have been different if such surveys would have existed 30 years ago.

    As for Friedman’s complaints regarding China’s leadership in green technology: while there is some effort and money being spent on resident green energy assets in China, the drive behind China’s foray into these technologies is primarily for the development of yet another export market and hence the cheap substitution of the manufacturing of such assets in the west – all with the help of discriminating trade policies – as is more often than not the case when it comes to China. In solar technology they are the largest producer already and in wind technology they have been trying very hard to catch up but the technological gap seems more tricky to bridge there. China is definitely not green for green’s sake but rather in order to take advantage of promoting government policies for green energy in the west.

  29. Gravatar of Andy Andy
    18. March 2010 at 22:49

    BPO – why don’t you list your arguments, instead of just attacking Scott? To compare Scott’s well-reasoned points to someone who believes in conspiracy theories is pure lunacy.

  30. Gravatar of scott sumner scott sumner
    19. March 2010 at 05:34

    123, Thanks, that’s a very good observation.

    Steve, I did say why his economics were wrong:

    1. US monetary policy is not powerless; even Krugman admits that his argument only works when we are “stuck” in a liquidity trap and can’t use monetary policy to boost AD.
    But we can use monetary policy to boost AD.

    2. China has a right to save more than it invests, indeed it might well be a sensible policy for China.

    3. There is no reason to single out China because it is big, other East Asian countries have CA surpluses 7 times as big on a per capita basis.

    4. Tariffs cause a lot of economic harm, and are bad for utilitarian reasons.

    Tell me why those aren’t economic arguments.

    Gregor Bush, That’s a very good point. Yes, I probably should have mentioned how tariffs hurt AD, but at least in my previous post I mentioned that a trade war would hurt business confidence, the stock market, and investment.

    Rafael, Yes. Another way of saying that is that exports and imports must be equal in the long run. So if you run a bigger CA surplus now, you will run a bigger CA deficit in the future. So if the exchange rate is “undervalued” (relative to what would balance the trade account) today, then it will be overvalued in the future. I think all economists accept that proposition, as it is really just accounting. Exports are the way we pay for imports.

    JMcL; You said:

    “It is unsustainable. Economic output cannot grow indefinitely.”

    I strongly disagree. Economic output not only can but will grow indefinitely (unless we blow ourselves up.) I do agree that we can’t keep exploiting the earth’s resources at this rate, but I fully expect that technological changes will address environmental problems in the future. Indeed in many ways our environment is much cleaner than in the past. You are right that rapid growth in the LDCs does worsen the environment in some areas, but as those countries get richer they will devote ever more resources to cleaning up and using alternative energy. I believe that in 500 years the Earth will be much much cleaner than today.

    Yes, I read Diamond’s essay on Easter Island, and strongly disagree with its relevance to our current situation. The Easter Islanders didn’t have a good understanding of environmental problems. We do.

    I don’t agree with your description of happiness surveys. I’ve done a lot of research on happiness surveys, and there is a very strong correlation between per capita income and happiness. And I don’t think people in China were “happy” back in the old days when they went to bed hungry every night, and 10s of millions starved to death. The girls that leave their villages today to work in the cities do so because they are desperately unhappy in those villages.

    I should add that I have doubts about happiness surveys, as Mexico scores very high. Yet for some reasons millions of Mexicans prefer to move to the US. Actions speak louder than words.

    Although I haven’t lived in East Asia, I know many Chinese people, and their lives are definitely much better than in the old days. Chinese society does have many flaws, for instance many people grew up under up under a communist system that discouraged philanthropy. (Nor was the pre-communist system very good.) The Chinese aren’t used to giving to charity, so their civil society is weaker than in the West. But it will strengthen over time as NGOs increase in importance. (I’m not a Christian, but I would note that Christianity is also rising fast, and it provides a non-materialistic value system.)

    I also disagree with your views on green technology in China. I have seen the country make big strides in this area, for instance their cars are much cleaner than in the 1990s. And many of the solar panels are installed in China, my guess is a majority. So they aren’t just for export.

  31. Gravatar of JimP JimP
    19. March 2010 at 09:32

    Samuel Brittan of the FT endorses nominal spending targeting.

    “Headroom for economic recovery”

    http://www.ft.com/cms/s/0/c66af1a2-32c7-11df-a767-00144feabdc0.html

    In only Obama or Summers read the FT! Or if Congress did. Or anyone did who wants to be (re-)elected president in 2 (otherwise 10% unemployment) years from now.

  32. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    19. March 2010 at 09:58

    We have discussed ERs a lot and I have a question – what you think about the following from NY Fed:
    “”Some have discussed whether the draining of excess reserves has effects on the economy beyond the implications for short-term interest rates. In my view, it would be surprising if there were significant effects on the real economy or inflation associated with substituting one short-term, liquid, risk-free asset (reverse repos or term deposits with the Fed) for another (reserves), except for the degree to which that substitution affects the Fed’s control of overnight interest rates.”

  33. Gravatar of mbk mbk
    19. March 2010 at 10:11

    For the record: Diamond’s conclusions on the reasons for Easter Island’s “collapse” have been criticized before:

    http://www.americanscientist.org/issues/feature/rethinking-the-fall-of-easter-island/1
    http://www.staff.livjm.ac.uk/spsbpeis/EE%2016-34_Peiser.pdf

    And the concept that during economic development of a country, the environment first degrades, and later improves (because of both increased means and increased increased appreciation), is known as the environmental Kuznets curve. There seems to be some disagreement as to whether the phenomenon really does exist, personally I strongly believe that it does.

  34. Gravatar of Steve Steve
    20. March 2010 at 03:21

    Ok, they are economic in a way, but less so than most of your posts so far.

    “1. US monetary policy is not powerless; even Krugman admits that his argument only works when we are “stuck” in a liquidity trap and can’t use monetary policy to boost AD.
    But we can use monetary policy to boost AD.”

    I agree, this is an economic argument that you have made a lot of times.

    “2. China has a right to save more than it invests, indeed it might well be a sensible policy for China.”

    “to have a right” is not economics. Isn’t the high savings a consequence of an undervalued currency, at least partly? What happend in Japan? There is much more “economics” you could do on this point, I would be happy to hear it!

    “3. There is no reason to single out China because it is big, other East Asian countries have CA surpluses 7 times as big on a per capita basis.”

    Is this economics? This is defending China by pointing out obvious flaws in other people’s argument. However, how do these other countries achieve this CA surplus? By intervening in their currency valuation? THAT would be more economics, don’t you agree?

    “4. Tariffs cause a lot of economic harm, and are bad for utilitarian reasons.”

    Right, but that is well known. Nothing new here in terms of economics.

    It seems you are leaning towards becoming Krugmanish, starting out as an economic blogger, but then turning into a blogger you tries to defend his own political agenda. Ok, that was harsh. But you know what I mean.

  35. Gravatar of Steve Steve
    20. March 2010 at 06:20

    Let me add a question unrelated to China: what about deleveraging (by households, companies, financial institutions)? Empirically, deleveraging follows most financial crises, as far as I know. GDP growth is negatively affected during the years of deleveraging.

    Could you give some insights on deleveraging in combination with your NGDP futures targeting idea? And maybe some general insights on why deleveraging occurs and why it is a problem. That would be great!

  36. Gravatar of ray l love ray l love
    20. March 2010 at 07:44

    I am surprised that the Triffin Dilemma has not come up on this thread. “In the wake of the Financial crisis of 2007-2008, the governor of the People’s Bank of China explicitly named the Triffin Dilemma as the root cause of the economic disorder, in a speech titled Reform the International Monetary System. Zhou Xiaochuan’s speech of 29 March 2009 proposed strengthening existing global currency controls, through the IMF.”

    I don’t know if this is China’s official position but it would be interesting to get Scott’s take on this.

  37. Gravatar of ssumner ssumner
    20. March 2010 at 14:46

    Thanks JimP, He’s right that NGDP targeting goes way back, but he’s wrong in saying the fall in NGDP didn’t cause the recession.

    123, That’s pretty depressing. So if the MB increased 100 fold tomorrow, the only impact on AD would occur through changes in interest rates? What about the Quantity Theory of Money? Do Fed officials really believe that money doesn’t matter?

    Thanks mbk, And even if it was as described by Diamond, I don’t see any relevance for the global environment.

    Steve, No, the high savings rate is not a consequence of an undervalued currency. If anything, the high saving rate may cause the currency to look “undervalued.” And I don’t see China’s reason for accumulating foreign exchange reserves as being any less defensible than the other 5 countries I cited. Any country that accumulates a lot of foreign exchange reserves is intervening in the forex market.

    You said;

    “This is defending China by pointing out obvious flaws in other people’s argument.”

    Yes, I was pointing out flaws in Krugman’s argument for a 25% tariff on Chinese goods. That was the purpose of my post. Whether Chinese policy is sensible is a much more complicated argument, and I suggested that the answer isn’t clear. But I think it is clear that Krugman does not offer any good reasons for suggesting a 25% tariff, and that was the purpose of my post.

    You said;

    “It seems you are leaning towards becoming Krugmanish, starting out as an economic blogger, but then turning into a blogger you tries to defend his own political agenda. Ok, that was harsh.”

    I don’t think you’re being harsh. My political agenda is free trade and each country take care of its own AD problems. And yes, I am trying to defend that political agenda.

    Regarding your last question, I think falling NGDP was the biggest cause of deleveraging. So I definitely think that NGDP targeting would reduce that problem significantly (albeit not completely as borrowers were somewhat overextended even if NGDP growth had continued at 5%.)
    I don’t think deleveraging is a problem, but rather a response to earlier mistakes.

    ray, I don’t see how the Triffen Dilemma applies here. China can revalue the yuan if they think our policy is too expansionary, so I don’t see the problem.

  38. Gravatar of JMcL JMcL
    20. March 2010 at 20:16

    Scott, I wish I were as optimistic about the future as you are. The fact is that consumers and corporates do not pay for the negative externalities they cause and judging from the progress the world has made in terms of committing to environmentally sustainable targets, national selfishness will continue to render supra-national efforts useless. What are environmentally sustainable targets anyway? Who would be the ultimate authority to define them? After all, there are still people in the developed world who deny the relevance of greenhouse gases and global warming. However, many at least suspect that we cannot go on at the rate we are currently exploiting the world’s natural resources but the impact of one’s action in favor or against this trend is not immediately visible, so we tend to defer or come up with excuses why not to make a start and behave more responsibly by perhaps not buying something we do not really need or by taking a bus rather than the car or… And as long as there is no higher authority that forces us to make those changes, the current trend will never stop… and – as mentioned above – it is highly unlikely that there will ever be such an authority with the necessary policing powers. And as long as there is no safe and credible technological alternative to our dependence on hydrocarbons for energy and as a raw material, we are heading for the abyss… but it may well be that we blow ourselves up before we get there.

  39. Gravatar of Steve Steve
    21. March 2010 at 03:42

    Dear Scott,

    thanks for your answer. I am surprised about your openness regarding your “agenda”, but you should think again about this, as many people, when defending their agenda, become less interesting because they use any argument that brings them closer to winning a debate – and thereby boring those that don’t care about who wins but rather, what the best arguments are. The less you try to defend your own agenda, the more interesting your blog is. Nobody really interested in these issues reads Krugman, since he is ONLY defending his agenda. Or Delong for that matter. I remember reading a Cochrane piece on fiscal stimulus, and how it was a welcome pause in the polemics of the debate. Not that I share his views entirely, but they were well argued and just interesting. Just like most of your posts! I thought your China pieces fell behind a little.

    Ok, back to economics. The willingness to save does not fall from heaven. You trade off consumption today vs. tomorrow. If there is an undervalued currency, goods from abroad are more expensive, so you might save more than without the undervalued currency. Or where is my mistake here?

    Regarding deleveraging, I really think that is worth a separate post. The reason is not only the public debate of the topic, but also that deleveraging and monetary policy are closely linked.

    S

  40. Gravatar of ssumner ssumner
    21. March 2010 at 06:08

    JMCL, I doubt the world would allow catastrophic warming, we’d use geoengineering before we’d let temps rise 5 degrees.

    I don’t want to leave the impression that I am not worried about global warming, I think it is a big concern, I just happen to think the risk of pandemics is much higher.

    Steve, I think you are making the same mistake people make with ordinary supply and demand. Most people think that a high price leads consumers to purchase less of a good. But that is not true. Rather a high price due to high demand leads consumers to buy more, and a high price due to lower supply leads consumers to buy less. So the price is just a mechanism to equilibrate supply and demand. It’s better to say that high demand leads to more consumption, and lower supply leads to less, and not even mention price.

    The same is true for exchange rates. You don’t want to focus on the exchange rate, but rather on the forces that cause it to change. If the yuan is weak because the PBOC is buying lots of US dollars, then the high savings rate of the Chinese government is the root cause of the weak yuan.

    Regarding my arguments; I try to use good arguments, whether political or economic. I don’t always succeed, but that’s what I shoot for. I like reading John Cochrane, but he has a very strong agenda. He is strongly opposed to big government.

    What is the link you see between deleveraging and monetary policy?

  41. Gravatar of 123 – TheMoneyDemand 123 - TheMoneyDemand
    21. March 2010 at 11:00

    “123, That’s pretty depressing. So if the MB increased 100 fold tomorrow, the only impact on AD would occur through changes in interest rates? What about the Quantity Theory of Money? Do Fed officials really believe that money doesn’t matter?”

    NY Fed was talking not about the changes of the size of the Fed’s balance sheet, they were talking about the changing composition of liabilities of Fed.

  42. Gravatar of Jim Glass Jim Glass
    21. March 2010 at 18:51

    If Europe did to us what Krugman wants us to do to China, how would Krugman react?

    E.g., from the London Telegraph, via MJ Perry
    ~~~~
    [The US Dollar depreciated by 37% between 2002 and 2008.]

    Obama really should tread carefully … the US is now at risk of sparking what could be an all-out trade war.

    The reality is that America’s “weak dollar” policy – its long-standing practice of allowing its currency to depreciate in order to lower the value of its foreign debts – amounts to the biggest currency manipulation in human history.

    At the same time, the US has, for years, shamefully stalled on various rulings passed by the World Trade Organisation that show America to be breaching global trade rules…
    ~~~~~

  43. Gravatar of Steve Steve
    22. March 2010 at 02:41

    “If the yuan is weak because the PBOC is buying lots of US dollars, then the high savings rate of the Chinese government is the root cause of the weak yuan.” Well, yes! And that is Krugman’s argument, isn’t it? If the PBOC stopped buying lots of dollars, then (I make the same mistake again) exports will decline due to a higher yuan. I understand your argument that you want to look at the root cause of declining or increasing demand and see price as the equilibrium device, but for AD, that does not matter: if the PBOC stops, AD will decline.

    Regarding deleveraging and monetary policy, I hoped to hear something from you. But ok, let me get it started. Deleveraging occurs when banks (and others like households and firms) reduce their debt/equity ratio. Banks, as the more important here, reduce lending (why? If the loan is profitable, they should do it regardless of their debt/equity ratio) in order to deleverage, reducing AD further in a situation of weak AD. Now, your monetary policy should in such a case increase expectations for NGDP and thereby increase AD. So is deleveraging just another weakening factor of AD, nothing special. However, banks are at the core of the monetary transmission mechanism (aren’t they?) and therefore, if they fail to act and lend money, monetary policy is even harder. Yours may be not. Looking forward to hear more from you.

  44. Gravatar of malavel malavel
    22. March 2010 at 03:36

    “It’s like putting a band-aid on a deep knife wound.”

    A dirty band-aid which might cause an infection (trade war).

  45. Gravatar of ssumner ssumner
    22. March 2010 at 06:51

    123, OK, Then I don’t have an opinion.

    Jim Glass, Good point. Also note that we have a much worse record than Europe on greenhouse gases, and Krugman favors carbon tariffs on imports from China.

    Steve, I agree that Krugman is complaining about high Chinese savings rates, and that the yuan is a side issue. I just want to be clear others understand that. It is one thing to say:

    Stop manipulating your currency!

    and quite another to say:

    Stop saving so much, be more like us low saving Americans!

    Do you think his readers would find his real argument to be equally persuasive as the argument they think he is making?

    My response is that it is up to China to decide how much they want to save. I don’t see why it is our concern.

    I don’t think banks are at the core of the transmission mechanism. You might google “the money illusion, a short course on monetary economics” to see if you can find an old post that discusses this issue. Deleveraging would cause a change in the composition of AD–away from activities fueled by debt, and toward activities not fueled by debt.

    Malavel, I agree.

  46. Gravatar of Scott Sumner Speaks Sense « The Droning Inquisition Scott Sumner Speaks Sense « The Droning Inquisition
    22. March 2010 at 22:10

    […] Sumner Speaks Sense This is probably the most sensible thing I’ve read today. China is a very, very, big country.  We all read about its 1.4 billion population, but I don’t […]

  47. Gravatar of vimothy vimothy
    24. March 2010 at 04:30

    Scott,

    In order for China to (net) save, someone has to (net) spend. Do you agree?

    When you say:

    “Stop saving so much, be more like us low saving Americans!”

    It sounds like you don’t, which is incredible.

    China’s high saving rate and the low saving rate in the US are twins. (Tho US govt has started helping out a bit recently).

    China’s saving rate is its own business. Treat the (neo-mercantilist) SEAN like adults. I almost agree with both of those statements. However, China (et al) net nominal saves by manipulating its currency and running massive trade surpluses, not by running govt deficits. So China’s saving rate is not simply its own business–it is also America’s low saving rate.

    If the US govt were to step in and replace demand leakages such that China could net save USD paper assets at the same time that US private sector could net save USD paper assets and GDP was at potential, then China’s trade surplus would be less of a big deal. Still not great because of all sorts of other complicating factors (wage arbitrage, e.g.), but we’re nowhere near even this.

  48. Gravatar of ssumner ssumner
    24. March 2010 at 06:10

    vimothy, You said;

    “China’s high saving rate and the low saving rate in the US are twins. (Tho US govt has started helping out a bit recently).”

    Sorry, but this is completely mistaken. It is quite possible for all countries in the world to increase saving at the same time. Perhaps you were thinking about CA balances, but even in that case it is possible for the US and China to both run CA surpluses. But it is true that if China runs a CA surplus, then the rest of the world, combined, must run a CA deficit.

    The US should save more. I have no opinion on whether the US should run a CA surplus or deficit.

    If we have a NGDP (or AD) shortfall in America, that is our problem, not China’s. It is the Fed’s job to determine the growth track of NGDP.

  49. Gravatar of vimothy vimothy
    24. March 2010 at 07:09

    The Fed’s job is to determine monetary policy, implement it, regulate the financial sector, protect consumers and ensure the smooth functioning of the payments system.

    I never claimed that it is not possible for all countries in the world to increase their saving rates at the same time. Not sure where you got this from. A net (of investment) nominal saving rate is not possible for the global economy as a whole.

    I was actually referring to the fact that China’s private and public surpluses find their twin in US private (and now public) deficits. It is of course possible for China and the US to run simultaneous current account surpluses. The US CA surplus would increase nominal income without the Fed ever doing anything. It’s just not very likely with the current set up. China’s growth strategy is predicated on it.

    It is impossible for China’s public and private sectors to net nominal save without help from outside. That’s where the US comes in. The (consolidated) US (sector) supplies the paper wealth (i.e. the income) (a consolidated) China wants to save. If the Chinese private sector wants to net save, the Chinese government should net spend. That’s the way it should happen.

  50. Gravatar of EconomyBeat.org – user-generated content about the economy » Blog Archive » The China currency debate EconomyBeat.org - user-generated content about the economy » Blog Archive » The China currency debate
    24. March 2010 at 11:34

    […] response, economist Scott Sumner, whose research is in monetary economics, writes on his blog TheMoneyIllusion that going after China misses the point of our current economic predicament. …we don’t […]

  51. Gravatar of ssumner ssumner
    25. March 2010 at 05:13

    Vimothy, I don’t know what net nominal saving is, I have never heard the term.

    You seem to be arguing that countries should have current account balances of zero. Is that your argument? If so, why do you believe this? As you know, many American states have huge CA deficits or surplues with other states. Is this also a bad thing? Does it cause suffering in the states that have CA deficits?

  52. Gravatar of TheMoneyIllusion » Good news out of China TheMoneyIllusion » Good news out of China
    21. June 2010 at 06:33

    […] why is it good news?  In March I had this to say about China’s yuan peg: Deflation was my fear for China in late 2008 and […]

  53. Gravatar of Class Assignment « Observations of a Naive Undergraduate Class Assignment « Observations of a Naive Undergraduate
    2. September 2010 at 20:57

    […] http://www.themoneyillusion.com/?p=4441 […]

  54. Gravatar of Does the zero bound bind? | Bruegel Does the zero bound bind? | Bruegel
    12. February 2016 at 07:59

    […] Scott Sumner writes that the problem with second best policies is that they are usually implemented by third best economists and achieve fourth best results.   If central bankers don’t do their job how can we keep fixing the problem with all these second best policies, whether they are fiscal stimulus, bank bailouts, or threats of protectionism.  In previous posts, Summer has consistently argued that central banks continue to have plenty of options for boosting the economy after the federal funds rate neared 0%. […]

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