Paul Krugman recently did a post mocking those Europeans who complain about the Fed actually trying to do its job.  He quoted a European policymaker whining that monetary stimulus in the US would depreciate the dollar and thus hurt Europe.  Here’s Krugman’s response:

In other words, how dare you act to protect your economy from deflation and double-digit unemployment? By doing so, you make our inappropriate tight-money policy even more destructive!

I love it.  But at the same time it’s important to recall Bryan Caplan’s admonition that we Americans are much too quick to perceive harm inflicted by others, and reluctant to recognize when we are the villains.  So I tried to re-work the quotation, so that we could see how our complaints might appear to someone living in China:

In other words, how dare you Chinese act to protect your economy from deflation and double-digit unemployment by refusing to revalue the yuan? By doing so, you make our inappropriate tight-money policy even more destructive!

I look forward to future Krugman posts that point out how America’s China-bashers overlook the fact that the Federal Reserve System has the power to do much more, but simply refuses to use that power.  And how do I know this?  By reading a Paul Krugman post written just one day earlier.

Here’s something for fans of the Keynes/Krugman “beggar-thy-neighbor” model to think about:

NEW YORK (AP) — U.S. stock futures and forex signals are rising, following world markets higher after the central bank of Japan moved to weaken the yen.

Japanese stocks jumped 1.5 percent after the Bank of Japan moved to push the yen down, a move that will help big Japanese exporters like Toyota.

Japan’s central bank cut its key interest rate to virtually zero and is looking to buy government bonds in an effort to boost the faltering Japanese economy.

The most important concept in economics:  It’s not a zero-sum game.

Ryan Avent did a pretty good job of demolishing Paul Krugman’s recent foray into protectionism.  But he didn’t have time to address all the problems, as Krugman has 3 recent posts and one full NYT column.  In these posts, Krugman seems to make not one, but two powerful arguments against the very policy he favors.  Let’s start with a slightly more recent post where he makes a Keynesian argument that protectionism is OK under certain conditions:

If you think in terms of models, however, you know that the case for free trade is profound, but also conditional: it depends, among other things, on having sufficient policy levers to achieve more or less full employment simultaneously with free trade. Without that, the picture is very different. As Paul Samuelson wrote long ago,

“With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.”

So what I’ve been saying about China comes out of the same model I’ve been using to make sense of our broader economic problem. That doesn’t mean I’m necessarily right about the policy, since we are talking about political economy rather than straight economics. But if you just start yelling “Protectionist!”, you’re demonstrating that you don’t understand what economics is about.

Where does one start?  At least Krugman’s argument isn’t quite as simplistic as Samuelson’s.  Krugman argues protectionism might be justified if you lack “sufficient policy levers.”  Samuelson is making a very different argument—that protectionism is justified any time unemployment is anything less that “full.”  That’s probably at least 50% of the time!  And not just some of the discredited mercantilist policies, all of them.  This includes every single trade idea ever propagated by people like Pat Buchanan, including his argument for tariffs on countries whose people have yellow skin, and free trade with countries full of people with white skin.  Yes, they are all suddenly valid—most of the time.

Of course Krugman’s too smart to believe this nonsense, and so is Samuelson.  But why quote a Samuelson passage that makes him look like a fool?  The guy’s dead, and can’t even defend his reputation.

Krugman says there’s an argument for protection if a country has no macroeconomic policy levers.  But elsewhere Krugman insists that the US has not just one, but two levers.  Unfortunately (from his perspective) we chose not to use them.  We chose not to do the needed $1.3 trillion fiscal stimulus, or raise the inflation target to something higher than 2%.  But he’s right, we have sufficient levers, we just chose not to use them.  This is a very powerful argument against protectionism, although Krugman doesn’t seem to realize it.

Krugman’s outraged that people are calling him a protectionist for advocating trade barriers against China in order to reduce American unemployment.  Perhaps it would help if he talked about more than one country.  Over the past 12 months Russia’s trade surplus is about 85% as large as China’s and Russia has 1/10th China’s population.  When you go after the favorite target of American protectionists on the grounds it will save America jobs, people are going to regard the argument as protectionist.  Especially when the logic of your argument (only if insufficient policy levers are available) actually argues against trade barriers.

In his NYT column, Krugman seems even more populist in an essay entitled “Taking on China”:

They deny that they are deliberately manipulating their exchange rate; I guess the tooth fairy purchased $2.4 trillion in foreign currency and put it on their pillows while they were sleeping. Anyway, say prominent Chinese figures, it doesn’t matter; the renminbi has nothing to do with China’s trade surplus. Yet this week China’s premier cried woe over the prospect of a stronger currency, declaring, “We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs.” Well, either the renminbi’s value matters, or it doesn’t “” they can’t have it both ways.

Yes, you can’t have it both ways.  So does Mr. Krugman think that a much stronger yuan would have no effect, and would fail to stem the tide of Chinese exports?  Or does he think that it would work, that it would throw millions of desperately poor Chinese workers out of work?  He doesn’t say, but doesn’t the logic of his argument point to the latter interpretation?

Some of my more nationalistic readers might say; “So what if Chinese lose their jobs, it’s American jobs that matter.”  But Krugman’s a liberal, and liberals are supposed to believe every person’s welfare is equally important, and indeed that the poor are those in most need of assistance.  I doubt Krugman would favor abolishing US humanitarian aid on the grounds that it would help US taxpayers.  Admittedly the Chinese trade issue is somewhat different from foreign aid.  Nevertheless, in all the things I’ve read Krugman write about China, I’ve never gotten the sense he really understands that China is a very poor country, much poorer than Mexico.  If you are going to raise the specter of mass unemployment in a country without a safety net, don’t you think it would be appropriate to say one or two things about what that means?  About why you favor “taking on China” despite the appalling humanitarian disaster it would cause?  But all we get is silence.  In the very next paragraph Krugman moves on.  He’s done his job, catching the premier in a logical error, there’s no need to consider the impact on the Chinese themselves.

It’s always important to recall that there are real people behind abstract entities.  I loved it when someone renamed the “War on Drugs” as “The War on Drug-Using Americans.”  I wish people would stop talking about “taking on China” and instead talk about “taking on the Chinese people.”  It would make it easier to see what the real issues are.

Krugman concludes the post mentioned above as follows:

All Geithner did here was signal to the Chinese not to worry, U.S. officials will keep making excuses for China’s behavior and doing nothing, regardless of provocation. Remember, this statement comes after China blatantly reneged on earlier promises about the exchange rate. They must take us for fools “” because we (or at least some of us) are.

If I was writing for the NYT, here’s what I would have said:

By reappointing Bernanke and leaving several Fed seats empty for over a year, Obama signaled to the Fed not to worry.  US officials and economists keep making excuses for the Fed, despite their blatant disregard of their dual mandate for price stability (defined as 2% inflation) and high employment.  They must take us for fools “” because we (or at least some of us) are.

Yes, it’s possible that China could prevent massive unemployment with a major stimulus push.  But of course that begs the question of why we don’t do the same.

Here’s what FDR told the country in October 1933, when the recovery was faltering under the higher business costs imposed by the National Industrial Recovery Act (perhaps the most misnamed act in US history.)

“although the prices of many products of the farm have gone up . . . I am not satisfied . . . If we cannot do this [reflation] one way we will do it another.  Do it, we will. . . . Therefore the United States must firmly take in its own hands the control of the gold value of the dollar . . . I am authorizing the Reconstruction Finance Corporation [RFC] to buy gold newly mined in the United States at prices to be determined from time to time after consultation with the Secretary of the Treasury and the President.”  (NYT, Oct. 23, 1933, p. 3.)

FDR doesn’t blame foreigners; he realized we needed to put our own house in order, make our own monetary policy much more expansionary with an explicit price level target, and reduce the value of our own dollar.

And here is President Obama:

UNITED NATIONS “” President Obama increased pressure on China to immediately revalue its currency on Thursday, devoting most of a two-hour meeting with China’s prime minister to the issue and sending the message, according to one of his top aides, that if “the Chinese don’t take actions, we have other means of protecting U.S. interests.”

No call on the Fed to adopt a higher price level target.  Instead, we are blaming foreigners for our weak aggregate demand.  Of course the “other means” refers to protectionism, which FDR understood was not the answer.  And what does he mean by “protecting US interests?”  Not yours or mine, but rather car parts makers in the rust belt threatened with Chinese competition.  I suspect it’s too late; five weeks from now the rust belt will vote Republican, repudiating a modern technocratic Democratic party that has lost touch with its working class constituents.

Where’s our modern William Jennings Bryan?

My friends, we declare that this nation is able to legislate for its own people on every question, without waiting for the aid or consent of any other nation on earth; and upon that issue we expect to carry every state in the Union. I shall not slander the inhabitants of the fair state of Massachusetts nor the inhabitants of the state of New York by saying that, when they are confronted with the proposition, they will declare that this nation is not able to attend to its own business. It is the issue of 1776 over again. Our ancestors, when but three millions in number, had the courage to declare their political independence of every other nation; shall we, their descendants, when we have grown to seventy millions, declare that we are less independent than our forefathers?

No, my friends, that will never be the verdict of our people. Therefore, we care not upon what lines the battle is fought. If they say bi-metalism is good, but that we cannot have it until other nations help us, we reply that, instead of having a gold standard because England has, we will restore bi-metalism, and then let England have bi-metalism because the United States has it. If they dare to come out in the open field and defend the gold standard as a good thing, we will fight them to the uttermost. Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests and the toilers everywhere, we will answer their demand for a gold standard by saying to them: “You shall not press down upon the brow of labor this crown of thorns! You shall not crucify mankind upon a cross of gold!”  (italics added)

Between 2005 and 2008 the Chinese yuan appreciated by a bit over 20%.  Then when the recession got bad in late 2008, the yuan was (wisely) re-pegged to the dollar.  Now Fred Bergsten calls for another round of yuan appreciation:

C. Fred Bergsten, director of the Peterson Institute for International Economics, a leading research organization here, told House lawmakers on Wednesday that a similar increase over the next two to three years would create about 500,000 jobs. He said it would reduce China’s current account surplus by $350 billion to $500 billion, and the American current account deficit by $50 billion to $120 billion.

The United States should seek to mobilize the European Union and countries like Brazil, Russia and India to press China to realign the renminbi, and should seek W.T.O. authorization to impose restrictions on Chinese imports if it does not do so, Mr. Bergsten said.

I’m not opposed to modest yuan appreciation, and indeed I think it will gradually occur over the next three years.  But I am opposed to a trade war, which is utter madness in a world struggling to recover from the Great Recession.  Here’s what I don’t understand however.  Between 2004 and 2008 the Chinese CA surplus rose from about $70 billion to about $430 billion.  Why does Bergsten now expect “a similar [yuan] increase over the next two to three years” to reduce the Chinese CA surplus by roughly that amount?

And for those of you expecting a Republican Congress to rescue us from Obama’s foolish statist polices, check out this quotation:

Mr. Grassley added: “The administration should go one step further and bring a case against China’s unfair currency manipulation at the W.T.O.”

In 1985 Paul Krugman (p. 7) argued that the dollar needed to fall sharply in order to prevent chronic CA deficits, which he said would lead to “infeasible” foreign debt levels.  He was right about the dollar, it did fall sharply after 1985.  But we’ve had 25 years of almost nonstop CA deficits, and no sign of a light at the end of the tunnel.  Why?  Because the falling dollar didn’t address the fundamental cause of the CA deficit, a saving/investment imbalance produced by a fiscal regime that is profoundly anti-saving.  You can’t fix that with a band-aid.

Policymakers need to go back and reread Mundell.

PS. Perhaps the term ‘reread’ represented my own triumph of hope over experience.

HT:  Mike Belongia