Because I teach several courses today, I don’t have time to respond to all the comments right now.  But I skimmed those after my Krugman post and I really think almost everyone is looking at these issues in the wrong way.  People are confusing historical claims with theoretical presumptions, and making distinctions between “natural” and “artificial” that are themselves . . . well, totally artificial and arbitrary.

Start with this statement by Paul Krugman:

You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history.

That could mean several things:

1.  Every time there is a trade surplus, there is an undervalued currency.

2.  Every time there is an undervalued currency, there is a trade surplus.

3.  The more undervalued the currency, ceteris paribus, the bigger the trade surplus

It seems to me that 99% of Krugman’s readers would assume he meant #1 or #2.  But obviously both are wrong, even my critics seem to agree on that.  (As I’m sure Krugman would.)  After all, they define “undervalued” on the basis of government intervention in the foreign exchange market to depress exchange rates below their natural value.  So to defend Krugman you have to assume he meant #3.  And I imagine he did.  But what a misleading way to make a point.  He would then merely be saying that there is a theoretical presumption that undervalued currencies make surpluses bigger.  But then why suggest there are no historical counterexamples?  There is no real world evidence I could cite that would disprove that assertion.  No matter how many countries I found with CA deficits, that were also depressing their currencies by buying foreign exchange, he could say that the action was still, ceteris paribus, making the CA deficit smaller. When you challenge people to find one real world example that would refute your argument, as Krugman does in that sentence, there is an assumption that he is asserting something more than a tautology.  And I’m sure his readers read it that way.  “Look, China has a big surplus, find me one of those that wasn’t caused by an undervalued currency.”  If his defenders’ interpretation is correct, then his call to search the world for a counterexample is essentially meaningless.

An even bigger problem occurs when people try to differentiate between “good” surpluses due to “natural forces” and bad surpluses that are “artificial.”  This is associated with confusion about the role played by China’s exchange rate peg.  Here are some key points:

1.  If China stopped pegging the yuan and let it float, but continued buying $100s of billions in foreign exchange every year, then China would continue to run large CA surpluses.  The root cause is high Chinese saving (relative to investment) and the currency is merely the transmission mechanism.  As an analogy, the root cause of less gasoline consumption in 1974 was OPEC producing less, and the transmission mechanism was the high price.  OPEC didn’t even need to peg the price, just produce less.

2.  If China stopped pegging the yuan, and stopped buying dollars, they would still run a huge CA surplus as long as the Chinese government found some other way to save a lot.  Suppose they set up a Norwegian-style sovereign wealth fund, and bought $100s of billions worth of German, French and British equities each year.  Nothing from the US.  Chinese aggregate saving would still exceed aggregate investment, implying a big CA surplus.  And the Chinese would not be interfering at all in the forex markets, as the term is usually defined.

3.  Ah, but some of you laissez-faire types (who strangely support Krugman) will say that’s not pure enough, not virginal enough.  The Chinese government is still involved in all that saving.  It’s artificial.  You’d say “saving should be done by the free markets, not governments.”  You’d say only in that case is a CA surplus OK.  Otherwise the exchange rate is still at an artificial level.  Evil countries like China and Norway must be punished for all their governmental saving.

4.  OK, the Chinese government stops intervening in the foreign exchange markets, and stops saving of any kind.  But instead they set up a Singapore fiscal regime, and force all workers to set aside 31% of income into various private forced savings accounts.  China would still save more than it invests, and still run a huge CA surplus.  Indeed Singapore’s CA surplus is much bigger in relative terms than China’s.  Is this OK?  After all the Chinese government is not saving or intervening in the forex markets. It is private citizens doing the saving.  I can just see people responding; “No, that high saving is still tainted, still artificial.  To be truly virginal, truly free of sin, the country has to save without any government encouragement.”

5.  I give up.  Sorry for being so ridiculous, but I’m trying to make the point that we are thinking about the entire issue in the wrong way.  Seriously, at what point on the preceding list does the distinction between natural and artificial become at all meaningful?

What I find so bizarre about these “natural” and “artificial” distinctions is that in trade theory they are almost universally viewed as bogus.  If Korea exports cars to US at a low price, when is it evil?  When they directly subsidize production?  When the government builds schools that train automotive engineers?  When they provide cheap land for car factories?  Economists usually roll their eyes at those distinctions.  All that matters is whether the US gains from being able to buy low-priced cars from Korea.  Similarly, if foreign CA surpluses really did hurt us we should oppose them whatever their cause.  To be fair, Krugman has criticized Germany’s free market surplus, arguing the German government needs to save less.  So he clearly understands the point I am making.  Where he and I disagree is that I don’t think foreign CA surpluses hurt us by reducing NGDP, because I believe NGDP is determined by monetary policy.  So I’m not upset with either China or Germany, and I certainly don’t draw any moral distinctions between the two cases.

Nick Rowe asked:

Think back to your earlier analogy, that if all countries intervene in forex markets, and buy each others’ bonds, it is like every country doing QE. Which is good. But if the Bank of China can buy US bonds, but the Fed can’t buy Chinese bonds (because China won’t allow it), then it’s asymmetric.

I’m not quite sure what Nick is getting at here.  If he is saying that if each the 20 biggest countries bought $100 billion in bonds from the next country to its west, or to its east, it would be like a global QE, then I agree.  Of course the exact same effect would occur if they each country bought $100 billion of their own bonds.  If China doesn’t want to sell us bonds, we can weaken the dollar against goods and services (which is all we care about) by buying German bonds, or even US bonds.  It makes no difference.  Of course that’s assuming the transactions affect the money supply.  But there is no necessary effect of Chinese forex purchases on the Chinese money supply, as I presume they sterilize them to prevent inflation.  Only if China’s peg forced it to buy more forex than they felt comfortable holding, would the Chinese purchases be monetized.

Another reason the exchange rate is very misleading is that people focus on the nominal rate, which the Chinese government pegs.  But it is the real rate that matters.  It is true that China can influence the real rate, but only by adjusting the amount of government saving.  Which against shows it is the saving/investment relationship, not the exchange rate, that is the key to understanding CA surpluses.

Andy Harless said:

The argument would be that currencies are undervalued whenever governments collectively engage in reserve transactions that result in a (sufficiently large) net increase in the availability of that currency in foreign exchange markets. (Obviously if the US were to offset China’s dollar purchases by buying yuan, this would not be the case.)

That seems like a pretty good argument to me: if the value of the currency is what the private sector would determine it to be in the absence of official reserve transactions, then it is fairly valued (on the assumption that private markets are efficient enough to give it a fair valuation). If net official reserve transactions are reducing the actual market value of the currency relative to that “fair” market value, then it is undervalued.

First of all they aren’t buying dollars, they are buying bonds.  Yes, they are bonds denominated in dollars, but it would make no difference whether they bought bonds denominated in euros, or Swedish kroner, or stocks denominated in euros.  All that matters is the impact on Chinese national saving.  Again, there are lots of countries that have governments buying forex, which also run CA deficits.  Whether you run a surplus depends on the saving/investment balance.  I am not denying that governments can influence that relationship, and I am not denying the Chinese government has influenced it (as has our government, by massively discouraging saving), what I am denying is that the “official reserve transactions” affect the CA surplus more than some other form of government saving.

In the previous post I said:

“The standard argument is that trade surpluses (actually CA surpluses) are caused by excesses of domestic saving over domestic investment.“

Andy Harless responded:

That doesn’t sound right to me. The level of the CA surplus is simultaneously determined with the levels of saving and investment, but the levels of one do not cause the levels of the other. If the quantity that a country wishes to invest and the quantity it wishes to save are both fixed (inelastic) at certain levels, then those quantities will determine the CA surplus, but they will do so largely by affecting the exchange rate. (For example, the excess saving will bid down domestic interest rates, thus making the domestic currency less attractive and causing it to depreciate, so that domestic goods become more attractive relative to foreign goods, thus inducing a CA surplus.) The exchange rate is still the proximate cause of the CA surplus. There is no “immaculate transfer.”

This is like the oil example.  The OPEC cutback in production was the root cause of Americans’ driving less.  If you want to call higher oil prices the “proximate cause,” that’s fine.  I’d call it the transmission mechanism.  Suppose OPEC had gradually increased prices in the 1970s and 1980s by making “National Parks” out of land they had previously intended to drill new wells in.  That sounds very environmentally conscious, doesn’t it?  But it would have had the same effect on prices as an “artificial” order to the oil companies to produce less.  I’m saying those distinctions are meaningless.  It doesn’t matter why oil production fell, only the fact that it did.  Norway gets praised for its high national saving rate; “They are so wise to put their oil money into a sovereign wealth fund, unlike all those less civilized countries.”   You know the things people say.  But when China does the same thing, they are viewed as being “sinister.”  Yes, the CA surpluses are probably not in China’s interest (unlike Norway), but that’s hardly a reason to punish the Chinese people.

So what am I missing here, as everyone seems to disagree with me?

Paul Krugman skillfully dissected many arguments for protectionism and industrial policies in the book Pop Internationalism.  Now he seems to have fallen prey to many of these misconceptions.  But first let me acknowledge that there is a semi-respectable argument that can be made against countries running large trade surpluses in a world economy that is stuck at the zero rate bound.  I don’t agree with that argument (monetary policy isn’t really out of ammo), but I can see why someone like Krugman might find it appealing.  I seem to recall him explicitly making this point in earlier posts.  But with each new column, the arguments seem cruder and more simplistic:

And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.

Here he seems to have shifted his ground.  No longer is a liquidity trap required, now merely a “depressed economy” is required for Chinese trade surpluses to depress aggregate demand in the rest of the world.   I know of no respected macro model that supports this claim.  And I’m guessing that for most of the rest of my life Krugman will consider our economy to be “depressed,” whether interest rates are zero or not.

Some background: If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality “” namely, that China is deliberately keeping its currency artificially weak.

The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.

I have no idea what this means.  The standard argument is that trade surpluses (actually CA surpluses) are caused by excesses of domestic saving over domestic investment.  Now it may be true that a government can cause that to happen by purchasing vast quantities of foreign exchange.  And arguably China has done that.  But every country in history with a trade surplus?  Is the Swiss trade surplus also some sort of government conspiracy?  Or might it reflect an imbalance between private saving and private investment in Switzerland?  Unless Krugman wants to tautologically define “undervalued currencies” as currencies in countries with trade surpluses, I can’t imagine what point he is making.

BTW, if he intended a more sophisticated argument that currencies were undervalued any time the country’s government purchased foreign exchange, that argument would be equally fallacious.  It is quite possible for every country in the world to buy foreign exchange, but clearly every currency can’t be undervalued.  Krugman’s smart, so I probably misread him.  Tell me what he meant in the comment section.

So what should we be doing? U.S. officials have tried to reason with their Chinese counterparts, arguing that a stronger currency would be in China’s own interest. They’re right about that: an undervalued currency promotes inflation, erodes the real wages of Chinese workers and squanders Chinese resources. But while currency manipulation is bad for China as a whole, it’s good for politically influential Chinese companies “” many of them state-owned. And so the currency manipulation goes on.

Nice try, but I’m afraid the export sector is dominated by private firms, whereas the state-owned enterprises dominate the domestic economy.

Clearly, nothing will happen until or unless the United States shows that it’s willing to do what it normally does when another country subsidizes its exports: impose a temporary tariff that offsets the subsidy. So why has such action never been on the table?

Krugman’s made it clear that trade surpluses always represent undervalued currencies.  There are no exceptions in all of world history.  And undervalued currencies are export subsidies (again in his view, not mine.)  So is he saying the “normal” thing to do is to put tariffs on every single country that has a trade surplus?  Or on any government that buys foreign exchange?

Aside from unjustified financial fears, there’s a more sinister cause of U.S. passivity: business fear of Chinese retaliation.

Consider a related issue: the clearly illegal subsidies China provides to its clean-energy industry. These subsidies should have led to a formal complaint from American businesses; in fact, the only organization willing to file a complaint was the steelworkers union. Why? As The Times reported, “multinational companies and trade associations in the clean energy business, as in many other industries, have been wary of filing trade cases, fearing Chinese officials’ reputation for retaliating against joint ventures in their country and potentially denying market access to any company that takes sides against China.”

Similar intimidation has surely helped discourage action on the currency front. So this is a good time to remember that what’s good for multinational companies is often bad for America, especially its workers.

Sinister?  I feel like I’m reading Pat Buchanan here.  In all of economics there is no more discredited theory than the view that “dumping” hurts the importing country.  I thought Bastiat had disposed of that fallacy 170 years ago.  What’s even more ironic is that the Chinese are accused of dumping green products.  Think about it.  Krugman’s already suggested we might want to put barriers on Chinese products because they emit so much CO2, now he’s suggesting that we should put tariffs on Chinese green products, thus raising their price and discouraging the rest of the world from installing solar panels.  Once you start looking at the world from a left-wing perspective, it seems there is no end to the number of reasons you can find to abandon free trade.

What would really be bad for American workers?  It would be to make the same mistakes we made in 1930.   To mindlessly lash out at foreigners because we are too lazy or too stupid to tell our own Federal Reserve to boost NGDP.

Krugman has told the Fed to get moving.  I wish he’d stick to that message.

PS.  Ryan Avent was even less impressed than I was, and found lots of other problems.

One of the most long-established propositions in international economics is that a 10% across the board tariff on imports, when combined with a 10% across the board subsidy to exports, would have essentially no effect in the long run.  And this is true despite the fact that each policy, considered in isolation, would distort trade and reduce welfare.

The intuition here is simple.  Exports are the way we pay for imports.  So this combined tax and subsidy would be like the Federal Government simultaneously imposing a 10 cent tax on the purchase of gasoline, and a 10 cent subsidy on the sale of gasoline.  This is why I specified the long run; in the long run all imports must be paid for by exports.

The combined tariff/subsidy policies are also very similar to a 10% devaluation of a currency.  And it is well known that a 10% devaluation will not change the real exchange rate in the long run, as the domestic wage and price level would simply rise 10% in response.  But in the short run wages and prices are sticky, and thus either a 10% devaluation or a 10% tariff/subsidy scheme could lead to a real currency depreciation, and hence would affect trade.

I don’t doubt that author of Pop Internationalism is well aware of what I just wrote, but I think Paul Krugman’s readers may well have misunderstood his argument:

An export subsidy is WTO-illegal. An import tariff is WTO-illegal. A deliberately undervalued currency, maintained by massive foreign exchange intervention over a period of years, is in effect a combination of an export subsidy and an import tariff.

So how can China’s actions be legal, and a US response illegal? Well, the rules on currency manipulation are written in a confusing fashion, and seem to pass the buck or maybe the yuan “” back and forth between the WTO and the IMF.

But I basically can’t believe that the fine points here can override the clear merits of the case. If China’s currency policy were two separate policies, the US would have every right to respond; arguing that by combining the policies China somehow acquires immunity is just too tricky.

I can’t tell whether Krugman is referring to legal arguments or moral arguments.  There is no moral argument against a permanent tariff/subsidy combo, because it is neutral.  But “clear merits of the case” seems to imply a moral argument, not a legal argument.

It is important to distinguish between arguments that policy X will cause trade distortions, and those that claim policy X will lead to trade surpluses.  Trade surpluses are not caused by trade barriers; rather they occur because of high levels of private or government saving within a country.  Real exchange rates (on average) reflect economic fundamentals (including government saving as a fundamental.)  China is currently experiencing a higher inflation rate than the US, because that’s nature’s way of moving its real exchange rate to equilibrium when the Balassa-Samuelson effect is pushing the yuan higher but the government pegs the nominal rate.  Will this process eliminate China’s trade surplus?  No, because the surplus is caused by high levels of Chinese saving, not a nominal exchange rate that is out of line.  Again, I think Krugman may agree with this, as in earlier posts I recall that he suggested the deeper problem is the Chinese government’s massive accumulation of foreign exchange (i.e high saving) and the undervalued yuan merely reflects that policy.

But if the real problem is Chinese government purchases of foreign exchange, which permanently depresses the real exchange rate for the yuan, then it’s hard to draw an analogy to a tariff/subsidy combination, which doesn’t have any real effects once prices and wages adjust.

The intellectually respectable case for banning tariffs and subsidies is that, in isolation, they are trade distorting.  I.e., these policies should not be outlawed by the WTO because they affect trade balances, but rather because they distort trade.  On the other hand, a policy of massive foreign exchange accumulation can have a long run effect on trade balances, but is not trade-distorting in the usual sense of the term.

If the WTO wants to install a set of rules that ban countries like Germany, Japan, Switzerland and Singapore from pursuing high saving rates through government policies, then by all means do so.  But if they aren’t go to do so, then it is disingenuous to single out a country that is half communist and thus forced to pursue its high saving policies in a more obvious and unsubtle fashion.

What do I mean by “unsubtle?”   Policies that encourage private saving are more subtle than those that involve public savings.  And policies that achieve high public savings rates through budget surpluses are more subtle than policies that pursue public saving through foreign exchange accumulation.  China saves money in just about the most unsubtle way possible.

But make no mistake; there are many countries who are running trade surpluses that are vastly larger than China’s on a per capita basis, or even as a share of GDP, but are not being singled out because they are much smaller, and achieve the objectives using more subtle methods.

Krugman seems to want to deputize the WTO to enforce his theory of macroeconomics in a liquidity trap, which is that there is nothing that deficit countries like the US can do (or will do?) to offset the negative impact of Chinese trade surpluses on our domestic aggregate demand.

If we are going to have the WTO and IMF doing any investigations, I’d like to see them examine whether the Fed, ECB and BOJ are artificially raising the value of the dollar, euro and yen—where value is measured against goods and services, not other currencies.

PS.  Don’t respond with “in the long run we’re all dead.”  I get the fact that we need more economic stimulus RIGHT NOW.  I just think we’re more likely to get it from a robust price level target than a futile attempt to twist the arm of the Chinese.  US stocks soared early last week on strong Chinese exports numbers.  That doesn’t prove cause and effect; both items probably reflect a stronger world economy.  But there is very little evidence that growing Chinese exports are what’s keeping the US depressed while many other countries are recovering rapidly.  We need to look in the mirror.

Here are a few brief comments on the blogosphere before discussing 1932.

1.  Is there no one available with both a head and a heart?

Mark Thoma must be pretty influential; Obama picked Yellen right after he posted this call for new Fed governors.  Over the last year I have struggled with the issue of which group is more appalling; right wing economists who opposed monetary stimulus in 2008-09, or left wing economists who didn’t think it is was possible to use monetary stimulus once rates hit zero.  Last year I had this post on Yellen.  In another post (I can’t find) I argued that her failure to understand that monetary stimulus was still possible at zero rates should be an automatic dis-qualifier for the Board of Governors, roughly equivalent to a Supreme Court nominee who opposed Brown vs. Board of Education.  Some will say “but at least she’s a dove.”  It’s a given that Obama was going to appoint non-hawks, what we needed was someone who also understood that the Fed was capable of actually doing something.  Rumors are that only one of the three appointees will be an expert on monetary policy.  Let’s hope this isn’t the one.

2.  Yglesias vs. Krugman

Matt Yglesias makes the following point in a discussion of the Chinese yuan:

Meanwhile, if you ask me this inflation tends to vindicate China’s earlier much-complained-about currency policy. Keeping the renminbi cheap was a form of monetary stimulus that kept the economy growing throughout a global downturn. Now that Western demand is increasing again and China’s exports are rising rapidly you’re starting to see some inflation, which is precisely what happens as you come to the end of a successful stimulus cycle. Now it’s time for policymakers to start backing off from these measures.

I think that is about right.  During 2008-09 I strongly opposed attempts by Krugman and others to pressure China into a strong yuan policy.  At the time I suggested that at some point during 2010 they might want to consider appreciating the yuan.  If it happened tomorrow, in three months, or in six months I’d be fine with that.  If they wait a few years I might start gently chiding them to raise the yuan for their own good.  But never, ever, because it benefits the US.  They are rather nationalistic, and outside pressure is just as likely to backfire.

3. Tax burden tables using income in the denominator are meaningless.

In this post Krugman criticizes Ryan’s tax plan because the top tax rate is only 25%.  Given how much this country spends, Krugman is right.  If we are going to switch to a consumption tax (which is what Krugman claims the Ryan plan is) then the top rate needs to be closer to 40%.  But the chart he uses to illustrate this point is meaningless, as it divides taxes by current income, rather than consumption.  As a result Krugman makes it look like the rich would only pay 12% under the Ryan plan.   Krugman’s not the only one to do this, but it really annoys me when I read this sort of nonsense.  I don’t have time now, but this summer I plan a long post on why the income tax is widely misunderstood by progressives.  It is a moral abomination, and grossly inefficient as well.

4.  Who’s promoting loan sharks?

I must have missed something in this Krugman post.  I thought the standard view among economists (yes, I know, excluding Adam Smith) was that usury laws were counterproductive because they merely forced people to go to loan sharks.  In that case not only did borrowers have to pay high interest rates, but your legs were broken if you couldn’t repay the loan.  Yet in this post Krugman seems to be criticizing those who oppose usury laws.  What am I missing?  Is there new research out there suggesting usury laws are actually good?  Or is this just one more example of Krugman moving away from economic orthodoxy, like his “bizarre” recent claim that unemployment insurance doesn’t raise the unemployment rate?  (Check out this reply from David Henderson.)

Here’s the first part of the 1932 chapter (which supports 123’s theory of Congressional markets):
Den ganzen Beitrag lesen…

Michael Pettis has the best blog on the Chinese economy that I have been able to find.  If you are interested, you should check out his recent post on how the policy debate looks from within China (and yes there is vigorous debate inside China.)

But today I want to respond to one comment I don’t entirely agree with, which he made in a post in early January:

For those who remember the 1980s, when many policymakers in Japan insisted that Japan’s trade surplus had nothing to do with the value of the currency, and everything to do with domestic competitive advantages in manufacturing, it is a little weird seeing them now worry so much about the impact of a rising yen on their manufacturing sector and on the process of economic recovery.  Currencies do matter, I guess.

I’m paranoid.  Since I was one who didn’t think the value of the yen explained the 1980s surpluses, and who also strongly believes the strong yen has recently devastated their manufacturing sector, I naturally assumed he was talking about me (despite the fact that I’ve never even made any public statements about 1980s yen policy.)  The thing is, I don’t see any conflict at all.

Here’s how I think about things.  The real exchange rate is not determined by the government, but rather by the propensities to save, invest, import, export, etc.  Beginning in the 1980s, Japan saved much more than they invested, so it was natural for them to run trade surpluses.  Indeed given their demographics, it would have been foolish to do anything else.  Even with all the surpluses they have run up, I have no idea how they are going to address their demographic time bomb.  All during this period their trading partner Australia was running massive current account deficits.  Whose shoes would you rather be in today?

[However I do agree with Mike Pettis that the Japanese government’s explanation, that it was all due to their manufacturing prowess, was silly.  South Korea was running deficits at the same time.]

The nominal exchange rate is a completely different animal from the real rate.  Monetary policy determines the nominal rate.  That doesn’t mean the central bank should target nominal rates, indeed I favor NGDP targeting instead.  But let’s say the central bank isn’t targeting NGDP, indeed it doesn’t have any coherent monetary strategy.  It just drifts along with nominal rates stuck near zero.  What then?

In that case I’d say a sharp rise in the nominal value of the yen might be an indicator of an excessively tight monetary policy, that is, a monetary policy that was driving NGDP expectations sharply lower.  This would be even more true if there were other market indicators showing money was too tight, like falling stock and commodity prices, and (surprisingly) falling long term bond yields.

The argument against my position is that the central bank can also control real exchange rates over a significant period of time, say at least several years.  I accept that, but I think persistent trade surpluses are an extremely long term issue, lasting over decades, and I don’t think monetary policy has real effects over a time frame of more than a few years.  I still think the classical dichotomy holds in the very long run.  Indeed the unwelcome deflation in Japan during the late 1990s, and again recently, is partly a reflection of the fact that Japanese monetary policy was pushing the real value of the yen up to unsustainable levels.  This forced the real exchange rate to adjust downward through painful price level adjustments.

As for the seeming inconsistency of my position, consider this analogy.  You are a development economist at the IMF.  You tell the Indian government, “Don’t think you can speed up the pace of economic development by merely printing money.  Development requires improvements in human capital, infrastructure, better institutions, etc.”  Then a few years later the IMF economist comes back and says “Egad, you drove India into a recession with your tight money policy!”  Was he being inconsistent, first arguing that printing money doesn’t make a country richer, and then arguing that tight money made it poorer?  Not really, there are theories appropriate for business cycles, and very different theories appropriate for long term economic growth (unless you are a RBC economist, in which case life is blissfully simple.)

PS.  If you want to know why I like his blog so much, consider this quotation from the same January 9th post:

Already some of my students whose parents own their own businesses have been telling me that Chinese speculative money held abroad is flowing back into the country.  One of my students from rich coastal city Wenzhou, the most free-wheeling and business-savvy city in China, and perhaps the world, just rolled his eyes when I asked him if his family and friends were tying to bring money into the country.  “Of course,” he said.  I didn’t get the impression that he thought mine was an especially astute question.

Meanwhile all the big guns in the “monetary alarmist” camp in China have been pounding the table (in the discreet way preferred of policymakers here) about the risks of monetary expansion.  As everyone now knows, the PBoC yesterday sold three-month bills at a higher interest rate for the first time in 19 weeks.  Long Chen, one of the students in my PBoC Shadow Committee seminar, reported to the class via email as soon as it happened: “Hey guys, the primary yield of 3M PBOC bill increased this week. Significant sign.”

Yes, although the increase was tiny, it may indeed be a significant sign that the PBoC no longer wants to wait and is starting to tighten conditions, although I can only add that conditions are so alarmingly loose that it would take an awful lot of tightening to get back just to “loose”, and it would be hard to do this without seriously undermining current growth and employment in the short term.

First of all, Wenzhou is crying out for a serious sociological study.  (Or has one been done?)  In a nation of fairly entrepreneurial people how can this one middle size city stand out so dramatically?  Their relative success within China is roughly comparable to that of what Thomas Sowell called “middlemen minorities” (Indians in Africa, Chinese in SE Asia, pre-war Jews in Eastern Europe, etc.)  And yet to us Americans the Chinese (or at least the 92% of them who are Han) seem a fairly homogenous group.  You won’t think China is a simple place after reading Pettis.  And he writes very well.

And how about that inside info from his former student!  Take a look at this graph showing how the Hong Kong stock market has done in the three weeks since he provided his money tightening tip on January 9th.  I know, I’m an EMH guy.  Still it never hurts to check your horoscope, and also Mike Pettis’ blog.