Please China, keep “beggaring your neighbors.”

The best thing that happened to the world economy in 1933 was that FDR sharply devalued the dollar against gold.  Prices and output started rising rapidly, and the US began to suck in a lot more imports from the rest of the world.  Our trade surplus got smaller.  Even better, this policy inspired other countries to devalue as well.  Paul Krugman knows all this, and often cites FDR’s actions with approval.

The best thing that happened to the world economy this year, indeed just about the only good thing, was the V-shaped recovery in Asia, almost certainly led by China.  This recovery was aided by the Chinese government’s decision to stop appreciating its currency.  The Asian growth spurt was also a major factor behind the recovery in the US, which began in asset markets in March and spread to the real economy a few months ago (although we need a much faster recovery.)  Paul Krugman does not seem to know this, indeed he is now arguing that the Chinese need to reverse the very policies that provided green shoots to the world economy in the dark days last winter.  Here is what Krugman has to say:

Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.

But China has been keeping its currency pegged to the dollar “” which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.

And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.

Do you see where Krugman goes wrong?   He is mixing up two very different issues.  One is the question of international payments accounts, which is a zero sum game.  The other is the broader macro problem of a depressed world economy, which is anything but a zero sum game.  Krugman is a very skilled macroeconomist, and it is rare to see him make this error.  A cynic might argue it shows the increasing extent to which the General Theory is affecting on his analytical skills.  But first we need to consider what is really going on here.

In 1933 FDR was not trying to depreciate the dollar against other currencies, he was trying to depreciate it against goods and services.  Krugman and I agree that we should be trying to do the same today.  But if the Chinese were to appreciate their currency they would be imposing deflationary monetary policy on their economy.  Krugman might reply that China is not an open market and that the Chinese could sterilize any impact and thus prevent a deflationary shock to their economy.  But is that really true?  When the real Chinese exchange rate appreciated in the late 1990s (due to the SE Asian crisis, and the fact that the yuan was pegged to a strengthening dollar) China experienced a very unwelcome period of deflation, which slowed real growth quite sharply (and probably more than the official statistics showed.)  They didn’t seem able to prevent this impact, despite the fact that they have exchange controls.  After China joined the WTO in 2002 their economy took off, and by 2005 inflation was becoming such an acute problem (due to the Balassa-Samuelson effect combined with the dollar peg) that China decided to strongly appreciate the yuan.  It was their only option for preventing a return to the high inflation of the early 1990s.

It is a mistake to think about exchange rate policy as trade policy, it is fundamentally a form of monetary policy.  China’s current account surplus is driven by its high saving rate, and changing the nominal exchange rate won’t have any significant effect as long as the savings rate remains high.  In fairness to Krugman, he might argue that part of that saving is Chinese government accumulation of foreign assets, and that he has in mind both a much stronger yuan and less government saving.  But even if this were done the impact on the world economy would be trivial compared to the effect of monetary policies on aggregate  demand.

When you think about exchange rates from a trade perspective, they seem like a zero sum game.  If the dollar goes up the yuan goes down, and vice versa.  But from a monetary perspective things look much different.  It is possible for both the yuan and the dollar to simultaneously appreciate, or depreciate, against goods and services.  For any given US monetary policy, a decision to appreciate the yuan is a decision to tighten monetary policy in a country whose PPP economy is $8 trillion dollars, and that means tighter monetary policy at the world level, and lower world aggregate demand.

A recent post by David Beckworth addressed an interesting “problem” facing countries trying to back out of the extremely loose monetary policies that have been adopted by almost all central banks.  If they do so by raising interest rates then they risk an appreciation of their currencies, which could in turn depress their already weak economies.  So is this a problem?  Go back and look again at what I just wrote.  Do you see the error that I (purposely) made?  I said money is loose all over the world.  But of course it isn’t—rather nominal rates are low.  In fact, money is too tight almost everywhere.  We need central banks to set higher NGDP growth targets (or inflation targets.)  In my next post I plan to say good things about Krugman’s recent strong opposition to any move toward tighter money in the US.  In fact I’d go further; tighter money would be a mistake almost anywhere in the world.  So here is how I interpret the dilemma noted by Beckworth.  US policy is still far too tight for reasons discussed in this post by Bill Woolsey; we are far below the NGDP trend line, even using a 3% trend.  If other countries try to tighten a bit and their currencies appreciate, that is the forex market’s way of telling those governments: “You are making a mistake, 2% interest rates might seem an expansionary policy, but given the current position of the equilibrium Wicksellian real interest rate they are actually much too contractionary for your economy.”

Not only should China be trying to depreciate its currency, but almost all countries should be trying to do so—against goods and services.  Fortunately, as Krugman points out the Chinese don’t have to do very much.  Because of their rapid productivity growth, even holding their exchange rate steady is equivalent to depreciation in terms of its impact on aggregate demand.  This is why China recovered first, and as it sucked in imports of commodities this demand shock started to spread beyond its borders.  Forget about trade balances; look at commodity prices.  China stopped the world spiral into deflation, and began raising the Wicksellian equilibrium interest rate after March 2009.  It turned expectations around.  That made US monetary policy slightly more expansionary, even at the zero bound, and began shifting expectations here as well.  When China started to recover the tail risk of a deep world depression was essentially chopped off.

[Yes, China is now recovering briskly, so maybe a higher yuan would be appropriate at some point.  But neither inflation nor NGDP growth is particularly high in China, and their export industries are still extremely depressed.  It is up to the Chinese to decide when a stronger yuan would be appropriate to prevent excessive nominal spending.  (And of course the bigger problem is how to transition to more activity in the countryside and private sector, and less in the bloated urban SOEs.)]

Because the growth that comes from rising AD strikes our intuition as a sort of “something for nothing” process, we are especially likely to fall into the mistake of thinking in zero sum game terms whenever examining international economic linkages.  Common sense suggests that a low yuan cannot help both China and the rest of the world.  One country’s trade balance improvement is offset by another’s deterioration.  But when you remember that an exchange rate is also a price of money and that the price of money affects both domestic and world AD, things look much different.  If during normal times the US suddenly adopted an ultra-tight monetary policy, then the US dollar would appreciate and we’d go into a deep recession.  But the rest of the world wouldn’t boom, they’d also suffer an economic slowdown despite the fact that their currencies depreciated against the dollar.  Indeed this is roughly what happened between the US and Europe last July through November, when the dollar was appreciating against the euro and US monetary policy had become highly deflationary.  Just one more example of “the money illusion.”  Krugman usually has razor sharp analytical skills; it is unusual for him to miss this point.

As Barry Eichengreen pointed out a few months ago, a series of competitive devaluations might be just what the world needs.  (Just as it was exactly what the world needed in the 1930s.)

HT:  Clark Johnson.



30 Responses to “Please China, keep “beggaring your neighbors.””

  1. Gravatar of Dilip Dilip
    24. October 2009 at 10:24

    The Economist also commented on this:

  2. Gravatar of dlr dlr
    24. October 2009 at 11:43

    I’m not sure I find your argument that China would have trouble simultaneously appreciating against the dollar and preventing deflation convincing. China today is a lot different than China in the 90s; reserve ammunition abounds. Good luck to the Soros equivalent who tries to outflank a Chinese intention to appreciate the Renminbi. If China was really stuck in the one nominal target model like a more typical open economy, you would have thought it would have had more trouble with its concurrent dollar currency peg and sterilization program as it managed to keep its peg and control inflation in recent years. If China widened its peg to 5 – 10 and targeted 2% inflation without seeing the Yuan appreciate then maybe I’d believe you, but that outcome seems unlikely.

  3. Gravatar of ssumner ssumner
    24. October 2009 at 12:35

    Thanks Dilip, It is interesting that they accept the “zero-sum game” part of Krugman’s analysis, but not the broader message.

    dlr, My research on the Great Depression has convinced me of the importance of credibility and expectations. A higher exchange rate tends to create lower inflation expectations, and vice versa, almost regardless of what happens to the short term money supply. Markets know that nominal exchange rates drive the relative price level in the long run, and look past any short term manipulation in the money supply. And it wasn’t just the late 1990s, even in 2005 China was struggling to hold down inflation, despite the fact that doing so involved the seemingly easier route of adding to reserves. But that didn’t really do much good.

    And consider what has happened in this recession. China has experience significant deflation despite:

    1. Stopping the appreciation of their currency.
    2. The Balassa-Samuelson effect
    3. A massive and by all accounts fairly effective stimulus package. I don’t know if it should be considered monetary or fiscal–it bascially consisted of loosening restrictions on the big state-owned banks, and encouraging them to lend. And despite all this prices fell. I shudder to think of what would have happened if China had also had to struggle with an appreciating exchange rate. Take a look at the link from The Economist in Dilip’s comment. It argues (correctly) that China is not as powerful as it seems from the outside. Those reserves are being accumulated for a reason, markets correctly understand that China would be reluctant to allow significant losses, hence appreciation would lead to deflationary expectations.

    I’d turn your argument around and point it right at the US. Suppose there are two tools? Why can’t Krugman call on our Fed to do massive QE? Then if the Chinese want to keep their currency from appreciating, the PBoC must match the Fed in its stimulus.

    So you do raise a good point, but I think it can cut both ways. I certainly don’t accept Krugman’s defeatism about the propsects for US monetary policy. Indeed since we have no foreign exchange pegs to worry about, we have a much freer hand than the Chinese.

    Krugman implicitly has a model where countries can move nominal (and real) exchange rates around with the flick of a wrist, but all the huffing and puffing by central banks can’t budge the price level of NGDP one iota. That is a bad model. And it can lead to international discord that is totally unnecessary.

  4. Gravatar of Greg Ransom Greg Ransom
    24. October 2009 at 13:44

    All hail Zimbabwe!!

  5. Gravatar of Doc Merlin Doc Merlin
    24. October 2009 at 14:17

    The reason for this crash was in large part china’s attempt to keep “beggaring its neighbors.” China’s inflationary policies have led to chinese buying a massive amount of foreign assets and securities in an attempt to protect themselves from inflation.

    This has, in the short term, benefitted China with a massive production capacity and the rest of the world with loads of cheap credit and money. However, it caused huge problems because of too much money chasing western securities and not enough consumption in China. This led to too much consumption in the west and not enough savings/investment. The inevitable correction to this manipulation was a very nasty one.

  6. Gravatar of jean jean
    24. October 2009 at 14:18

    There is some truth in Krugman argumentation: China can still do conventional things at home (its overnight rate is 5%), but USA no longer can. Would’nt it be better if China lowered its interest rates? China would still be in conventional zone while the US would have a lot less purchases to do.

    Another piece of Krugman:

  7. Gravatar of dlr dlr
    24. October 2009 at 15:46

    I agree with you that Krugman has been unnecessarily defeatist about the prospects for unconventional monetary policy. Maybe he really believed that expectations weren’t going to change until the US government bought every long term asset on the planet (seems that Arnold Kling would agree, except Kling doesn’t need a liquidity trap to make unflappable expectations the dominant factor.) Maybe he was recognizing the political reality that the Fed had more hawks than usual who wouldn’t support that course. More likely, maybe this seemed like an opportunity to have his money and spend it, too. In any case, the question of whether a country with extraordinary capital controls can meet twin monetary aims should still be evaluated separately from how easily the US could have escaped a liquidity trap.
    I don’t like the part of your argument using the recent recession as evidence that China can’t do both. You say that China saw deflation despite A, B and C, so therefore it needs to depreciate (or not appreciate) the currency (do more of A) to avoid deflation. But I know we agree that inflation is about the supply and demand of money, and that if the demand for money goes up a lot, factors that seem like loose supply side policy may actually be tight policy. So when someone says that we must need fiscal stimulus because super loose monetary policy hasn’t worked, we would both say ‘you mean because excessively tight monetary policy hasn’t worked.’ Same response here: just because China did some things that seem loose doesn’t mean they were loose enough to counter changes in velocity. And just because they weren’t loose enough doesn’t mean that the peg (or fiscal policy, in our case) is a requisite piece of the puzzle. I’ll give you this much: the middle of March when demand for money seemed to be growing rapidly wasn’t the time to start worrying about something like the peg, regardless whether an exacta could be pulled off.
    Somewhat similarly, that China relaxed the peg in 2005 doesn’t seem like convincing evidence of anything. For one thing, nobody argued that China could sterilize indefinitely and hold the price of Yuan at any ratio it wanted. Believing that China given its capital controls can have twin-targets in certain circumstances is far from thinking it omnipotent. More importantly, China had many reasons to let the currency appreciate slightly in 2005 that aren’t identical to being forced by inflation (which wasn’t actually very high, though I’m not staking my argument on anyone’s measured inflation let alone China’s). Its export model was working maybe better than planned and political pressure was getting louder. It was accumulating dollars quickly and its sterilization program was requiring a lot of bond issuance. You could just as well say that it made sense to take a little off the gas even if they could have continued to sterilize more to counter inflation. And I agree that expectations are crucial, but that’s doesn’t mean that expectations about all things (like exchange rates) have the same importance to the demand for money in all regimes. China is running a very unusual regime for many reasons in that sense, and I don’t think applying historical expectation correlations from different regimes is going to be helpful. This argument isn’t just about monetary policy for everyone. For those who disagree with your belief the peg is a sideshow and that instead exogenous (to distortions caused by the peg) high savings rates are the real cause of trade imbalances, the threat of a return to those imbalances under a peg is a meaningful concern.

  8. Gravatar of Dilip Dilip
    24. October 2009 at 21:21

    I wonder if he is talking about you here:

  9. Gravatar of Kevin Donoghue Kevin Donoghue
    25. October 2009 at 02:03


    That doesn’t look like a response to anything Scott has written lately. Krugman avoids naming whoever it was that prompted this latest attack on the “immaculate transfer” notion, which he has been bitching about for decades. This recent interview with Stephen Roach of Morgan Stanley Asia provides a depressing example of the hold which that undead idea has over some minds:

    Last year, the United States ran bilateral trade deficit with almost one-hundred countries. And the reason for that is that we have a savings problem. And when you have a major savings problem, you have to import surplus savings from abroad in order to grow and you run multilateral trade deficits with a broad cross-section of a number of economies. The Chinese piece is the biggest because of the outsourcing decisions made by U.S. multinationals that you alluded to. But if we were to close down trade with China through some ill-begotten trade legislation or currency adjustment, we don’t save the deficit. It just goes somewhere else. And they usually go to a higher-cost producer, which taxes the American public.

    Scott does seem to wander into similar territory at times, but not so blatantly. For example, I’m sure Krugman would object to this: “China’s current account surplus is driven by its high saving rate, and changing the nominal exchange rate won’t have any significant effect as long as the savings rate remains high.” But most likely he would just ask what sort of model Scott has in mind here; if the savings rate drives the surplus, what drives the savings rate? Also, doesn’t a change in the nominal exchange rate typically generate a change in the real exchange rate, with real consequences?

  10. Gravatar of Bill Woolsey Bill Woolsey
    25. October 2009 at 04:25


    You need to thinking about nominal expenditure targeting.

    The U.S. is currently 9% below its long run trend growth rate of nominal expenditure.

    During the last decade, nominal expenditure in Zimbabe grew at a growing rate. It broke through growth path after growth path. Long ago, it broke through an either 3% or 5% growth path.

  11. Gravatar of ssumner ssumner
    25. October 2009 at 06:22

    Greg said:

    “All hail Zimbabwe!!”

    Believe it or not, Krugman once had a post claiming the Fed couldn’t create Zimbabwe style inflation even if it wanted to.

    The optimal policy right now is a linear combination of current Fed policy and Zimbabwe policy, albeit a bit closer to the Fed.

    Doc merlin, China would have grown faster if it followed the South Korean model from the 1970s-1990s. Korea didn’t run up useless surpluses of cash, but instead took the money they earned for exports and bought machines to develop even faster. Thus Korea generally ran trade deficits during it’s high growth phase. That’s one reason that Koreas developed even faster than China. So I don’t agree that China’s surplus has helped its growth, and I don’t think it has caused any significant harm to us.

    The only defense I can see for their huge surpluses is that they are still half communist and know that they lack effective ways to spent all that cash, and also need to save up because they lack effective social insurance schemes. I hope it is a nest egg to eventually develop a Singapore-style social insurance system. They tend to like the Singapore model.

    jean, The banks in China lend mainly to inefficient SOEs. The low exchange rate helps the more dynamic part of the Chinese economy, which is smaller private export-oriented firms. So a lower interest rate might make the Chinese economy even more distorted.

    For me, the bottom line is that faster Chinese growth helps a world economy mired in recession. If China had not recovered after last March, I shudder to think of what would have happened to the world economy. Deflation expectations might have set in.

    dlr, This time around I am much more sympathetic to your argument. China is very complicated, as you say, and my analysis did oversimplify a bit. But my response would be that the burden of proof is on Krugman if he is going to argue that the US government should pressure China to revalue. In my preceding reply to jean, I made a pragmatic argument that I didn’t use in the original post, which is that revaluation combined with domestic monetary stimulus will push growth toward the SOEs and away from the market. So although you made a number of astute points, I think if we look at China in all its complexity it makes it even harder to make Krugman’s simplistic case.
    I gather you aren’t backing Krugman so much as staking out a more nuanced position that is intermediate between ours, and I think that’s fine.

    Regarding 2005, I agree that inflation hadn’t yet gotten very high, but the pressures were building rapidly. Without the 20% revaluation over the next 3 years I think the economy would have really overheated. Speculation for a future revaluation would have built up, and lots of money would have evaded exchange controls. China was red hot as it is.

    BTW, there’s lots of things I think the Chinese government should do that it isn’t doing.

    Dilip, Yes I noticed that too. I’m guessing it was someone else as he focuses on slightly different topics. I think any international economist would have seen flaws with his piece. My friend Clark Johnson who knows a lot about open economy macro and is much less right wing than me, was also very negative about the Krugman piece that he sent me.

    Kevin, I don’t have any big problem with the Roach piece, I think differential savings and investment rates drive long run CA deficits between countries as they obviously do between states. I presume Krugman wouldn’t argue that California’s big CA deficit during the 1950s-80s reflected the wrong exchange rate between California and NY.

    I agree with you in one sense. The savings rate in China is partly (though not completely) a facet of government policy. And I think I did make that point somewhere in the post, granting Krugman the point that if the Chinese government decided to save less (i.e. accumulate less foreign reserves) then the CA surplus would fall. Maybe not one for one, as others in China might save more, but it would fall substantially.

    You did correctly notice that my main argument was elsewhere, that Krugman was treating something as a trade issue that needed to be addressed as a global money/aggregate demand issue. And he was treating competitive devaluations as a zero sum game. I was frustrated by this Krugman post partly because I know he is aware of Barry Eichengreens analysis of competitive devauations in the 1930s. As you probably sensed this post doesn’t involve any of the left/right issues that usually separate me from Krugman. Eichengreen is a liberal.

    On your final point: I have no trouble with the nominal exchange rate changing in the US direction because the Fed eases (say agressive QE, or a higher NGDP target), I don’t want it to change in our direction becasue China tightens. That’s the global money/macro picture that I think Krugman missed by just focusing on a single number, which can reflect various forces. Does this make sense? I now think the post should have been a bit longer, as there are so many ways to look at this issue, and I don’t know if my main point came across clearly.

    Bill, I agree.

  12. Gravatar of Doc Merlin Doc Merlin
    25. October 2009 at 10:44

    I agree that China following the South Korean model would have been better. However, China wasn’t exactly a capitalist country in the 1970’s. They did and do, now, however have very fast growth (although I don’t think as fast as the government stats are saying).
    Wrt. China hurting us, I think it was mostly in the sense that it helped bubbles form by lowering the cost of borrowing below market price.

  13. Gravatar of Jim Glass Jim Glass
    25. October 2009 at 12:08

    Re China: “if the savings rate drives the surplus, what drives the savings rate?”

    Lee Kuan Yew was asked exactly this question by Charlie Rose last week (in a really very good conversation — on LKW’s part, not Charlie’s).

    His answer: “The Chinese people have experienced disaster after disaster with their central government failing them for 5,000 years. They know they always have to be prepared to take care of themselves. They’ll have this savings rate for two generations after China becomes urban, and the population is still dominatingly rural, that is several decades away.”


  14. Gravatar of marcus nunes marcus nunes
    25. October 2009 at 17:52

    Without mentioning you (maybe because he doesn´t want his readers (in the hundreds) to think you are “dum zombie”)he writes: “Whenever exchange rates enter into discussion, certain zombie fallacies “” ideas that you kill repeatedly, but refuse to die “” inevitably make their appearance”.
    Read all in

  15. Gravatar of ssumner ssumner
    26. October 2009 at 04:20

    Doc Merlin, With China it is always the glass half full/half empty. They started the reforms in 1979 from a position as poor as India and Africa. The fruits of Mao’s policies. So even moving halfway away from communism was a big improvement. They are much better off now, but (the half empty part) haven’t done as well as they should have if the reforms had been faster.

    Jim Glass, I strongly agree, much of the high saving in China (and some other Asian countries) is cultural, not government policies. My impression is that Chinese immigrants to the US also save more than non-Asian Americans of similar economic status. Does anyone know if that has been studied?

    Marcus, Krugman simply assumes that the “imbalance” in our current account must go away, even as we return to prosperity. But I see no reason why this must occur. People also predicted that in the previous recesion, and yet the imbalance got worse. I do agree that if the imbalance is to get smaller, the exchange rate can facilitate the transition.

    But the more fundamental problem is that he doesn’t address my point that what we need is a weaker dollar, not a stronger yuan. The problem isn’t China, it is the US.

  16. Gravatar of saifedean saifedean
    26. October 2009 at 05:04

    Sorry to be raining on your parade, Scott, but…

    Don’t you think that perhaps the fact that the recovery from the GD only started in 1945–a full 12 years after this dollar devaluation–might suggest that perhaps this was not the wisest and most successful policy ever?

    I mean, if today’s economy only started recovering in 2020, would anyone but the insane claim that the policies of Bush/Obama in 2008-9 were the cause of the recovery, rather than the cause of the 12 intervening years of depression?

    From where you Monetarists/Keynesians see it, the devaluation leads to exports, which prompts an increase in production, which leads to a recovery, which then makes the world happy. Charming. But you fail to notice the 12 year gap between those two. And you fail to notice that the dollar and the US received, in 1945, the massive boost of the USD becoming the global reserve currency.

    An alternative (Austrian-flavored) view would see the devaluation as the unfortunate but inevitable result of the earlier bout of crazy inflation (or Scientific Management of the Price Level, as you would call it) and statist management of the economy. This inflation led to the unsustainable boom, the crash, and the deflationary contraction. The bail-outs and the massive money-printing to fund Hoover and FDR’s statist programs led to the devaluation of the dollar. This was practically a giant transfer of wealth from everyone holding dollars to interest-groups receiving favors from the government.

    From that point onwards, money went from being a store of value into a US government loyalty-scheme. The government spent it like crazy on strong political constituencies, and on ways that make the data improve. Recovery only came when this crazines stopped–not because of this craziness.

  17. Gravatar of David Stinson David Stinson
    26. October 2009 at 06:47

    Doesn’t the concern on the part of many countries with the trade-related impacts (as opposed to monetary policy implications) of their exchange rate stem in large part from a confusion between absolute and comparative advantage?

  18. Gravatar of Greg Ransom Greg Ransom
    26. October 2009 at 11:20

    “long run trend growth rate”

    I believe in the real existence of this socially constructed fiction even less than Scott believes in the real existence of “inflation”.

  19. Gravatar of Robert Simmons Robert Simmons
    26. October 2009 at 11:58

    How do you measure depreciation against goods and services rather than against other currencies, if you don’t believe in inflation? Nominal GDP expectations?

  20. Gravatar of OGT OGT
    26. October 2009 at 12:14

    Sumner and Jim Glass- I certainly don’t buy the cultural argument as Michael Pettis pointed out recently on his China Financial Markets blog many of the things ascribed to ‘culture’ in China were equally true of the west one hundred years ago. Instead they are economic characteristics of still poor and rural developing countries, they will change as the economy changes.

    But, the high relatively high household savings rate does not explain the growth in China’s saving’s rate in the last eight years. In fact, household savings has been falling as a percent of GDP, because household income has fallen from 60% of GDP to 50% according to the IMF. The rise in savings is a SOE and state phenomona, not household and not cultural or market driven.

    Also, your commodity story only makes if that copper is being purchased for production with an end demand user. However, there are many signs that this is just a lending induced asset bubble.

  21. Gravatar of ssumner ssumner
    27. October 2009 at 15:55

    saifedean, You said;

    “Don’t you think that perhaps the fact that the recovery from the GD only started in 1945-a full 12 years after this dollar devaluation-might suggest that perhaps this was not the wisest and most successful policy ever?”

    If FDR had raised nominal wages by 20% in July 1933, the Great Depression would have been essentially over by late 1934 or 1935. Industrial production rose 57% between March and July 1933, regaining have the ground lost in the previous 3 1/2 years.

    You said;

    “From where you Monetarists/Keynesians see it, the devaluation leads to exports, which prompts an increase in production, which leads to a recovery, which then makes the world happy.”

    I’m not a monetarist or a Keynesian, and I never argued that the devaluation promoted recovery through exports. Our trade balance actually got much worse in 1933. Exports played no role in the recovery. Some people may believe that nonsense, but not me.

    And the massive money printing played no role in the devaluation of the dollar–Hoover’s policies were highly deflationary, not inflationary, check the data.

    David, You may be right. There is such massive ignorance about trade that one hardly knows where to begin. Krugman wrote a fine expose of how even high government officials often don’t even know the most basic concepts of international trade theory.

    Greg, How about “time-varying long run rate of growth?”

    Robert, Yes, I prefer NGDP. This year a $1 bill buys a bigger share of GDP than last year. I use inflation a lot because other people use it. I recall an Austrian who thought the Fed should be abolished. He was asked why he carried cash. He said it was like when traveling in a different country you need to carry foreign currency. When he got his bill at a restaurant he’d ask whether the waitress wanted to be paid in gold, silver, or Federal Reserve notes. I’m kind of like that guy. I am stuck in a world where everyone thinks in terms of inflation, not NGDP. So I have to use the disgusting term.

    OGT, I still think culture plays a big role. I know lots of Chinese people in America, and their saving rate is far higher than non-Chinese Americans of the same income category. So I think culture plays a role. But in my recent post I acknowledged that government savings also plays a role. It is difficult to know how much the Chinese would save if the government saved less. The lack of a safety net explains some of the saving. They need to save for retirement, health emergencies, etc.

    I don’t recall what I said about commodities. But Chinese purchases of copper that push up world prices are expansionary. This is true regardless of whether the copper is immediately used, or used later.

  22. Gravatar of Robert Simmons Robert Simmons
    27. October 2009 at 19:54

    I still don’t understand. So is you’re evidence that China devalued that NGDP grew?

  23. Gravatar of OGT OGT
    28. October 2009 at 08:23

    Even if household savings is partially culturally determined, again, that doesn’t explain the rise in savings in the last ten years. Because the rise has not been in the household sector given the falling percentage of income filter down to households.

  24. Gravatar of ssumner ssumner
    28. October 2009 at 17:42

    Robert, I meant that monetary policy (and in China that means exchange rate policy) should target NGDP. If NGDP is growing at the target rate, then policy is fine. If it is growing less fast that the government wants, then further depreciation is warranted. That has been the case in China over the past 12 months. They would have preferred to have had faster NGDP growth. So a weaker yuan was desirable.

    Other things equal, a more expansionary monetary policy should do lots of things. It should depreciate the currency, cause inflation, and raise NGDP. I am saying that NGDP is the right benchmark to decide if monetary policy (and the exchange rate) is at the right level.

    I don’t blame you for being confused, it is an unusual way to visualize the issue.

    OGT, I’d be the first to admit there are structural distortions in the Chinese economy, and that these may have reduced saving. But changing the exchange rate doesn’t get rid of these distortions. I think reducing the role of the government would help. A lot of saving is either government saving or SOE saving. Also keep in mind that Chinese data has been questioned, although I think you are probably right about the high and rising savings rates.

  25. Gravatar of Robert Simmons Robert Simmons
    29. October 2009 at 05:52

    I guess my problem is that the reasoning seems circular to me. We look back and see NGDP growing nicely and say that it’s because of good monetary policy. How do we know it’s good monetary policy? Because NGDP grew nicely. I suppose it follows from the assumption that monetary policy controls NGDP, but I’m not quite convinced that that’s true. Also not convinced that it’s not.

  26. Gravatar of Scott Sumner Scott Sumner
    30. October 2009 at 11:27

    Robert, I see your point, but the crucial thing you miss is that I favor targeting expected NGDP, not actual. And I favor creation of an NGDP futures market. As an example, we already have CPI futures. So I am saying that if the Fed wants to target inflation at 2%, then they need to expand until the current 2 year CPI contract shows 2% inflation expectations. And they can do this in real time, not just looking back at what happened in the past. If they target expectations and the actual turns out to miss, I won’t make any criticism of the Fed. I am only criticizing them for not even targeting their own forecast.

  27. Gravatar of Robert Simmons Robert Simmons
    30. October 2009 at 13:10

    So, would you say then that you think that China had good monetary policy based on the results, but that without an NGDP futures market for them that your confidence in that statement is weaker than it otherwise would be? I’m still thinking these things through, so not sure if I agree with that, but it seems like a reasonable position.

  28. Gravatar of ssumner ssumner
    31. October 2009 at 07:19

    Robert, That is a tough question. In a perfect world it would ahve been better for China to have had an even more expansionary monetary policy—a lower value for the yuan. NGDP was a bit lower than desirable. However political pressure from the US and EU made that option difficult. So I think China did pretty well in a difficult world situation.

  29. Gravatar of Robert Simmons Robert Simmons
    1. November 2009 at 18:13

    Rereading my comment it’s my own fault, but you answered the wrong aspect of my question. My intent was more to get at the process you use to evaluate, less the conclusion. Of course both are important, but I’m trying to understand what methods you use, what measures you look at, how you weigh them, etc., in the absence of NGDP futures markets.

  30. Gravatar of ssumner ssumner
    2. November 2009 at 06:36

    Robert, Now I see your point. Without a NGDP future market, I would be inclined to look at actual NGDP, which slowed sharply.

    They could also look at market inflation expectations in countries like the US and UK, which do have CPI futures. This gives them a sense of where the developed world is headed. And of course China’s growth prospects are linked to the rest of the world.

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