Why does Forbes have such contempt for the markets?

Here is a quotation from a recent article in Forbes:

China’s mercantilist trade policy is another contributor to its asset bubble. By artificially depressing the value of its currency and making it difficult for locals to invest abroad, China has forced an artificially large amount of capital to chase after domestic investments, inflating property and stock prices. It’s the same scenario China pursued in late 2007, before its stock market lost two-thirds of its value, but that era was characterized by monetary restraint compared with today.

“It’s a pure debt game,” says Andy Xie, an economist who advises private investors and sees the current bubble as “much worse than previous ones.”

In late November China’s ruling Politburo declared that the nation’s monetary and fiscal promiscuity will continue into 2010. The markets, predictably, were overjoyed. Economists who see parallels to the Russian and Brazilian financial crises a dozen years ago are less sanguine.

Let’s see if we can figure out Forbes’ agenda.  The 2007 policies of mercantilism blew up a big bubble.  And according to Forbes this somehow explains the sharp rise and fall of Chinese stock prices.  And what about the fact that stocks also rose and fell sharply in countries that did not pursue mercantilist policies?  No answer.  And why didn’t stocks stay high?  After all, they are still pursuing those policies, aren’t they?  Again, no answer.

And how about those “Economists who see parallels to the Russian and Brazilian financial crises a dozen years ago?”  Would those be the same economists who (as a whole) failed to predict the Russian and Brazilian crisis (and almost every other economic crisis in world history?)  To its credit, Forbes does admit that the record of economists is something less than perfect:

China naysayers have been wrong before. Gordon Chang, author of the 2001 book The Coming Collapse of China, has warned–wrongly, so far–that doom lies around the corner. Cushioning China’s economy is its high growth rate, an estimated $260 billion (but declining) annual current account surplus and, at $2.3 trillion, the world’s biggest foreign exchange reserve.

But the statement that really jumped out at me was “The markets, predictably, were overjoyed,” from the first passage I quoted.  Note how the statement is dripping with sarcasm.  You’d think it was uttered by someone like Paul Krugman.  But no, it was Forbes magazine, the self-styled “capitalist tool.”  With friends like Forbes capitalism hardly needs enemies.  If Forbes is right, and the markets are made up by a bunch of fools, then why not go with socialism?

Here’s what I think is really going on.  The right has a political agenda.  When the stock market agrees with that agenda, the Wall Street Journal and Forbes love to cite its response to policy initiatives.  For instance, in an earlier post I mentioned how the markets were strongly opposed to Smoot-Hawley, and seemed to favor NAFTA.  But when markets don’t agree with the right’s deflationary agenda, suddenly the markets are just as unreliable as a Marxist economist.

You might wonder how I can claim that conservatives favor deflation?  Well look at the sentence that preceded Forbes sarcastic dismissal of markets:

In late November China’s ruling Politburo declared that the nation’s monetary and fiscal promiscuity will continue into 2010.

That’s right, even though China has been in the grip of deflation over the past 12 months, Forbes characterizes their monetary policy as “promiscuous.”  If it were Playboy magazine that might be a compliment, but in context I am pretty sure Forbes is saying monetary policy is much too expansionary.

Of course this should be no surprise, as the right also thought monetary stimulus was excessive in the early 1930s, even as prices fell sharply.  In contrast, those foolish stock investors greeted FDR’s devaluation of the dollar with a huge rally.  And of course many voices on the right, some in Forbes itself, have leveled a steady drumbeat of criticism against the supposedly excessive monetary stimulus of the Bernanke Fed over the past 18 months.  And again, the markets don’t agree, rather they think that even more monetary stimulus would be helpful.  So what does the right do when the markets bring them the message that deflation is not helpful to capitalism, and instead just opens the door to left wing demagogues?  They don’t rethink their views.  Instead they blame the messenger.

BTW, I have no opinion on where Chinese stock or housing prices are headed.  China has always had dramatic ups and downs in its markets, and will continue to do so.  China’s overall economy will continue to grow rapidly, with occasional sharp recessions, as in 1990.  And just as in every previous recession and bear market, the majority of economists (including me) will fail to see it coming.  And as for “overbuilding,” Forbes ain’t seen nothing yet.  Over the next 30 years China will construct a mind-boggling amount of new residential and commercial buildings.  The comparisons with Japan circa 1990 are just plain silly.

After writing this post I came across two other stories that I thought were worth mentioning.  Today’s Wall Street Journal had a scary story about the current debt binge in China.  But it also contained a couple odd paragraphs that seemed to undercut their argument:

China’s banks used to be, in effect, lending arms of the government. That led to an enormous pile of nonperforming loans that, by the late 1990s, rendered most state banks technically insolvent. In response, Beijing stripped nearly $200 billion of rotten debt off the banks’ books and injected tens of billions of dollars more in capital. It also pushed the banks to adopt risk-based lending systems, an effort that made major progress in recent years.

But with the economic downturn last year, Beijing told banks to open the credit floodgates. About a quarter of new loans in the first nine months of the year went into infrastructure, but riskier manufacturing and property investments accounted for about 5% each.

So the previous loan fiasco of the late 1990s led to a $200 billion dollar bailout, and was followed by an enormous economic boom.  Is that so bad?  And will this debt binge be any different?  One other question for any China experts reading this: Are those 5% figures misprints?  Most of the bubble fears seem related to manufacturing overcapacity and a possible housing bubble.  Almost no one thinks China doesn’t need more infrastructure.

Take a look at this link I found on marginalrevolution.  In 1994 I took a train to Wuhan—it wasn’t a pleasant trip.  They just opened a new 700 mile line between Wuhan and Guangzhou—three hours by train and nearly the distance between NYC and Chicago.    Check out all the train stations pictured.  Almost every single one is located in an inland city, the ones that American journalists are always telling us are missing out on the great coastal boom.  Actually, many of those inland provinces are now growing faster than coastal provinces, and will continue to do so (albeit from a lower base.)

PS.  Speaking of China, I got a lot of grief for arguing that the Chinese weak yuan policy helped China recover after March 2009, and that this also helped the world economy.  This year’s Chinese trade surplus fell sharply from $295b to $198b, but mostly due to lower Chinese exports.  Check out Bloomberg’s prediction for 2010, and the forces that will drive the Chinese trade surplus still lower:

Bloomberg) “” China’s trade surplus may slide 19 percent in 2010 as imports surge because of growing domestic demand, Bank of America-Merrill Lynch said.

The amount will narrow to $160 billion from an estimated $198 billion this year, Lu Ting, a Hong Kong-based economist for Merrill, said in an interview today.

A smaller surplus may reduce friction between China, which is poised to become the world’s biggest exporter, and its major trading partners, the commerce ministry said Dec. 16. Disputes with the U.S. or Europe span shoes, tires, screws and the Obama administration’s complaint this week that Chinese plans to foster “indigenous innovation” are erecting a trade barrier.

“The key factor in the narrowing of the surplus will be the increase in imports, driven by rising domestic demand,” Lu said. In 2010, imports may climb 16 percent, outpacing a 9 percent gain in exports, he added, forecasting an economic expansion of 10.1 percent.

Another 16% increase in imports as China continues its “mercantilist” policies.

And then there is this story from today’s Wall Street Journal:

Could a solution to Japan’s economic malaise be just across the East China Sea? While China is a growing rival to Japan, it also looks like one of the best routes to lift Japan out of its malaise.

Already, in 2009, China has displaced the U.S. as the largest overall buyer of Japanese goods, including its top exports: machinery, and electronic goods and parts. It now accounts for nearly one-fifth of Japan’s exports by value.

Being more closely tied to fast-growing China is certainly a welcome development for Japan’s export-reliant economy, which shrank to 2004 levels in the recent financial crisis. Some uncommonly upbeat reports from Japan reflect the shift. Exports to China jumped almost 8% in November from a year earlier, the first increase since September 2008. Those to the U.S., meanwhile, fell by about the same percentage.

UBS estimated earlier this year that a 10% increase in exports to China would add about 0.2 percentage point to Japan’s annual economic growth. Marginal? Not for an economy that has averaged only a bit more than 1% annual growth in the past decade.

To summarize, I keep hammering away at two big China myths.  The weak yuan does not hurt the world economy, and thus shouldn’t be discouraged.  And China is not a bubble.  China may contain all sorts of bubbles (certain property sectors, SOE investment) but China isn’t a bubble.  It is a huge growth story that is slowly but surely getting better governance.



16 Responses to “Why does Forbes have such contempt for the markets?”

  1. Gravatar of StatsGuy StatsGuy
    30. December 2009 at 19:24

    Much of China’s reorientation toward domestic production is driven by the central government’s realization that an excessively export-oriented economy with high fixed assets and transportation infrastructure creates a form of dependence on foreign demand – and that’s an evil word in China. (It’s an evil word in the US too…) Hence, there is a deliberate move toward building the domestic market.

    Not going to re-hash the Yuan debate too much; the contention was largely over your assertion that a “weak” Yuan was good for the world economy (kind of like Krugman arguing that deficits saved the world). Both are true in a limited sense, but only because so many other policy stances are backwards. And when we you finally elaborated, you clarified that you were not arguing that (IF the US had engaged in proper monetary policy) the world was better off with a Yuan that was artificially suppressed via exchange rates. There’s a secondary question of whether China should keep the Yuan low by letting the Yuan float and using conventional monetary tools – that’s more complicated, and that’s where I would argue that charges of Mercantilism are legitimate. Existing policies clearly suppressed domestic consumption as a way to build a huge foreign currency war chest. I still don’t know where you stand here, but to argue that a 20 year policy of suppressing domestic consumption and funneling currency reserves into export-oriented firms was “good” requires a stark deviation from free market economics. I may even agree with you (in the long run, the world needs a China that is NOT poor), but were currency controls the best way to get there? Maybe. But let’s call it what it was – mercantilism.

    Last note – you comment that $200 billion is a small price to pay for a decade of growth. This is basically the same argument that US banks have made regarding the Moral Hazard argument in the US. i.e. The final bailout costs would have been CHEAP if the Feds had just rescued Bear and Lehman and WaMu earlier… And isn’t that a fair price to pay for 10 years of growth? The counterargument is Andrew Haldane’s “Doom Loop”.


    And, interestingly, you recently seemed sympathetic to the notion that Moral Hazard was a significant (perhaps the largest) initiating-cause of the recent crisis. There appears to be a slight inconsistency here, though I could be missing something. (The pro-regulatory response, btw, is that good macroprudential/administrative regulation of bank lending in combination with supportive monetary policy can get most of the good while limiting the bad.)

    BTW, you are correct about how the right interprets the market; variously characterized as “dumb” or proof that govt policies will fail, whichever is convenient. Also, have you noticed a recent conservative press/blogger blitz about how China simply _must_ implode soon? While at the same time arguing that China is going to own the US soon because the US is debasing the dollar? Care to speculate on this?

  2. Gravatar of ssumner ssumner
    30. December 2009 at 22:25

    Statsguy, There are two meanings of “mercantilism.”

    1. Protectionism
    2. Government saving by accumulating foreign assets.

    The first is far worse than the second (although of course every country has some barriers to trade.)

    The question of whether China should accumulate a lot of foreign assets is a complicated one. I would break it down into two parts. Should the Chinese governemtn save a lot of money? And should those savings be put into foreign or domestic assets? I don’t know the answer to either question. On the question of whether they should save a lot, I can think of pros and cons:

    1. Con: It violates free market principles which say we should let the public decide how much to save. And it makes sense for a poor, rapidly growing country to borrow against future income.

    2. Pro: It makes sense for a country which will within a few decades be mostly middle class, and aging rapidly, and yet lacks a social security system, to have the government put away some savings. You probably noticed that I am very pro-saving, mostly as I see it as a way of reducing the size of government in the future. I hope China can avoid the sort of unfunded social security monstrosity that we have.

    So let’s say China should save quite a bit. The next question is whether the Chinese government should purchase lots of domestic assets, or lots of foreign assets. If they are trying to move away from communism, there is something to be said for the Chinese government refraining from buying up trillions in domestic assets.

    In the end I don’t have strong views one way or another, except that this form of mercantilism is much more benign than the protectionist mercantilism.

    You misunderstood my point about the $200 billion dollars. I certainly am not in favor of that sort of policy. But I think outsiders often fail to grasp what is at stake in a country like China. There are 100s of million of very poor people. The sense I get reading many of these news articles on China, is that they think it is a sort of bubble that is about to burst, plunging an already developed country into distress. And that’s what I am questioning. I don’t doubt that all sorts of Chinese bubbles will eventualy burst, and I don’t doubt that there is lots of problems with moral hazard that they would be better off without. What I do question is whether these problems are severe enough to seriously derail the Chinese boom. What matters in China is not banks, not foreign exchange reserves, not even trade, it is the living standard of 1.35 billion people.

    In contrast, the US is already a developed country, so we worry about much smaller things. I get outraged by the waste involved in the S&L fiasco of the 1980s, even though its effect on the average American’s living standards was relatively minor.

    And finally, there is the historical perspective. Perhaps the reason why I seem more optimistic on China than most others, it that I remember that when I was in grad school it was poorer than India, poorer than sub-Saharan Africa. So while the problems everyone discusses are real, I think the doomsters are missing the bigger story. Would people be negative about Africa right now if sub-Saharan Africa had made as much progress in the last 30 years as China? If all the major African cities were being connected by sleek new high-speed rail lines? I don’t think so.

    You said;

    “Last note – you comment that $200 billion is a small price to pay for a decade of growth. This is basically the same argument that US banks have made regarding the Moral Hazard argument in the US. i.e. The final bailout costs would have been CHEAP if the Feds had just rescued Bear and Lehman and WaMu earlier… And isn’t that a fair price to pay for 10 years of growth? The counterargument is Andrew Haldane’s “Doom Loop”.”

    I totally disagree with the banks. They were private, the government should not have bailed them out. (At best it might have been a second best policy to prevent the Fed from screwing up.) In the 1990s the Chinese banks were government owned, they had to be bailed out.

    You said;

    “BTW, you are correct about how the right interprets the market; variously characterized as “dumb” or proof that govt policies will fail, whichever is convenient. Also, have you noticed a recent conservative press/blogger blitz about how China simply _must_ implode soon? While at the same time arguing that China is going to own the US soon because the US is debasing the dollar? Care to speculate on this?”

    Yes, there is a lot of silliness in all these predictions of doom. The exact same things were written in the 1990s. They were right that there were a lot of bad loans, but wrong about what that implied about future Chinese growth. And as you say, some of these arguments are not even internally consistent.

    To summarize, I am not saying people should look at China trhough rose-colored glasses, just have a sense of perspective. To develop a country needs to do three things; build lots of houses, build lots of factories, and build lots of infrastructure. That won’t make you as rich as the US, but you can become developed that way. And that is what China is doing. To get as rich as the US they need sophisticated services like dog psychologists, first rate universities, and sophisticated high tech industries like software and biotech. But right now China just needs to become developed.

  3. Gravatar of david glasner david glasner
    31. December 2009 at 03:37

    Here is the comment I posted on the old blog

    Scott, We have talked about this before, and I think that we have a slightly different take on Chinese policy. I agree with you that there is no problem with the Chinese pegging their currency to the dollar. In fact, an appreciating remnibi would be downright dangerous because of its potential deflationary effect. But that is not to say that the Chinese are blameless, but the problem with China is not the value of the remnibi. It is that they are sterlizing enormous inflows of dollars and accumulating huge (2+ trillion and counting) holdings of dollar reserves. This is forced savings with a vengeance, and is indefensible. If the Chinese had allowed their domestic money supply to expand rapidly as they were accumulating dollars , Chinese consumers would have been able to consume more imported products than they did and Chinese producers could have sold more products in the domestic market than they did instead of having to export. Chinese inflation would have been higher than it has been, but that is what one expects in a country, with a fixed exchange rate in terms of another currency, whose productivity is increasing faster than that of the country in terms of whose currency its exchange rate is fixed.

    The Japanese collapse in the 1990s was caused by the deflation that resulted because they yielded to pressure to allow the yen to appreciate against the dollar. Of course the Japanese were also sterilizing dollar inflows and accumulating excess dollar reserves, precisely the model that the Chinese have been following. Forcing the Chinese to tolerate a significant appreciation in the remnibi would cause just the collapse in the Chinese economy that the debt binge in China is supposedly leading to.

  4. Gravatar of OGT OGT
    31. December 2009 at 06:51

    I don’t quite understand your distinction between there are bubbles in China and China as bubble, this time is different, with Chinese characteristics? I suppose it depends on the scale of the bubble and whether it will materially affects the pace of growth in China.

    There are a couple of crucial differences bewteen now and the 1990’s bubble. One is the scale of the lending this year has been unprecedented, much larger even as a percentage of GDP than the 1990’s credit bubble. Second, they escaped the 1990’s financial crisis by exporting their way out, does anyone see that happening this time?

    Finally, on the question of infrastructure there is the question of whether the current investment are appropriate to China’s level of development. As, Michael Pettis notes, if the total economic benefits are less than the cost of investment we can not assume away the difference, some part of Chinese society will have to pay for it.

    China is clearly on the world stage to stay, and their growth rate will almost certainly outpace the US for some time. But, past performance is guarantee of future results, especially, in this case, where I’d argue, Chinese officials are going to the same well one time too many.

  5. Gravatar of StatsGuy StatsGuy
    31. December 2009 at 07:29

    OGT –

    At risk of being utterly stupid… (has that stopped me before?) this time is different for China. The reasons are simple: the trade surplus and the currency reserves.

    I happen to agree with Ssumner that China may have been wise to accumulate large savings in foreign assets (though it may have overdone a good thing) – but I’ll add a new reason to the pile: the punitive aspects of the fickle international capital markets.

    The massive foreign reserve is a war chest that insulates China from the ebbs and flows of international capital markets – which can drive both booms and busts in an economy with heavy trade exposure. For a long time, the US dismissed these concerns as inconsistent with free market principles – and they are – but the US had a privileged position as the only country that could print the international reserve currency (not to mention its huge accumulated wealth post WWII) so it was not under threat of a currency run. But if you look to other countries… Argentina has been on the receiving end of this punitive action for a very long time.

    The unfortunate thing is that China’s savings have come at the expense of a US deficit, and the sheer magnitude of that saving stockpile (combined with persistent deficits in the US, both trade and CA) has put the reserve currency in jeopardy. The US is now beginning to feel the ebb and flow of the international capital market tides, and it’s making us a little sick. Hence the 2008 commodity run on the dollar.

    It think it’s very important to think a little differently about money in an international setting (with no central authority) – money is an IOU, essentially an obligation that is unenforceable. However, the _domestic_ costs of reneging on that IOU (e.g. inflation) are substantial. Thus, financial security (saving) comes at the expense of someone else owing (jeopardy). This means countries that owe a lot pay a risk premium, and are subject to runs… No one wants to owe (unless they are forced by domestic demand and govt deficits, like over-consuming western economies), especially poorer countries trying to grow – thus, many successful growth stories in the last 50 years have been financed by forced domestic savings. (You can call this anti-free market if you want, but it’s true.)

    Meanwhile, the lesson that countries like Brazil and China and Korea have taken away from the currency runs of the 70s and early 80s (and later the east asian economies in the 90s) is NOT that import substitution or export promotion is bad or domestic investment is bad, but rather that overconsumption (relative to net exports) is bad.

    As an aside, one of the virtues of Gold is not so much that making more is hard (though, perhaps not that hard). But rather that as an _exogenous_ source of money, the provision of this as a means of international savings does not require that one country (or a couple countries) place themselves in debt (jeopardy) to allow other countries to build up savings (security). In that sense, of course, gold could easily be replaced by an international treaty system (e.g. an IMF special drawing rights system) that could have many of the features.

  6. Gravatar of ssumner ssumner
    31. December 2009 at 08:01

    I moved this Doc Merlin comment from the old blog:

    Doc Merlin
    29. December 2009 at 23:24 (#)
    I hear the fed is planning on issuing its own debt. If they do that, have they officially made the treasury department irrelevant?

  7. Gravatar of OGT OGT
    31. December 2009 at 08:12

    Statsguy- We are perhaps talking past each other, which given the number of typos in my last comment is not surprising. I am very specifically refering to the domestic credit explosion in China the last 15 months being directed into housing, infrastructure, ship building, commodity stockpiles, the stock market, car purchases (rumored as SOE fleet cars) and factory production.

    However, I think you refute your own argument to an extent by noting the magnitude of China’s savings and the destabilzing effects on the dollar (and, hence, world economy). The so-called Asian model development path (also pursued by the US in the past) is not open to China, at this stage, due to its size and the debt levels in the west. No one, I gather, thinks India and China could pursue export intensive savings strategy at the same time.

    David Glasner- While I take a dimmer view of China’s currency peg, I quite agree with on the steilization being at least as important as the peg itself. The financial repression that is part of the peg, and bank recapitalization, has significantly distorted the path of development in China and the world economy.

    I’d quote a recent Pettis post on that:


    The low deposit rates mean that Chinese savers are effectively being taxed to replenish bank capital. Although this may be necessary in order directly to maintain the health of the banking system, it indirectly undermines the banking system in another way. By forcing Chinese households not only to subsidize China’s very low cost of capital for producers and SOEs, but also to protect the banks from the effect of economically non-viable policy loans, Chinese households are bearing a pretty hefty share of the cost of China’s investment-led boom, and it is these same households whose surging consumption will be necessary to absorb the increased production resulting from the investment boom.

    Given the increased financial burden being placed on them, I doubt that they will be able to do so. After all, it is because of lesser versions of these same policies in the past that the enormous gap between production and investment exists in the first place. And if they cannot raise their consumption sharply to absorb all this additional excess production, the banks will be stuck financing rising inventory and unprofitable companies. It’s a vicious circle.

  8. Gravatar of Doc Merlin Doc Merlin
    31. December 2009 at 08:26

    Heh, oh Scott that reminds me. I agree with you on one thing. Foreign countries (who don’t owe us lots of money) launching massively inflationary monetary stimuli is wonderful for our own economy, at least in the short term.

    In the short term it has all the benefits of launching our own monetary stimulus with fewer down sides, for us.

  9. Gravatar of ssumner ssumner
    31. December 2009 at 08:44

    David, I partly agree, but not totally. As you can tell from my long reply to statsguy above, I see the accumulation of foreign assets as distinct from monetary policy, rather as a sort of fiscal policy. The Chinese did experience significant inflation in the middle of the decade, due to the Balassa-Samuelson effect that you describe. They could have had a somewhat more expansionary monetary policy with their fixed yuan policy during 2008-09, but not that much more expansionary, as the weak world economy pushed China towards deflation (due to PPP.) Recall that in 1998 the weak East Asian economy pushed China into deflation, even though the Chinese government was obviously trying to avoid it. PPP is more powerful than many people think, especially in a country like China where price competition is fierce. (Much less so for countries like Germany.)

    The term ‘sterilization’ may be correct, but note that it’s implications are much different under a system of (mostly) floating fiat currencies, than under the gold standard.

    China also did a massive fiscal stimulus, which is something foreign countries who worried about world AD should have welcomed.

    As I said to statsguy, I think the question of whether China should be accumulating foreign reserves is a close call. I can see arguments on both sides. But one thing I am pretty certain about–this is not something western countries need worry about. If the Chinese are hurting anyone, it is their own consumers.

    OGT, I actually agree with your comment in many ways. The Chinese will not be able to export their way out of the crisis, they are simply too big and there is not enough demand out there. I also agree with you and Michael Pettis that much of the infrastructure they are buliding is far too good for a country like China. On the other hand there are worse problems out there. Subways, highways, highspeed rail and airports last a long time—and China will be much richer in the future. So we are not talking about white elelphants like steel mills in Nigeria or Sicily, these are projects built a few years too soon, not useless projects.

    Again, it all comes down to the glass half full/half empty distinction. Compared to Switzerland there are huge flaws in the Chinese model. Compared to the China of 1979 it is paradise.

    When I say China isn’t a bubble, I am thinking of countries like Romania in the 1970s, which showed nearly 10% growth rates if my memory is correct, and we later found out that it was all a house of cards. That is not what is going on in China, despite all the very real problems that you point to.

    Since you know quite a bit about China, any thoughts on those 5% figures for housing and manufacturing loans? Do you think it was a misprint by the WSJ? I would have thought the percentages to be much higher.

    Statsguy, You said;

    “The unfortunate thing is that China’s savings have come at the expense of a US deficit, and the sheer magnitude of that saving stockpile (combined with persistent deficits in the US, both trade and CA) has put the reserve currency in jeopardy.”

    But whose fault is this? Germany has run huge trade surpluses despite higher wages than the US. So doesn’t this trade deficit in the US reflect specifically American issues, rather than being the necessary offset to a Chinese surplus. Yes, the US and China are big, but there are lots of other countries out there that we have deficits with.

    You said;

    “This means countries that owe a lot pay a risk premium, and are subject to runs… No one wants to owe (unless they are forced by domestic demand and govt deficits, like over-consuming western economies), especially poorer countries trying to grow – thus, many successful growth stories in the last 50 years have been financed by forced domestic savings. (You can call this anti-free market if you want, but it’s true.)”

    Yes, but recall that a country which is arguably most similar to China today, South Korea of the 1970s and 1980s, ran persistent CA deficits. So CA surpluses are not necessary for successful development.

    You said;

    “Meanwhile, the lesson that countries like Brazil and China and Korea have taken away from the currency runs of the 70s and early 80s (and later the east asian economies in the 90s) is NOT that import substitution or export promotion is bad or domestic investment is bad, but rather that overconsumption (relative to net exports) is bad.”

    I hate to see these models mixed together. Pure import substitution is anti-trade. In Latin America this was the policy prior to 1980. But East Asia was different. Yes they had tariffs, but the export subsidies mostly negated the effects of the tariffs in terms of the total amount of trade (though obviously not its composition.) So East Asia had a much more pro-trade policy regime than Latin America.

    Regarding your final paragraph, recall that while debts are a zero sum game, net wealth is not. It is possible for all countries in the world to save more, and for all to simultaneously improve their net wealth position.

    Doc Merlin, I doubt that they will issue anywhere near that much, but I am no expert.

  10. Gravatar of StatsGuy StatsGuy
    31. December 2009 at 10:10

    OK – since you’ve brought up South Korea a few times now:

    1) Let’s review the data – the “negative” CA balance was not that negative, and in the period of most aggressive growth (80s and onward) was flat-to-positive most of the time. (And in spite of that S. Korea still had a currency crisis that required IMF rescue in the 1990s).


    2) S. Korea was incredibly resource poor and devastated by war, and therefore could not finance its own industrialization with resource-based exports. Looking at the composition of the deficit – much of the CA “deficit” thus went to structural investments and industrial plant. Thus, the _modest_ and non-persistent deficits in the 70s and the first couple years of the 80s (but not the latter 80s) is not an argument that S. Korea was not using trade policy to force savings.

    3) Even earlier, much of S. Korea’s deficit went to schools and basic infrastructure (following the Korean War), and indeed much of _that_ was financed by foreign aid from the US (due to S. Korea’s critical role in the Cold War). Throughout, S. Korea had strong trade policies (as you’ve noted). Also, the CA deficit may have been held down because some of that early trade deficit was paid for by remittances of international workers/family members… which was a very significant source of funding, to the tune of billions of dollars a year.

    If S. Korea is the best example of how running persistent CA deficits can still be good for growth, I struggle to see the case. Meanwhile, on the other side, we have _many_ examples of the strongest growing developing economies being ones that used trade policies to suppress consumption – and that’s mercantilism.

    So if you are arguing that mercantilist policies can be helpful for developing countries to escape the poverty trap, then yes – I agree with you.

    Indeed, because of long term gains from trade, wealthy countries may even be better off allowing this _as long as it isn’t taken to an extreme_.

    Regarding the question of “whose fault is the trade imbalance” – you’ve indicated the problem is with the US. Perhaps too much govt. spending? (But Germany has us beat there…) Maybe we just like to spend without paying taxes (yep)… But part of the problem is also the fact that the dollar was overvalued due to global exports of dollars (which were in high demand). This too would cause deficits with most trading partners. And they both were present. Bilateral Chinese/US trade is just the most egregious case.

  11. Gravatar of OGT OGT
    31. December 2009 at 10:33

    SSumner- I guess we are in a fair amount of agreement. I suspect there are some white elephants out there given the quality of local governance in China, but overall your are right that much of the infrastructure investment will eventually have some positive return. There are certainly worse places funds could have gone to (and some are).

    I guess the half empty side comes from the scale of loan issuance and building projects relative the Chinese economy. The changed global environment. And the pattern losses have been paid for in the past, through implicit taxes on households.

    Those 5% numbers seem low to me as well compared to other things I’ve read. As I understand it, there are many moving parts to the stimulus, perhaps the WSJ is referring to the major banks only. I believe the smaller banks, which are subject to more local government pressure, have been more involved in real estate and factory loans.

  12. Gravatar of Marcus Nunes Marcus Nunes
    1. January 2010 at 05:19

    Krugman is square on the “China is Mercantilist” canp:

  13. Gravatar of david glasner david glasner
    1. January 2010 at 10:04

    Scott, You make a reasonable point that the Chinese government might want to engage in some collective savings by holding US dollar denominated assets (except that the return on those holdings will almost certainly be negative over the relevant time horizon, so your premise needs more than a little bit of repair work). There is also a reasonable argument that there is a liquidity return to the Chinese and other developing countries from holdings of dollar assets. But can those arguments plausibly rationalize accumulating 2 trillion dollars in the space of five years? I really can’t imagine how that would work.

    Since the effect that I am describing does not pertain to developing countries in general, but to Chinese sterilization of dollar inflows in particular, I don’t think that it is properly descibed as a Balassa-Samuelson effect. It is rather the (Max) Corden exchange rate protectionism effect in which a country sterilizes inflows of foreign currency to prevent either domestic inflation or currency appreciation as a way of holding down its real exchange rate for the purpose of subsidizing its tradable goods sector at the expense of its non-tradable goods sector. The two are obviously related, but they aren’t the same. I agree that PPP will tend to limit the Balassa-Samuelson effect, but it won’t limit the Corden effect until the cost of exchange rate protection become prohibitive.

  14. Gravatar of ssumner ssumner
    1. January 2010 at 19:51

    Statsguy, I read that graph very differently than you. S. Korea’s high growth period was 1964-97. That’s 34 years. I only see 4 clear surplus years in that period. Since 1998 Korea has entered a slower growth phase, and they run surpluses. I don’t see that as even coming close to supporting the view that Korea developed through CA surpluses.

    I also think it depends how you define “mercantilism.” You mention policies that suppress consumption. What about Singapore and Hong Kong? As I see things 2 of the famous four dragons were free traders, another had tariffs but mostly ran CA deficits during its high growth phase. I don’t know what Taiwan’s policy was. Now you could argue that Singapore suppressed consumption, but I regard that as fiscal policy, not trade policy.

    In Latin America, Chile is the most successful country. They have some tariffs, but in general they are more of a free trader than many other Latin American countries. So I am skeptical of mercantilism, at least as I’d define the term.

    OGT, We probably aren’t far apart. With China it’s like the blind man feeling the elephant; you get a very different perspective depending on how you look at things, and which part of the Chinese economy you focus on. I like to emphasize that the Chinese miracle is going from an unbelievably inefficient policy regine, to simply a very inefficient policy regime. That change was enough to increase RGDP something like 8-fold. But more work needs to be done.

    Marcus, Thanks, I’ll have something to say about that tomorrow. I think that is one of his worst posts ever.

    David, I don’t mean to suggest that foreign exchange accumulation was the Balassa – Samuelson effect, I was referring to increases in the real exchange rate that occur when countries grow fast.

    I agree the dollar probably won’t be a good investment, but where can China park 2 trillion dollars outside the US. The Yuan will also appreciate against the euro and yen.

    I still think the main motivation of the low yuan policy is not to help exporters but rather to accumulate a large stock of foreign exchange. Relative to the size of their economy, the cash hoard is not all that large. And their demographic time bomb combined with no real social security system has to have the government worried. If they want to set up a Singapore-type fiscal regime, and I have to think they are smart enough to see that Singapore’s approach is far superior to ours, then they will need a lot of money–much more than $2 trillion.

  15. Gravatar of StatsGuy StatsGuy
    1. January 2010 at 23:08

    “I don’t see that as even coming close to supporting the view that Korea developed through CA surpluses.”

    But I’m not arguing that – I’m arguing:

    1) that Korea is not a good example of development by running persistent (and significant) trade deficits as part of a free trade policy. Indeed, I’m skeptical there’s any normal country with a good/long track record of strong development that ran huge 20 year CA deficits.

    2) Yet, there are several countries with strong development track records that ran huge 20 year surpluses

    If we exclude the years leading up to the crisis and post-crisis, and look at just S Korea in 1980-1995, we get an average of half a billion in CA deficit a year, which is close to breakeven. There was a very large deficit leading up to 1997, which probably helped trigger the crisis, and the response was to run a huge surplus afterwards…

    I’m too tired to get into the idiosyncracies of Hong Kong/Singapore – both of which were very special cases in that they were small production economies that transitioned into gateway economies and wealth havens (a very unique role). (nor did they run large & persistent negative CA balances from 1980 on) Chile is probably your best example, although it did run a general tariff of 10% for a long time (in spite of a currency that was historically undervalued due to fears of political instability). Also, Chile didn’t exactly run a “strong peso” policy…


    You argue that forcing savings via fiscal policy is often better than forcing savings via trade policy – no challenge there, and if you stand by that as your main point, I concede it.

    Meanwhile, if you look at post-1997 behavior, ALL of these countries shift toward surpluses… which could reflect a desire to build reserves to insulate against currency runs (or could just be an overvalued dollar).

  16. Gravatar of ssumner ssumner
    3. January 2010 at 11:53

    Statsguy, Compared to most developing countries at the time, a 10% flat rate tariff was relatively close to free trade. There are no perfect examples of laissez-faire in the developing world, that’s why those countries are poor. The two freest developing economies, are also the two richest today, but of course supporters of interventionist policies say they are not representative because of their small size. Chile is the most successful in Latin America, but people point it had flaws like a 10% tariff. My response is that if it had a 0% tariff like Hong Kong, it would have done even better. People see what they want to see in all these examples. But recall when we look at developing countries today (and that excludes Singapore, HK, Korea and Chile, all considered developed) we are looking at failed states. So I’d say there aren’t many lesson to be learned. China is one of the poorest countries in E Asia, not a model for anyone.

    I don’t see how the dollar could be overvalued. It’s value is set in a free market. Foreign governments that hold T-bonds are part of that free market. No one would say that the international oil market is not a free market just because some of the buyers of oil are SOEs. I suppose this is just semantics, but the foreign demand for reserves is a part of the market, and the dollar’s value properly reflects that fact.

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