Interview of Brandeis economics professor Catherine Mann.
Archive for March 18th, 2010
Mr. Krugman is getting crazy these days. If his proposal was implemented, every country will engage in trade war like another Great Depression. Forget about recovery. This is simply stupid.
The final argument I hear about the renminbi is that it’s useless to make demands, because the Chinese will just get their backs up, refusing to bow to external pressure. The right answer is, so?
Here’s how the initial phases of a confrontation would play out – this is actually Fred Bergsten’s scenario, and I think he’s right. First, the United States declares that China is a currency manipulator, and demands that China stop its massive intervention. If China refuses, the United States imposes a countervailing duty on Chinese exports, say 25 percent. The EU quickly follows suit, arguing that if it doesn’t, China’s surplus will be diverted to Europe. I don’t know what Japan does.
Suppose that China then digs in its heels, and refuses to budge. From the US-EU point of view, that’s OK! The problem is China’s surplus, not the value of the renminbi per se – and countervailing duties will do much of the job of eliminating that surplus, even if China refuses to move the exchange rate.
And precisely because the United States can get what it wants whatever China does, the odds are that China would soon give in.
Look, I know that many economists have a visceral dislike for this kind of confrontational policy. But you have to bear in mind that the really outlandish actor here is China: never before in history has a nation followed this drastic a mercantilist policy. And for those who counsel patience, arguing that China can eventually be brought around: the acute damage from China’s currency policy is happening now, while the world is still in a liquidity trap. Getting China to rethink that policy years from now, when (one can hope) advanced economies have returned to more or less full employment, is worth very little.
US policy makers should understand the harder they pressure China to revaluate Yuan, the less likely they are going to get it. China is not another Japan.
What the US should do is to let Chinese policy makers appreciate that it’s mutual beneficiary to appreciate Yuan: with Yuan pegged to US dollar, China is essentially ‘importing’ the super easy monetary policy of the US, which adds fuel to fiscal and credit stimulus, potentially leading to even higher inflation.
Watch this FT video analysis on China’s recent exchange rate.
Paul Krugman says the US should take on China, and imposes 25% tariff. According to Mr. Krugman, a Nobel winning trade economist, he came to "propose this turn to policy hardball lightly":
What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down. Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.
It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.
So we have no reason to fear China. But what should we do?
Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”
But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.
Greg Mankiw, defending free-trade principle, argues that it's very hard to say whether Chinese Yuan is still overvalued after almost 21% appreciation since 2005. Blaming China during time of crisis is simply not very constructive.
Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.
There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy.
The situation is much the same as when the price of imported oil falls, as it has done in recent months. Domestic oil producers may see lower profits, but American consumers are better off every time they fill up their tanks. Consumers similarly gain when a cheap yuan reduces the prices of T-shirts and televisions imported from China.
Perhaps the oddest thing about Mr. Geithner’s move is that his complaint seems out of date. The yuan-dollar exchange rate has moved considerably in recent years. After a long period of completely fixing the exchange rate, China allowed its currency to start moving in July 2005. Since then, it has appreciated by 21 percent.
DIRECTING attention to the China currency issue amid a worldwide recession and growing fears of depression is more than a distraction. It is downright counterproductive. Senators Charles E. Schumer, Democrat of New York, and Lindsey Graham, Republican of South Carolina, have long proposed dealing with the yuan undervaluation by imposing tariffs on Chinese imports. The Treasury secretary’s comments risk stoking those protectionist embers.
Indeed, protectionist influences seem to be finding their way into the stimulus bill winding its way through Congress. The bill passed by the House included a provision banning the use of foreign iron and steel in infrastructure projects. The Senate has adopted a somewhat more flexible restriction (after voting down an amendment by John McCain to strip the “Buy American” provision from the bill).
I have always been wondering whether governments, through regulation, can prevent bubbles. I tend to think this is not the case. "Smart" people (frenzy investors, investment banks, etc.) can always find loopholes and circumvent the regulation. Also remember, in democratic societies, regulations are also the bargaining outcome of various interest groups. If government can single-handedly kill the bubble, we wouldn't find any bubbles in tightly regulated economies. In fact, what we actually observe proves otherwise.
Fan Gang, a well-known economist in China, argues Chinese government has learned the lesson from Japanese bubble 20 years ago, and Chinese bubble is an illusion. (source: Project Syndicate):
BEIJING – On the eve of Chinese New Year, the People’s Bank of China (PBC) surprised the market by announcing – for the second consecutive time in a month – an increase in banks’ mandatory-reserve ratio by 50 basis points, bringing it to 16.5%. Shortly before that, China’s government acted to stop over-borrowing by local governments (through local state investment corporations), and to cool feverish regional housing markets by raising the down-payment ratio for second house buyers and the capital-adequacy ratio for developers.
This latest round of monetary tightening in China reflects the authorities’ growing concern over liquidity. In 2009, M2 money supply (a key indicator used to forecast inflation) increased by 27% year on year, and credit expanded by 34%. In January 2010, despite strict “administrative control” of financial credit lines (the PBC actually imposed credit ceilings on commercial banks), bank lending grew at an annual rate of 29%, on top of already strong expansion in the same period a year earlier. While inflation remains low, at 1.5%, it has been rising in recent months. Housing prices have also soared in most major cities.
These factors have inspired some China watchers to regard the country’s economy as a bubble, if not to predict a hard landing in 2010. But that judgment seems premature, at best.
To be sure, China may have a strong tendency to create bubbles, partly because people in a fast-growing economy become less risk-averse. Thirty years of stable growth without serious crises have made people less aware of the negative consequences of overheating and bubbles. Instead, they are so confident that they often blame the government for not allowing the economy to grow even faster.
There are also several special factors that may make China vulnerable to bubbles. China’s large state sector (which accounts for more than 30% of GDP) is usually careless about losses, owing to the soft budget constraints under which they operate. Local governments are equally careless, often failing to service their debts. In addition, various structural problems – including large and growing income disparities – are causing serious disequilibrium in the economy.
But a tendency toward a bubble need not become a reality. The good news is that Chinese policymakers are vigilant and prepared to bear down on incipient bubbles – sometimes with unpopular interventions such as the recent monetary moves.
Whatever one thinks of those measures, taking counter-cyclical policy action is almost always better than doing nothing when an economy is overheating. Whereas some policies may be criticized for being too “administrative” and failing to allow market forces to play a sufficient role, they may be the only effective way to deal with China’s “administrative entities.”
In any case, the new policies should reassure those who feared that China’s central government either would simply watch the bubble inflate or that it lacked a sufficiently independent macroeconomic policy to intervene. The consequences of burst bubbles in Japan in the 1980’s and in the United States last year are powerful reasons why China’s government has acted with such determination, while the legacy of a functioning centralized system may explain why it has proven capable of doing so decisively. After all, although modern market economics provides a sound framework for policymaking – as Chinese bureaucrats are eagerly learning – the idea of a planned economy emerged in the nineteenth century as a counter-orthodoxy to address market failures.
Some people would prefer China to move to a totally free market without regulation and management, but the recent crises have reminded everyone that free-market fundamentalism has its drawbacks, too. No one has proven able to eliminate bubbles in economies where markets are allowed to function. But if the fluctuations can be “ironed out,” as John Maynard Keynes put it, total economic efficiency can be improved.
Government investment, which represents the major part of China’s anti-crisis stimulus package, should help in this regard. Roughly 80% of the total is going to public infrastructure such as subways, railways, and urban projects, which to a great extent should be counted as long-term public goods. As such, they will not fuel a bubble by leading to immediate over-capacity in industry.
Moreover, roughly 40% of the increase in bank credit in 2009 accommodated the fiscal expansion, as projects were started prior to the budget allocations needed to finance them. Over-borrowing by local government did pose risks to the banking system and the economy as a whole, but, given China’s currently low public-debt/GDP ratio (just 24% even after the anti-crisis stimulus), non-performing loans are not a dangerous problem. Indeed, they may be easily absorbed as long as annual GDP growth remains at 8-9% and, most importantly, as long as local government borrowings are now contained.
Finally, the leverage of financial investments remains very low compared to other countries. Using bank credits to speculate in equity and housing markets is still mostly forbidden. There may be leaks and loopholes in these rules, but firewalls are in place – and are more stringently guarded than ever before.
So is a Chinese bubble still possible? Perhaps. But it has not appeared yet, and it may be adequately contained if it does.