No, I’m Not Being Paid by the Chinese Government

No one has asked yet, but I’m sure someone will after this post.

Part One.  Who’s to blame for US unemployment?

Paul Krugman thinks the Chinese are a significant factor:

For something I’m working on: we know that China is pursuing a mercantilist policy: keeping the renminbi weak through a combination of capital controls and intervention, leading to trade surpluses and capital exports in a country that might well be a natural capital importer. We also know, or should know, that this amounts to a beggar-thy-neighbor policy — or, more accurately, a beggar-everyone but yourself policy — when the world’s major economies are in a liquidity trap.

But how big is the impact? Here’s a quick back-of-the-envelope assessment.

Start with the Chinese surplus. It has been temporarily depressed by the world trade collapse, but seems to be on the rise again. Blanchard and Milesi-Ferretti, at the IMF but speaking for themselves, project a Chinese current account surplus for 2010-2014 of 0.9 percent of gross world product.

.   .   .

In turn, this negative shock is like a negative shock to government purchases of goods and services. So it should have a similar multiplier. Multiplier estimates are all over the place, but tend to cluster around 1.5. So we’re looking at a negative impact on gross world product of around 1.4 percent. Not huge — China isn’t the principal obstacle to recovery — but significant.

And, if we think of the United States as bearing a proportionate share, and also use the rule of thumb that one point of GDP = 1 million jobs, we’re looking at 1.4 million U.S. jobs lost due to Chinese mercantilism.

Let’s start with the data.  Because I couldn’t find CA surplus forecasts, I’ll use trade data.  (Isn’t it trade surpluses that are a problem in the Keynesian model?)  In any case, the Chinese trade surplus was $295 billion in 2008 and $198 billion in 2009.  This year it is expected to fall to $160 billion.  If you believe in silly Keynesian C+I+G+NX “models,” then the change in China’s surplus has recently been a net positive for the rest of world.  And $160 billion is barely 1% of US GDP.

But let’s assume Krugman is right and that the trade surplus gets much bigger in the out years.  What then?  According to Krugman’s own model these surpluses only depress output if you are in a liquidity trap and can’t get out.  He sees the US economy as like that old codger on those TV commercials (“I’ve fallen and I can’t get up.”)  But almost no one thinks we are going to be in a liquidity trap in 2014, indeed many believe the Fed will begin its so-called “exit strategy” this year.  If so, that would completely invalidate Krugman’s argument.

But it is even worse.  Even Krugman doesn’t think we’ve fallen and can’t get up.  He has repeatedly emphasized that the Fed could still boost AD via inflation targeting.  The real problem is we’ve fallen and we won’t get up.  But if the US has the ability to raise NGDP through monetary policy, then the failure to do that is the US’s fault, not China’s.  China’s trade surplus has zero effect on US employment if we aren’t “trapped.”

BTW, I notice that Germany’s trade surplus over the past 12 months is $168.8 billion.  Saudi Arabia’s is $212 billion.  Yes, Germany is in the eurozone, but after all, they could leave the eurozone and revalue their currency upward.  I doubt Krugman would be mollified if China adopted the US dollar at the current dollar/yuan exchange rate and continued running surpluses.  One of the things I always disliked about Pat Buchanan is that he seemed to favor trade barriers against Asian countries, but not white countries.  I’d hate to see a liberal like Krugman slip into that trap, even if only accidentally.

You might be thinking “wait a minute, the post you linked to doesn’t advocate trade barriers aimed specifically at China.”  No but this one seems to:

Let me quote from a classic paper by the late Paul Samuelson, who more or less created modern economics: “With employment less than full … all the debunked mercantilistic arguments” — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He then went on to argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.

The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation.

Now it seems you no longer need a liquidity trap, just employment that is “less than full.”  Of course politicians think employment is always “less than full,” so this opens the door to almost unlimited trade wars.  (Note, Krugman is right and Samuelson is wrong, monetary policy must be “trapped.”)

There are many other problems with Krugman’s argument; so many one hardly knows where to start.

1.  It is misleading to focus on exchange rates.  Changing the nominal exchange rate does not eliminate trade imbalances if the underlying forces remain in place.  The yen has risen from 360 to the dollar in the 1960s to 85 to the dollar, and they continue to run big CA surpluses. Indeed all the big East Asian economies do, often much larger as a share of GDP than China.  And some are relatively open economies, without exchange controls.  The reason is simple; these are high saving nations with very low population growth.  When Japan was pressured to raise its nominal exchange rate they ended up with deflation, so their real exchange rate remains highly competitive.  When the Chinese yuan became overvalued during the East Asian crisis of 1997-98 they did not devalue, instead they experienced deflation until their real exchange rate was again competitive.  When the yuan became undervalued in 2005, China experienced rising inflation.  Nominal exchange rate changes, by themselves, solve nothing.  I do think Krugman understands this as he also mentions the underlying drivers of China’s surplus:

Under normal circumstances, the inflow of dollars from those surpluses would push up the value of China’s currency, unless it was offset by private investors heading the other way. And private investors are trying to get into China, not out of it. But China’s government restricts capital inflows, even as it buys up dollars and parks them abroad, adding to a $2 trillion-plus hoard of foreign exchange reserves.

This is the real issue. It is not about “subsidizing exports” (the sort of crude argument Krugman used to ridicule in his Pop Internationism days.)  Indeed contrary to what he says in this editorial, the Chinese government favors big SOEs, not the predominantly private exporters.  No, the real issue is China’s fiscal policy.  In other East Asian countries that have a high CA surplus, notably Singapore, there is a very high rate of savings.  This reflects the fact that Singapore has perhaps the world’s best fiscal policy regime.  China is still half communist and very underdeveloped.  They cannot simply wave a magic wand and copy Singapore.  But if they are smart (and I think they are) they understand that the Singapore high-saving model is much more sensible that the Western system of unfunded social insurance schemes.  So they have accumulated a nice $2 trillion dollar nest egg.  That may seem large, but when you think about the looming demographic nightmare they face, it is arguably far too small to set up a Singapore-type regime in the future.  China’s official GDP is only about $5 trillion, but in the blink of an eye it will be $20 or $30 trillion (due to 10% real growth, inflation, and yuan appreciation that will resume by 2011.)  They will soon need a much bigger nest egg.

To summarize, if we give Krugman the benefit of the doubt he isn’t so much asking for a higher nominal exchange rate, but rather for the Chinese government to stop saving so much.  BTW, what does this imply about the other East Asian countries that run surpluses because their private citizens save so much, often because they are forced to by the government?  Should we also put tariffs on their exports?

2.  Now let’s assume that everything I’ve said about Chinese government saving is wrong.  After all, it is a poor country.  And there are good counterexamples; Korea usually ran CA deficits during its 1960s-90s high growth phase.  Even in that case Krugman’s argument is completely indefensible on both practical and moral grounds.  For the moment let’s stop obsessing about our unemployment problem, and spare a thought for the millions of Chinese workers in coastal factories who were thrown out of work during late 2008 and early 2009.  Who’s to blame for that crisis?  I am pretty sure Krugman would say we are.  He thinks that the financial crisis of 2007-08 was caused by reckless policies in the US and in some European countries as well.  So we are to blame for the deflationary shock that hit the world economy in late 2008.

Now ask yourself what Keynesians think a central bank should do when faced with a deflationary world environment.  Krugman’s hero Keynes said FDR was “magnificently right” when he sharply devalued the dollar in 1933, even though we had a trade surplus and even though Keynes was British.  The devaluation was seen (correctly) as a way of reversing the deflation.  And it worked.  Indeed Krugman’s colleague Svensson called devaluation a foolproof way out of a liquidity trap, and recommended Japan adopt this policy.  And Japan also has big CA surpluses.

But China did not devalue, just as they refrained from devaluing in the 1997-98 Asian crisis.  All they did is temporarily halt their ongoing policy of currency appreciation.  As a result they still suffered some deflation in 2008-09.  Furthermore they adopted a massive fiscal stimulus, surely a policy that Krugman would approve of.  So the combined effects of this fiscal stimulus (widely seen as the world’s most effective in this crisis), and the monetary stimulus provided by putting currency appreciation on hold, was still not enough to prevent deflation.  But apparently this is still too much for Krugman.  He favors an even higher value of the yuan, which would have meant even steeper deflation in China.

But it’s even worse than this.  As I noted above, even Krugman doesn’t think that the unemployment suffered by the villains of the story (The US, UK, Spain, Iceland, etc) is caused by China.  We created the crisis, and then we in the US failed to adopt the sort of inflation targeting that could have prevented a big fall in US aggregate demand.  So let’s summarize Krugman’s apparent views and other generally accepted facts:

1. The US and other rich countries created this worldwide macroeconomic disaster through reckless policies.
2. Many innocent bystanders such as Chinese workers lost jobs as a result of US policies.
3. China is running a trade surplus due to government saving, but the deflationary impact of that surplus on the US could be offset with inflation targeting.
4. The Fed refuses to engage in effective monetary stimulus, and is on the verge of tightening policy.
5. Therefore let’s blame the Chinese.

How does Krugman think the richest country in world history should react to its own shameful policy incompetence?  He seems to think we should follow the example of Herbert Hoover and adopt protectionist policies.  Even worse, protectionist policies aimed at 1.3 billion mostly poor people.  Here is a question for sensible Democrats like Matt Yglesias, Brad DeLong and Mark Thoma:  Is that the sort of leadership from Obama that would restore US standing with the rest of the world?

Part 2.  China saved the (third) world in 2009.

Not only is China not to blame for the world’s problems, but the stimulus achieved by stabilizing the yuan and encouraging bank lending led to a surprising boom after March 2009.  As this article points out, this led to the fastest annual gain in commodity prices in 40 years (albeit from a low base last winter):

Dec. 31 (Bloomberg) — Commodities posted the biggest annual gain in four decades, led by a doubling in copper, sugar and lead prices, as Chinese demand compensated for the longest slump in the global economy since World War II.

In 2009, the S&P GSCI Index of 24 raw materials rose 50 percent, the most since at least 1971, and commodities drew record investment of $60 billion this year, Barclays Capital estimated. This year, the MSCI World Index of stocks in 23 developed nations climbed 27 percent, and U.S. Treasuries fell 3.5 percent, according to Bank of America Merrill Lynch indexes.

China, the biggest consumer of commodities such as copper and iron ore, expanded 8.5 percent this year, according to the median estimate of economists surveyed by Bloomberg. The nation imported record amounts of both raw materials this year, making up for slack demand in the U.S. and Europe.

This is the single most important reason why commodity producers from Brazil to Indonesia to Russia were able to do much better than expected in 2009.  Those three countries all saw their stock markets more than double in dollar terms.  Overall, stocks in developing countries rose 72% in dollar terms as of December 19th, while developed markets rose 27%.  Most people live in the third world, and of course they are much poorer than we are.  In pure utilitarian terms the Chinese weak yuan policy was the single best thing that happened in 2009.  In contrast, our shameful policies destroyed a lot of wealth both here and abroad.

Thank God the Chinese can’t be bullied into a deflationary policy of appreciating the yuan prematurely.  We all saw what happened in Japan.