When you read this you’ll see why I couldn’t resist falling off the wagon. Paul Krugman has again called for the US to pressure the Chinese to revalue the yuan. The reasoning is even more puzzling than usual:
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.”
As you may recall, back around 2005 a number Congressman were insisting that the Chinese revalue the yuan by 27%. In fact, they did revalue their currency by 22% over the next 3 years. But now we are told they need to do another 20% to 40%. And people wonder why the Chinese are so frustrated with the West. Does this game ring any bells? I seem to recall that back around 1970 the US government kept insisting that the Japanese trade surplus was caused by an undervalued yen. Then the yen was revalued 20%, but the “problem” continued. Then another 20%, then another 20%, then another 20%, then another 20%. The yen has now gone from 350 to 90 to the dollar. My math isn’t very good, but that sure seems like a lot of 20% revaluations. And the Japanese still run a current account surplus that is more than half the size of China’s surplus, despite having less than 1/10th China’s population. I think it’s fair to say that international economists have become increasingly skeptical of the notion that simply by manipulating nominal exchange rates you can eliminate current account imbalances that represent deep-seated disparities of saving and investing. But I guess hope springs eternal. Maybe this time it will finally work.
Krugman also repeats his argument that US monetary policy is paralyzed, and this time he rather bizarrely extends the argument to most of the major economies in the world:
Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.
Does Krugman really think the US is “stuck” in a liquidity trap? Obviously not, otherwise why would he have started criticizing the Fed for what he claims is an excessively restrictive monetary policy? No his policy views depend on which audience he is addressing. When talking to Bernanke, he suggests the Fed do much more, when talking to the Chinese he pleads that the Fed has done all it can. I can just see the frustration in Chinese central bankers reading this NYT article: “Those Americans must think we are a bunch of fools. Don’t they know we are Western-educated, and can read English newspapers? Do they really think that when they say one thing to their own Fed, and something completely different to us, that we won’t understand?”
But this time it’s even worse, as Krugman now claims that ”Most of the world’s large economies are stuck in a liquidity trap.” At least with the US you can sort of make the liquidity trap argument. And perhaps with Japan, if you ignore that fact that the BOJ recently rejected their finance minister’s request for a more expansionary monetary policy. But who else? I don’t think there is anyone who believes China, India, Brazil or Russia are stuck in liquidity traps. Australia and South Korea have been raising rates. Nor is there anyone claiming Germany, France, or Italy are stuck in liquidity traps. The ECB raised its policy rate to 4.25% in July 2008, and then cut it to 3.75% when the global economy collapsed in October 2008. Yes, rates have since gradually come down much further, but at no time in 2008-09 did it look like the zero bound was constraining the ultra-conservative ECB. Indeed the ECB has frequently emphasized that it doesn’t want to cut rates further and that it is focused on keeping inflation below 2%. So even if you wrongly believe that countries with zero percent interest rates are “stuck” with tight money, that condition only applies to a few countries.
So what does Krugman suggest we do?
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.
This comment surprised me. I had thought that nobody still believed the dollar was overvalued in 1971. I do realize that back in 1971 many of Krugman’s fellow liberals believed that the US economy was suffering from an “overvalued” dollar, but I also thought that this view had been pretty well discredited by Mundell and others. Keep in mind that in 1971 we had 6% unemployment and 4% inflation. Does that seem like an economy that needs to devalue its currency? In any case, Krugman got his way; the Europeans gave in and revalued their currencies. And I suppose you could say the “problem” was solved. By 1979 I don’t recall too many people worrying about the dollar being overvalued. Although come to think of it I don’t recall that pesky Japanese current account surplus going away either. There must be a lot of distinguished European economists who like reading Paul Krugman. Imagine their reaction this morning reading him appear to praise Nixon’s crude attempt to force the Europeans to revalue their currencies in 1971 in order to solve America’s 6% unemployment problem.
Think about the following questions: How many economists today honestly believe that America’s economic problems in 1971 were due to the European currencies being 10% undervalued? How many economists today honestly think that if the Chinese give us another 25% revaluation that this will significantly improve America’s economy? And how many of you think that 40 years from now, when we look back on the American economy in 2010, that most economists agree with Krugman’s argument that a significant part of our economic problems were due to an overvalued yuan? In contrast, how many people think that 40 years from now most economists will agree with Krugman’s claim that our economic dilemma is due to the stubborn refusal of the Fed to set a higher inflation target?
My claim is that in 40 years most economists will agree with Krugman. I mean the good Krugman. The guy who wrote Pop Internationalism. Not the guy who says we’re “stuck” in a liquidity trap and who ends his NYT editorial with the crude populist slogan “It’s time to take a stand.”
BTW, I notice that Krugman often implies that those who oppose health care reform and unemployment comp. extensions are just a bunch of cruel, heartless, right-wingers. Does Krugman know that if his proposed 25% tariff “works,” and does in fact sharply reduce Chinese exports, that millions of extremely poor Chinese workers will lose jobs in exports industries? Workers who are much worse off than even the bottom 10% of American workers.
One final point. If we do nothing the Chinese will probably revalue the yuan by about 5% to 10% this year, with vague assurances that further increases will occur as conditions allow. If we threaten a trade war there will probably be some compromise in the end, and China will revalue the yuan by 5% or 10% this year, with vague assurances that further increases will occur as conditions allow. But in the second case a lot of bad blood will be stirred up, financial markets will be depressed by uncertainty, and the world recovery might even slow down a little bit. And that’s the best case from his proposal. If a trade war actually does occur I shudder to think what the effect would be on world markets, and the world economy. If you go back another 40 years before Nixon’s threats against the Europeans, there really was a trade war.
Krugman points out that the Treasury must make a decision by April 15th (another reason to dread that date.) Eighty years ago on April 17th, 1930, the US stock market was up 48% over post-crash lows, on hopes for economic recovery. But as the Congressional debate over Smoot-Hawley became more acrimonious the market began dropping sharply. The biggest drop of the year occurred the day after Hoover announced he’d sign the bill. Then other countries started retaliating. By mid-June stocks were down more than 25% from mid-April levels, and hopes for a recovery had been dashed. Let’s not re-enact that fiasco this spring. Instead let’s do what Krugman and I both agree should be done; let’s have our own Fed solve our own problems (of inadequate AD.) That would be a win-win-win-win policy. Good for workers, good for investors, good for foreigners, and good for shrinking our budget deficit. I wish more Americans would “take a stand” against our own monetary policymakers, not foreigners.
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Before the Great Depression foreign trade was 6 percent of GDP. It fell to 2 percent of GDP. Even if Smoot-Hawley was the sole cause, which is unlikely, how does a 4 percent of GDP decline in trade translate into all the damage you blame on Smoot-Hawley? Before Smoot-Hawley tariffs were already 40 percent and had averaged about 30 percent for the past 100 years.
Ben Bernanke’s “Essays on the Great Depression” contains the following passage:
“Might the real shocks that occurred during the 1930s have been the functional equivalents of technological shocks to industry productions functions? For example, it might be conjectured that trade restrictions affected the cost or availability of intermediate inputs; substitution away from intermediate inputs toward labor show up as negative productivity shocks in our empirical analysis, given that we must measure output as total production rather than value added. However, while this is a theoretical possibility, the direct evidence for a disruptive effect of trade restrictions is weak: In particular, the Smoot-Hawley tariff of 1930 primarily affected import of agricultural goods and finished manufactures, not intermediates (Eichengreen 1986). Indeed, because of the worldwide glut of raw materials and commodities, the real price of most imported intermediates (inclusive of tariffs) fell during the depression.”
That’s a very thoughtful response so let try to be the same as devil’s advocate. The total effect of the Smoot-Hawley is debatable and we could use the money. Jakob B. Madsen (2002) estimated that of the 33% contraction in worldwide trade between 1929 and 1932, only 8% was caused by increases in tariff rates.
Why not take care of our debt and stimulate the economy at the same time? We can easily devalue our own currency by having the Fed print lots of it. Congress made a mistake taking over the bailout from the Fed; we have to pay that money back. The Fed had their own bailout going at the time. Maybe we should let them resume. We could put everybody to work even before exports take off.
Of course our earnings would be devalued too but done right, we could kick-start our all kinds of green industries, vaulting us back to the top. Raises would come.