Sunday, June 8, 2008

Just how deluded is the Wall Street Journal. Let me count the ways...

Sometimes the best discussions in blogs comes in the comments afterward. As the post ages, you have a chance to discuss an issue with someone that disagrees without other posts getting in the way. I had that experience posting this week on Brad Setser's blog. His original post was called "Really?" He was questioning a nonsensical statement in a Wall Street Journal editorial. Here is the discussion afterward between myself and Twofish who has his own blog at http://twofish.wordpress.com/:

Howard Richman Says:
June 6th, 2008 at 8:14 pm
Just how deluded is the Wall Street Journal. Let me count the ways:

1. They started out this editorial saying, “Mr. Bernanke’s words have come as a great global relief. As the dollar has strengthened in welcome response, the price of gold and oil has fallen in each of the last two days. But, just two days later the price of oil leaped upward!

2. They wrote what you pointed out was deluded — the idea that the falling dollar was causing a huge transfer of wealth out of the U.S..

3. They wrote that the poor Chinese are practically *forced* to peg the yuan to the dollar and that’s why they’re suffering from inflation. But if they weren’t working so hard to keep out American imports, they would let their currency rise to the level it should be, they would eliminate their 30% tariff on Michigan-made auto parts and their 30% tariff on US-made vehicles (including Pennsylvania-made Harley Davidson Motorcycles), and they would eliminate their just-imposed tariff on Wisconsin-made Bucyrus heavy mining equipment.

4. They missed the real cause of the weak dollar. While, it is true, as they claimed, that when the Federal Reserve borrows more dollars to raise the US short-term interest rate, it causes private foreigners to lend us more money, which can help the dollar rise in value. However, such borrowing is at best a short-run fix. It is like solving your debt problem by taking out a new loan. The fact is that the weak dollar is caused by our huge trade deficits!

Howard Richman
http://www.trade-wars.blogspot.com

Twofish Says:
June 7th, 2008 at 5:00 am
Richman: they would eliminate their 30% tariff on Michigan-made auto parts and their 30% tariff on US-made vehicles (including Pennsylvania-made Harley Davidson Motorcycles), and they would eliminate their just-imposed tariff on Wisconsin-made Bucyrus heavy mining equipment.

I really don’t think that would change things. If China removed all auto tariffs, then they would end up being imported from Mexico rather than the United States. The interesting thing is that the WTO negotiations between China and the United States were nowhere near as tough as the ones with Mexico.

There are two things that make US-China trade very different from US-Japan trade with respect to labor. The first is that with the exception of textiles, change the US-China trade balance really does not help manufacturing in the US. If China disappeared, then you’d end up with manufacturing going off to Mexico, Vietnam, or Bangladesh.

The second thing that makes the politics very different is that there are labor unions that benefit greatly from China trade. The International Longshore and Warehouse Union for one and the Teamsters for another.

Finally, I really think that the root cause of all of this is Iraq (just like a lot of the economic turmoil in the 1970’s was the result of paying for Vietnam). Think about it. The US has spent hundreds of billions of dollars fighting a major regional war. Your taxes didn’t go up. Where is this wealth to fight the war coming from? I don’t think it is much of a coincidence that the world economic system changed right almost the second that US troops marched across the border.

Howard Richman Says:
June 7th, 2008 at 9:01 am
Twofish,

I think you’ve missed the point of China’s increasing dollar reserves, as documented so ably by Brad Setser on this blog. China is following a strategy of maximizing exports and minimizing imports.

Mexico is not following that strategy. If their exports would go up with the United States, the peso would go up in value and they would import more U.S. products. Our trade with Mexico would go up withough our trade deficit increasing.

Although your analysis of the US economic problems during the Vietnam War is the conventional one, I disagree. Last year I took the time to look up what happened to money supply during that time period. Arthur Burns was increasing money supply far faster than the economy was growing. He was causing the inflation that occurred.

Howard Richman
http://www.trade-wars.blogspot.com

Twofish Says:
June 7th, 2008 at 8:52 pm
Richman: China is following a strategy of maximizing exports and minimizing imports.

I don’t think it is. In fact, I don’t think that the Chinese government really has anything that could be called a “trade strategy.” Things happen. The government reacts.

During WTO negotiations, China was extraordinarily flexible on a lot of issues, and there are lots of people in the Chinese government who think that a zero balance of payments is a good thing. There are people who disagree. This is makes decision making slow and rather ad-hoc.

One thing that is important to point out is that until 2003, China had a zero balance of trade. It imported large amounts of raw materials from resource rich countries and exported finished products to the developed world. This system broke down with the strain of the Iraq War.

Richman: Mexico is not following that strategy. If their exports would go up with the United States, the peso would go up in value and they would import more U.S. products.

Suppose China opens up to auto part imports. China gets those parts from Mexico. US plants get shut down. That doesn’t affect US-Mexico trade at all.

Richman: Arthur Burns was increasing money supply far faster than the economy was growing. He was causing the inflation that occurred.

Economic events tend to be multi-causal and can often be looked at in certain ways. For example, what was putting a drag on the growth in the US economy. Vietnam.

Also Burns had some limits in what he could do that are strikingly reminicient to some of the constraints that China is under. He couldn’t revalue the US dollar because that was pegged under Bretton Woods. He couldn’t really influence monetary policy because the US had fixed interest rate. He couldn’t influence fiscal policy because that was in the hands of Congress. So he really couldn’t do anything even if he wanted to, and since he was working under wrong economic theories, he didn’t want to change them.

One interesting thing is to read about Arthur Burns and his economic beliefs. It’s almost like reading something written in Medieval times since the economic theories he was using were so archaic (the Philip Curve, price controls, demand push inflation). But I have sympathy for him. What I worry about is the incorrect and disastrous thing that I believe that people will be laughing at thirty years from now.

Twofish Says:
June 7th, 2008 at 8:56 pm
I suppose it involves your point of view. The industries I’ve worked in (software and high technology ones) all make a great deal of money exporting to China, and so there isn’t this sense of China restricting imports at all.

Twofish Says:
June 7th, 2008 at 9:06 pm
One thing reason I think that China isn’t intentionally following an export oriented strategy is this.

Suppose in January 2001, you got a committee of Western politicians, labor union leaders, business executives, and economists together and asked this question. Do you think that China should adopt a fixed or floating exchange rate for the next ten years? I’ll bet that 90% of them would have said fixed exchange, and that all of them would have argued that it would have been dangerously irresponsible for China to consider floating exchange rates.

In January 2001, the main concern was that China would devalue its currency to boost trade and a fixed exchange rate was intended to prevent that. No one in 2001 that I know of predicted or even imagined that the US dollar would drop as it has, and so the idea that China adopted a system of fixed exchange rates to promote exports is flawed because that policy was adopted long before the current situation occurred.

For most of the 1990’s, the exchange rate was set so that China was running an overall trade surplus, and no one was complaining. And personally, I think China has been moving off the peg as fast as it can.

Howard Richman Says:
June 8th, 2008 at 9:06 am
Twofish,

I don’t think you are correct when you wrote that China was not following a strategy. Their strategy was invented by the Japanese. Economists call it “monetary mercantilism.” Peking University economics professor Heng Fu Zou explained how it works in a 1997 paper.

You are definitely correct that the economics problems of the Vietnam era had many causes. But I am also correct that the main cause of the inflation was Arthur Burns loose money supply. This was proved when Paul Volcker ended the inflation by tightening money supply.

Just because China had balanced trade with the world in 2003 doesn’t mean that they weren’t intentionally producing trade surpluses with the United States. They were getting a lot of direct investment in 2003. In general, such investment would cause trade deficits. Chinese dollar reserve accumululations have mirrored their trade surpluses with the United States since 2001.

As far as China buying autoparts from Mexico, I don’t think that is completely true. Last time I looked, Detroit automobilies still consisted mostly of parts made in the United States and Canada.

Whether exchange rates are fixed or floating does not matter in the least. The yen floats, yet the Japanese government controls the rate through their dollar purchases. The key is the Chinese government’s dollar purchases, not whether the rate is fixed.

Howard Richman
http://www.trade-wars.blogspot.com

Follow the following link to read these entries on Brad Setser's blog: http://blogs.cfr.org/setser/2008/06/05/really/.

Howard

3 comments:

natteng said...

Great info…keep it comming

Anonymous said...

Curious that twofish wants to make the IT argument, an area my family knows quite well. IT is one of those areas that has fled to places like China and the Philippines...and not just in assembly.

For example, new developments here are often off-shored for further development and testing.

As an aside, foreign companies inside China account for almost 80% of the IT exports....

Anyone who thinks that a country 100 years behind the U.S. can suddenly become a prime exporter of IT without hmmmmm help...needs help.

100 years, by the way, is how far behind the U.S. the Chinese consider themselves to be.

Stormy said...

My comment above.