Paul Krugman has issued a provocative call for a surcharge on Chinese imports, in order to counter the effect of their exchange rate policy, which:
“seriously damages the rest of 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.”
Given that Krugman got his Nobel for trade policy, this is extraordinarily provocative, and has provoked some tit-for-tat with Ryan Avent of the Economist (start it here). But both of them agree that it is in China’s interests to devalue revalue. Avent writes:
He should respect China enough to know that its leaders understand that RMB appreciation is in their interest.
Whatever clever tricks you can play with monetary policy (and Advent is probably right that the zero-bound need not bind – see also Credit Where It’s Due), it seems preferable that the surplus nations spend to the deficit ones. I agree with Richard Koo on this one: no matter what current or expected future rates are, if you think you have too much debt relative to your assets, you want to save to pay it down. Models that don’t include the balance-sheet positions are incomplete. (This is a flaw in my Credit Where It’s Due paper.) Martin Wolf’s passionate column today is all about this, begging the surplus nations to adopt some common-sense.
The balance sheet is a factor that I find Professor Sumner dismisses too easily; he seems not to see how if one part of the economy determinedly pursues savings, then output may fall. His comment says it all: “Less consumption doesn’t mean less output, just different kinds of output (investment and exports.)” That seems extraordinarily complacent. If households save suddenly, why would businesses invest? If every Western household wants to save, why do exports rise?
I believe that he is similarly misguided when attacking the idea that a remnimbi appreciation may boost US production. His EconHistory counter-example is Japan; in 1971 Japan had a big surplus. Its currency has increased in value from 390 to 95 to the dollar. But it still has a surplus. Ergo, currency values don’t do the trick.
Scott Sumner is one of the very brightest people writing about anything today, and so this is not aimed at him. But it strikes me that there are good ways and bad ways of reducing imbalances, and that by altering the terms of trade between two blocks, you can ensure the good way takes place. To illustrate this, consider these two tables. They consider two idealised economies: the US signifies deficit nations, and Chermany the surplus. For simplicity they are the same size.*
(the embarassingly crude 30 minute spreadsheets are here)
In the first example, the US starts off spending 80% of its GDP on its own stuff, adn 30% on Chermany’s. It gradually works this down, by a simple rule (spend 80% of the previous year on US stuff, and a diminishing proportion on Chinese). The key variables are Chermany’s (it is the dog not the tail). It is programmed to increase consumption of both by 6% per annum. As a result of these actions, we get a good equilibrium, with high growth in both areas, and the trade deficit falling.
In the bad way, the Chermans keep their currency at such a level that they consume only 20% of their GDP on US goods. They grow their own consumption at 4%. Because Cherman goods remain cheap, the US keeps spending 30% of their GDP on them. Their trade deficit remains high, and growth low.
So observing a continuing trade deficit is no proof at all that the right things have not happened. That growth between the US and Japan continued for 20 years after 1971 suggests to me that the devaluations were the right thing. What would have happened if the Japanese had kept their currency at 300 to the $?
In fact, if the bad way had continued, at some point there might have been a crisis – you know, like that 2008 crisis – where the capital being used to support US consumption is withdrawn for some reason. Then the US might slow its consumption rapidly. In this scenario, I have it dropping to 75% of GDP on its own stuff, and trending down the Chinese stuff:
I’m still on Wolf’s side here. Where I am not so sure is whether the Chinese understand what is in their interests, as Avent implies. But I agree with him that ignoring the political ricochets from punitive actions is unwise. We need to send Wolf over to China, stopping off in Berlin on the way.
*It makes no fundamental difference.