I read an article in the Financial Times earlier this week (September 23, 2023) -…
There is currently an international cacophony being created by economists, politicians, political commentators and any-one else that thinks they have something to say which goes like this: China’s export orientation and its “manipulation” of the renminbi to stop it appreciating is damaging World demand and plunging the Western world into unsustainable debt levels and persistent unemployment. The simple retort is: the commentators have it all backwards and are ignoring the policy options that the Western world has but which policy makers will not fully utilise. But it is an interesting debate and the institutional attachment to the debate is not necessarily predictable as you will see.
In the FT on Tuesday (March 16, 2010) University of Tokyo economics professor Takatoshi Ito wrote that China’s property bubble is worse than it looks but his argument can be distilled down to making a case for the revaluation of the renminbi:
The Chinese authorities are doing better than their Japanese counterparts in the 1980s. The central bank is tightening regulation of loan-to-value ratios and trying to end easy credit. But they are hesitating to take up the best policy – interest rate hikes and appreciation of the Chinese renminbi. The property bubble is a clear sign of overheating … If the renminbi is appreciated, any overheating of China’s export sectors will be slowed, while standards of living will improve with higher purchasing power.
Along the same lines, Paul Krugman’s column last Monday (March 14, 2010) – Taking On China – continues his attack on China as some sort of cause of the global financial crisis and the inability of Western nations to get growth going again.
He outlines what he thinks is the problem, which is in effect a non-problem:
To give you a sense of the problem: Widespread complaints that China was manipulating its currency – selling renminbi and buying foreign currencies, so as to keep the renminbi weak and China’s exports artificially competitive – began around 2003. At that point China was adding about $10 billion a month to its reserves, and in 2003 it ran an overall surplus on its current account – a broad measure of the trade balance – of $46 billion …
The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion – 10 times the 2003 figure … it’s a policy that 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.
But as we will see this is not the problem. Notice he only talks about monetary policy as the vehicle out of the depressed domestic demand in many countries. The overall point that we will explain here is that even though net export deficits drain demand this does not “cause” a recession or allow the recession to “persist”.
The reason the Western nations are mired in gloom has little to do with the Chinese exchange rate manipulation, which really only damages the Chinese. Further, an opposite view has been put by the United Nations Conference on Trade and Development (UNCTAD) this week where they argue that the Chinese have helped the World out of a depression. Certainly, the Australian case study in avoiding a recession at all owes some part to the fiscal policy decisions made by the Chinese government. The early and significant fiscal intervention was dominant but it helped that our trade position didn’t deteriorate very much.
Krugman also wants some patriotic American in the US Treasury Department to dob the “manipulative” Chinese into authorities (you can read what he said about this if you want to).
However, much of the fear in the US is based on the misplaced idea that if the US gets too tough with China, the latter will dump its US dollar assets and cause havoc.
Krugman is smart enough to know this is a “common misunderstanding”. He said “we have no reason to fear China”:
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.
All of this is sound reasoning except that if the US dollar falls in value that is hardly an advantage to the US. It means their real terms of trade declines – I will come back to that later.
But if you think about Krugman’s overall argument – there is clearly a tension. He thinks that the China is depressing world demand on the one hand, but on the other hand, that the US has them over a barrel. This confusion – I was too kind too call it a “tension” – is sourced in the faulty overall reason that emerges from mainstream macroeconomics about trade relationships and policy options in fiat currency systems – again I will expand on that later.
Based on his faulty logic he then goes off the wall by suggesting the following:
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 stan
Hmm, a trade war … and totally unnecessary.
If successful this would in the short-term further reduce the material standard of living of Americans who are already suffering under with the unemployment and income loss fallout of their collapsed economy. By denying the US citizens access to the cheapest possible imports the US government would be compounding the consequences of their failure to implement fiscal policy of sufficient magnitude and jobs focus as private demand collapsed.
But the US government would also be promoting a lower US dollar parity overall which would just entrench these “costs” (lower real terms of trade) over time.
And, as I said totally unnecessary as I will explain below.
Yesterday’s (March 16, 2010) New York Times Editorial – Will China Listen? was more of the same:
The drumbeat of complaints in Washington about China’s manipulation of its currency – and the deafening silence pretty much everywhere else – might lead one to think that this is just an American problem. It isn’t.
China’s decision to base its economic growth on exporting deliberately undervalued goods is threatening economies around the world. It is fueling huge trade deficits in the United States and Europe. Even worse, it is crowding out exports from other developing countries, threatening their hopes of recovery.
The so-called “huge trade deficits” are benefits to the United States and Europe.
Further, as long as the developing countries haven’t signed up to IMF-bullied currency-pegs or other limitations on their currency sovereignty, they have the domestic capacity to improve standards of living without a reliance on net exports (with exceptions when food is totally imported).
And on the other side of the Atlantic, Martin West in the FT took up the beat-up China cause. In his column on Tuesday (March 16, 2010) – China and Germany unite to impose global deflation – he also blames China for depressing world demand. However, given his location he also implicates Germany in the crime. US commentators (and news in general) is the most nation-centric of all places and rarely considers foreign developments unless they impact on them.
Wolf noted that:
China and Germany are, of course, very different from each other. Yet, for all their differences, these countries share some characteristics: they are the largest exporters of manufactures, with China now ahead of Germany; they have massive surpluses of saving over investment; and they have huge trade surpluses.
Both also believe that their customers should keep buying, but stop irresponsible borrowing. Since their surpluses entail others’ deficits, this position is incoherent. Surplus countries have to finance those in deficit. If the stock of debt becomes too big, the debtors will default. If so, the vaunted “savings” of surplus countries will prove to have been illusory: vendor finance becomes, after the fact, open export subsidies.
First paragraph is factual and fine.
First two sentences in the second paragraph are fine and shows the nonsensical stance taken by China and Germany in this regard.
Third sentence in the second paragraph is backwards logic. Modern Monetary Theory (MMT) demonstrates that the external deficit countries “finance” the desire of the external surplus nations to accumulate financial assets denominated in the currencies of the deficit countries. If the deficit countries stopped purchasing that desire would be unfulfilled.
Further, to pursue that desire, the surplus countries are willing to net ship resource benefits (goods and services) to the deficit country. What do they get in return? Bits of paper and electronic bank balances.
His comment on the “stock of debt” is unclear. Is he talking about public or private debt? Certainly, the private sector can only carry so much debt. But, that reasoning does not apply to the public sector.
In the main I agree with Wolf on the EMU – he is not a fan. He particularly has implicated the inconsistent position of Germany – which wants to be a huge exporter but at the same time wants the nations it exports to to destroy the purchasing power in their economies through fiscal austerity programs. Unless Germany is prepared to increase domestic demand then it cannot expect fiscal austerity among its principle trading partners to help its export ambitions.
The fact that Germany is now in this imbrolgio is a reflection of the failed structure of the EMU. They won’t admit that but that is the core problem.
Wolf says that China is also caught in the same conflict:
Germany is in a supposedly irrevocable currency union with some of its principal customers. It now wants them to deflate their way to prosperity in a world of chronically weak aggregate demand. Mr Wen has the same idea. But the economy he wants to pursue this goal is the US. Fat chance!
I completely agree with this. But then Wolf advocates a position supportive of the view that China is hurting domestic conditions in the US and trade should be rebalanced by allowing exchange rates to move.
His policy bias is reflected in the statement that:
… countries that ran huge external deficits in the past can cut the massive fiscal deficits that result from post-bubble deleveraging by their private sectors only via a big surge in their net exports. If surplus countries fail to offset that shift, through expansion in aggregate demand, the world is inevitably caught in a “beggar-my-neighbour” battle: everybody seeks desperately to foist excess supplies on to their trading partners. That was a big part of the catastrophe of the 1930s, too.
The 1930s was the gold standard and trade imbalances really mattered because they constrained domestic demand policy. The US does not have to rely on increasing net exports to accomplish the necessary “post-bubble deleveraging by their private sectors” – that is Wolf’s prejudice against fiscal policy.
The US can accomplish the post-bubble deleveraging by their private sectors by stimulating domestic demand through fiscal policy and via the income growth allowing private saving ratios to rise. What China does is irrelevant to that capacity. I will come back to this later.
The theme against China is continued in the most recent World Bank Quarterly update on China, which “provides an update on recent economic and social developments and policies in China”.
In the March 2010 Quarterly update, the World Bank argues for revaluation of the renminbi.
In terms of the growth that the Chinese economy has enjoyed despite the World recession, the World Bank say that “(g)overnment-led investment was the key driver of growth for much of 2009” given consumption was flat and net exports growth declined.
Interestingly, they suggest that substantial restructuring of demand is already happening:
Gross exports were 27 percent of GDP in 2009, compared to a peak of almost 40 percent of GDP in 2007. We expect this ratio to recover somewhat in 2010. However, with domestic growth likely to outpace exports in the medium term, we expect the importance of exports in the economy to gradually decline again thereafter. The share of China’s exports to emerging markets around the world rose further in 2009 as the share of exports to US, EU and Japan declined to 46 percent, with the share of the US at 18.4 percent.
So government policy seems to be steering growth towards domestic spending (investment and consumption) and reducing the reliance on net exports. In that context, it would be expected that they would allow the currency to strengthen over time anyway to increase the living standards of the population relative to the rest of the World.
What is also not spoken of much in the public debate is the fact that China’s trade is internationally diverse but it pegs only against the US dollar. So the World Bank note:
China’s effective exchange rate continues to fluctuate even as it stays unchanged against the US dollar. Since end-2008 the RMB has been re-pegged to the dollar. However, a large and increasing part of China’s trade is with countries other than the US. Thus, as a result of movements of the US dollar versus other currencies, movements in China’s trade-weighted exchange rate have differed significantly from movements against the US dollar. China’s nominal effective exchange rate … has appreciated 12.3 percent between July 2005 and early March 2010, after depreciating in 2000-05, and is now broadly at the same level as in 2000 …
But despite this they still argue for appreciation:
Strengthening the exchange rate can help reduce inflationary pressures and rebalance the economy. Over time, more exchange rate flexibility can enable China to have a monetary policy independent from US cyclical conditions, with is increasingly necessary.
The last point is interesting and relates to any pegged currency. It means that monetary policy (interest rate settings) in the pegged country is tied to that of the country they are pegging against. If interest rates get too far out of kilter between the two nations, financial flows via the capital account will make it hard to maintain the peg.
But the point is that the government in the pegged economy cannot use monetary policy in any counter-cyclical way if its domestic economic conditions are not similar to those existing in the other country. So at present, with the US stagnating with zero interest rates and China growing rapidly (some say heading into a real estate bubble) the claim is that monetary policy has to tighten.
The problem then is that with the peg operating, China’s central bank will be reluctant to push up rates despite the US monetary policy stance not being “appropriate for China”. Accordingly, the World Bank argues for “(m)ore exchange rate flexibility … [which] … would make monetary policy more independent” and allow it “to raise interest rates even though interest rates in high income countries remain low”.
From a MMT perspective there are competing ideas here. First, currency sovereignty requires flexible exchange rates. It is not only monetary policy that is tied under any sort of peg arrangement. Fiscal policy is also constrained.
A country that operates on a gold standard, or a currency board, or a fixed exchange rate is constrained in its ability to use the monetary system in the public interest, because it must accumulate reserves of the asset(s) to which it has pegged its exchange rate.
This leads to significant constraints on both monetary and fiscal policy because they must be geared to ensure a trade surplus that will allow accumulation of the reserve asset. This is because such reserves are required to maintain the exchange rate parity. If a country is running a fixed exchange rate and faces a current account deficit, the domestic economy has to bear the brunt of the required adjustment.
So the government has to depress domestic demand, wages and prices in an effort to reduce imports and increase exports. Accordingly, the nation loses policy independence to pursue a domestic agenda. Floating the exchange rate effectively frees policy to pursue other, domestic, goals like maintenance of full employment.
Please read my blog – Modern monetary theory in an open economy – for more discussion on this point.
The caveat is that these constraints are not binding where a nation experiences a strong trade position such as China at present. In those case, there is fiscal space courtesy of the Balance of Payments capital account (financial flows boosting foreign reserve buffers). The general problem of external surplus countries is also avoided in these cases – that being that export-oriented growth resulting in persistent external surpluses reduces the domestic standard of living – because China has the capacity to offset this impact via fiscal policy.
In the current downturn, it has led the World in its use of domestic policy initiatives to ensure that unemployment impacts were muted and growth continued. I don’t advocate the political system that China maintains via force but it sure puts a lid of the deficit-terrorists that have crippled the fiscal response in so-called Western democracies.
The second point about all of this from a MMT perspective is related to the first but worth noting separately. MMT places a primacy on fiscal policy and thus considers monetary policy to be the weaker of the two in terms of its capacity to pursue effective counter-cylical stabilisation (that is, boost aggregate demand when private spending falls and vice versa). As I have noted often, there are many uncertainties about the use of monetary policy. It is a blunt instrument (that is, impacts across all regions if at all) and thus cannot be targetted. It’s final impact is also depenendent on distributional nets which are not clear – creditors and fixed income receivers gain, debtors lose – what is the net effect on spending?
For these reasons, fiscal policy is preferred and so the conventional arguments about the flexibility of monetary policy being constrained by a pegged currency are less important to MMT. But as noted above, all aggregage policy (fiscal and monetary) is constrained under a peg in unproductive ways.
Third, MMT takes a different view on trade to that outlined in mainstream economics textbooks. Imports are benefits to a nation while exports are a cost. The mainstream position is that imports are somehow bad too many of them is worse and exports are virtuous. Exports involve a nation giving up its resources to another nation so the citizens in the latter can enjoy them. That is a cost. Imports are the opposite.
So in that context, it is unclear why US commentators and politicians would be so down on China at present. China’s exchange rate policy is holding the US dollar up against the renminbi. But the nation with the stronger currency has the upper hand which is contrary to the way the mainstream economists and public commentators think.
A strengthening currency tells you that the real terms of trade are improving. That is, more real goods and services can now coming into shore on boats than have to leave shore. That is a net benefit. You can buy more real goods and services from abroad for less sacrifice in costly exports.
The appropriate policy reaction to the “demand draining impacts” of this outcome is to use fiscal policy to maintain strong aggregate demand and employment. In that way, the nation can maximise its “enjoyment” of its superior currency position – it generates enough income (and saving) in the private domestic sector to purchase goods and services on offer as well as being able to buy on superior terms the goods and services that arrive on boats from abroad.
Now given all that, there was another angle pushed into the public debate this week in the form of an interesting Policy Brief from the The United Nations Conference of Trade and Development (UNCTAD) – entitled – Global monetary chaos: Systemic failures need bold multilateral responses (No. 12, March 2010)
UNCTAD begin their focus on the resumption of the global casino:
The international community has allowed global monetary incoherence to reign before and after the crisis. Indeed, “markets” were permitted to manipulate currencies in a way that made some sovereign governments and central banks look like penniless orphans. The need for a new approach to global macro-economic governance is more urgent than ever, because today’s currency chaos has become a threat to international trade and could be used as an alibi by major trading countries for resorting to protectionist measures …
Institutional “investors” are back in business in global currency markets. With their resurgence, countries are again facing huge inflows of hot money that cannot be put to any productive use, but which create severe price misalignments and trade distortions. The global “casino”, nearly empty a year ago, is crowded again, and many new bets are on the table.
UNCTAD see the faith in “market fundamentalism” as being “unswerving” and claims it “continues to sustain the naïve belief that a solution to misalignment may be found by leaving the determination of exchange rates to unregulated financial markets”.
At this point I disagree. Progressives have often criticised me for advocating flexible exchange rates. They read that Milton Friedman also advocated them so they immediately conclude they are monetarist free-market plots to oppress social equity (I avoid using the term right-wing or neo-liberal here!).
But as explained above, flexible exchange rates are a core part of MMT which is light years away from monetarism in its understandings of the way the fiat currency system operates.
Pegging currencies is never an answer to the casino-like behaviour that UNCTAD correctly identifies as being damaging to nations of all stages of development. The solution is to eliminate the casino – not peg the currency.
UNCTAD note that speculative flows have been exploiting differentials in interest rates that have arisen from the disparate growth performances in the recent years. So “Brazil, Hungary and Turkey” are experiencing real appreciations in their currencies which is allegedly damaging.
Once again, refer back to my earlier comments on this. The countries with appreciating currencies have all the sway. The point is that domestic policy has to play ball as well and UNCTAD fail to discuss the increased fiscal space that countries in these situations have available to them.
UNCTAD correctly note that:
In the brave new world of liberalized global trade and finance, the treasuries of sovereign governments of the largest developing economies – and even some developed countries – can be seriously challenged by the power of financial flows.
That is clear and is why you have to address the speculative behaviour head on and not assume it will persist and try to set up “market disincentives” to curb it. A rules-based regulative approach (declare it illegal) is the best way to proceed while keeping currencies flexible to maximise domestic policy sovereignty.
Then UNCTAD get to the China question:
Amidst continued financial crisis, the question of the global trade imbalances is back high on the international agenda. A procession of prominent economists, editorialists and politicians have taken it upon themselves to “remind” the surplus countries, and in particular the country with the biggest surplus, China, of their responsibility for a sound and balanced global recovery. The generally shared view is that this means permitting the value of the renminbi to be set freely by the “markets”, so that the country will export less and import and consume more, hence allowing the rest of the world to do the opposite. But is it ? This policy brief contends that the decision to leave currencies to the vagaries of the market will not help rebalance the global economy.
UNCTAD rejects the idea that it is “reasonable to put the burden of rebalancing the global economy on a single country and its currency”. They note that “China has done more than any other emerging economy to stimulate domestic demand, and as a result its import volume has expanded significantly” in recent years.
They also note that in the “preceding decade, real private consumption, at an average 8% growth rate, was an important driver of growth, backed by wage and salary increases in the two-digit range and strong productivity growth”.
They argue that China has been facing a “continuous loss in competitive power even with a fixed exchange rate” and:
Expecting that China will leave its exchange rate to the mercy of totally unreliable markets and risk a Japan-like appreciation shock ignores the importance of its domestic and external stability for the region and for the globe.
In this context they contend that “both absolutely fixed/pegged and fully flexible/floating exchange rate systems are suboptimal. These so-called “corner solutions” have added to volatility and uncertainty and aggravated the global imbalances”.
I disagree – it is the rise in the financial sector and its ability to garner a greater share of the real output in nations that has been the problem. That trend has been aided and abetted by policy makers bent on deregulation. Sound evidence exists to suggest that the policy makers have benefitted materially from allowing the financial sector to run loose – ultimately creating the havoc we are enduring at present.
I don’t implicate flexible exchange rates in this for reasons outlined above. I do, however, consider that nations running fixed exchange rate regimes (and that includes the EMU nations individually) have left themselves open to a greater real crisis than was necessary. The current crazy situation in the EMU where nations are being bullied into pro-cyclical fiscal settings at the height of a recession-cum-depression is illustrative of this point.
So while I agree with UNCTAD that the casino-economies are dangerous the solution is not to start fudging exchange rates.
But UNCTAD propose to regulate world exchange rates to limit “the degree of exchange rate deviations from the fundamentals” to reduce international imbalances. In this regard, they propose a “constant real exchange rate rule”.
What does that mean? Well the real exchange rate is just the inflation adjusted nominal rate (across both nations). So this rule would allow the nominal exchange rate to devalue when there in a rise in the inflation rate differentials between countries and vice versa.
Whenever you read that a policy rule is preferred always be suspicious. For all the reasons I have outlined it is never preferable to move back to any pegging arrangements (partial or otherwise). The preferred solution is to outlaw the casino-economy.
The appropriate policy response is not to start trying to modify trade or worry about what China is doing. The US government and other sovereign governments have all the capacity they need at present to stimulate domestic demand and create high levels of employment.
Ultimately China will realise that its citizens want more than bits of paper in foreign currencies and they will allow the exchange rate to float.
Don’t misinterpret me though. I also think the renminbi should float but for different reasons than those given by the pundits in the current assault on China. The point is that I think it is a side-show for the rest of us.
What we need to do on a multi-lateral basis is to curb the financial sector and force it to correspond only with the needs of the real sector. This would require large policy shifts which would outlaw most of the current trading behaviour and would require speculative behaviour to be advancing the stability of the real economy.
This is a blog not an academic journal article or book. If you read my academic writing you will find it dry and without much partisanship. But billy blog is my personal perspective on things where I combine my academic research insights (if there are any!) with personal opinion – more the former than the latter but still my values and ideology are there.
That is what a blog is about.
But I am careful to differentiate my ideological positions from the “science”.
One commentator today noted that monetarism was neither right- or left-wing. I disagree. The whole edifice of mainstream economics – indeed its roots – are ideologically disposed towards what we call right-wing thinking. Modern mainstream economics is an extension of the marginalist school which emerged in the second half of the C19th to combat the fears the industrialists had about the growing popularity of Marxism.
While this is a whole blog in itself you might like to research these origins and you will then never conclude that monetarism is neutral. Its basic presumption is loaded – Quantity Theory – which assumes that free markets will always create full employment. Then you delve a bit further and you realise that it basically denies any meaningful concept of unemployment.
It all comes down to voluntary decisions and unemployment is cast as an “optimal leisure state”. But even the most cursory examination of economic and political history will expose documentary evidence that points to capital badgering governments who promote full employment as a danger to the capacity of the system to generate profit.
That is not neutral.
Finally, one of the hallmarks of the neo-liberal era has been to try to convince us that “ideology is dead” and that the old class distinctions are irrelevant now – so yesterday!
This argument is extended to argue that right-wing and left-wing are meaningless constructions that just amount to name calling. I vehemently disagree with those claims and I think there is substantial content in the concepts as descriptors of ideological positions and “theoretical” constructs that are used to buttress positions.
Having said that – I think it is increasingly hard to define a left-wing position given how far the debate has shifted to the right.
Anyway, I mostly try to provide alternative economic insights based on my role as one of the academic developers of MMT. Occasionally I provide personal opinion laced with sarcasm. I hope you differentiate the two and enjoy both or either. But most important is the role I have as a macroeconomics teacher in this environment and so I wouldn’t want you to be put off by the latter and ignore the former.
That is enough for today!