I’m deeply confused by a Paul Krugman article in the October 22 New York Times. He argues that the Chinese are ruining the world economy, and our economy, by keeping their currency weak. Chinese exports are too cheap. I can’t figure out why this is bad. Would we be better off if we paid higher prices for Chinese-made car parts, electronics, clothing, etc.? Wouldn’t that leave us with less money to spend on other stuff and therefore worse off?
And what about this finance professor from University of Chicago, John Cochrane, who tears apart one of Krugman’s earlier pieces? Whom are we to believe, the Nobel Laureate Krugman or a glider pilot who lives in a part of the country with no ridge lift (see the bottom of his papers page)? Cochrane seems to be a bit of a contrarian, arguing in the Wall Street Journal that the Lehman failure did not cause the Collapse of 2008.
“But Chinese authorities didn’t let [the yuan] rise. They kept it down by selling vast quantities of the currency…”
Isn’t this a convoluted way of saying they inflate? If put in those terms then any economist (noble prize not needed), or even post first year econ course student, would immediately say that China is hurting their people. It seems the only way to prevent price rise for a in-demand fixed quantity good is to, well, make it no longer fixed. Print more yuan, inflate, hurt savers in China. Why would “China” hurt their people? Why would governments anywhere hurt their people? Because it benefits politically connected groups (“important” people), at a cost to nonpolitically connected groups (“unimportant” people), AND/OR (foreshadowing) the action is a painful but necessary reaction to some other actors actions.
But wait, the argument gets worse. “They kept it down by selling vast quantities of the currency, acquiring in return an enormous hoard of foreign assets, mostly in dollars.”
So China sells yuan to the US government, or if not directly then to a market that is saturated with US dollars. And China is thus bad. Hmm… perhaps if you don’t like the trade then don’t trade? Or if you don’t like lots of yuan floating around don’t have lots of dollars floating around that they can exchange for?
“But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.”
So now he sorta clarifies that China is running the printing presses… But wait, they are simply pegging. If the US dollar is going down despite being the reserve monetary supply… Oh, yeah. Maybe the Fed should turn off those printing presses…
“Suppose the Chinese were to do what Wall Street and Washington seem to fear and start selling some of their dollar hoard. Under current conditions, this would actually help the U.S. economy by making our exports more competitive.”
Doesn’t the US have something like a 40% deficit? I assume that “dollar hoard” really means “bonds” and “selling” means “no longer buy” which means “oh-oh, how are we going to run a deficit now?” and “vapid feel good statements and robbing our future taxpayers will no longer work, we could be in trouble here…”. Also, ideally, don’t you want exports to be zero, if you can get away with that? “here is our precious resources, which we have improved with our labour, please send us food for them…” versus “give me those sweet TV’s, I’ll give you some money you can put back into our financial markets which allow us to develop”. Um, I’ll take deal #2, if I can get it…
“In fact, some countries, most notably Switzerland, have been trying to support their economies by selling their own currencies on the foreign exchange market. The United States, mainly for diplomatic reasons, can’t do this; but if the Chinese decide to do it on our behalf, we should send them a thank-you note.”
Krugman has apparently gone totally insane. A few paragraphs earlier China was EVIL for selling their currency. Now the good guys, like Switzerland, are trying to do the same, and are some reason good for doing so, and the USA should do the same, or if China – apparently the only country with balls since America “can’t” even though they should – decides too do it for US a thank you is in order. Huh? So why is China evil again?
“Something must be done about China’s currency. ”
Krugman is really saying “stop selling bonds to China”, but that would mean “cut government budget by about 40%” which would be against his ideology. So he confuses the issue to allow all problems to be blamed on foreigners.
So how to explain this? Krugman is an economist, yet this opinion piece is at odds with what most economists would say – or at the very least is a very muddled discussion. But Krugman is also selling something – opinion. It has to be biased and it has to shill directly to some group, otherwise they will get some other provider, and it has very little quality control (excluding self respect) as most buyers of the product just want reinforcement of their opinion. So the tendency will be muddled and dishonest discussion that makes some ideological group feel good. Krugman has found his market. Sure the product is flawed, if “truth” is your measure, but the pay is nice.
Krugman’s argument is as follows:
1. China is artificially keeping its currency devalued
2. Thus Chinese exports are cheaper
3. And that Chinese exports are not cheaper because they have higher productivity or better technolgy at manufacturing these exports
4. As a result, most of the manufacturing is taking place in China
5. Had this not been the case, other countries, US included, could have produced these goods
6. This would have improved the employment rates in the country
7. Thus, China by devaluing its currency is adding to the woes of high unemployment in the US
Jud: By this argument, all trade is bad, no? If there were no workers or manufacturing in other countries, all manufacturing would be done in the U.S. I’m still confused by Krugman’s argument. If Chinese goods were more expensive and we had to pay more for them, how does that make us better off? Alternatively, suppose that Chinese goods were available for free. We could have anything made in China for nothing, in unlimited quantities. Would we therefore become impoverished? The Chinese make cars, TVs, building materials, furniture, food (sometimes with free Melamine!), etc. So we’d have most of the necessities of life at no cost. That should lead to more money in consumers’ pockets here and increased prices for everything not made in China, including American labor and American goods. More cash chasing the same supply of goods.
I can’t find the link at the moment but an economist recently observed that if it would be desirable to receive products we want from China for free that paying an absurdly low price for those same products should be the next best thing.
I’m still confused by Krugman’s argument. If Chinese goods were more expensive and we had to pay more for them, how does that make us better off?
As I understand it, in normal circumstances, when the US economy is at full employment, it’s fine for China to keep its currency artificially low. It just means that for people in the US, Chinese goods are cheaper, and you can buy more of them.
But when the US economy–and the world economy, in fact–is suffering from low demand and high unemployment, the fact that Chinese currency is artificially low means that demand for Chinese goods is higher (which is good for Chinese workers, since they have more jobs), but demand for everyone else’s goods is lower (which is bad for everyone else, since they’re suffering from unemployment).
To take a concrete example, suppose a Chinese-made flat-screen TV sells for $1000. If China can lower its currency so that it sells for only $500, then some US consumers who would be unwilling to buy one at $1000 would now buy one; perhaps they’ll put off a flight home for Thanksgiving. Demand for Chinese goods has increased (keeping Chinese employment down), while demand for US goods and services has decreased (pushing US unemployment up).
Alternatively, suppose that Chinese goods were available for free. We could have anything made in China for nothing, in unlimited quantities. Would we therefore become impoverished?
Impoverished, no. Unemployed, yes.
In a slightly different scenario, if Chinese goods are not completely free but extremely cheap, people who are unemployed would indeed be impoverished–they’d have no income to buy the goods.
I think Krugmans thinking runs along the following line.
“Everything can be steered”. And so he builds on “model” afte the other and claimes that reality behaves as his model.
He does not get the fundamentals right and so it’s like a calculation with wrong numbers. The following can be completely right, with the wrong starting arguments the result is still wrong.
The other stuff is explained by Jud. Krugman is a real danger because he speaks for mor intervention. And about manipulating money buy a allmighty “knowing” Unit probably named Fed. He does not get it right that manipulationg the currency just is the straight way into bankruptcy.
Philip,
You seem to define the world economy only as ony way trade between the USA (importing) and China (exporting). I like Jud’s summary. China is not (only) hurting the US by keeping their currency too cheap (Krugman’s position), but mostly other (poor) countries that cannot fairly compete with China (unless they all start to manipulate theire curreny).
From a consumer perspective you can neglect all this and just be happy that your DVD-player only costs $25. But stealing is even cheaper but also not fair.
keeping Chinese employment down
Oops: that should have been Chinese unemployment, of course.
Regarding Krugman vs. Cochrane, there’s a more general disagreement between “saltwater” and “freshwater” economists, greatly aggravated by the current economic crisis. As I understand it, freshwater economists (associated with lakeside universities like Chicago) argue that free markets are always self-correcting, and that government intervention in case of mass unemployment is unnecessary. They’ve invented various theories to explain the business cycle of booms and busts, such as Real Business Cycle theory. According to RBC theory, investors always behave optimally. If we have mass unemployment, there’s an underlying reason for it–some kind of change in technology, or a desire on the part of workers for greater leisure–and the government shouldn’t do anything to intervene.
Saltwater economists (associated with coastal universities like Harvard, MIT, and Berkeley), on the other hand, argue that mass unemployment is basically a technical problem, not one with deep underlying causes. If everyone tries to hold onto more cash at the same time (because of a sudden drop in confidence caused by a stock-market crash, for example), they’ll start spending less on goods and services. As demand drops, unemployment rises; as people get more and more worried about losing their jobs; they’ll spend even less. And in normal times, there’s a simple solution: when demand drops, the central bank lowers interest rates to compensate. Krugman describes this in a 1997 Slate article, Vulgar Keynesians.
The reason there’s such an ugly split now between the freshwater and saltwater economists is that monetary policy (interest rates) isn’t working: the US interest rate required to restore full employment is negative 6%. The saltwater diagnosis is that in this situation (as in the Great Depression), the government needs to provide the missing demand, through deficit spending. In normal times, deficit spending is bad; in times of mass unemployment, deficit spending is good. An early calculation by Krugman: if output is going to be 7% lower than normal, government stimulus should be at least 4% of GDP.
What happens if government stimulus is too small is that you end up with a situation like Japan’s in the 1990s–ongoing deflation and high unemployment. Adam Posen: Fiscal Policy Works When It Is Tried.
Of course, freshwater economists are viscerally opposed to deficit spending. I think the Krugman article and Cochrane response that you linked to are pretty good representatives of the two schools of thought. As a layman, I have to say that the saltwater economists make a lot more sense to me–the Real Business Cycle theory seems pretty plainly contradicted by reality.
Krugman’s concerns aren’t primarily about employment. His earlier works reveal that he does not generally hold that Chinese imports are bad for employment in the U.S. On the other hand, he has expressed some concern that in our current, abnormal economic landscape, Chinese imports might be increasing unemployment in the U.S. and the rest of the world. But his main concern is not employment.
Krugman’s long standing concern is the fact that capital is flowing from China, a developing economy, to the U.S. a developed economy. This is the opposite of the typical scenario where capital flows to the developing world funds investment. This capital flow is made possible by Chinese manipulation of their currency among other things. This capital flow creates an unstable economic situation and was one of the factors that fueled the housing bubble.
If your income is derived from more-or-less static assets valued in dollars, you want the value of the dollar to remain high. Cheap Chinese imports are then a good thing.
If your income is derived from work, and work is scarce, you do not have money to buy cheap Chinese imports, so they are an unclear benefit.
Our current “Western economic system” (not the greatest work of software) in the face of rising productivity seems to have only two stable solutions: high activity with exports absorbing gains in production, and low activity with a small number very wealthy / large number very poor. China has opted to keep the exports going by devaluing their currency (their main goal is political stability). Makes it harder for most everyone else to be economically stable (or closer to the more desirable solution).
Of course, China is a problem, but not the main problem. The main problem is a economic system evolved over a long period when surplus (capital) was relatively scarce. When surplus is abundant (and rising), there seems with the current system no good stable state.
Assuming that David Smick’s “The World is Curved” is a good map to the “financial” tribe’s world view, they have an enormous blind spot, and they do not want to muck with the software that has served them well.
John: Krugman’s concerns aren’t primarily about employment.
In the current situation, Krugman’s concern is indeed primarily employment. Krugman: “[Devaluing the yuan is] a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand (emphasis added). By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.”
Folks who think we’ll be better off if Chinese goods are more expensive: The Chinese have stolen our jobs by making some goods cheap, eh? Let’s look at some other things in the U.S. that are cheap. We live in a country with a lot of fresh water. In countries where water is scarce, people find jobs drilling wells, carrying water, building drip irrigation systems, building and working in desalination plants. God has ruined the U.S. economy by causing rain to fall on us and rivers to flow. Considering how much more important water is to human life than a DVD player, imagine the great jobs we would all have if fresh water cost $100 per gallon to produce.
Krugman’s argument only makes sense to me if the basket of possible things to buy is fixed and the kinds of jobs that people could have are fixed. So if you start the day with $1000 and find that you can get the necessities from China for $100, you don’t spend the remaining $900 because there is nothing else that you want or can find. That doesn’t jibe with my experience of the world. A person who saves money on household goods may spend the surplus on a vacation, on a cleaner or babysitter, on meals and entertainment, on commissioning an artist, on landscaping, etc. All of those things create additional jobs in the U.S.
I would be interested to read something of Paul Krugman’s that wasn’t either completely obvious, completely wrong, or an apology piece for his liberal welfare-state ideology. (His self-description, not mine.)
People are constantly fooled into heeding economists as if they had any intellectual authority. Macro-economists are not scientists. They do not use the scientific method, and cannot predict the future outcome of a situation based on current conditions.
> Alternatively, suppose that Chinese goods were available for free.
I am reminded of the argument I have seen several times recently that we are
actually making things worse for some east African countries by continuing to give them free food, as opposed to helping them develop ways to better provide food for themselves.
The short explanation of Krugman’s concern is that there is more to a healthy U.S. and world economy than cheap clothes at Walmart. For example, try selling something to China when the yuan is being kept artificially low.
Looking beyond simple winners and losers from trade: China maintains the yuan’s price by being willing to hold enormous dollar reserves. This has been a tremendous boon for the U.S. mortgage market and homeowners. And as long as China never unloads those reserves, everything will be fine…
Philip: “That doesn’t jibe with my experience of the world. A person who saves money on household goods may spend the surplus on a vacation, on a cleaner or babysitter, on meals and entertainment, on commissioning an artist, on landscaping, etc.”
In normal circumstances, yes. But right now we’re in paradox-of-thrift mode (everyone tries to increase their savings at once, which causes everyone’s income to fall): since last year, and especially since last fall, both businesses and households are trying to hold onto their cash. Take a look at this graph showing the US personal savings rate (from the Bureau of Economic Analysis). It shows that between the first quarter of 2008 and the second quarter of 2009, the savings rate increased more than four times, from just over 1% to 5%.
In normal circumstances, when the economy’s at full employment (meaning unemployment is about 5%), when a particular product gets cheaper–whether through trade or technology–everyone’s better off. Employment in that sector will fall, but there’ll be other sectors in the economy which need more workers; they’ll invest more and hire more workers. If need be, the central bank will lower the interest rate, compensating for the reduced demand.
But suppose we were in the middle of a Great Depression, with unemployment at 30%. Suppose that the central bank can’t lower interest rates, and that the government is committed to balanced budgets, so it won’t stimulate the economy through deficit spending. So unemployment is stable at this level; nobody’s willing to either spend or invest, and this is true across all sectors.
Now suppose that there’s some new technical innovation which means we no longer need a large number of the workers who still have jobs–say another 10%. Under these circumstances, all that happens is that unemployment rises to 40%.
In the real world, of course, governments are willing to compensate for reduced demand by deficit spending, at least to some extent; they reduce the unemployment rate by borrowing money and spending it. So China’s artificially low exchange rate, or the hypothetical technical innovation, wouldn’t result in a higher unemployment rate; it would result in more government borrowing.
Or, for governments which are limited in how much they’re willing to borrow (like the US), it’ll result in some combination of increased borrowing and increased unemployment.
(Again, this line of argument does not apply in normal circumstances, when the economy’s at full employment; when that’s the case, improved efficiency through trade and technology is definitely a good thing.)