Trade and The Dollar 2

This morning Paul Krugman has an op-ed in the New York Times explaining some of what I was alluding to last Friday.

The key point to bear in mind is that trade and currency issues often lap over into domestic policy decision making. So what may appear to be a little abstract to the average American can quickly become very relevant.

Take, for example, Krugman’s reference to Chinese criticism of US fiscal and monetary policy. The Chinese have a huge hoard of US dollars, they have been accumulating that hoard for months. They also have a pile of US Treasury bonds – they are quickly emerging as our largest overseas creditor [please bear in mind that by far the largest share of US debt is owned by Americans citizens through pension funds and so on. Foreigners own a good but much less significant share]. So they are naturally concerned about a fall in the value of those assets as the dollar depreciates against world currencies. They go so far as to argue that we should be raising interest rates in order to protect the dollar’s value.

This is, of course, exactly what we should not be doing. If we could we would be lowering rates even more in order to help deal with unemployment. But we are stuck at the bottom – rates are close to zero and cannot go any further down. This is one reason that the economic outlook is a difficult to predict: our most important ‘normal’ policy lever is impotent.

The Chinese are being extraordinarily self serving, almost to the point of being self destructive. Their economy has bounced back and is growing between 6% and 9% a year. Developing countries always have higher growth rates than developed countries since the opportunities are much more obvious and more easily taken advantage of. This rapid growth is making China a world power in economics. Its trade balance is just as tilted as ours is, theirs is in the black, ours is in the red. These huge trade flows are unhealthy for each country because they skew their respective domestic economies. In China’s case there is far too little local demand for locally made products, so manufacturers seek exports. The Chinese government stimulates that over production by keeping its currency pegged against the dollar rather than allowing it to float. There is no doubt at all that the Chinese currency – the renminbi – is way under valued. Were it to float up to a more reasonable valuation it would make Chinese exports more expensive and choke off that trade surplus. It would also encourage an inward flow of investment which would help stimulate local demand. Ultimately the goods that are now being exported to places like America would still be made, but they would be consumed locally. It is also likely that foreign goods, some of which would be from the US, would become cheaper to Chinese consumers and so would be imported. This would help reduce the Chinese trade surplus too and would help stimulate economies around the world, not least here in the US.

All this is very clear.

It is also politically charged, so getting a Chinese revaluation is not going to happen any time soon. Presumably the topic is firmly on the agenda during Obama’s visit there. Our difficulty is that the imbalances created by the dollar’s fall and our insatiable appetite for oil, plus the Chinese intransigence, make the upcoming transition period in the world economy very difficult. For a more stable medium term growth outlook to emerge the US needs to raise its domestic savings, reduce its debt, cut its government borrowing, and settle for a more cooperative world economic policy. Much of that agenda has to await the improvement in unemployment here. But it also depends highly upon a shift in Chinese policy.

We both would benefit from the change.

First we both have to recognize what part of the blame resides at home.

That’s the hard part.

Don’t hold your breath on this issue.