(What’s Left of) Our Economy: Establishment China Experts Who Can’t Shoot Straight

Tags

China, China content levels, currency, currency manipulation, devaluation, Donald Trump, Eswar Prasad, exchange rates, exports, Matthew Slaughter, protectionism, The Economist, The Wall Street Journal, The Washington Post, Trade, yuan, {What's Left of) Our Economy

This last week has made clear that it’s not just China’s economy and leadership that have been cut loose from their moorings. It’s also the leading economists and Big Media journalists who pretend they know much more about Chinese economic policies – and how America should deal with them – than the rest of us know-nothings.

Indeed, within the last two days, no less than two economists and The Economist magazine have published pieces intended to show the folly of those who have long urged American crackdowns on predatory Chinese economic practices like currency manipulation (which makes Chinese-made goods and services artificially cheaper versus all foreign counterparts all over the world), intellectual property theft and technology extortion, and illegal subsidization and the dumping into foreign markets of the resulting surplus output at cut-rate prices. And as always, you can be sure that the prominent placement of these pro-status quo messages reflects their endorsement by the publications in question.

The first addle-brained attempt to assure Americans that their government’s do-nothing China policy is on the right course came in a Washington Post article by former senior World Bank China expert Eswar Prasad. One of his main goals – which is anything but weird for an establishment voice – is debunking Donald Trump’s claim that “China is killing us” when it comes to trade. But then the weirdness comes non-stop.

First, Prasad seems to think that the way to discredit the Republican presidential front-runner is to show that China’s growth has not been “driven primarily by cheap exports” – and especially by sales of “cheap consumer goods.” But that’s never been Trump’s main concern, or that of voters critical of America’s China trade policies. Instead, it’s been the destruction of family-wage American manufacturing jobs by predatory Chinese trade practices.

Second, Prasad joins the crowd of so-called experts who try to show that China’s trade surplus with the United States isn’t as big as the headline figure suggests. The reason: So much of what the Chinese sell to this country consists of U.S.-made parts, components, and other inputs. But as I’ve pointed out, the evidence Prasad cites is of no comfort to American workers whatever. The Apple iPhone he uses as an example of a semi-faux Chinese export turns out to be made not mainly of American parts, but of other (protectionist) countries’ parts. And as made clear by his criticisms of Washington’s approach to trade with countries like Mexico and Japan, Trump fully understands that China isn’t America’s only international economic challenge.

Even weirder is that Prasad then goes on to point out that China’s manufacturing “has started moving up the value-added chain, shifting from a focus on low-cost, low-tech goods such as shoes and textiles to more sophisticated products with a higher technological content. “ He’s absolutely right. But does he think that none of these more advanced manufactures goes into China’s exports? If he does, he obviously isn’t familiar with findings from the World Bank and the International Monetary Fund – which show that the Chinese content of China’s exports has risen dramatically over the last 20 years.

No less bizarre was Matthew Slaughter’s Wall Street Journal op-ed yesterday arguing that “Movements in the yuan’s nominal exchange rate do not affect long-term trade flows or jobs in the U.S.” This Dartmouth economist is on reasonable ground in contending that “The exchange rate that matters for trade flows is the real exchange rate, i.e., the nominal exchange rate adjusted for local-currency prices in both countries,” and that this real exchange rate “in turn, reflects the deep forces of comparative advantage such as technology and endowments of labor and capital.”

What Slaughter seems to forget, however, is that China’s labor market is heavily repressed, and its government still tightly controls capital flows (although China has taken some steps towards liberalization). In other words, these determinants of comparative advantage are thoroughly manipulated by Beijing, and according to Slaughter, they do influence trade flows and their impact on national growth and employment. So by extension, China is manipulating that real exchange rate – and if the United States cares about the impact on its economy, it has no choice but to respond.

Just as odd – despite the author’s opposition to countering the trade effects of Chinese currency policy, he does acknowledge that China “has too many barriers to trade and investment, too much favor for local companies, too weak protection of intellectual property,” and that U.S. leaders need to “encourage China to overcome its policy shortfalls that truly do cost America good jobs at good wages.” Trump’s China trade position paper recognizes many of these “shortfalls.” But unlike Slaughter and other stand-patters, he understands that “encouragement” has failed for decades, and that stronger responses are needed.

The third example of China inanity comes from The Economist, which also seems determined to ease concerns about China’s currency manipulation even though it doesn’t mention the yuan’s recent slide. According to the magazine – which has always championed the cause of unfettered international flows of trade and other economist assets – currency devaluations are not nearly as big a deal as they once might have been because they’ve become less and less successful in artificially stimulating exports.

One big problem with this claim, however, is that it assumes devaluations are seen by trade policy critics as export boosters in all cases. And that’s a straw man. After all, export success depends on numerous factors, and if a national economy is otherwise a mess – as is the case with countries mentioned by The Economist like Russia and Brazil, cheaper currencies can’t possibly be panaceas. To some extent the article recognizes various complications. But they don’t come up until the piece is well underway.

And what’s also peculiar is that The Economist touts a method of calculating the appropriateness of exchange rates that pegs China’s yuan as – get this – nearly 50 percent undervalued. Does anyone seriously think that if Chinese exports became 50 percent more expensive, all else equal, they’d sell nearly as briskly?

Here’s a suggestion: How about Prasad, Slaughter, and The Economist writers get together, try to hash out their own differences, and see if they can produce a China article that’s halfway coherent? Almost anything has to be better than what they’ve done separately.

(What’s Left of) Our Economy: China is Snookering the IMF and US (Again) on Currency

Tags

capital controls, China, currency, currency manipulation, devaluation, dollar, IMF, International Monetary Fund, Obama, reserve currency, TPP, Trade, Trans-Pacific Partnership, yuan, {What's Left of) Our Economy

Even given the laughably bad U.S. government record in gauging China’s trade and economic intentions and defending American economic interests against Chinese predation, Washington’s recent pronouncements and decisions on China’s currency policies have been abysmal. And they look worse and worse by the day.

Specifically, the Chinese seem to have taken the United States – and the rest of the world – to the cleaners. On the one hand, Beijing has apparently convinced American and global authorities that it’s becoming a responsible global financial player. On the other hand, it’s unmistakably resumed weakening its currency for trade advantage.

In recent years, the case for optimism about China’s role in the world economy has rested on what has been described as Beijing’s growing commitment to economic and financial reform. As the optimists noted, China had loosened its control over its currency even though this freer float had resulted in a strengthening of the yuan versus the U.S. dollar. All else equal, this approach eroded the price advantage enjoyed by Chinese goods versus their foreign counterparts due to China’s longstanding efforts to keep the yuan artificially cheap.

This increasingly hands-off currency policy, in turn, appeared to signal a broader resolve by China’s leaders to turn its entire financial sector into a genuine banking system rather than a mechanism for the state to dominate resource allocation. At the end of that road arguably lay a fundamentally more market-based, and thus healthier, Chinese economy – and possibly even a more democratic China, since the government would no longer be calling so many crucial economic shots.

In return, China has received nearer-term two major rewards. First, the International Monetary Fund (reflecting the views of the United States and other major economic powers that set its policies) admitted the yuan into it’s so-called basket of international reserve currencies. The main impact was symbolic, reinforcing the reality of China as a leading force in the global economy. But this is the kind of status that’s highly prized not only by Chinese leaders but by the entire society they rule – not to mention by many of their Asian neighbors.

Second, the yuan’s rise eased some of the pressure China faced to trade more freely. Here, the effect was mainly multilateral. The U.S. government has never responded effectively to Beijing’s currency manipulation, but the stronger yuan clearly helped Congress decide to fast track President Obama’s Trans-Pacific Partnership (TPP) agreement when it began considering passage despite its lack of enforceable currency rules. Although China is not yet a member, it stands to benefit handsomely, if only because of the deal’s loopholes, and its new currency stance enabled the president to portray a successful, informal jaw-boning campaign against the world’s leading instance of exchange-rate protectionism as a better approach than formal rules and sanctions.

Yet it’s become ever clearer that the yuan’s most recent months of strengthening reflected not a Chinese conversion to so-called fair trade, but the Chinese government’s need to stem the capital flight brought on by its broader prestige-focused financial reform measures. In effect, Beijing was facing the inevitable price of liberalization – especially in the face of an economic slowdown and a burst of turmoil in its so-called stock markets.

The United States and the world’s other leading powers might have been able to hold China’s feet to the fire by postponing the yuan reserve currency decision until Beijing demonstrated that its reforming ways would persist despite short-term economic pain. (A tougher TPP would have helped, too.) But they squandered their leverage by rewarding China prematurely – and the Chinese have taken full advantage. Since the yuan was officially brought into the reserve currency basket on November 30, its value versus the dollar has slid by nearly 0.80 percent. In the world of exchange rates, that’s a big change, especially in less than two weeks.

Further, this yuan weakening has come on top of the gargantuan near-two percent devaluation announced by China in mid-August. All told, since then, the yuan has fallen versus the dollar by a stunning 3.85 percent. Moreover, it’s been reliably reported that China has just tightened its capital controls again, and in recent weeks has ramped up its efforts to close the black market channels through which wealthy Chinese have been illegally transferring massive amounts of wealth abroad. The obvious implication is that, however much they value global prestige and the long-term economic benefits of reform, China’s leaders remain first and foremost determined to keep propping up the economic growth on which their political power ultimately depends.

As a result, unless the IMF kicks the yuan out of the reserve currency basket, and/or the United States either adds meaningful currency manipulation curbs to the TPP or, even better, acts unilaterally (don’t hold your breath), China and its leaders will be able to reap all the benefits of greater protectionism while continuing to pay none of the costs. For years, the world’s economic powers-that-be have been declaring China to be an increasingly “responsible stakeholder” in the global economy. But it actually looks more and more like they have a much bigger stake in perpetuating this delusion.

(What’s Left of) Our Economy: A Gathering Storm?

Tags

Alan Greenspan, bottom line growth, bubbles, China, commodities, currency, currency wars, devaluation, emerging markets, executive compensation, Federal Reserve, Financial Crisis, free trade agreements, George W. Bush, infrastructure, interest rates, Janet Yellen, mergers and acquisitions, Obama, productivity, profits, quantitative easing, recovery, secular stagnation, stimulus, stock buybacks, stock markets, stocks, top line growth, Trade, valuations, yuan, {What's Left of) Our Economy

The wild swings of stock markets around the world today should caution anyone against reading too much into recent global financial turmoil. As should be obvious to everyone – but is so easy to forget – these stock market declines are anything but the first that have been seen, and they’re anything but the worst that have been seen. The same goes for the economic situation in China and elsewhere – which matters much more.

But although this clearly is no end-of-the-world moment or even close, the latest news is a warning that the dangerous weaknesses that plunged the world into genuinely terrifying financial crisis and then savage recession just seven years ago have only been papered over, and have begun worsening again. More seriously, the United States and the rest of the world look much less capable of resisting powerful downdrafts.

Just to review very quickly, as I see it, the last crisis resulted fundamentally not from failures to regulate Wall Street adequately, the housing bubble, or any largely financial conditions. These were simply symptoms of mounting weaknesses in America’s real economy stemming largely from disastrously shortsighted trade policies. Both major parties became so enamored with offshoring-friendly trade deals and other policies that they sent overseas a critical mass of the U.S. productive base, and therefore a critical mass of the income-earning opportunities available to middle- and working-class families.

The George W. Bush administration, the Congress, and the Federal Reserve under then-Chairman Alan Greenspan could have reversed or even slowed this trade policy approach in order to restore these crucial domestic sources of income- and wealth-creation. Instead, they decided to double down on the offshoring. But to enable consumers (who are after all voters) to preserve their living standards, they decided to create then-unprecedented amounts of easy money, which made possible substituting borrowings (typically based on the bubble-ized home prices) for inadequate paychecks. Until that bubble’s inevitable bursting, the results were widely praised as having produced an economy whose “fundamentals” were “strong.“

Once the crisis struck, the Fed and other major world central banks have sought to reestablish and preserve national and global economic momentum through yet greater money printing and thus credit-creation. National governments in the United States (during President Obama’s first year in office) and especially in China lent a big hand through stimulus programs aimed at creating new government-supported demand for goods and services, and therefore for workers.

Seven years later, the results are in, and it’s fair to say that they have produced growth and employment levels that keep lagging historical standards not only in the United States, but everywhere. In fact, largely because the Fed so quickly and energetically capitalized on its massive credit-creation powers, America is a conspicuous out-performer. But as I’ve also pointed out, the makeup of the U.S. economy still strongly resembles that of the housing- and consumption-heavy bubble decade, which is why a more compelling description of America’s situation is not “ho-hum recovery” but “secular stagnation.” This concept, popularized by former Clinton-era Treasury Secretary and Obama chief economic adviser Larry Summers, holds that the nation has lost so much productive oomph that it’s forced to rely on Fed-created bubbles for whatever growth it can muster – and thus to run the ongoing risks of bubble-bursting as well.

Something, though, has clearly changed in recent weeks. The one-word description is “China” but the real answer is of course much more complicated, and looks to be a function of a seemingly fatal flaw of global easy-money policies: They’ve fostered way too little productive, growth-boosting investment, and way too much mal-investment. The latter has barely kept growth in positive territory but that’s gifted Wall Street and executives at big publicly traded companies with huge windfalls thanks to a (so far) mutually reinforcing cycle of share buybacks and rising stock prices that has supercharged their largely stock price-based pay. Other uses for cash and credit that have seemed more tempting than servicing economically fragile and in many cases still-cautious American consumers included buying up other companies and, mainly for Wall Street, simply parking the money at the Fed, where big finance firms could earn a bit of interest on trillions of dollars for doing absolutely nothing.

But still other distorted investment choices have included so-called emerging markets. In those lower income countries, higher levels of risk brought attractive levels of return, but investors (and not just financiers) were also impressed with relatively high growth rates. And that’s where much of the latest round of troubles is rooted.

Several big and chronic weaknesses and vulnerabilities of these countries – including China – were largely overlooked. First, because incomes were comparatively low, these countries were never able to grow mainly by turning out goods and services for their own populations. Growing fast enough to spur significant economic progress required finding markets “where the money is,” which meant abroad generally and disproportionately in the United States. When growth in the United States merely kept slogging along, many of the new factories that were built with American consumers in mind began looking awfully risky.

Just as bad, many of these emerging market countries themselves got greedy. Their governments and central banks took advantage of low global interest rates by trying to juice extra growth and rising incomes by offering easy credit to their consumers, home-builders, and other businesses, too. But they weren’t able to borrow sufficiently in their own currencies, and many jumped at the chance to take on abundant dollar-denominated debt – including companies that could borrow on their own, without working directly through their governments. Moreover, many of these low-income countries (and some wealthy counterparts, like Australia and Canada) had gotten an added boost from China’s seemingly endless demand for their raw materials, which produced the lion’s share of their growth. But they failed to use earnings from the resulting high commodity prices to diversify their economies and take at least a few eggs out of that basket.

Lately, both China and the Federal Reserve have hit the emerging world with several punishing whammies. China itself continued to depend heavily on exports for its growth, and therefore started slowing itself as global demand continued disappointing. Its performance was additionally undermined by a decision to let permit the yuan to strengthen, in order to win it reserve currency status and greater long-term economic independence.

Beijing had also been trying to subsidize more growth led by domestic demand. But as with other third world countries, because Chinese incomes remain so low even after impressive pay raises, massive amounts of stimulus ranging from infrastructure and housing investment to (most recently) stock market manipulation did more to saddle that country with immense debts than to keep growth and job-creation at levels that were both economically acceptable, and politically essential – i.e., strong enough to keep the masses reasonably happy.

If official data is close to accurate (hardly a certainty), China’s growth rate is still world-class. But even its recent decline from previous blistering levels clearly has been enough to ravage global demand for fuels, industrial metals, and foodstuffs alike – and in turn the economic prospects of the commodity producers. Since the economic prospects of these erstwhile johnny-one-note high-riders began worsening so markedly, foreign investors began pulling money out, putting downward pressure on their currencies, and consequently on their ability to import – including from the United States. At the same time, China’s own recent yuan devaluation deepened this predicament – by further diminishing the PRC’s own purchasing power, and by reducing the price competitiveness of all the finished goods that the commodity producers and their more manufacturing-oriented third world counterparts needed to sell.

If anything, the Fed’s impact on the developing world has been still more destructive. Like the United States, much and even most of its recent growth has depended on artificially cheap credit. But unlike the United States, it can’t borrow in its own currencies. As a result, these countries are exposed to exchange-rate risk (created mainly by the rising dollar) as well as to interest rate risk (which can be created not only by the actual Fed interest rate hike that Chairman Janet Yellen and colleagues have been promising, but by a perception of impending hikes that reduces the third world’s creditworthiness and thus their access to affordable new money.

The real U.S. economy is more than capable of staying relatively unscathed by this global turmoil. For despite the best efforts of American leaders, it’s still less reliant on trade, foreign investment, and the well-being of the rest of the world than practically any other economy. U.S. stock markets, by contrast, could be in for greater trouble, which could be the single most important reason for their recent drop (keeping in mind that their levels are always determined by a great variety of long and short-term influences).

The reason? Among the major props for stocks during the current feeble U.S. recovery has been American companies’ remarkable ability to grow profits despite the real economy’s woes. As widely noted, much of this growth has been on the bottom line – resulting from greater efficiencies rather than better revenues. Human ingenuity’s power should never be underestimated, but by the same token, it’s hard to believe that infinite amounts of blood can be drawn from that stone. Indeed, faltering recent American productivity performance strongly indicates that diminishing returns are in store for these efforts. Emerging markets, with their historically high growth rates and gargantuan populations, have long been viewed as business’ best future hope for accelerated top line growth, and so far they’ve performed well enough to justify considerable confidence.

This latest set of emerging market troubles, including China’s, signals that this ace in the hole really isn’t – which understandably raises questions about whether current stock valuations can be sustained. As usual, please take all forecasting efforts, including mine, with a big boulder of salt. But it seems to me at least conceivable that, just as Wall Street has for years comforted itself by observing that “the stock market is not the economy,” unless Washington screws up royally, Main Street will start becoming grateful for this divide.

But that doesn’t mean that a healthy speed up in the recovery is in sight. Speculation has abounded lately that the Fed might not only postpone those interest rate hikes but need to launch another round of bond-buying – i.e. “quantitative easing.” Yet why a new influx of easy money would generate more sustainable growth than its predecessors isn’t at all apparent.  Washington could return to greatly increased deficit spending, but with so much of U.S. consumer and business demand being satisfied by imports, and with foreign currency devaluations likely to continue, the growth and employment benefits seem more certain than ever to leak overseas.  In principle, this new spending could be targeted on domestic infrastructure, but however popular this idea has been in Washington, it hasn’t yet been popular enough to produce enacted programs, and the intensifying presidential cycle could well turn into a new obstacle.

What about tariffs on imports, which could spur growth by cutting the trade deficit – and without budget-busting tax cuts or stimulus programs? As usual, they’re completely off the table. Indeed, new trade agreements, and therefore higher deficits and even slower growth, appear to be next on that front – though perhaps not until both Democrats and Republicans are safely past the next election.

That leaves fostering an unhealthy speed up in the recovery – kicking the can down the road yet again secular stagnation-style, for the usual unspecified reasons expecting meaningfully different results, and acting surprised when crisis clouds begin gathering anew.        

 

Making News: Podcast of New BBC Interview on China and Global Markets

Tags

BBC, China, China stock markets, currency, currency wars, devaluation, emerging markets, export-led growth, Federal Reserve, finance, interest rates, investing, Making News, monetary policy, recovery, Trade, Wall Street, yuan, ZIRP

I’m pleased to announce that I was interviewed on the BBC this morning on China’s economic and financial turmoil, and how it’s been shaking the world’s economy and financial markets.  Click on this link for the podcast.  My segment is titled “Global Markets React to China’s ‘Black Friday'” and yours truly comes in at about the 7 minute-50-seconds mark.

Moreover, even as we speak, I’m working on a more detailed analysis that I hope to post shortly.  Stay tuned!

(What’s Left of) Our Economy: New Body Blows for Three Major China Currency and Economy Myths

Tags

Australia, Canada, China, Congress, currency, currency manipulation, devaluation, dollar, export-led growth, Federal Reserve, infrastructure, Jack Lew, Janet Yellen, New Zealand, purchasing power parity, The New York Times, The Wall Street Journal, TPP, Trade, Trans-Pacific Partnership, Treasury Department, {What's Left of) Our Economy

For all the intensive and wide-ranging media coverage of China’s yuan devaluation just over a week ago, three crucial aspects with big implications for Sino-American trade relations and for President Obama’s Trans-Pacific Partnership (TPP) have been neglected.

First, compelling new evidence has emerged that China’s currency move does indeed represent manipulation to achieve advantages in trade – a conclusion that the U.S. Treasury Department has long balked at reaching in its Congressionally mandated reports on foreign exchange rate policies. Of course, Treasury has for years called the yuan undervalued. But it’s excused Beijing of the currency manipulation charge by (most recently) citing the yuan’s “real progress” in appreciating in real terms versus the dollar and China’s reduced intervention in foreign exchange markets.

Treasury, however, will be hard pressed to explain away The New York Times‘ disclosure earlier this week that:

“In a little-noted [July] advisory to government agencies, [China’s] cabinet said it was essential to fix the export problem, and the currency had to be part of the solution….Soon after, the Communist Party leaders issued a statement also urging action on exports. It all set the stage for the currency devaluation last week that resulted in the biggest drop in the renminbi since 1994. The cabinet’s call to action: The country needed to give the currency more flexibility and to reinvigorate exports. If officials did not act, China risked deeper turmoil at home, threatening the stability of the government.”

In other words, the entire top Chinese leadership – not just the Ministry of Commerce, which has explicitly championed a cheap yuan as an export booster frequently in the past – is now on record as having supported a deliberately weakened yuan in order to improve China’s global price competitiveness. What else do American authorities need to make the manipulation accusation officially?

More important, because a Treasury manipulation finding does not, contrary to the conventional wisdom, require any policy follow up, how can supporters of the TPP now justify the agreement’s failure to incorporate effective curbs on such exchange-rate protectionism? During Congress’ recent debate, lawmakers who opposed such measures, along with the administration, insisted that TPP currency sanctions could backfire against the United States because they could be legitimately used to counter any currency effects of the easy money policies of America’s Federal Reserve.  So did Fed Chair Janet Yellen herself, along with Treasury Secretary Jack Lew.

Now, however, it couldn’t be clearer that trade-related currency devaluations having nothing to do with monetary policy are a clear and present danger to the U.S. economy. It’s true, as I’ve noted, that even strong currency language in the Pacific Rim trade deal would not automatically amount to solving the problem, since many other first round and follow-on TPP countries have powerful incentives to retain a currency manipulation arrow in their policy quiver. But at the very least, it’s no longer possible to argue that TPP currency provisions inevitably create a dangerous downside for the United States. And however unlikely, an upside can’t be completely ruled out. The case for unilateral American responses, which the president also adamantly opposes, just got a lot stronger, too. 

Second, new data challenges the claims of administration and other opponents of any currency curbs that the yuan undervaluation problem is steadily solving itself thanks to China’s voluntary actions. Yes, the International Monetary Fund in April declared that the yuan is now appropriately valued. But exactly the opposite conclusion looks more accurate upon bringing into the picture one widely accepted tool for dealing with analytical complications arising from the often dramatically differing price levels among economies – especially those at different stages of economic development.

Thus according to Purchasing Power Parity methodology, the yuan is still more than 40 percent undervalued versus the dollar. Not far behind is the Japan’s yen. And the currencies of three other first-round TPP countries – Australia, Canada, and New Zealand – also supposedly belong in this category.

Finally, even more new data debunks another major argument against strong currency manipulation actions – the contention that China is shifting dramatically from an export-led growth model to a demand-led blueprint. Optimists on this score typically cite figures showing much faster growth in investment in China than in exports. But yesterday, an important Wall Street Journal piece featured an insight regarding the makeup of China’s economy and growth that decision-makers and analysts urgently need to understand: Properly measuring the importance of exports to China requires counting much more than the country’s total overseas sales or even its trade and current account surpluses. It requires counting all the infrastructure spending on all of the roads, bridges, ports, airports, and other projects that are needed to support exports, and that have been one of China’s major competitive strengths.

Figures reported by Journal correspondent Greg Ip show that, when the export sector is properly defined, its contribution to China’s growth is down since 2010, but “still remarkable amid slower growth in its trading partners and a higher yuan.” In the process, he supported a point that I’ve been making for several years. On top of this finding, data I’ve previously spotlighted shows that, given its overall growth slowdown and expanding trade surpluses, China has been getting even more export-oriented lately.

A China that’s unmistakably manipulating its currency and increasingly export-heavy, and a yuan whose value remains massively distorted by Beijing don’t of course guarantee that Congress will start expressing big second thoughts about endorsing President Obama’s TPP and China trade status quos. But they do mean that lawmakers will be even shorter than usual of reasons not to.      

(What’s Left of) Our Economy: Why America’s Trade Problems with China are Much Bigger than the Yuan

Tags

broad dollar index, China, currency, currency float, currency manipulation, currency peg, devaluation, dollar, exchange rates, import prices, manufacturing, prices, Trade, yuan, {What's Left of) Our Economy

So much has been written about China’s devaluation of its currency last week that it’s hard to believe that all the major angles haven’t been covered. In fact, they’ve been generally neglected, and none more so than what matters most to the U.S. economy – how the yuan’s government-controlled movement affects the prices, and therefore the competitiveness, of Chinese imports that compete with American counterparts in the American market.

The big takeaway is that although of course China’s policy of artificially manipulating the yuan’s value versus the U.S. dollar has a lot to do with whether American customers buy Chinese- or U.S.-made goods – with big effects on American growth and employment levels – currency movements are far from the only determinant. As a result, U.S. policymakers need to keep in mind all the other measures China uses to gain trade advantages for reasons having nothing to do with free trade or free markets.

Let’s start to show why by looking at where the yuan stood on July, 2005. That month, a dollar bought about 8.28 yuan, an exchange rate that had stayed constant since the fall of 1998, thanks to Beijing’s determination to peg its currency to the dollar even though economic conditions signaled the yuan should have been getting much stronger. But on July 21, China began letting the yuan float versus the dollar to a limited extent – that is, allowing market forces to play a limited role in setting the exchange rate.

This tightly circumscribed “float” continued through July, 2008, when the weakening global economy persuaded China to reestablish the peg. During those three years, the yuan strengthened versus the dollar by more than 16 percent – which should have provided a major competitive boost for American goods and services competing against Chinese imports (as well as against Chinese rivals in China’s own market).

But U.S. Labor Department data on import prices shows that those from China rose by only 5.18 percent during that period. Clearly, something else was influencing Chinese cost levels – notably a wide range of state-provided subsidies. But largely because Washington ignored all these Chinese government props, those three years were a time of huge American manufacturing trade deficits with China, which translated into major production loss and even worse job destruction.

More evidence that Chinese price levels were huge outliers: During this period, the dollar weakened by 14.94 percent versus a statistical basket consisting of most other foreign currencies (the Federal Reserve’s “Broad” index). That’s slightly less than it weakened versus the yuan. Yet the prices of U.S manufacturing imports overall (a good point of comparison since manufactures dominate what America buys from China), rose by 15.90 percent – more than three times faster than the prices of China’s imports.

These divergent relationships have persisted through the various ups and downs experienced by the dollar, the yuan, and other foreign currencies since then. To some extent, that’s not terribly surprising, given all the other factors that affect the prices of traded goods, and given that prices never change in lockstep with exchange rates. But what is surprising – and disturbing – is how consistent China’s outlier behavior has remained over the decade since that first July, 2005 loosening.

During this period, until the Chinese devalued on August 11, the yuan became 25.10 percent stronger versus the dollar, while the dollar became 4.46 percent stronger than that Broad index of foreign currencies. Yet import prices from China rose by less than half the amount that overall U.S. manufacturing import prices (4.26 percent versus 11.50 percent). And not surprisingly, despite widespread claims that China is steadily losing competitiveness versus rivals both from the United States and from other developing countries, China’s merchandise trade surplus with the United States is still rising strongly – though its latest 9.80 percent year-to-date increase through June lags the growth of the world’s manufacturing trade surplus with America (15.85 percent).

Asking Washington to focus on that full range of artificial Chinese competitiveness supports seems pretty unrealistic given the bipartisan, decade-long failure to do anything about currency manipulation. Unfortunately, that’s also largely why a return to full health for the U.S. economy, fueled by investment and production rather than borrowing and spending, seems pretty unrealistic, too.

Making News: Talking China Devaluation on Connecticut Radio This AM

Tags

China, currency, currency wars, devaluation, Financial Crisis, Making News, Trade, WATR-AM, yuan

I’m pleased to announce that I’ll be appearing this morning on WATR-AM (Waterbury, Conn.) radio to talk about China’s de facto devaluation of its currency – which threatens the U.S. and global recoveries, and could hasten the eruption of Financial Crisis 2.0.  The segment is scheduled to begin at 11:10 AM EST, and if you’re interested, you need to listen live at this link – because WATR doesn’t do podcasts yet!

(What’s Left of) Our Economy: Why China’s Devaluation is a Huge, and Very Dangerous, Deal

Tags

2016 elections, Bernie Sanders, bubbles, China, Congress, currency, currency manipulation, debt, Democrats, devaluation, Donald Trump, exchange rates, export-led growth, exports, Federal Reserve, Financial Crisis, Global Imbalances, Hillary Clinton, Janet Yellen, Obama, protectionism, QE, quantitative easing, Republicans, TPP, Trade, Trans-Pacific Partnership, yuan, ZIRP, {What's Left of) Our Economy

China’s de facto currency devaluation last night has sent a vitally important message to the President Obama and his trade policy advisers, to a Congress that has just endorsed his strategy for handling currency issues in the proposed Pacific Rim trade deal, and to presidential contenders in both major parties. Their reactions will go far toward determining whether China’s renewed exchange-rate protectionism will further slow the already sluggish American and global economic recoveries, or worse, generate more central bank stimulus that further addicts the nation and world to unhealthy, credit-fueled growth. Indeed, downplaying and coddling a weaker yuan – which could well be cheapened further – may further widen the kinds of international economic and financial imbalances that set the stage for the last global financial crisis.

Constructively dealing with Beijing’s gambit will require correctly understanding its origins and likely effects. This latest example of currency manipulation is not mainly a Chinese attempt to regain competitiveness following the yuan’s rising exchange rate versus export-oriented Asian rivals. Taiwan, Korea, Japan, and others are also seeing their exports fall due to weakening growth in their major final-consumption markets – which are outside Asia. Indeed, China’s trade surplus year-to-date is up more than 200 percent over 2014’s absolute record level. And China’s move into higher value manufacturing – including production of previously imported components of advanced consumer electronics products it once mainly assembled – is proceeding apace.

Instead, China’s decision greatly to widen the yuan’s trading band reflects a determination to boost its economy by increasing its market share even in a world where growth has stagnated or shifted into reverse. As such it’s a quintessential example of beggar-thy-neighbor trade predation. China’s intentions should also be obvious from the devaluation’s timing – two days after the release of trade figures showing a much worse-than-expected year-on-year drop in July exports. And if Beijing really considered the global economy a win-win proposition, it would have sought to juice its own expansion by stimulating domestic demand yet again, which could have helped both foreign-based producers as well as China-based producers. Devaluation, by contrast, bolsters the latter at the former’s expense.

As a result, contrary to many optimistic interpretations, the sluggish global macro picture does not limit the devaluation’s potential to inflict damage on the United States or the rest of the world. In fact, China’s devaluation decision – which is by no means sure to stop with this initial step – arguably could destabilize global finances more dangerously than during the bubble decade. Then, the lopsided financial flows resulting from China’s massive trade surpluses with the United States provided the critical mass of cheap credit that supercharged the intertwined American housing and consumer sectors – and eventually pushed the entire world to the brink. But then, too, U.S. and global growth were stronger. And the Fed and other central banks hadn’t yet created previously undreamed of floods of credit to stave off disaster.

Yet containing the effect of China’s mercantilism this time, without yet more massive – and even reckless – U.S. debt creation, will require the kind of push-back emphatically rejected so far by President Obama and by most Congressional Republicans. Clearly influenced by multinational company interests whose China production benefits from an artificially cheap yuan and other Chinese export subsidies, America’s Democratic and Republican leaders have opposed both sanctioning currency manipulation either unilaterally or through Mr. Obama’s proposed Trans-Pacific Partnership trade agreement (TPP). But they’ve also received cover from no less than Federal Reserve Chair Janet Yellen. She has endorsed the claim that combating currency manipulation could expose the United States to international retaliation because central bank easing – like the Fed’s quantitative easing (QE) and zero interest rate (ZIRP) policies – puts downward pressure on currencies.

The aforementioned timing of China’s action, however, makes this case much harder to make. So does the now greater likelihood that an American failure to respond on either front could well flash a bright devaluation green light before other trading powers – including present and future TPP countries – thinking of continuing (as in the case of Japan) or embarking on this course. Consequently, expect greater pressure on Congress to reject any TPP emerging from ongoing negotiations that lacks strong, enforceable currency manipulation curbs.

One almost certain source of this pressure – this year’s crop of presidential candidates.

As a long-time trade policy critic, Vermont Senator Bernie Sanders seems sure to weigh in quickly on China’s decision and the TPP, and will find a receptive audience among his Capitol Hill Democratic colleagues. He and other Democrats are also bound to turn up the heat on rival White House hopeful Hillary Clinton, whose trade policy and TPP positions have been more ambiguous. After weeks of refusing to comment on the TPP – whose development she must have shaped as President Obama’s first Secretary of State – Clinton declared that a final deal must “address” currency manipulation “either directly or indirectly.” But although this statement left the presumptive Democratic nominee with lots of wiggle room, it also left this flank highly exposed.

At the same time, Congressional Democrats need to remember that currency manipulation is hardly the only protectionist policy pursued by China at the expense of domestic U.S. businesses and their employees, and that even tough currency measures in the TPP text hardly ensures solving the problem. After all, many current and prospective members (like Japan and China, respectively) have vital interests in ensuring that this option remains available. As a result, whatever the merits, they’ll be highly likely to block American currency actions in the treaty’s dispute resolution mechanism. Legislative currency sanctions supporters on both sides of the aisle, therefore, will need to press just as hard for unilateral U.S. currency responses, too.

The politics on the Republican side are clearer. Front-runner Donald Trump has blasted U.S. trade policy with China as a disaster, and has just gotten a huge supply of fresh ammunition. His GOP White House rivals have all supported these China policies with varying degrees of enthusiasm. Will they start backing off? Will they continuing ignoring the subject, even though China’s trade predation inflicts nearly all of its damage on a private sector they claim to prize? Much will depend on whether conservative talk radio and Fox News decide to give this issue any coverage – and of course on whether Trump can keep focused on this subject and stay out of personal feuds.  If he can, he could display more seriousness on critical China issues than most of the rest of the American political establishment – low bar though that is.   

(What’s Left of) Our Economy: The Real Economics of Currency Manipulation

Tags

central banks, currency manipulation, currency wars, devaluation, exchange rates, fast track, Federal Reserve, Financial Times, Great Depression, John Plender, Obama, protectionism, QE, Robert Aliber, TPA, TPP, Trade, Trade Promotion Authority, Trans-Pacific Partnership, University of Chicago, {What's Left of) Our Economy

Since Congress is finished with its fight over fast track negotiating authority for President Obama, and the next big trade deal in the offing – the Trans-Pacific Partnership (TPP) – is still being negotiated, issues like foreign currency manipulation have virtually disappeared from the media.

That’s more than a shame, since the effects of China’s longstanding exchange-rate protectionism – which gives Chinese-made goods artificial price advantages in all global markets – still weigh on American manufacturing production and employment.  And let’s not forget that Mr. Obama and Congress’ Republican leadership successfully beat back efforts to include strong disciplines on manipulation in the TPP – even though prospective TPP member Japan looks like another huge manipulator.

Here’s hoping, though, that when these subjects return to the spotlight, decision-makers will read John Plender’s excellent post in yesterday’s Financial Times explaining why this predatory practice needs to be abolished – and not just for America’s sake.

Plender makes two main contributions to the heated currency manipulation debate. First, he explains that the main argument against curbing manipulation is a straw man. It doesn’t much matter whether national currencies weaken because the governments in question are explicitly seeking trade advantages or not. It’s true, as manipulation soft-liners note ad nauseam, that the recent spate of central bank monetary easing policies pursued all around the world generally has been bound to weaken their countries’ currencies. It’s also true that America’s own Federal Reserve has eased massively itself – though the dollar has remained strong over the long run partly because of its unique status as the world’s predominant currency, and partly because the U.S. economy has outperformed that of most other major powers lately.

But as Plender notes, the distortions to trade flows take place all the same. He could have added, as opposed to only suggesting, a point I keep making: Monetary easing by a trade- and export-led economy (like China’s or Japan’s) is much likelier to stem from trade-related concerns than easing by a consumption-led economy like the United States. (Other considerations let America off the hook, too.)

His second contribution: observing that the universally condemned currency devaluations that helped deepen the Great Depression were by no means all made to beggar trade partners. Yet as trade policy critics are constantly reminded, trade flows suffered anyway. In fact, Plender cites this stunning claim from University of Chicago economist Robert Aliber: measured in terms of the worldwide trade imbalances that have resulted, “today’s currency wars are more severe than those of the 1930s.”

Indeed, this is a great opportunity to revive another point I’ve made in the context of of the fast track/TPP currency manipulation debate: The devaluations of the 1930s and the economic and military calamities they brought closer taught the American and other architects of the post-World War II global economic order a seminal lesson: that such currency movements needed to be controlled in order to create and maintain a viable international trade system. Unless Mr. Obama and his fellow globalization cheerleaders now believe that this conviction was wrong, they need to make sure that U.S. policy helps end or severely punish manipulation, and finally treat genuinely free trade like a priority, not a talking point.

(What’s Left of) Our Economy: Can Greece Ever Bounce Back?

Tags

Asia, Austan Goolbee, competitiveness, currency, devaluation, education, European Union, Eurozone, exports, Gary P. Pisano, Greece, Harvard Business School, human capital, industrial commons, manufacturing, Marc Champion, productivity, recovery, savings, technology, trade surpluses, Willy C. Shih, {What's Left of) Our Economy

Trying to cover the Greece crisis is the analytical equivalent of driving through a very small town. If you blink, you might miss the latest development. So rather than try to keep up with each new twist and turn, let’s look at the most important economic question raised by the country’s predicament: Is there any hope for a return to decent, healthy growth rates?

The textbook economics conventional wisdom seems to be Yes, albeit with great difficulty. I’m a lot less sure, for reasons that reveal many fundamental flaws with textbook economics – mainly its inability to eliminate political, social, and cultural differences.

That conventional wisdom was recently summed up by the University of Chicago’s Austan Goolsbee, who served as President Obama’s chief White House economist. As Goolsbee told the Washington Post, Greece’s main problem is a woeful lack of price competitiveness. Its costs to produce goods and provide services – and especially its labor costs – are way too high, and its productivity and quality levels are way too low to give its businesses much hope of outselling foreign rivals. In other words, unless you ignored economics completely, or there was simply no choice (as with many personal services), you’d have to be an idiot to Buy Greek in most cases.

Goolsbee proceeded to note that countries in this situation can generally at least hope to gain competitiveness by devaluing their currencies. This step makes the price of anything turned out by the devaluing country cheaper than foreign counterparts (all else, like productivity, equal). But since Greece is a member of the Eurozone, it lacks this option. Its price gap can only be closed if enough of its fellow Eurozone members stoke inflation in their own economies, or if it boosts its own productivity by slashing wages (and/or in principle other business costs, like excessive regulations).

But let’s say Greece takes one of these two basic roads. Does anyone honestly think it will start winning in global markets, or even its home market, even once a respectable stretch of time passes? If so, they shouldn’t. To begin understanding why, let’s recall that Greece got into its mess in the first place largely because a big macro-economic prediction failed. Specifically, Greece’s entry into the European Union (in 1981, long before the Eurozone currency area was born in 1999) didn’t bring nearly enough durable convergence with its more prosperous and better run neighbors.

As required, Greece brought its laws and standards in line with the new European norms. And it made non-trivial economic progress – particularly after it began receiving huge injections of foreign aid. But that’s about where convergence worthy of the name stopped. Bloomberg’s Marc Champion tells the story well. Unlike most of the rest of the European Union, Greece collectively took the money and ran, embarking on a huge spending and stealing (literally) spree rather than investing in productive activity. The Euro’s creation wound up simply giving Greece many more resources to waste, as it enabled Greeks to borrow at the kinds of low rates much more appropriate for a much better-run economy. And for good measure, Greek governments for years lied massively about the nation’s finances – with a helping hand from Wall Street.

That is, Greece squandered nearly all the economic opportunities that macro-economics had predicted from its membership in Europe because – like the rest of the currency union in particular – it was free to remain largely autonomous politically. In every way other than economic, Greece was free to remain Greece, and too much of that identity had become a formula for profligacy.

But just as macro-economics can’t come close to adequately explaining Greece’s descent into economic degeneracy, it struggles at best to illuminate a plausible path to real recovery. For Greece needs much more than competitive prices to return to some semblance of economic viability. It needs a reliable legal and regulatory environment, to persuade domestic capital to stay home for productive use and to persuade foreign capital to give it a chance. Even if it had noteworthy natural comparative advantages in any sectors other than some farm products that are hardly staples, it would need the kind of scale that few of its extractive and especially manufacturing industries boast.

And to achieve that end, it would need what Harvard Business School professors Gary P. Pisano and Willy C. Shih and Samuel P. Pisano have called an industrial commons – the “R&D know-how, advanced process development and engineering skills, and manufacturing competencies” needed to produce the high value products and services upon which first world living standards ultimately depend. Countries without these capabilities are doomed to lengthy servitude in what’s called the low-value ghetto – simple, labor-intensive activity that pays very low wages, fosters very little learning or innovation, and, by the way, is an awfully crowded neighborhood in today’s global economy.

As numerous Asian countries have demonstrated, the low-value ghetto can be left behind by economic strategies that (to simplify a bit) successfully encourage very high rates of domestic saving and a laser-like focus on quality education that can create the wherewithal needed to advance up the value and skills ladder. In some cases, such progress has been able to start attracting – and effectively absorb – the foreign capital and knowhow that can provide a vital boost. Does that sound like spendaholic Greece today? Of course, as the Asian experience also demonstrates, it’s also essential to have a robustly growing global economy that can accommodate ever greater exports and indeed trade surpluses. Does that sound like the wheezing global economy today?

Greece does boast formidable human capital – just take a look at the math, science, and engineering faculties of any number of major American colleges and universities. That suggests potential in fields like software development, as well as lower value tech work like call centers (which are much likelier to create significant job opportunities). The country’s geography also suggests continuing possibilities in logistics (which is why shipping has always been strong).

But it’s precisely these kinds of changes that will have to begin and take hold for Greece to escape basket-case status. If they don’t, expect to keep hearing nonsense on the order of “If enough wealthy Germans and other Europeans would just take more vacations there, Greece’s problems would be solved.” That may make macro-economists feel good, but it represents a cruel hoax on Greece.