Today’s markets are being somewhat roiled by news of accelerating inflation in China, leading to worries that China will have to tighten monetary policy. But, you know, that’s not what China is supposed to do in this situation.
There’s an oldie but goodie in international macro known as the Swan Diagram — not instructions for making an origami swan, but the insightful analysis developed by the Australian economist Trevor Swan. He suggested that we think of countries as having two objectives — keeping unemployment as low as is consistent with stable inflation, but not lower — and keeping the trade balance at an acceptable level. He also suggested that we think of two kinds of policies: things like monetary and fiscal policy that affect the overall level of domestic spending, and exchange rate policy that affects the competitive position of exporters and import-competing industries.
He summarized all this with a diagram:
There are four “zones of economic unhappiness”; getting out of them requires some combination of exchange rate adjustment and changes in domestic demand.
So where’s China? It’s clearly in the lower zone: a trade surplus at levels that is raising international tension, plus inflation. It’s actually not clear which way domestic demand should do — but renminbi appreciation is clearly indicated, for China’s own sake, not just to head off the outraged reactions of the rest of the world.
There are obviously political considerations keeping the Chinese from doing the right thing. But with a little encouragement — say, a Treasury report saying that yes, they do manipulate their currency — things might happen.
34 Readers' Comments
Raising the point that the Obama administration should have the same policy, and when attacked by the right, simply say " We are defending American markets " - succinct, to the point sound-bite.
Furthermore, the unions in this country should adopt a mantra of " We want it back " to counter-act the corporate lobbyists who are supported by the Chief Justice in his comments at the Univ. of Alabama Law School this week.
btw-it is fatuous in the extreme for the Chief Justice to characterize the mouthed response of Justice Alito as ' judicial temperament ' when a 5-year old can look at the video and turn to ask his parents " what did that man say, mommy ? "; the Chief's remarks indicate how dire our situation is and that there is no time to waste.
- Wonks Anonymous
Why not criticize the Chinese currency manipulation on grounds that it rewards the rich in China at the expense of the masses? That is, after all, exactly what it does. the owners of the means of production pocket the surplus that accrues by dint of the competitive exchange rate while, at the same time, the public has less value in its pocket to buy goods because their currency is devalued. I'm sure some economist could make a better case than I could along these lines.
But the sticking point in China is obvious: I have never seen anybody with a stake in China criticize the government there. I'm sure one cannot criticize with impunity.
How could this be possible?
The answer comes if you set aside Krugmanist ideology, and recognizes that markets, regardless of their imperfections, produce better outcomes than political processes.
A relationship that would state free markets are not in play on either side of the Pacific?
Of course I ask this because if we are involved with a new form of Mercantilism, we might as well face it. Also, there seems to be a disconnect between much of the theory that has promoted free trade without recognizing the context in which it might take place. In fact, my concerns are whether or not free trade can be manipulated at the gov't level. In other words, can we use Gatt type treaties that undermine free trade, have we?
I do know this, while we've reported with great excitment that the service sector economy ushered in a more sophisticated economy...as we've deindustrialized, gotten rid of "smoke stacks"...still, between 90 - 98 manufactures accounted for over 50% of world GDP! Such a consequent misstatement of how the world "works" seems to be doing us no good. (well, many of us, anyway) So, again, I ask is such a state of affairs now locked in to the way the world economy operates?
Thanks!
The "dismal science" indeed.
Let's not fortget, China is the proof for the succes of a government led stimulus policy, and the Chinese government will be very cautious to withdraw their stimulus measures (including letting the currency appreciate) too early. Yes, there are many challenges ahead for the Chinese policy makers: unsustainable imbalances between China and its debtors, export economy vulnerable to external shocks, overinvestments leading to overcapcity, excessive liquidty creating infaltionary pressure, to name just a few. And the Chinese policy makers are conscious of the fact that they have to eventually let the currency appreciate, but it will not be done because of a memo from the US Treasury, but only because it is beneficial to the domestic economy, with a view to maintain internal stability.
If letting the renminbi appreciate is truly in the Chinese national interest, then our government is probably best off saying nothing, and letting them make the change without losing face.
I can not decide if pressing them as a currency manipulator will doing any good, I like the idea of it, but they seem stubborn and the harder the push the more they will hold back. Our best policy is the policy that gets them to drop the peg as soon as possible. We do have option, one option is to debase the currency to the extent that it causes them severe inflation to maintain the peg (we obviously take some pain too) or we could enact much greater protectionism, neither are great ideas, but what do you do when a nation will not drop a peg to your currency (Which can be ok when it is a small economy but disastrous when it is a big country manipulating exchange rates)
If we (individuals or countries) all possessed the privilege to arbitrarily create the value of our currency, think of how that would disrupt an economy.
I fully agree with Dr. Krugman’s statement regarding USA Treasury intervention.
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