Paul Krugman, NY Times, "Taking On China":
Tensions are rising over Chinese economic policy, and rightly so: China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done.Peter Schiff, EuroPacific Capital, "Paul Krugman Versus Reality":
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.
Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.
And 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.
So how should we respond? First of all, the U.S. Treasury Department must stop fudging and obfuscating.
Twice a year, by law, Treasury must issue a report identifying nations that “manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” The law’s intent is clear: the report should be a factual determination, not a policy statement. In practice, however, Treasury has been both unwilling to take action on the renminbi and unwilling to do what the law requires, namely explain to Congress why it isn’t taking action. Instead, it has spent the past six or seven years pretending not to see the obvious.
Will the next report, due April 15, continue this tradition? Stay tuned.
If Treasury does find Chinese currency manipulation, then what? Here, we have to get past a common misunderstanding: the view that the Chinese have us over a barrel, because we don’t dare provoke China into dumping its dollar assets.
What you have to ask is, 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.
So we have no reason to fear China. But what should we do?
Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”
But if sweet reason won’t work, what’s the alternative? 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 stand.
In his latest weekly New York Times column, Nobel Prize-winning economist Paul Krugman put forward arguments that were so nonsensical that the award committee should ask for its medal back.
Recent rhetoric from Washington has put the economic relationship between the U.S. and China squarely on the front burner, and Krugman is demanding that we crank up the flame. This week 130 members of Congress sent a letter to Treasury Secretary Timothy Geithner demanding that the Obama administration designate China as a "currency manipulator". Following that, a bipartisan group of senators introduced a bill that looks to force the Obama administration's hand. For its own part, Beijing invites criticism by continuing to deny its utterly obvious currency agenda.
As these tensions escalate, most economists urge Washington to tread lightly because of the negative fallout for America if China were to begin selling its enormous cache of U.S. Treasury bonds. Krugman pushes back, asserting that the U.S. risks little by playing hardball, and that China has more to lose. He asserts that a Chinese decision to end its purchases of U.S. Treasury debt would make only a marginal impact on long-term interest rates. Did you hear that Stockholm?
According to Krugman, our secret weapon of economic invincibility is the Fed's ability to print dollars endlessly. If China were to foolishly decide to attack us by selling our debt, the Fed could simply step in and buy the excess with newly printed greenbacks. (In other words, Krugman sees no difference between funding the debt and monetizing it. See my latest video blog on the subject.). For Krugman, China would gain little from such an attack, but would lose the ability to export to its best customer and suffer severe losses in the value of its dollar holdings. Krugman's worldview is reassuring - but it has absolutely nothing to do with reality.
There is a huge difference between selling your debt to another and "selling" it to yourself. When China buys our debt, it uses its own savings. In order to purchase a trillion dollars of U.S. Treasuries, the Fed would have to expand our money supply by a corresponding amount. Even Krugman acknowledges that this would cause the dollar to lose value; however, he feels that a weaker dollar is good for America and bad for China.
Krugman does not believe that a tanking dollar will translate into higher interest rates or higher consumer prices at home. No matter how many dollars the Fed creates, or how much value those dollars lose relative to other currencies, he is confident that as long as unemployment remains high, rates will stay low and inflation will remain under control. This is absurd.
If the dollar were to nosedive, the Fed would normally look to protect the currency by raising interest rates, thereby increasing foreign demand for the currency. But with an economy currently on crutches, the Fed will ignore a weakening dollar and continue to try to boost employment with near-zero rates.
But keeping the Fed Funds rate low only holds rates down for U.S. government debt. If the dollar weakens substantially, other rates offered to other borrowers will rise as investors demand greater returns to compensate for inflation. To keep rates low for homeowners, credit card borrowers, corporations, municipalities, and state governments, the Fed would be forced to buy, or guarantee, all forms of dollar-denominated debt. The Fed would become the lender of only resort.
Once the Fed shows that its commitment to low rates is limitless (the value of the dollar be damned), private creditors will quit the game. Even average Americans would hit the Fed's bid. It would be a race for the exits, with no one wanting to be left holding a bag of worthless paper dollars.
Most economists, Krugman included, see cheap money as a panacea for all ills. And while it's true that a falling dollar, by lowering the real value of U.S. wages, would help make U.S. goods more competitive, it would also lead to skyrocketing consumer prices, rapidly rising interest rates, and a collapse in American living standards. Make no mistake: this is the end game of Krugman's "get tough on China" policy.
This apocalyptic scenario can only be avoided if Washington jealously guards the status quo, avoiding confrontation with China at all costs. Yet, even that is an outcome that no one can rationally expect. Given exploding U.S. government deficits and the inability of U.S. citizens and corporations to repair their balance sheets, the United States faces financing needs that even China's gargantuan savings stockpile will be unable to cover.
Krugman is right about one thing - China's currency peg is destabilizing the global economy and must end. But he fails utterly to understand the implications for the U.S. and China. If China were to reverse its role in the U.S. Treasury market, both economies would be destabilized in the short-term. But in the medium- and long-term, China would clearly emerge as the winner.
Absent Treasury-bond purchases, the value of the Chinese currency would rise sharply, causing goods prices to tumble in China. This long-delayed increase in purchasing power for everyday Chinese will unleash pent-up demand in what is already the largest middle class in the world. Chinese factories would retool in order to produce goods for their own citizens to consume. In RMB terms, commodity prices would plunge, making it easier for China to produce all kinds of stuff, such as automobiles, while also making it cheaper for the Chinese to buy gas. Millions will trade in bikes for cars, and Chinese oil imports will swell.
The opposite would occur in America, where an artificial, consumer-based economy, supported by Chinese lending, will come tumbling down. Without the ability to import cheap goods from overseas, Americans will pay more and get less. While gas and food become cheaper for the Chinese, they will simultaneously become much more expensive for Americans - so too will automobiles, consumer electronics, furniture, and just about every other product we want or need (even those few we still make ourselves).
Washington's best option is to recognize that the current relationship is unsustainable and to plan, as best as possible, for a more viable future. We Americans also must be honest with ourselves and recognize that we have been living beyond our means and that our lifestyle has been largely financed by austerity in China. We must conceive of a plan that weans us from this dependence without provoking China to pull the rug out from under us before we have a firm footing. To construct a policy around Krugman's ridiculous assumption that we benefit China more than they benefit us is to invite catastrophe on an unimaginable scale.
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