The highly intelligent Greg Mankiw lines up on the side of the highly intelligent Tyler Cowen and Larry Lindsey on what the U.S.'s China policy should be:
Greg Mankiw's Blog: Cowen on the Yuan: In today's NY Times, economist Tyler Cowen argues:
The United States should not be spending its international political capital on yuan revaluation.
I agree. Larry Lindsey put the economic logic well in a Wall Street Journal column last April:
America, however, benefits from this arrangement. The Chinese clearly undervalue their exchange rate. This means American consumers are able to buy goods at an artificially low price, making them winners. In order to maintain this arrangement, the People's Bank of China must buy excess dollars, and has accumulated nearly $1 trillion of reserves. Since it has no domestic use for them, it turns around and lends them back to America in our Treasury, corporate and housing loan markets. This means that both Treasury borrowing costs and mortgage interest rates are lower than they otherwise would be. American homeowners and taxpayers are winners as a result.
There are losers, of course, most notably American producers of goods that are now made in China. Yet the losses to these producers are outweighed by the benefits from Chinese subsidies of our imports of consumer goods and the reductions in our borrowing costs from generous Chinese lending. Though correct, in politics these gains are now beside the point.
Once again, I agree.
Everything that Larry Lindsey says is correct. But I cannot join Greg in Tyler's conclusion because of worries about how the situation will be unwound. At some point China's State Council will tell the People's Bank of China to stop buying dollar-denominated securities. What happens then? Bad things. And if I listen to my inner Friedrich Hayek about how the cost of unwinding a fundamental resource-allocation and investment disequilibrium rises more than one-for-one with the magnitude times the duration of the disequilibrium, I can get very worried indeed. Dollar crashes, financial crises, large-scale housing defaults, deep recessions, panics, revulsions, discredits--and at the very least the movement of 8 million workers in the U.S. out of construction, consumer services, and supporting occupations and into export and import-competing manufacturing, and the movement of 40 million workers in Asia out of export manufacturing and supporting occupations and into... what?
We should be moving toward Andrew Samwick's policy of a cyclically-appropriate on-budget government surplus in order to put downward pressure on domestic absorption, and we should be strongly advising the Chinese and others to shift from export-led growth and allowing their real exchange rates to adjust, in order to reduce the risks of a really unpleasant episode.
Only if I could throttle and silence my inner Friedrich Hayek could I line up with Tyler and Greg on this one. And I can't.
I should surf on over to Brad Setser's website and see what he has to say...