Greg Mankiw Endorses Tyler Cowen on the Yuan

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.

We aren't.

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...

Comments

[Barkley Rosser]

brad s is having a cow, unhappy at Tyler's
characterization of his arguments, and with good reason. Tyler is trying to cover himself now.

Yes, probably a gradual appreciation of the RMB/yuan would be better than standing back. However, I do agree that spending massive amounts of political/diplomatic capital on forcing PRC to adjust is a waste of time and, well, that kind of capital. They are going to what they damned well please in this department. They will have to figure out for themselves that such a gradual adjustment is probably wise.

[elliottg]

Highly intelligent is not the only requirement for honest debate. There's the honest part too.

[John Emerson]

"At some point China's State Council will tell the People's Bank of China to stop buying dollar-denominated securities."

Ya think?

[STS]

Brad,

You've mentioned the 8 million jobs figure once or twice before. Could you describe how you you arrived at that figure for the degree our economy currently overweights housing & related employment?

I think Setser makes an important point about the shift in "concentrated" vs. "diffuse" interests in regard to international trade. The players have swapped roles. Republicans 100-150 years ago ran on vital "Protection" and the high tariff walls that favored industrialists opposed to free trade. The modern Republican party does the reverse, not because they've been converted to Bryanism, but because the game has been changed in a fundamental way. The insiders are winning by "free" trade so now the benefits of trade are prone to be exaggerated rather than understated.

[Slocum]

"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."

But why would they do that 'at some point' -- given that the 'bad things' would include very bad things for China itself? The Chinese leadership are nothing if not a cautious, conservative bunch -- I see no reason to expect that they're going to precipitate a crisis with a sudden, drastic policy shift. It would be totally out of character.

[Blissex]

«This means American consumers are able to buy goods at an artificially low price, making them winners. [ ... ] both Treasury borrowing costs and mortgage interest rates are lower than they otherwise would be. American homeowners and taxpayers are winners as a result.»

Very clever, to use «consumers», «homeowners» and «taxpayers» as if to imply that all of them are «winners».

Which is manifestly incorrect at least in the case of those who see their terms of trade negatively impacted by the added competition.

Sure, asset owners and workers not exposed to the China trade win big, perhaps by more than 100% of the net benefit to the USA of the China trade, because their relative terms of trade improve.

The massive purchase of extraordinarily expensive USA bonds by China, Japan, Saudi Arabia have paid in effect a large part of both the Bush tax cuts for the rich and the Bush war in Iraq, and I reckon that they have thus been a big help to get Bush re-elected. It is amazing that they are doing this purely out of their generosity.

[Blissex]

«This means American consumers are able to buy goods at an artificially low price, making them winners. [ ... ] both Treasury borrowing costs and mortgage interest rates are lower than they otherwise would be. American homeowners and taxpayers are winners as a result.»

Very clever, to use «consumers», «homeowners» and «taxpayers» as if to imply that all of them are «winners».

Which is manifestly incorrect at least in the case of those who see their terms of trade negatively impacted by the added competition.

Sure, asset owners and workers not exposed to the China trade win big, perhaps by more than 100% of the net benefit to the USA of the China trade, because their relative terms of trade improve.

The massive purchase of extraordinarily expensive USA bonds by China, Japan, Saudi Arabia have paid in effect a large part of both the Bush tax cuts for the rich and the Bush war in Iraq, and I reckon that they have thus been a big help to get Bush re-elected. It is amazing that they are doing this purely out of their generosity.

[Noah Yetter]

"At some point China's State Council will tell the People's Bank of China to stop buying dollar-denominated securities."

Why is this stated as fact without argument? Why are we expected to accept the implication that there will be a sudden halt rather than a gradual decline? I have not yet seen anyone describe why the PBC would change its behavior, nor so much as a hint as to why they would do so suddenly. In the absence of such a theory, I remain skeptical.

[Bruce Webb]

"However, I do agree that spending massive amounts of political/diplomatic capital on forcing PRC to adjust is a waste of time and, well, that kind of capital."

Does the US really have much in the way of political/domestic capital to begin with? It seems to me the Bush Administration has squandered most of what we had, whether considered in moral, financial, military or diplomatic terms.

If somebody can identify a single pressure point we retain over Chinese policy on anything I would be interested to see it. We need them for any action on Korea or Iran and as noted they have $1 trillion of our debt. They are also lining up their own sources of resources in Africa and elsewhere. If we were to set out tomorrow to punish China in any substantive way that quite literally would not hurt us more than it hurt them, what would be be able to do?

[John Emerson]

"The Chinese leadership are nothing if not a cautious, conservative bunch -- I see no reason to expect that they're going to precipitate a crisis with a sudden, drastic policy shift. It would be totally out of character."

1. Leadership could change.

2. Chinese leadership (not necessarily different than any other leadership) has always played a long game. So ten years of the same thing does not necessarily mean that there will be ten more years of the same thing. It might be preparation for a different thing.

3. The Chinese have previously shown a willingness to sacrifice economics for politics -- it wouldn't be Communist politics this time, but geopolitics. And they have a lot of cash to cushion the bump with.

4. The Chinese might end up being able to use the mere threat of economic disruption to get their demands met. They would not necessarily actually have to act on their threats, and thus could get a cost-free victory.

[Stuart Robinson]

In the cycle of bubbles and corrections, doesn't the bit where smart guys like Mankiw + Cowen rationalise the distortion as a good thing usually come just before the correction?

[shah8]

Guys, ummm, look at politics. The chinese leadership, political and economics use the undervalued currency to extract more performance per diem. The fact that China as a country loses is irrelevant. Foriegn trade has choke points that trade trolls of various stripes makes a huge killing off of. You will not see a policy change until inflation is completely out of hand and the cities are at the edge of riot....

[wkwillis]

Well, the people in construction will just mover from building houses and infrastructure and office buildings and retail and service buildings in one location to building them in another.
I expect spot shortages in some trade specialties, of course.
After Roosevelt took over in 1933, there was unemployment in most building trades, but not brewery plumbing people.
I suggest you pull your kid out of Harvard and send him someplace to learn how to weld thick pieces of metal. Not thin pieces, thick pieces, such as are in synfuel plants, etc.

[touche]

"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."

The other possibility, of course, is that US consumers will exhaust their ability to service any more debt. The amount of consumer debt is rising much more rapidly than GDP or personal income and has been for years.

Year Q CMDEBT / DPI
1990 1 81.6%
2000 1 93.1%
2001 1 96.9%
2002 1 101.2%
2003 1 107.9%
2004 1 112.7%
2005 1 116.8%
2006 1 127.3%

http://research.stlouisfed.org/fred2/series/CMDEBT/
http://research.stlouisfed.org/fred2/series/DPi

[rumple]

I agree with the concept of stop trying to revalue the yuan, it seems like a self defeating endeavor. Intuitively, the Pacific Basin and America have been in a competitve game of currency devaluation. Every time the US tries to force the dollar down the mercantilists print more money, sop up dollars, and maintain their cheaps import status. The world is awash in liquidity because of the game. Why isn't inflation out of control ? The simple answer: it is, we just don't count the energy, food, commodity, housing, and asset inflation as inflation.

The best policy for America seems to be a strong dollar. Let Asia slug it out being the most worthless currency. Of course, as the supply of dollars drops and demand remains the same, the dollar will rise in value. Interest rates will stabilize at a slightly higher level but US inflation will subside. The Asian mercantilists will bid each others' currencies even more worthless than they already are. Savings will continue to flow to the US because of dollar stability.

Equities, housing, commodity bubbles will subside. Pressure on Congress to stop the fiscal imprudence may actually wake a few of them up.

This is the only logical way to deal with the currency issue. Maintain a relatively strong dollar with buying power. We will still get as much foreign manufactured goods as we are dumb enough to allow. Unilateral trade can be dealt with later, first stop the financial insanity.

[Jack]

"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."

I think that the consesus is that it would be good but painful to do something now. As time goes on it is becoming more painful to do something about it even as it becomes a better idea.

Politicians of all stripes handle that kind of situation very badly -- short term pain for long term gain is rarely an easy sell. If a gradual solution actually exists, why is it not yet being implemented? What will trigger its eventual implementation?

Those anticipating an orderly resolution must explain why it isn't happening now and face up to the extent that they are relying on a Chinese communist government to have interests that coincide with those of the US and to exercise them rationally.

Relying on shared interest in stability and rationality already assumes that only simple economic factors enter Chinese calculations and not, for example,the fate of Taiwan or access to Kazakh oilfields.

[Randolph Fritz]

"[...]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[...]"

Name of the gods, manufacturing *what*? Exporting *what*? It would take at least a decade to build the factories--what do they do in the meantime? Starve?

[a different chris]

>and the reductions in our borrowing costs from generous Chinese lending

I'm self-employed, so my income is pretty much proprotional to the hours I put in.

But I want more free time but am not ready to lower my living standards. My credit rating is good, so I think I'll just cut back 25% and borrow the difference so I can continue to live in what I feel is the appropriate style.

What could possibly go wrong?

[Barkley Rosser]

It should be kept in mind a major motive for the Chinese leadership. I am generally for free trade, but there is some zero sum game stuff going on here vis a vis employment, even as I accept that the job losses in the US have been overstated by some folks.

The motive for China is that this massive and historic transformation they are undergoing involves the largest and most rapid migration of people from the countryside into the cities ever seen in world history. As an undemocratic state, the Chinese leadership is terrified of these people being seriously unemployed and rioting to overthrow the state. Chinese history is rife with such instability and sudden collapses of regimes. This is why they keep the RMB/yuan undervalued.

[jon livesey]

I agree that if China stopped recycling Dollars into US debt, "Bad things(TM)" would take place. But I wonder if a different sort of "bad thing" could happen first. It could go a) housing bubble bursts, b) US consumer reins in spending and increases savings, c) import demand is reduced, and trade deficit is reduced, d) overseas economies too dependent on exporting to the US go down the tubes, e) mass unemployment leaves previously rural populations marooned in Chinese cities, leading to civil unrest in China, f) you name it.

It may be a bit fanciful, but it's worth recalling that in the twenties, German expansion was export-led, and when the Depression sent world trade into a downward spiral the really ugly political events took place in the countries that lost their export markets and lacked adequate internal demand to make up for it.