Why Meg Whitman Came to California
As an Anxious Observer, I Recommend that Henry Farrell Stop Reading Megan McArdle...

Department of "Huh?!": John Cochrane Edition

You read the start of John Cochrane's Wall Street Journal op-ed:

John Cochrane: Tim Geithner's Global Central Planning: The Chinese government's accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort...

And the only thing you can say is: "HUH?!?!?!?!?!?!?!?!?!"

Has Cochrane talked to anybody in China?

If you ask anybody--anybody--anybody at all--in China why the Chinese government has invested so much money in dollar-denominated assets, nobody will say:

  • "because we expect a high rate of return on those assets," or
  • "because we believe that they are negative-beta assets that have a use as insurance."

Instead, anybody--anybody--anybody at all--in China, when asked why the Chinese government has invested so much money in dollar denominated assets, will say something like this:

Look. China has 900 million rural dwellers who are still living at a standard of living not that far above subsistence. The pressure to migrate from the countryside to the coastal cities is enormous. China needs to grow at more than 8% per year in order to avoid mass unemployment in the coastal cities. And mass unemployment in the coastal cities is likely to be followed by political collapse and turmoil on a gigantic scale.

Part of growing at 8% per year is to continue to rapidly expand exports to the North Atlantic core of the world economy. But in order to expand exports Chinese-produced goods must look like good values. And if demand for dollar-denominated assets falls and the value of the dollar falls, Chinese-produced goods will no longer look like good values. We know very well that when we unwind these purchases of dollar-denominated assets a generation from now the financial rate of return on our investments will be lousy. But in the meantime we get something much more important to us--export growth, full employment in Shanghai, and societal stability.

So what does Cochrane think he is doing? Who does he think will believe him?

When Cochrane writes:

Economists are full of bad ideas.... Mr. Geithner starts with a dramatic proposal: "G-20 countries should commit to undertake policies consistent with reducing external imbalances below a specified share of GDP [later reported to be 4%] over the next few years." Since when is every trade surplus or deficit an "external imbalance" in need of correction? It makes sense for a country that has good investment prospects to import a lot of goods, run trade deficits, and borrow money. Years later, the country puts the resulting products on boats to pay the lenders back. The U.S. borrowed abroad to finance our railroads in the 19th century and ran surpluses when Europe was rebuilding after World War II. Were these "imbalances"?

does he genuinely not understand that China's investment in the United States does not reflect a belief on the part of China's savers that the U.S. offers high rates of return? Does he genuinely not understand that this is a government-run foreign-exchange intervention program--the largest one in history?

Did nobody bother to tell him? Does he have no friends?

He denounces:

the army of economists in the basements of the International Monetary Fund (IMF) has no clue exactly how much each country should be saving, or where the best untapped global investment opportunities are around the world—including whether trade patterns are "normal" or "imbalanced."... The economists hidden away in the sub-basements of the IMF may try to decide what currencies "should be" worth across vastly different countries.... [I]t is a pipe dream that busybodies at the IMF can find "imbalances," properly diagnose "overvalued" exchange rates, then "coordinate" structural, fiscal and exchange rate policies...

But any one of the members of this army of economist, these economists hidden away in the sub-basements, the busybodies at the IMF could have told him--if he had asked--what organizations in China are responsible for asset accumulation.

But he did not ask.

Now I do not think that the United States should pressure China--much--to more rapidly appreciate the yuan. The United States ought to help China become richer as fast as possible--and allowing them to run an undervalued currency and a big export surplus for a while is a good way to do that. The United States, as the hegemon of the world economy, ought to be able to manage the level of its own and of global demand without pushing for demand-shifting policies. A little pressure on China to figure out how to shift more rapidly to internal demand-driven growth is good for them and good for us. But too much pressure--I don't think so.

Nevertheless, that an economics professor is pretending that China's dollar asset-purchase policy is "a tragic investment decision, not a currency-manipulation effort" makes me want to hide my head in shame.