Eichengreen on the dollar

by Russ Roberts on June 7, 2011

in Podcast

This week’s EconTalk is Barry Eichengreen talking about the dollar–its role as a reserve currency, the advantages of that role for the US, and whether another currency might take over that role.

For me, the most interesting part of the conversation was a discussion of China’s alleged currency manipulation to keep their exports high. Eichengreen argued that this is bad for the US as a whole–that is, it is bad that China is willing to sell us cheap stuff. I have never understood this argument in good or bad times. But Eichengreen made the argument clearly–there is a “fixed lump” of aggregate demand and by keeping the prices of Chinese products low, US aggregate demand goes to China rather than the US. I don’t know what it means to say that there is a fixed lump of aggregate demand. But that’s the argument. I pointed out that Keynes also embraced protectionism during the Great Depression. I am glad I am not a Keynesian. Besides the fact that I do not understand how a nation can thrive by producing things at a higher cost, the political incentives of such a view are not so healthy.

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Daniel Kuehn June 7, 2011 at 10:34 am

So the question of whether currency manipulation is even going on is still an open question I suppose – but assuming that it is going on, I don’t see why it’s so difficult to understand why a price distortion is damaging. Price distortions are always damaging. I don’t think demand needs to be a “fixed lump” or even aggregated to understand the point. You can imagine a billion markets, with new markets and products emerging daily – if they’re all trading for one good – money – and the price of that one good is distorted, it’s going to have the same effect. A “lump of demand” is just easier to talk about for some people I think.

re: “I am glad I am not a Keynesian”

I love how you say this like it is some kind of deformity one is born with :)

re: “I do not understand how a nation can thrive by producing things at a higher cost”

But apparently you can understand how a nation can thrive by selling things at a higher cost against nations selling things at a lower cost? It’s not a question of “we want higher costs” – it’s a question of “we don’t want price distortions”. “Higher costs than yesterday” is not the same thing as “too high”. Yesterday costs might have been too low, after all. I would think someone who thinks Greenspan and Congress and cheap credit played a role in the housing crisis could more easily understand why sometimes costs need to go up.

Methinks1776 June 7, 2011 at 10:38 am

So the question of whether currency manipulation is even going on is still an open question I suppose

There’s little doubt in my mind that China is trying to manipulate its currency. Every country does. The case that’s hard to make is that it’s successful. Currency manipulation rarely is.

Jonathan M. F. Catalán June 7, 2011 at 10:52 am

Price distortions are damaging: but the question here is damaging for whom? It’s clear that Chinese currency manipulation hurts its own people by subsidizing U.S. purchases with inflation, but it’s not so clear that it hurts the United States.

Daniel Kuehn June 7, 2011 at 11:05 am

It hurts Chinese demanders and it hurts U.S. suppliers. It’s just a simple deadweight loss assignment question. Only in this case, the lost surplus is country-specific – if you are receiving money in the U.S. in the transaction you’re worse off, but if you’re providing money in the U.S. in the transaction you’re better off. If you are receiving money in China you’re better off, if you’re providing money in the transaction in China you’re worse off.

Because production isn’t allocated efficiently between the two countries, on net everyone loses. More specifically, American suppliers lose demand and Chinese demanders lose supply. And since – today – in 2011 – it’s demand that we’re lacking, it’s not a trivial problem for us. If our economy were overheating I might say differently.

magilson June 7, 2011 at 11:15 am

Daniel, you are guilty of the very thing you love to come here to point out. Namely you’ve completely ignored what was actually written and said in order to take it off onto a tangent of your own choosing. (I don’t believe the bloggers of this site are guilty of this, but you consistently do.)

“Eichengreen argued that this is bad for the US as a whole…”

It is unquestionably bad for Chinese consumers. And it may be bad for U.S. producers. But markets don’t exist for the sake of producers. They exist for the sake of consumers. (Producers are ultimately consumers, but if you even begin to go down this road you are more Keynesian than even you’ve been willing to admit. In which case you can successfully stop trying to change anyone’s mind about that.) Your argument is as silly as worrying about comparative advantage among the States. Since currency is just like any other overhead cost when it comes to value manipulation you’re arguing that artificially raising their overhead is wrong. Like a company that spends extra to prevent n+1 injuries when n is already an acceptable (and perhaps untreatable) situation. You are making a personal value judgement; not an economic one.

Else I’ll expect you to start having problems with a lot of other natural price variations within the U.S. if you want anyone to take these kinds of statements seriously.

Daniel Kuehn June 7, 2011 at 12:29 pm

I don’t have the teleological view of markets that you do.

I know markets exist. I try to figure out in what way in which they exist. I don’t pretend to try to answer questions about “what they exist for”.

re: “Else I’ll expect you to start having problems with a lot of other natural price variations within the U.S. if you want anyone to take these kinds of statements seriously.”

All I’m saying is that this particular price variation isn’t “natural”, and it’s worth thinking through the consequences. Maybe it’s fine. It seems less fine than it otherwise would be, since we’re in a depression right now.

Jonathan M. F. Catalán June 7, 2011 at 11:21 am

If demand it’s lacking it’s real demand, not nominal demand. It’s movement of real goods. That Americans are buying Chinese goods may cause the prices of American goods to fall, but it doesn’t mean that Americans can no longer demand these goods. It just means that the structure of production has to adapt to new consumer preferences. If there wasn’t such artificial resistance to these adaptations then the problem wouldn’t be as rigid as it’s being made.

Btw, Chinese subsidization can also help American suppliers, because whatever factors of production they purchase are now cheaper (although, by imputation the value of factors of production bought domestically should also fall as nominal demand for their goods fall).

Daniel Kuehn June 7, 2011 at 12:31 pm

re: “Btw, Chinese subsidization can also help American suppliers, because whatever factors of production they purchase are now cheaper”

Ummmm… if you are purchasing something you are a demander, not a supplier.

Don’t confuse “supplier” with “firm” and “demander” with “consumer”.

You are a supplier if you are taking money for goods or services.

You are a demander if you are giving money for goods or services.

Almost everyone is both.

Ryan Vann June 7, 2011 at 1:23 pm

Way to completely miss the point Daniel. If factors of production are cheaper, it allows domestic producers to offer more supply; that is all Jon was saying.

Daniel Kuehn June 7, 2011 at 1:38 pm

Ryan – I did not miss that point at all. In fact I reiterated that point. I only responded to say that that doesn’t change the fact of price distortion.

Jonathan M. F. Catalán June 7, 2011 at 1:39 pm

Daniel,

You missed my point. By supplier I meant a capital goods industry.

Jonathan M. F. Catalán June 7, 2011 at 1:40 pm

And… you did miss my point, because your response to my argument was some semantic complaint against something that somebody else perfectly understood. You never addressed what I actually wrote!

Ryan Vann June 7, 2011 at 1:44 pm

It’s abundantly clear you missed the point entirely. Your “these aren’t the drones you seek” handwaving isn’t going to convince anyone otherwise.

Daniel Kuehn June 7, 2011 at 2:03 pm

Jonathan –
Perhaps I should have just responded “so what?”

Your point was crystal clear.

I didn’t touch your first paragraph, it’s true, because I didn’t know why anyone would think Americans could “no longer demand those goods” or what consumer preferences have to do with a Chinese policy decision.

Jonathan M. F. Catalán June 7, 2011 at 5:20 pm

Daniel,

You said that buying cheap goods from China reduces demand for American goods. I’ve shown that that’s not true.

joe June 7, 2011 at 11:48 am

But a common proposal to fix the price distortions is to increase tariffs in the US on imported goods.

Doesn’t that worsen the price distortion problem? Also, does raising prices for US consumers (with a tariff et al) help efficiency?

Daniel Kuehn June 7, 2011 at 12:43 pm

Common?

Maybe. I don’t hear it all that much – certainly among economists, but not even really all that much among politicians.

The better proposal would to be (1.) to convince the Chinese to stop, or better yet (2.) to print a bunch more dollars ourselves. Those are better for precisely the reason you mention – protectionism further distorts prices.

Basically a billion prices are too low and one price is too high. We have pretty decisive control over the one price that’s too high, and pretty poor (and variable) control over the other prices. It seems dumb to try to raise the billion prices – it seems smarter to just lower the one price.

Jonathan M. F. Catalán June 7, 2011 at 1:42 pm

Right, because China printing a bunch of renminbi is a price distortion, and the U.S. printing dollars isn’t. Or, better yet, because we know enough to stop a price distortion through more inflation.

Justin P June 7, 2011 at 4:09 pm

Your on a roll today!

Daniel Kuehn June 7, 2011 at 5:13 pm

Jonathan – you know better than anyone else on this thread what I think of monetary policy, so don’t play coy here. Printing dollars is a price distortion, but it’s the management of a particular price that doesn’t tend toward equilibrium. It’s the one price that doesn’t tend toward equilibrium. You read all those exchanges between me, Nick Rowe, Lee Kelly, etc. You know what I’ve said on this.

Now, given it’s all distortionary – what is to be done? Act sanguine about a policy that makes the distortion worse (Russ here), or make a conscious distortion decisions and currency management that will approximate a non-distortionary environment (Eichengreen, Nick Rowe, Lee Kelly, me, etc.)?

Don’t act like you don’t know the argument – of all the people here I know you do.

Jonathan M. F. Catalán June 7, 2011 at 5:22 pm

I just think that your idea of price distortion is, whatever literary device this may be intended, distorted. I don’t think you really understand the effects of the distortion, and I think that your alleged solution is just a means of making the problem even worse.

My point is that I don’t think matching Chinese inflation will rid us of the distortion, nor would it be desirable. As I’ve argued above, I don’t even think the Chinese distortion is particularly damaging for us. I damages the Chinese economy, to our benefit.

John Dewey June 7, 2011 at 1:48 pm

Joe: “a common proposal to fix the price distortions is to increase tariffs in the US on imported goods.”

Daniel: ” I don’t hear it all that much – certainly among economists, but not even really all that much among politicians.:

Just because YOU don’t hear it, Daniel, does not mean that politicians do not propose and vote for exactly such a fix.

H.R. 2378: Currency Reform for Fair Trade Act

To amend title VII of the Tariff Act of 1930 to clarify that countervailing duties may be imposed to address subsidies relating to a fundamentally undervalued currency of any foreign country.

This bill was introduced in the U.S. House of Representatives in May, 2009, by Rep. Timothy Ryan (D-OH). The bill had 159 co-sponsors.

The House of Representatives finally voted on this bill on Sep 29, 2010. The vote was 348 Ayes, 79 Nays, 6 Present/Not Voting.

Daniel Kuehn June 7, 2011 at 2:08 pm

John Dewey – I know they pass this stuff from time to time. I know tariffs and duties exist.

There is considerably more impetus behind monetary policy and just getting them to revalue their currency, though – and that’s a good thing.

What adjective should I have used to make you happy? I’m just making the point that acknowledging this issue doesn’t make you a protectionist and most serious discussion of the issue has nothing to do with protectionism. This bill isn’t going anywhere in the Senate.

All I said was “you don’t hear it all that much, even from politicians”. When you hand me a bill that languished in the house until it was passed and then fails in the Senate, to me that falls under “not all that much”. If you would have used different verbiage, by all means tell me what I should have said so I don’t bother you anymore.

Daniel Kuehn June 7, 2011 at 2:09 pm

You’re always one of the first to jump on my with non-sequitors, John Dewey. “Not all that much” means “it happens sometimes”. If you just read more closely you could save yourself a lot of trouble.

John Dewey June 8, 2011 at 8:37 am

daniel,

Correcting obvious errors in Cafe Hayek comments is really not very much trouble for me at all.

Justin P June 8, 2011 at 8:53 am

How do you know how many Dollars to print to negate the Chinese currency manipulation? What metric do you use to estimate this? What happens if your off?

argosyjones June 7, 2011 at 12:32 pm

Blessed are You, O Lord, King of the Universe, who have not made me a heathen. Blessed are You who have not made me a bondsman. Blessed are You who have not made me a Keynesian.

Daniel Kuehn June 7, 2011 at 12:40 pm

OK, this is the second time you’ve made me laugh today about Cafe Hayek :)

Sandre June 7, 2011 at 1:35 pm

We always are a joker, aren’t ya?

yet another Dave June 7, 2011 at 1:22 pm

re: “I am glad I am not a Keynesian”

I love how you say this like it is some kind of deformity one is born with

I don’t know if it’s genetic, but it surely is a mental defect. And one that cannot become extinct too soon.

Craig June 7, 2011 at 7:18 pm

I don’t see why it’s so difficult to understand why a price distortion is damaging.

You are absolutely correct, but you are also ignoring the price distortion created by American monetary policy since Nixon took us off the last vestiges of the gold standard. The long-running trade deficit is a result of just one thing — 40 years of inflationary monetary policy.

To blame China is the typical government authoritarian’s response made to deflect blame from the culprit — our own government.

Pingry June 7, 2011 at 10:42 am

Russ,

This is the argument I have been trying to make here, namely about the Swan Diagram (and Optimal Currency Areas and Impossible Trinity)

In the case of China, their fixed nominal exchange rate is bad for them because they’re now experiencing a higher rate of inflation at NAIRU, and for the US, it’s bad because we’re unable to have the dollar depreciate which would help boost exports and play a expansionary role in a depressed economy given that we’re up against the zero bound and fiscal policy is not politically palatable.

In dealing with current account imbalances, open economy macroeconomists talk about expenditure switching and expenditure reducing policies.

In the case of both the US and China, both need expenditure switching and expenditure reducing policies. We can go a long way if China were to change its monetary policy strategy away from targeting the exchange rate as its nominal anchor and instead having an explicit form inflation target.

But, of course, China doesn’t want this, and to be fair, it’s not such a big deal if both countries are more or less at full employment, but in the shortrun, of course, economies operate differently. Instead, China wants a beggar-thy-neighbor policy in which the US quit using expansionary policy and even experience a deflationary episode.

We all agree that prices should be allowed to fluctuate at the microeconomic level. And the exchange rate is just another price that should fluctuate (Don’t forget what Milton Friedman said!) given that wages and prices are sticky.

–Pingry

Manfred June 7, 2011 at 11:55 am

Pingry,

“And the exchange rate is just another price that should fluctuate (Don’t forget what Milton Friedman said!) given that wages and prices are sticky.”

Ok, but some other famous economists would not agree witih Milton Friedman; Robert Mundell comes to mind.
Also, wages and prices sticky? Again, famous economists would disagree, like Edward Prescott. Wages and prices may not all move with the same speed, up and down, like stock prices, but wages and prices all sticky?

Pingry June 7, 2011 at 12:05 pm

Yes, Mundell does come to mind, and it’s very ironic how the father of the euro and the economist who wrote so much of the book on optimal currency areas has been so wrong on the euro. The euro has not been a success, and I think Mundell was wrong to push so hard for it.

Also, Ed Prescott is wrong about sticky wages and prices. The evidence points toward precisely toward wage and price stickiness. Paul Krugman has a nice blog post about it (And a nice Mark Thoma blog post with plenty of links) one about Prescott and RBC) which I will copy-n-paste below, and I would also recommend listening to Russ’s EconTalk podcast with Ricard Reis.

Of course, there is so much more, but these provide a nice background.

http://krugman.blogs.nytimes.com/2011/02/05/exchange-rates-and-price-stickiness-wonkish/

http://economistsview.typepad.com/economistsview/2010/07/the-obama-shock-hypothesis-seems-ridiculous.html

http://www.econtalk.org/archives/_featuring/ricardo_reis/

–Pingry

Pingry June 7, 2011 at 5:45 pm

Russ and Don,

So why, again, is my second comment still awaiting moderation? This also happened on a previous post also.

It feels like I am being singled out here because I’m making strong arguments and producing evidence which you don’t like.

–Pingry

carlsoane June 7, 2011 at 5:55 pm

It may be because you included a link in your comment. At least, that’s why one of my comments was moderated recently, to protect against spamming, not strong arguments, I suppose.

carlsoane June 7, 2011 at 5:56 pm

It may be because you included a link in your comment. At least, that’s why one of my comments was moderated recently, to protect against spamming, not strong arguments, I suppose.

Vince June 7, 2011 at 6:17 pm

Wow that’s one of the funniest comments I’ve ever read here.

Methinks1776 June 7, 2011 at 9:09 pm

I’m sure you’re still making the same strongly weak condiment arguments as ever.

However, Pingry, you are not singled out. My bet is you had links in those comments and that’s why they are awaiting moderation. This has happened to all of us who have tried to post links. The comments will never make it out of moderation, so if you want them to show up, repost without the links.

MWG June 8, 2011 at 6:23 pm

“It feels like I am being singled out here because I’m making strong arguments and producing evidence which you don’t like.”

Probably not. I’ve had comments as recently as last week that were waiting moderation that were never approved for no apparent reason.

muirgeo June 9, 2011 at 1:57 am

They don’t like it if you link to sources… you are only to make claims and state them seriously so it sounds like a fact.

Methinks1776 June 7, 2011 at 10:44 am

It’s not a question of “we want higher costs” – it’s a question of “we don’t want price distortions”.

There’s a lot of things I want and can do nothing about. We can’t control China’s activities, we can only use China’s distortions to our advantage. I can now buy more stuff because it’s cheaper. I win.

“Higher costs than yesterday” is not the same thing as “too high”

It is when the alternative is lower cost.

Daniel Kuehn June 7, 2011 at 11:07 am

1. We do have some leverage with the Chinese, though.

2. Even if we didn’t that’s no reason to change the analysis of what’s going on.

You, methinks, can’t personally change what the Fed does. There’s no way! You’re far more powerless to change what the Fed does than Geithner is to change what the Chinese do. And yet you feel free to (1.) analyze the situation, and (2.) express concern. Right?

Methinks1776 June 7, 2011 at 11:18 am

How can Geithner change what China does?

Daniel Kuehn June 7, 2011 at 12:33 pm

Let’s just go with grandstanding.

Geithner’s grandstanding over the Chinese central bank is more efficacious than your personal grandstanding over the Fed.

Your relative lack of efficacy does not mean you should stop (1.) analyzing what the Fed does, and (2.) complaining about the Fed, does it?

Methinks1776 June 7, 2011 at 2:12 pm

Daniel,

Isn’t there enough comedy at the cafe? Grandstanding! You must be kidding equating “grandstanding” with “leverage”.

Daniel Kuehn June 7, 2011 at 2:31 pm

OK – let me lay this out clearly then. You have almost zero efficacy in changing the way Congress or the Fed or the White House works. That’s the same of almost every citizen (some have more power to do it than others). You still (rightly) feel entitled to (1.) analyze what they do, and (2.) criticize what they do.

Why should the case be any different at all for any other government we have no appreciable control over? Why do so many commenters here hide behind the “we can’t change them” mantra instead of coming out and saying they think a price distortion is good?

This is what I think is going on – well before commenters were sufficiently critical of Don he committed to this idea that price distortions in currency markets are good things if they make for a stronger dollar. After all, the people Don didn’t like politically wanted a weak dollar, the “protectionist” label was easy to grab and fling, so Don decided he was going to go in for a weak yuan.

As soon as someone pointed out that this is a price distortion, he’s certainly not going to change his tune on a point he argued so strenuously before. So there was nothing left for him to do but hide behind “well we can’t change the Chinese government’s mind”. He started saying that initially, and now more and more I see commenters parroting it.

A price distortion is a price distortion. Economic analysis of a price distortion shouldn’t change depending on national borders. Nobody on here that’s ever criticized rent control or food stamps should be sanguine about a policy that artificially lowers the price of goods produced south of Mongolia and north of Vietnam. Cause that’s all this is – it’s price control on all products produced in a certain geographic region.

Methinks1776 June 7, 2011 at 3:00 pm

What does any of that have to do with equating grandstanding with leverage? That is a patently ridiculous statement to make. What are you smoking?

Yes, I do have much more power of my own government than Timmy Geithner has over China. It is because the citizens demanded it that Fox and Bloomberg went after and got more disclosure from the Fed. And that’s just one example. Imperfect control does not mean no control. Timmy has no control over China.

Why do so many commenters here hide behind the “we can’t change them” mantra instead of coming out and saying they think a price distortion is good?

Because you’re wrong. Price distortion is not “good”. It’s beneficial to us and it punishes the Chinese, in this case. We live here. Don points out consistently that people who argue that it is we who are hurt are wrong. More than anything else, Don points out that punishing ourselves does not help us (ummm. Duh). Don has never once claimed that price distortion is a good thing in general – he has always pointed out the cost.

I’m going to simply ignore your other baseless accusations against Don. They are beneath contempt. I had no idea who or what a Russ Roberts or a Don Boudreaux were when I stumbled upon the cafe years ago. It’s because your accusations are completely untrue that I grew to respect them. You, on the other hand, are guilty of all the things you accuse Don of. In psychology that’s called “projecting”. I’d look into that tendency of yours.

Sam Grove June 7, 2011 at 3:50 pm

Why do so many commenters here hide behind the “we can’t change them” mantra instead of coming out and saying they think a price distortion is good?

I’m certain Don would agree that two wrongs don’t make a right, but that has not been the point of Don’s criticism of protectionist arguments, rather, his point is that the claim that China’s manipulations justify U.S. manipulations due to harm to U.S. citizens is not substantiated.

Seth June 7, 2011 at 10:44 am

I listened to that portion of the podcast this morning. As Eichengreen implied that it would be good for the U.S. to make flat screen TVs when a.d. and employment slacked, I wondered if he had considered that it’s not that we don’t make flat screen TVs that have caused unemployment. Rather its that we’ve created to many obstacles of letting new things emerge.

Seth June 7, 2011 at 10:46 am

“…too many…” I miss the edit button.

Don Lloyd June 7, 2011 at 11:06 am

Exports are a cost, not a benefit.

Jobs are not inherently limited, but are artificially limited by politically-driven government policies of near infinite variety.

Regards, Don

Nemoknada June 7, 2011 at 11:20 am

Cheap goods from abroad are like manna from heaven. They necessarily enrich “us.” But if the Chinese government decided to give every Chinese American $1,000,000, that would be a gift, too, yet somehow, I suspect that it would not be welcomed here, even by libertarians by our body politic merely because it increases “our” wealth. It would, after all, give Chinese Americans an unfair advantage in the competition for goods. In other words, the issue is not whether China’s action increases “our” wealth; it’s HOW do we distribute the wealth that it increases.

The wealth represented by cheap foreign goods is distributed primarily to consumers in the form of low prices. The rest is concentrated in the hands of owners of import businesses. Frankly, I’m not concerned about the concentration in this context. I am concerned about the difference between giving a small gift to all price-conscious American consumers and giving a large one to all Chinese Americans. What makes the first acceptable and the second objectionable?

The obvious anwer, I think, is the perceived “fairness” of the allocation. In the Bible, manna was allocated per capita. Low prices come close enough for most to achieving that sort of distribution. But then there is the matter of unemployment. Certainly, would-be consumers who lose their jobs to foreign competition do not enjoy the benefits of the cheap goods. Not only are they casualties as an externality, but because their ability to shop is impaired by their lack of funds, they don’t even share in the gift itself.

Of course, the game doesn’t end there. Displaced workers may land on their feet, in which case they are not hurt, resources are used optimally, and everything is fine. But if the reason the cheap goods are coming is that they are produced by cheap labor (as opposed to, say, an abundant supply of a natural resource), the likelihood of displaced workers landing on their feet falls, because any job in the tradable sector worth paying someone to do can most likely be done more cheaply by someone in another country. In short, in compliance with the law of Comparative Advantage, labor-based cheap goods from abroad make our economy more capital intensive, and, therefore, by definition, less needful of displaced workers.

Even that’s not a bad thing if we can reduce the workforce and train for jobs in capital-intensive and service-sector jobs that would bring in enough money so that the benefits of lower prices are shared in a way that seems fair to a political consensus.

If a complete reworking of our labor markets MUST occur if cheap goods from abroad are to be viewed as a Godsend, then the less daunting expedient of paying a bit more for stuff may not be the wrong national strategy. To just “leave it to the market” is essentially a theological solution. It may be the right one, but it is, at the end of the day, essentially a leap of faith.

Methinks1776 June 7, 2011 at 11:35 am

But if the Chinese government decided to give every Chinese American $1,000,000, that would be a gift, too, yet somehow, I suspect that it would not be welcomed here,

Why not? I don’t care. The allocation of beauty, brains and talent is not equal. Life isn’t fair. I don’t understand people who cannot come to terms with reality. Accepting life as it is and not as we wish it could be is the foundation of a success.

But if the reason the cheap goods are coming is that they are produced by cheap labor (as opposed to, say, an abundant supply of a natural resource), the likelihood of displaced workers landing on their feet falls, because any job in the tradable sector worth paying someone to do can most likely be done more cheaply by someone in another country.

Again, who cares? How disappointingly unimaginative you are. Thousands of years of human innovation and you suddenly think the world will come to an end if some goods are cheaper to produce in another country. New goods are invented in the dynamic United States economy all the time. Those innovations provide employment. And let’s not forget that necessity is the mother of invention. How much innovation comes from people who are unable to find employment and seek to create it for themselves by becoming entrepreneurs? A lot.

And what, may I ask (as just one question of many that your comment begs to be asked), will happen to the cost of labour in a country where the cost of labour is so inexpensive that demand for that labour steadily rises?

Your handwringing implies that humanity is dumb, lazy and unimaginative. I see no evidence of that in any country that doesn’t seek to protect its citizens from the consequences of bad outcomes.

WhiskeyJim June 7, 2011 at 12:48 pm

Your post makes sense to me, until you come to the end:

If a complete reworking of our labor markets MUST occur if cheap goods from abroad are to be viewed as a Godsend, then the less daunting expedient of paying a bit more for stuff may not be the wrong national strategy. To just “leave it to the market” is essentially a theological solution. It may be the right one, but it is, at the end of the day, essentially a leap of faith.

Please reconsider the magnitude of the implication of your earlier post. There are billions of people who wish to crawl out of the muck. Subsidizing uncompetitive domestic workers would be like throwing money into the ocean. That is not a leap of faith, is it?

Subsidizing buggy whip makers was not a good idea. Neither would subsidizing flat screen TV’s. To your own point, the global economy is vast and with fits and starts growing, generally enriching all of us, including the yellow skinned Chinese.

To further illustrate that your own conclusion does not necessarily follow your argument, consider that our unemployment likely has much more to do with domestic government regulation and Fed policies than it does with anything the Chinese are currently making. For as sure as the sun will rise, the Chinese are currently making what in the future will be buggy whips.

Nemoknada June 7, 2011 at 6:22 pm

Jim – I somehow missed this comment and did not respond directly.

I did not conclude that we should subsidize; I said that we may HAVE to because our political system precludes our getting to nirvana from here right now. So we may get tariffs. But they won’t really matter much, because the jobs they create will go to robots who would have got them anyway, although tariff, like any subsidy, may accelerate the move.

In my view, the hierarchy of “labor” costs, to some extent now, and increasingly in the surprisingly near term, is (i) cheap foreign labor, (ii) american robots, (iii) American workers. Thus, whereas tariffs may be imposed to stimulate employment here, they will actually stimulate production of and by robots and 3D- printers. The tariffs will give our robotic manufacturers an unfair advantage over foreign competitors, but they won’t need it: once the work is being done by robots, the oceans will resume their rightful role as logistical obstacles.

The robots are coming. How we share the wealth they bring will be the challenge of the 2020′s.

vikingvista June 7, 2011 at 11:46 am

What does it mean for a government to NOT manipulate its fiat money? What would that look like? Has it ever happened in the history of government fiat money?

Ryan Vann June 7, 2011 at 1:29 pm

Exactly. In the giant shell game of national currency creation, manipulation is the entire point of the activity.

vikingvista June 7, 2011 at 9:48 pm

Some people really expose their confusion when they go on about fiat currencies being allowed to float freely on the market. It is as though they don’t know what a fiat currency is. Typically, currencies DO float freely on the market. It isn’t price fixing that central banks usually employ, but direct control of supply. And nearly everyone, including Milton Friedman and a number of libertarians explicitly recommend central bank currency manipulation.

There are few people who sincerely advocate for no currency manipulation. Most people who hurl the “m” word around as an accusation, merely want a different kind of manipulation.

Nemoknada June 7, 2011 at 12:09 pm

“And what, may I ask (as just one question of many that your comment begs to be asked), will happen to the cost of labour in a country where the cost of labour is so inexpensive that demand for that labour steadily rises?”

I would expect wages there to rise and the low-wage business to move to Vietnam or Bangladesh or Mexico or wherever. There are BILLIONS of people lining up to earn less than any American would work for. Do you want the benefits of free trade or don’t you? If you want them, you have to stipulate that they will persist for a significant period of time. Otherwise, why bother.

“New goods are invented in the dynamic United States economy all the time. Those innovations provide employment.” Abroad.

New goods are invented in the dynamic United States economy all the time. Those innovations provide employment. And let’s not forget that necessity is the mother of invention.” Lots of innovation. Innovation creates jobs for PEOPLE, not necessarily Americans.

You haven’t grokked this globalization thing, have you? “The Economy” means “the global economy.” Every job-creating effect you describe plays out where the labor to do it is cheapest. Once that place might have been hundreds of miles away in another state. Now it’s in another country. Nothing you have said is inconsistent with Americans being out of work, no matter how many “jobs” their neighbors create. All we get are the downstream distribution stuff. Manufacturing, the bulk of the employment, gets done elsewhere.

But actually, I am much more optimistic about trade than you apparently need to think I am. I expect robots to replace people in more and more jobs. We won’t work because we won’t have to. All we have to do is figure out who gets what when the goods manufacture themselves.

Shidoshi June 7, 2011 at 12:33 pm

And who will benefit from the use of robots in production? What will become of the humans that do not invent such robots?

John Dewey June 7, 2011 at 12:41 pm

And who will benefit from the use of mechanized looms in production? What will become of the humans that do not invent such mechanized looms?

Daniel Kuehn June 7, 2011 at 12:44 pm

They’ll think up cooler stuff to do.

Or they’ll invest in robots and play video games all day.

Slappy McFee June 7, 2011 at 12:46 pm

Consumers will benefit from robots in production if it means lower costs.

Nothing will become of the humans that did not invent the robots any more than if the robots never existed in the first place. The invention of the snowblower didn’t mean snow shovels don’t exist.

Nemoknada June 7, 2011 at 1:12 pm

“What will become of the humans that do not invent such robots?”

They will save Medicare by providing health care at depressed wages.

The theological libertarians believe that the Luddites were categorically wrong. Thus, they treat a reference to the Luddites as an actual argument, when it is really as an act of faith. Their argument boils down to “So far, so good.” They believe in the one true Industrial Revolution.

Maybe, they’re right. But only maybe, as they have done no actual analysis of how Moore’s Law is rearing its ugly head in the factory, what 3-D printing actually means, or, most depressingly, what a WONDERFUL thing it would be if we could figure out how NOT to have to work for a living.

Ryan Vann June 7, 2011 at 1:32 pm

I’m not sure how libertarianism is at all in conflict with a zero cost of production paradigm. Please elaborate.

Nemoknada June 7, 2011 at 3:33 pm

“I’m not sure how libertarianism is at all in conflict with a zero cost of production paradigm. Please elaborate.”

It isn’t. I was referring to what I explicitly called “theological libertarians,” those who respond as “John Dewey” did to Shidoshi.

Shidoshi June 7, 2011 at 3:08 pm

Interesting critique.

Shidoshi June 7, 2011 at 2:59 pm

I agree with all the answers to the questions I brought up, particularly in the immediate future. However, I also think of universalizing that trend going forward into the medium-term future. At some point, everyone will eventually need to build robots since that will be the way of providing goods and services to each other. Think – if you didn’t create a robot, how will you provide value in exchange for the owners of the robots that perform the tasks you need completed?

Sam Grove June 7, 2011 at 3:53 pm

A lot of people manage to provide for themselves by providing entertainment to others.

I do not doubt that there will be many options for people to create and exchange values without having to create robots.

WhiskeyJim June 7, 2011 at 12:59 pm

But actually, I am much more optimistic about trade than you apparently need to think I am. I expect robots to replace people in more and more jobs. We won’t work because we won’t have to. All we have to do is figure out who gets what when the goods manufacture themselves.

IMHO, this is a better conclusion than the one in your earlier post. But let us look at its implication.

If robotics replace most manufacturing labor, then the world will be more productive by multiple factors which will undoubtedly make the agrarian and industrial revolutions look like child’s play.

The resultant riches for the world could easily catapult us to the stars. What then will the world economy look like? There is no way to figure that out. But it will surely be a different place.

The more pertinent question might be whether we wish to retard that future by subsidizing the present.

The inherent paradox of Progressive ideology, and most subsidy, is that it markets itself as forward thinking when it really breeds statism and inhibits progress. If there were no poor people on the earth, it would be necessary for Progressives to invent them.

Nemoknada June 7, 2011 at 4:19 pm

“What then will the world economy look like? There is no way to figure that out. But it will surely be a different place. ”

Google on “post-scarcity economy” and knock yourself out.

“The more pertinent question might be whether we wish to retard that future by subsidizing the present.”

I agree. There is also the question of whether there is any chance that we will not, any way to see that we do not. I have argued that we should be lowering the SS retirement age and increasing the benefits as a way to accommodate the precipitously declining workforce and distribute the benefits of (nearly) zero-cost goods. But Libertarians gag on this statist solution. I believe we need to return to the one-earner family, but the feminists’ heads explode at the thought. I think public companies should pay employees in stock (as well as cash) so that they can retire earlier. But who will go first when it raises the cost of capital in the short run for the competitor who tries it? It’s a prisoners’ dilemma.

kyle8 June 7, 2011 at 5:58 pm

You are providing answers to a problem which has not come to be yet, and probably will never.

Humans will find new things to do, to create, and new ways of making money, they always have.

Lack of wealth is what leads to endemic poverty and unemployment, a surplus of wealth usually leads to a roaring economy, absent stupid government intrusion.

Nemoknada June 7, 2011 at 6:25 pm

“You are providing answers to a problem which has not come to be yet, ”

What did the Great One say – skate to where the puck will be.

“and probably will never.”

You may be right, but you have not made the case. You have merely joined the theologists in saying “so far, so good.”

WhiskeyJim June 7, 2011 at 12:11 pm

Using Eichengreen’s own Keynesian thinking, during periods of unemployment and lower than desired AD, why carp about China? Is not the more sensible and controllable route to drill, baby, drill?

We consume oil, and will consume it for decades regardless of emergent technologies. Domestic oil production does not hinge on Geithner successfully convincing foreign governments with yellow skin to change their policy. We just need to change domestic policy and bring the EPA back into some semblance of reality.

Oil exploration and production would provide millions of jobs, as they do in Canada, our largest oil source and trading partner by far, and they tend to have white skin.

Energy jobs are better paying than making flat screen TV’s and the country could compete in today’s market, making significant inroads on the dastardly trade ‘deficit’ (is unemployment important, but not as important as green energy?).

There. We have solved Eichengreen’s and Keynes’ and the Progressive problem. I look forward to a reply which does not contravene their own bull shit.

Nemoknada June 7, 2011 at 12:44 pm

“Oil exploration and production would provide millions of jobs, as they do in Canada, ”

Our oil and gas industries already account for 9.2 million American jobs according to the industry. The industry is promoting the figure 530,000 ADDITIONAL jobs by 2025 if they get the laws they want. That’s fine, but it’s hardly the solution to our unemployment mess. http://tinyurl.com/5sugpv7

WhiskeyJim June 7, 2011 at 1:08 pm

I believe those estimates are low on two counts. First, they under-estimate spin-off jobs. Second, as with all budgets, they tend to be on the low side.

The Canadian Tar sand projections on production and jobs have been doubling and tripling every few years since its inception. IOW, people get better at what they do.

As an aside, I am confused by oil company marketing. It seems cowardly to me. Where is the company that is proud of what it does and what it has done? Where is the offensive to counter the many just plain wrong things Progressives have said about it?

If I were in charge of such estimates, I’d jack them way up, in part because of historical track records, and in part to bring the opportunity cost of avoidance home to the political class that is impugning me.

Nemoknada June 7, 2011 at 1:31 pm

You saw the source. Do you really think the industry would overlook ANY possible job in claiming how many it can create?

WhiskeyJim June 7, 2011 at 1:49 pm

This question makes me wonder if you have ever worked for a large company, especially one embattled with political avarice.

WhiskeyJim June 7, 2011 at 1:15 pm

Answer part II. If one believes the Keynesian argument, oil does not have to provide ALL the jobs. It merely has to ‘spur aggregate demand,’ and get everyone spending again.

So it surely would provide a significant shove in the right direction. Consider the current economy in North Dakota, where by some estimates American reserves just increased 10x.

At least 8 states could easily replicate North Dakota’s boom but for the Federal government. That is far from insignificant.

TMI June 7, 2011 at 2:53 pm

(Laughed out loud.)

Funny how one can, in the moment, forget the mpc and its Keynesian effects in the next.
.

Justin P June 7, 2011 at 4:18 pm

I wonder what the Oil Multiplier might be? 2? 3? 27,345?
I’m guessing 213.

vikingvista June 7, 2011 at 9:50 pm

213.492

WhiskeyJim June 7, 2011 at 12:26 pm

Eichengreen describes advantages to a world currency, but I believe he understates the case by a large margin.

His example of Hungarian florints with car loans in Swiss francs is illustrative; when florints devalue all Hungarians with car loans risk losing their cars.

Consider then, the hundreds of millions of people in the world who use American dollars in their countries. What happens to their standard of living when the Fed intentionally devalues the dollar by say, 20% in less than 5 years, to prop up banks and the American economy?

I suspect there is a problem with devaluation. But it is not primarily caused by the Chinese. Eichengreen might talk about the effects of exporting American inflation to the world because their currency allows them. That is a far larger problem, and his argument seems to me a case of ranting about the speck in the Chinese eye while having a log in one’s own.

Justin P June 7, 2011 at 4:27 pm

Eichengreen could learn a lot form Sowell…”And then what?”

My problem with most Keynesian style thinking, is that they are so concerned with the short run, they forget to think about “and then what?”

Your comment is all about the “and then what” Which is exactly what Eichengreen fails to mention.

Chucklehead June 7, 2011 at 12:38 pm

You get a “A” for temperament and not crucifying the arguments of your guest. What I have never understood is what is so bad about deflation? It rewards savings, encourages capital formation, & lowers interest rates. As you stated in a earlier podcast ” society advances when it spends less resources to achieve a end, not more.” It seems that full employment is a goal they want to reach even if it means we all end up hunter-gatherers.

Nemoknada June 7, 2011 at 1:06 pm

“What I have never understood is what is so bad about deflation? It rewards savings, encourages capital formation, & lowers interest rates. ”

Deflation does not encourage capital formation. It rewards putting money under a mattress. Why risk it if it will grow in value at no risk? Thus, deflation lowers “interest rates,” but it raises the real cost of capital (nominal return – inflation rate), which is what drives capital formation.

The purpose of QE II is to drive down interest rates on risk-free assets (Treasuries) so that buying those assets won’t be so attractive, and capital owners will, therefore, take risks with their money, i.e, invest it in job-creating enterprises. Whether or not you agree that the job-creation outcome can be achieved, the LOGIC of it is sound: lowering the real return on risk-free capital encourages risk-taking. Raising the return on it – which is what deflation does – has the opposite effect.

The great debate that gave rise to Bryan’s Cross of Gold speech arose from the damage that deflation was doing to Western farmers, who could not meet their mortgages as they rose in value and the price of food declined.

Capitalism has a certain “use it or lose it” approach toward capital. The invisible hand works when capital is DEPLOYED to seek profit. No wealth is created when capital is withheld, so withholding it, per se, is punished by the system.

WhiskeyJim June 7, 2011 at 1:31 pm

Deflation does not encourage capital formation. It rewards putting money under a mattress. Why risk it if it will grow in value at no risk? Thus, deflation lowers “interest rates,” but it raises the real cost of capital (nominal return – inflation rate), which is what drives capital formation.

I have heard this argument for years. Perhaps you could help me, because cost in general in every industry, especially technology, has been declining for generations now.

Is the axiom you quoted above actually slowing investment in technology and other industries? Would investment in technology be even higher if computers were not getting cheaper? Would people consume even more computers if they were not dropping in price?

I am not being sarcastic. This is a vital question to me. I do not understand the economic argument for inflation, where, other than government controlled industries like health care, it seems to me that prices have been dropping for a hundred years+, and that is a good thing.

But my confusion rests primarily on my practical history as a business person. Successful innovation is driven by finding value in areas such as quality and lower prices. It drives business. But economists in general tell us that rising prices are good, not declining prices. Are you telling us that one of a firm’s driving motivations is actually bad for the economy?

Please help if you can.

Ryan Vann June 7, 2011 at 1:43 pm

The illogic behind the deflation bad meme goes like this. Deflation leads to higher real returns; investors and entrepreneurs hate high real returns. Thus, they won’t invest because…uh risk yeah risk. They won’t make risky investments even though those risky investments just became potentially more profitable under a deflation paradigm. It’s a silly narrative.

Nemoknada June 7, 2011 at 3:55 pm

“They won’t make risky investments even though those risky investments just became potentially more profitable under a deflation paradigm.”

And they became potentially more profitable how? The demand for all products is suppressed by the benefits of saving, but entrepreneurship is goig to be more richly rewarded? Savers who care only about having enough money at retirment will nevertheless send their money to mutual funds because…?

You can’t make a narrative “silly” just by denying it. Do you have an example of an episode of deflation that ended well?

carlsoane June 7, 2011 at 10:30 pm

“Do you have an example of an episode of deflation that ended well?”
Yes. 90% of them.

See this paper from Minneapolis Fed– http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.147.6290&rep=rep1&type=pdf — in which they evaluate 100 years of economic data from 17 countries. Their conclusion is “Our main finding is that the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929—34). We find virtually no evidence of such a link in any other period…What is striking is that nearly 90% of the episodes with deflation did not have depression.”

dsylexic June 8, 2011 at 5:08 am

watch the Keynes Hayek rap video part deux: Hayek says ” one data point and you are jumping for joy”. deflationary 1880-1914 were the best years of american growth

vikingvista June 7, 2011 at 9:54 pm

Nice post. It is amazing how many people believe deflation necessarily curtails investment. I mean really amazing. It doesn’t help that widely read keynesiac pseudeconomists are always pushing that snake oil.

Gil June 8, 2011 at 1:51 am

Is that because people and businesses should save before investing and expanding instead of borrowing to invest and expand?

Nemoknada June 7, 2011 at 3:38 pm

“If one believes the Keynesian argument, oil does not have to provide ALL the jobs. It merely has to ‘spur aggregate demand,’ and get everyone spending again.”

The suggestion of drilling was yours. Are you now disowning it or defending it? Did you mean it as satire (very risky on the ‘Net, where people don’t know your style).

Keynesian solutions are about “the economy.” The hole in ours – the fact that our multiplier spending buys stuff made abroad – leaves Keynes correct but irrelevant.

I don’t get the point about working for a large company. Are you saying that the oil industry’s pro-drilling propaganda overstates the number of jobs the industry creates?

WhiskeyJim June 7, 2011 at 7:17 pm

I used oil as an example, for it appeared to me that you were defending Eichengreen’s seeming preoccupation with low cost labor in yellow skinned countries; there are other things we can do. And they are right at home. That does not make Keynes correct.

I used the Keynesian defense of oil, which I thought was a smaller part of the larger point of my post, because you seemed to defend it. I was attempting to show that the Keynesians seem hypocritical to me in their arguments, as well as irrelevant.

As for the oil industry, many economists seem to discount that industries have cultures which define them on a host of planes; corruption, barrier to entry, subsidy, and risk aversion are examples. I don’t know your experience with oil executives, but they all tend to be incredibly risk averse. Many of them significantly minimized profits in the last decade because they were shorting the rising price of oil (Ironic then, that they are accused of extra profit taking). They were counting on prices reverting to means, seemingly unaware of changing political paradigms.

What would you call an industry that allows the environmental movement to paint them as Satan’s spawn, and responds with alligator arms? Their propaganda, as you call it, is anemic and apologetic and inadequate. IMHO, they should grow a pair and meet the enemy head on; simple game theory really. Their own PR, some of which you quote, is so meek and lacking in any aggressiveness that it invites being over run by their adversaries. If I was a principal shareholder, I’d fire the lot of them.

So no, I am not saying pro-drilling propaganda overstates. I am clearly saying it understates its case because the leaders in that industry are too frightened by political correctness to say what they and many business folk know to be true. Go get an oil executive drunk some time, and see what he really says when he doesn’t have a bunch of effeminate reporters accusing him of despoiling the planet.

Only the head of Chevron has even attempted to set the irrational and silly domestic energy policy straight. Shame on the rest of them for not defending their industry and the markets they operate in. They should be proud of what they do, and they are not, at least not in public. For that is surely what it will take to roll back some of the regulation that scares most jobs off shore these days, with silly Keynesian macro arguments that then explains the new levels of unemployment.

Nemoknada June 7, 2011 at 8:02 pm

“So no, I am not saying pro-drilling propaganda overstates. I am clearly saying it understates its case ”

Sorry, I got that backwards. I meant to say “understates.” Your view that the timidity of the industry leads them to understate the jobs they create seems to me the product of an undrawable inference, political correctness or no. But I don’t have any knowledge of the subject, and I’m more interested in the subject of whether we should do anything directly about China’s currency manipulation, as to which I think the geopolitical externalities trump the macroeconomics, than whether or not we should be drilling. I would say, though, that whether we drill should be independent of whether we should convert to other fuels. That’s a matter of comparative advantage. It might make more sense for us to go nuclear and export oil than to use the oil we drill.

Nemoknada June 7, 2011 at 3:45 pm

“cost in general in every industry, especially technology, has been declining for generations now.”

The value of the currency is declining, and the CPI is rising. That’s the inflation that drives investment and spending. Countertrends within industries or at the producer level don’t matter if they don’t make the mattress a good investment choice for the risk-averse saver.

Nemoknada June 7, 2011 at 4:05 pm

“But economists in general tell us that rising prices are good, not declining prices. Are you telling us that one of a firm’s driving motivations is actually bad for the economy? ”

Business strive to lower their prices relative to the competition. That effort happily results in lower REAL prices, aka prosperity. But in order for those lower real prices not to result in too few dollars chasing too many goods, the currency needs to be devalued faster, but only a bit faster, than the real cost of things drops.

The conflict you are asking about is between a falling apple and a rising orange.

Gil June 8, 2011 at 2:08 am

Why do folks like you keep diddling between “deflation due to growing productivity gains” and “deflation equal shrinking money supply” when it suits you? A society that has growing technology and productive gains will see real prices fall regardless of whether there was inflation or deflation. Hence today’s prices would make a time-travelling Austrian Economist from 1911 aghast despite the change in the standard of living. “Deflation is bad” refers to shrinking money supply.

Alternatively, it also depends on prices versus the same price most bang for your price. I could theoretically spend some $10,000 on some souped-up computer setup just as I could spend the same amount 15 years on a souped-up computer however the modern setup would be much, much faster and higher capacity than the previous. The pricse were the same the quantity was different. So the latest computer technology is still quite expensive but what qualifies for low-end computer technology gets better. I would say the same is with health care – tehchnology means more can be done at the cutting edge thus making extreme life-saving costs more expensive whereas a lot of down-to-earth treatments are dirt-cheap – anti-biotics and anti-septic creams which cure most of what culled the human race throughout history. Inevitably living without a car or computer is cheaper but so is not treating people with cancer and sending them to a hospice.

Chucklehead June 7, 2011 at 1:58 pm

How does money under a mattress lower interest rates?

Ryan Vann June 7, 2011 at 2:02 pm

It doesn’t, less money in banks means less money to supply, which would increase interest rates ceteris paribus.

Nemoknada June 7, 2011 at 3:57 pm

“which would increase interest rates ceteris paribus.”

Except that the ceteris aren’t paribus. In a deflationary environment, demand is crushed by deferred spending and profitable mattressing. Fewer shoppers means fewer shops with fewer employees. Less deployed capital, less GDP, less prosperity. Q.E.D.

vikingvista June 7, 2011 at 9:41 pm

Long term deflation, of course, would have no effect on demand, since people do not wait indefinitely to satisfy their wants. People would only reduce spending, if they anticipated that the deflation was only short term.

Chucklehead June 8, 2011 at 12:08 am

In a inflationary environment savers flee from bonds into commodities, which they put under the mattress, so it creates what it intends to destroy. Inflation it seems is just a bail out for existing borrowers, and adds another distortion to a market that is trying to correct its pricing.

Gil June 8, 2011 at 4:06 am

And deflation is an unfair gift for savers for doing nothing? In an active economy low inflation has no effect on the market since people are going to spend their money than sit on their savings indefinitely. Then since good “deflation” is when productivity is increasing thenthe really bad “inflation” is when productivity is going down.

indianajim June 7, 2011 at 2:06 pm

For me, a key point was Barry’s claim that aggregate demand theory should be substituted for appeals to emergent order via specialization according to comparative advantage during crises of low aggregate demand. Circular reasoning yes; but in the ebb and flow of the debate, and with the circularity not made explicit (Barry just called it a crisis as opposed to a crisis of low aggregate demand), the point flew relatively undetected under Russ’s radar.

carlsoane June 7, 2011 at 5:57 pm

Sorry. I may appear to be spamming now, but I’m actually just trying to reply to Pingry and instead my responses are appended to the root.

Martin Brock June 7, 2011 at 6:47 pm

Eichengreen does not explain Chinese monetary policy only in terms of a fixed chunk of aggregate demand. He does argue that aggregate demand is effectively fixed in the short run, and this constraint hinders U.S. economic recovery from recession in the context of China’s policy, but this theory isn’t his explanation for the Chinese policy. He maintains that China’s state buys foreign investment with its policy. It suppresses the consumption of its own people, to cheapen their produce in foreign markets, to attract foreign investors sharing the value of Chinese producers denied this value.

In other words, China’s monetary authority directs its economy to produce for export to the U.S. so that it will follow the lead of the U.S., producing what U.S. consumers demand and thus producing what U.S. producers once produced. In theory, U.S. producers react by finding new things to produce, but this adjustment doesn’t occur at an arbitrarily high rate, and with five times the U.S. population, at a time of historically unprecedented economic dynamism, Chinese producers can gain markets more rapidly than displaced U.S. producers can find new and valuable things to do.

Ultimately, if Chinese authorities really can forcibly suppress the consumption of Chinese people, they can also suppress the consumption of U.S. people competing with Chinese people to supply consumers in both economy. This suppression of U.S. consumption violates no accounting identity in the short term, because China’s population is five times larger. A suppressed but still growing rate of per capita Chinese consumption plus a suppressed and even falling rate of per capita U.S. consumption can be a positive growth rate.

WhiskeyJim June 7, 2011 at 8:44 pm

I believe I understand his argument, which you have summarized, quite well as usual.

My confusion throughout these comments is why he seems so uptight about subsidizing American consumption, when American currency devaluation surely has more significant effect on world trade than anything the Chinese do, especially given the fact that domestic federal deregulation could move so easily to counteract any perceived harm by the blunt instrument of fixed exchange rates in China.

It is like complaining about the mole on your cheek when you can not speak because of your own self-induced goiter.

Martin Brock June 8, 2011 at 9:33 am

Eichengreen does seem concerned about U.S. monetary policy in the longer run. I’m not sure I agree that dollar devaluation has a more significant effect on world trade. It has more effect on the U.S. economy, because it affects all external trading relationships, not only the Chinese relationship, as well as internal economic dynamics.

U.S. economic influence peaked sometime after W.W. II, and it’s now declining, relative to the rest of the world. I don’t expect this decline to reverse, and I don’t regret it. Five percent of the world’s population will not produce 30% of global output indefinitely. This historical event was transitory. The relative decline is a sign of progress in the rest of the world, and unfortunately, it’s also a sign of declining economic liberty in the U.S.

If the Chinese could only buy U.S. goods or genuine U.S. investments (as opposed to entitlement to rents) with a dollar surplus generated by their export subsidies, the policy might harm the U.S. economy less, although it could still drive the U.S. economy along an economic trajectory that is unsustainable when China changes its policy.

I have fewer problems with Chinese subsidies as long as the U.S. statesmen don’t cooperate with the Chinese policy by selling the Chinese entitlement to rents imposed on U.S. citizens, like Treasury securities; however, that’s like saying I have no problem with the rain as long as the skies are not cloudy all day.

I’m always surprised that analyses like Eichengreen’s don’t pay more heed to demographics and other fundamentals, as opposed to politics and finance. China’s export policy and U.S. monetary/fiscal policy do contribute, jointly, to economic trends, but I doubt that either policy is as important, in either the long term or the short term, as the demographic transition. This transition seems to explain foreign demand for U.S. rents as well as anything else, and demand for the rents explains the U.S. propensity to provide them, and the satisfaction of rent seekers explains the monetary policy. Treasury securities and mortgage backed securities with implicit government guarantees are only the tip of an iceberg.

WhiskeyJim June 8, 2011 at 2:10 pm

Good post. I wholeheartedly agree.

There are 2 billion people crawling into the middle class. That will be fantastic for people’s well-being, innovation, and the world’s enrichment. The teeth gnashing regarding USA’s #1 position, or the ‘competition with China,’ is silly.

China will soon become the number one English speaking nation in the world:) That our political betters are hastening our own decline is of much higher priority than anything the Chinese might be doing, and monetary policy is way down the list.

BCanuck June 7, 2011 at 8:31 pm

Pardon me if my comments have been addressesed is the 90+ entries above. I only got to about #50 and had enough of the bickering.

Why wouldn’t Chinese fix their currency to that of their largest trading partner? It seems like a rational policy to me. The exporting producers have one less variable to deal with.

A lot countries used to fix their currencies to the US dollar. If China set the currency and keeps it fixed at that level for 10 years, is it still considered a ‘depreciated’ currency. If they continue to ratchet the exchange rate down that is one thing, but if they set it and leave it at a set rate isn’t that different? Any advantage in the initial depreciation would have dissipated. So what if they want their currency to depreciate as quickly as the US dollar is. If they can handle the resulting inflation, that’s their business.

And could someone explain what a ‘trade deficit’ is? If one country sends goods over and the other country sends money in exchange, where is the ‘deficit’? Secondly, countries do hardly any trading. It’s firms and individuals LIVING in the countries that do the trading. If you buy goods at the local grocercy store and pay in cash, is there a ‘trade deficit’ between you and the grocery store, afterall you didn’t send him any goods at all in return, just plain old money. What am I missing?

Nemoknada June 7, 2011 at 9:07 pm

“And could someone explain what a ‘trade deficit’ is?”

A trade deficit is how much of your country’s money is in other country’s hands. That affects how capital flows into your capital users – through Main St. banks or Wall St. securitizers – what the risk tolerance of that capital is – will their be enough entrepreneurial capital in the country, or will it all seek (allegedly) safe investments in, say, mortgage-backed securities – the effect of your central bank printing money, the destination of the “multiplier” of domestic activity, and, I’m sure, a whole host of phenomena I have not thought of. That it’s called a “deficit” is the least important thing about it. What matters is that the money you spend flows back into through your economy other than as revenue of your businesses.

BCanuck June 8, 2011 at 1:30 am

I get it. A trade ‘deficit’ is actually a money ‘surplus’ for your trading partner. They sell you all their stuff but they’ll want to do something with the money you’ve paid them with. If they don’t buy YOUR stuff they’ll look for places to invest it. If they have hundreds of billions to invest, this matters. Wall Street must love trade deficits.

If the money is flowing out of the country and is not being circulated back into the economy in general (it’s being squirrelled away in esoteric derivatives, etc) can this lead to less than expected domestic price increases (inflation)?

Thank you for your reply above.

Nemoknada June 8, 2011 at 10:19 am

“Wall Street must love trade deficits.”

Yep.

“If the money is flowing out of the country and is not being circulated back into the economy in general (it’s being squirrelled away in esoteric derivatives, etc) can this lead to less than expected domestic price increases (inflation)?”

I wouldn’t think so. An awful lot of the money goes to suppress interest rates, which entices people to buy on credit, which is inflationary. And if you are the trading partner whose businesses benefit from American profligacy, having your government lend to Americans at cheap rates goes hand in hand with your ability to sell to them at cheap prices. THAT is what our trading partners are “investing in” – demand creation.

But there are too many Black Swans in the water to draw any empirical inferences. I don’t see any chance that the American economy without 9/11 is the same as the one we have now. The deficit would look entirely different. And the emergence of exponentially growing global manufacturing capacity has made it almost impossible for there to be too few goods for too much money to chase. (Natural resources are pretty much the only constraints and the principal sources of inflation despite the wild proliferation of dollars. That’s why “core inflation” has become a misleading number – it leaves out the two classes of goods most susceptible to excess money-printing in a period of rising manufacturing productivity.)

vikingvista June 7, 2011 at 11:35 pm

“Any advantage in the initial depreciation would have dissipated.”

Exactly right. Until recently the RMB was a $0.15 note, and prices quoted in RMB were adjusted accordingly. But resources are accrued to he who prints the money. So from the Federal Reserve’s point of view, the Chinese central bank setting itself up as a rogue branch of the Federal Reserve, was like a rival gang poaching on their territory.

As far as you or I or the typical Chinese citizen is concerned, there is no reason why we should prefer getting ripped off by the Federal Reserve instead of the Chinese government–especially when it is the same amount either way.

Nemoknada June 8, 2011 at 12:19 am

“…since people do not wait indefinitely to satisfy their wants. ”

No, but they would wait as long as they can, which is a permanent suppression of demand as the frequency of purchases drops (buying a new car every ten years rather than every four, say). Indeed, given long-term deflation, one would expect a cultural meme of thrift to arise to internalize the process, changing the entire consumer culture to a saving (but not investing) culture. Meanwhile, the savers would still refuse to take risk in sufficient volume to support full employment. There would be no pent-up demand for risk, just mounting evidence that it is not worth running.

Nemoknada June 8, 2011 at 1:21 am

“In a inflationary environment savers flee from bonds into commodities, which they put under the mattress, so it creates what it intends to destroy. ”

At 2% inflation? That’s what the Fed is targeting and I’m supporting.

Nemoknada June 8, 2011 at 2:14 am

“‘Do you have an example of an episode of deflation that ended well?’
Yes. 90% of them.”

The article does not show any detail. Deflationary damage is clearly a lagging indicator. It takes time for consumers and savers to realize and come to believe that prices will continue to drop, and then it takes time for their changed habits to take hold and affect the economy. An analysis that looks at growth while the deflation is occurring is completely useless.

Nemoknada June 8, 2011 at 2:30 am

One more thing. In a tight money (e.g., gold standard) regime, growth in real outputs CAUSES deflation – too few dollars chasing too many goods. To treat such periods as cases of deflation not stunting growth is much worse than useless: it’s downright misleading.

Nemoknada June 8, 2011 at 8:06 am

“deflationary 1880-1914 were the best years of american growth.”

Because growth suppresses prices under a gold standard. Deflation was a bad side effect of growth – ask any farmer of the day – not the cause of it. What would have happened absent WWI we’ll never know. But imagine how much faster the country good have grown in the cited period if the Fed could have printed up some money for entrepreneurs who couldn’t get it. (I’m still looking for someone on this site who actually runs the counterfactual thought experiment before saying what caused what.)

Sometimes, A causes B, sometimes B causes A. Sometimes A and B are coincidences. It would be nice if that weren’t so, at least for some people.

muirgeo June 8, 2011 at 3:33 pm

Key point; you can not consistently consume 6% more then you produce.

All the explainations ignoring or making excuses for this amountt to nothing….especially when the system is rigged to put all the profits and capital into the hands of a few who control all the credit and profit further by being the lenders to an ever more despararte wage starve citizenship.

Libertarianism is closing on communism in terms of total societal damage its amassed on most of the global population.

Daniel Kuehn June 8, 2011 at 3:39 pm

re: “Key point; you can not consistently consume 6% more then you produce.”

Of course you can – you just need to grow fast enough. Don’t substitute talking points for clear analysis. This goes right in line with this idea that we can’t perpetually run deficits of any variety (trade, budget, etc.). Of course we can. The conditions have to be right, or else counter-vailing adjustments will occur (currency adjustments, interest rate adjustments, etc.). But you can absolutely consume 6% more than you produce ad infinitum – if you’re growing at the right pace.

muirgeo June 9, 2011 at 1:56 am

And your proof is what the 9% unemployment rate…. yeah this is working out real good. The economics of manna…

rhhardin June 9, 2011 at 9:25 pm

I couldn’t follow it when it was said that China keeps its currency low by buying the dollar.

They earn the dollars, and if anything get rid of them by buying Treasuries.

The Chinese currency doesn’t enter in unless they’re buying the earned dollars from the exporters that earned them with Chinese currency, and then shipping the dollars to the US to buy Treasuries. Which they my be doing.

How they get the exporters to sell is another question, instead of say buying US goods with them.

Methinks1776 June 9, 2011 at 10:43 pm

rhhardin,

When china sells to the U.S., the U.S. importers pay Chinese importers with remnimbi (they sell dollars, buy remnimbi).

To purchase U.S. Treasuries, which are denominated in dollars, the Chinese exchange remnimbi for dollars (sell remnimbi, buy dollars).

The sale of the Remnimbi by the Chinese (in order to obtain dollars to buy treasuries) puts downward pressure on the Remnimbi and upward pressure on the dollar (since they’re buying it) relative to the Remnimbi. That’s how the alleged currency manipulation is carried out.

rhhardin June 10, 2011 at 5:36 am

Why isn’t that a wash? Remnimbi bought and sold cancel out of the transaction, which ends up as goods for treasuries.

Methinks1776 June 10, 2011 at 11:11 am

Not 100% sure what you’re asking, but I’ll take a stab.

The People’s bank of China (PBOC) must print more RMB to purchase USD in order to counter the effect of increased demand and keep Chinese exports cheap to United States consumers.

Technically, foreign firms are not allowed to hold RMB and Chinese firms are not allowed to hold USD (that may be changing – I’m not up on the latest developments in China’s easing of restrictions on the RMB). The U.S. importer pays in USD to the PBOC which then exchanges the USD for RMB and pays Chinese Exporter in RMB. The PBOC keeps the exchange rate constant by printing more or less RMB to buy those dollars. If they didn’t print more RMB to devalue it, the demand for Chinese goods, class A shares, RMB denominated bonds, etc. (and thus, RMB) would drive up the currency. That’s the basic idea anyway. I’m quite sure it’s more complex and I believe China moved to a managed exchange rate.

It’s not a wash because to keep the exchange rate stable and Chinese goods cheap in terms of other currencies, the amount of RMB keeps changing (usually upward). Hence the inflation in China.

The Chinese may be printing more RMB to buy USD outside of trade, but I don’t know how that would work given the restrictions China has on the RMB. I’m not intimately involved with the RMB and my International Monetary Relations class was a very long time ago :)

rhhardin June 11, 2011 at 1:29 pm

Thanks, I’m able to follow that.

The question then becomes why Chinese inflation doesn’t make Chinese goods more expensive, cancelling the currency ratio making Chinese goods cheaper, to US importers.

It seems to me that the Chinese are selling us stuff in exchange for Treasuries, in the end. Call it future dollars.

My guess is that actually a surplus of Chinese rural labor wanting upscale factory jobs holds wages down more than any currency activity does. When that equilibrates out, wages will rise, and that will be that.

Brian Vree June 11, 2011 at 1:16 am

Our debt is our single greatest weapon. We can simply announce, “Every nation and every person of the world, we will pay our debt to you — except China. We consider the debt we owe to you worthless and will not pay a penny for it. We will also not recognize any debt of ours you sell to any other person or nation.” Instant collapse of the Chinese economy, greater than any bomb ever invented.

Jerry June 16, 2011 at 1:22 am

Professor Roberts please speak to if the Greek people have it right that the banks who wrote the debt should take a write-down based on the fact that collected interest as a recognition of this risk premium and that the system must flush out that way. Please explain that current shortfall NPV is sixty to one hundred trillion conservatively and that therefore we are in the same boat and the bankers must take a haircut that no amount of punishing old ladies and welfare babies is going to make seven years’ GDP magically appear. Thanks for your work!

Methinks1776 June 7, 2011 at 9:11 pm

does the reply function not work? I didn’t read your comment before reply to Pingry because it wasn’t nested. I guess I’ll find out when I hit “submit”.

vikingvista June 7, 2011 at 11:37 pm

Sometimes it doesn’t work, and your comment gets posted at the root level.

Justin P June 8, 2011 at 9:00 am

I miss Disqus

Methinks1776 June 8, 2011 at 2:46 pm

ditto. Whine whine whine.

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