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Real-Cash-Balance Effect

Here’s a letter that my GMU Econ colleague Larry White and I sent to the New York Times yesterday:

Paul Krugman wants Uncle Sam to get tough on the Chinese government for subsidizing Americans’ purchases of goods from China, on the grounds that “these subsidized exports are hurting employment” in the U.S. (“Taking On China,” Oct. 1).  How does Beijing do this subsidizing?  By purchasing, as Mr. Krugman says, “$2.4 trillion in foreign currency” – including oodles of U.S. dollar-denominated bonds.  By purchasing and holding U.S. dollar debts rather than letting the renminbi rise in value against the dollar, Beijing keeps the prices of Chinese imports lower than otherwise for Americans.

This policy – whatever are its merits or demerits for the Chinese people – does not, contrary to Mr. Krugman’s claim, hurt U.S. employment.  Mr. Krugman blames unemployment on inadequate aggregate demand, so he thinks that less-expensive imports keep aggregate demand in the U.S. too low.  They don’t.

Beijing’s policy makes all consumer prices in the U.S. lower than they would otherwise be.  Therefore, any given volume of dollar spending allows Americans to purchase more real goods.  The volume of dollar aggregate demand depends most importantly on Federal Reserve policy, not on the Chinese.

In short, the purchasing power that the Chinese refuse to use does not disappear; it is transferred into the purses and wallets of Americans.

Donald J. Boudreaux
Lawrence H. White
Professors of Economics
George Mason University
Fairfax, VA 22030