August 14, 2015
The NYT went a couple of miles over the top with Peter Eavis’ analysis of China’s currency devaluation. It begins by telling readers;
“For years, China looked like the principled noncombatant. As other countries, seeking to secure an economic advantage, let the value of their currencies slide on international markets, China held firm on the value of its money.”
“The principled noncombatant?” What are they smoking over there? China accumulated more than $4 trillion in reserves to keep its currency from rising against the dollar. China looked to the world outside of the NYT like the principal combatant. This massive intervention led China to run massive trade surpluses, peaking at more than 10 percent of GDP in 2007.
Fans of economics everywhere know that fast growing developing countries like China are supposed to run large trade deficits, as capital is supposed to flow from slow growing rich countries to fast growing developing countries. Given China’s 10 percent plus annual GDP growth a trade deficit of 10 percent of GDP would have been reasonable, instead China had that reversed.
This also explains the massive housing bubble in the United States and other wealthy countries. With trade deficits creating enormous gaps in demand, the only way they could be easily filled was with demand driven by asset bubbles. (We could have filled the demand gap with large budget deficits, but people in positions of power in Washington are superstituous, so we can’t run large budget deficits to fill demand gaps.)
The rest of the article is no more in touch with reality. It tells readers:
“China’s devaluation stems in part from a desire to let markets influence the price of the renminbi, a shift global policy makers have advocated.”
Umm, no. China’s central bank is holding $4 trillion of reserves. A normal amount for a country of China’s size would be around $1 trillion. A market determined value of the renminbi would require dumping this $3 trillion of excess reserves. In that story, the direction of the renminbi is upward, not downward. (If this is getting too complex for you, just think of the Fed holding $3 trillion in assets. Just about every economist in the country thinks that the Fed holding this stock of assets is helping to keep down interest rates. You can’t believe that the Fed is keeping down interest rates and not believe that China’s central bank is also keeping down the value of the renminbi unless you are very bad at logic.)
Next, we get the fears that we will see currency fluctautions that will undermine international trade:
“The hope among global policy makers, of course, is that the changes in exchange rates are not excessive and do more good than harm. Still, history shows that currencies often go down too much or go up too far, interrupting the strong trade flows that have underpinned the global economy for decades.”
Fortunately, those of us with access to government data know that we have seen sharp fluctuations in currency prices for the last three and a half decades and still saw a rapid growth in international trade.
Then we get a seemingly nonsensical assertion:
“‘We are in a period of trade war — make no mistake,’ said Michael Pettis, a professor of finance at the Guanghua School of Management at Peking University. ‘People say it’s a zero sum game. It’s not — it’s a negative sum game.'”
A negative sum game? Really? How would that work? We are changing relative prices by changing currency values, not putting up tariffs to impede trade. There is no obvious way this ends up as a negative sum game. (The piece later warns against repeating the competitive devaluations of the 1930s. In the 1930s countries were putting up tariff barriers—and the impact of these on the world economy is often exaggerated.
The analysis then dismisses the idea that some sort of collective action on currencies, like the 1980s Plaza Accord is needed:
“Few, if any, analysts believe similar interventions are needed right now.”
Well, I can think of some people like Fred Bergsten, the founder and former President of the Peterson Institute for International Economics and Simon Johnson, the former chief economist for the International Monetary Fund, who have argued repeatedly for something like the Plaza Accords to regulate currency values.
The analysis goes on to tell readers:
“China, they add, has many reasons to avoid an uncontrolled plunge in the renminbi. A particularly important reason is that Chinese entities have borrowed over $1.6 trillion in foreign currencies. A big drop in the renminbi would make that harder for some Chinese companies to pay back, because they would need to earn more renminbi to service their obligations.”
Let’s see, what happens to the value, in Chinese currency, of the $4 trillion in foreign exchange reserves held by the central bank if the plunge in the renminbi continues? It doesn’t sound like China has much to worry about here.
Towards the end we are told:
“The enormous amounts of easy money pumped out by the Fed over the last decade helped stoke booms in other countries that became unsustainable. And as the Fed has pulled back, the adjustment has been jarring for huge economies, like Brazil and China.”
The only problem with this one is that the Fed has not pulled back. Those with access to the newspaper know that the federal funds rate is still zero, although there is some concern that interest rates will go up this fall. It would require some very creative writing to blame the problems facing Brazil and China on the Fed pulling back.
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