Will the US Declare Economic War on China?

[alfred russel]

The argument works on a macro level: there is an identity that a capital account surplus must be offset by a current account deficit. By buying huge volumes of U.S. capital assets to maintain their peg against the dollar, the Chinese are effectively exporting a capital account surplus in the amount of their purchases, or equivalently they are exporting an artificial current account deficit.

This reduces aggregate demand. In ordinary times, we could counteract the reduction in aggregate demand through either monetary or fiscal policy and enjoy lower interest rates. But current monetary policy is constrained through our current zero interest rate policy, and fiscal policy is constrained both politically and due to our already large deficit. What this means in practical terms is that our aggregate demand is lowered, and that will simply lower our GDP.

You are looking at the narrow view--the dollar is weakens, the price of imports increases. That is true. But higher domestic unemployment and increased contraction/reduced growth is deflationary. And imports are still a minority part of our economy.

I agree with the first para.  But a current account deficit does not reduce aggregate demand.  This seems to be a confusion of terms - in fact, it is strong aggregate demand that helped facilitate the situtation of current account deficits.  What is true is that a current account deficit (ceteris paribas) decreases GDP - that simply follows from the accounting definition of GDP.   But if the imports are associated with higher levels of domestic consumption (regardless of the way in which the causal arrow points) there is no net negative impact on GDP.

I do mostly agree with your essential point that a decline in the value of the dollar against the renminbi would not necessarily be inflationary over the short tem, due to the persistance of the deflationary conditions and apparent output gap as noted in your last post.

The artificial capital account surplus that the Chinese are exporting means that effectively the Chinese are exporting artificial savings to the US economy. The increase in savings during an economic downturn results in a reduction of aggregate demand (see the paradox of thrift).

[grumbler]

Why are you emphasizing "to China"?  Did you miss the point that AR was making that China's currency manipulation makes the dollar too expensive in general, and not just in relation to China?  It's stated in the quote to which you replied.

I am emphasizing "to China" because the yuan-dollar exchange rate is what we are discussing.  What AR wants to allege about the impact of the Chinese keeping the yuan too cheap on the dollar's value in general is not what is at stake, nor is it what the US government is alleging.

[alfred russel]

I saw that point too, but not an explantion for it.  To the extent other currency pairs trade relatively freely, I don't quite get how China can manipulate those rates by setting a dollar target.

If the relationship between the US dollar, Yuan, and Pound is 1, 7, and 2 respectively, and the Chinese wish to intervene to devalue the Yuan so that there are 8 yuan to the dollar, that is going to affect the strength of the pound. I guess in theory the relationship could become 1, 8, 2 and the devaluation be equal against the pound and dollar, but do you think if the Chinese were to dump $2 trillion in US dollars tomorrow the exchange rate between pound and dollar would be unaffected?

[grumbler]

It isn't a non sequitor--in the Great Depression, going into the depression, tariffs rose, which typically might be inflationary, but there was actually severe deflation. Why? In large part because of a severe output gap, which is disinflationary. When lots of people are out of work, there is a downward pressure on wages, and when there is reduced demand for products and services pricing becomes increasingly competitive.

I don't see what this has to do with the yuan being too cheap.  The US isn't trying to compete with Chinese labor.  Lack of US jobs isn't coming from importing too much Chinese underwear in preference to our own.

Today we have unemployment of close to 10%--another large output gap. Inflation is expected to be very low this year, even though the dollar has depreciated significantly off of last year's highs. I question whether another 20% depreciation would really be inflationary in this environment.

The US could take action to deflate its currency, without doing anything like tariffs on Chinese goods.  The fact that the US government is not acting to do so implies to me that they don't think that the problem is that the US dollar is too strong overall.  The complaint is, instead, (as the OP says), that "China is unfairly manipulating its currency against the dollar to promote its exports."

[grumbler]

I saw that point too, but not an explantion for it.  To the extent other currency pairs trade relatively freely, I don't quite get how China can manipulate those rates by setting a dollar target.

I don't think that the Chinese are doing this through currency trading per se, but by setting prices such that they give more of their currency for US bonds.

How freely is the yuan traded?

[DGuller]

I am emphasizing "to China" because the yuan-dollar exchange rate is what we are discussing.  What AR wants to allege about the impact of the Chinese keeping the yuan too cheap on the dollar's value in general is not what is at stake, nor is it what the US government is alleging.

In that case you should challenge that assertion directly.  What you did is quote it, not address it, and then make a statement that could possibly be valid only if the assertion were false.

[alfred russel]

It isn't a non sequitor--in the Great Depression, going into the depression, tariffs rose, which typically might be inflationary, but there was actually severe deflation. Why? In large part because of a severe output gap, which is disinflationary. When lots of people are out of work, there is a downward pressure on wages, and when there is reduced demand for products and services pricing becomes increasingly competitive.

I don't see what this has to do with the yuan being too cheap.  The US isn't trying to compete with Chinese labor.  Lack of US jobs isn't coming from importing too much Chinese underwear in preference to our own.

Today we have unemployment of close to 10%--another large output gap. Inflation is expected to be very low this year, even though the dollar has depreciated significantly off of last year's highs. I question whether another 20% depreciation would really be inflationary in this environment.

The US could take action to deflate its currency, without doing anything like tariffs on Chinese goods.  The fact that the US government is not acting to do so implies to me that they don't think that the problem is that the US dollar is too strong overall.  The complaint is, instead, (as the OP says), that "China is unfairly manipulating its currency against the dollar to promote its exports."

We obviously don't want to deflate right now--deflation is bad. What we would like is for a more favorable exchange rate, which is why we are talking about the Chinese manipulating the exchange rate, which is keeping the dollar artificially strong.

We aren't going to impose retaliatory tariffs, because a trade war would be worse than an overvalued dollar.

[The Minsky Moment]

The artificial capital account surplus that the Chinese are exporting means that effectively the Chinese are exporting artificial savings to the US economy. The increase in savings during an economic downturn results in a reduction of aggregate demand (see the paradox of thrift).

A capital account surplus means that the US financing the current account by surrendering claims on US assets.  From a domestic US standpoint - this is an act of dissaving, not saving.  It is the Chinese that are increasing their stock of savings by acquiring US capital assets in exchange for goods for current consumption.

If the relationship between the US dollar, Yuan, and Pound is 1, 7, and 2 respectively, and the Chinese wish to intervene to devalue the Yuan so that there are 8 yuan to the dollar, that is going to affect the strength of the pound. I guess in theory the relationship could become 1, 8, 2 and the devaluation be equal against the pound and dollar, but do you think if the Chinese were to dump $2 trillion in US dollars tomorrow the exchange rate between pound and dollar would be unaffected?

In the typical case, the market is going to set the dollar-sterling rate and the Chinese effectively peg to both by choosing the dollar peg.  And this indeed is a deliberate side effect of Chinese currency policy - they want to stay low vs. the euro and sterling as well as the dollar.

I agree with you that extreme interventions could so overwhelm the currency market that the other dollar pairs could be affected.

[The Minsky Moment]

Which helps the US consumer and harms the Chinese consumer, without harming the US producer.  Seems like something I want to keep up.

That makes sense, but only to the extent that the US can continue to finance its current account deficit without creating other disruptions.

[alfred russel]

A capital account surplus means that the US financing the current account by surrendering claims on US assets.  From a domestic US standpoint - this is an act of dissaving, not saving.  It is the Chinese that are increasing their stock of savings by acquiring US capital assets in exchange for goods for current consumption.

From a combined China-US perspective, it is an act of artificial saving. It makes us all worse off, and subsidizes the production of US goods in China (at a time US production is below optimal).

[alfred russel]

In the typical case, the market is going to set the dollar-sterling rate and the Chinese effectively peg to both by choosing the dollar peg.  And this indeed is a deliberate side effect of Chinese currency policy - they want to stay low vs. the euro and sterling as well as the dollar.

They have acquired vast reserves of dollars to keep the dollar artificially high against their currency. I just disagree that isn't going to have an effect on other currencies. If they announced that they were going to unwind their US reserves at the same rate they built them up the past couple of years, I have to imagine that would hurt the dollar against a broad basket of currencies. Don't you think that would hurt other pairs? And if so, why are you sure that taking them in hasn't affected those pairs as well?

[The Minsky Moment]

A capital account surplus means that the US financing the current account by surrendering claims on US assets.  From a domestic US standpoint - this is an act of dissaving, not saving.  It is the Chinese that are increasing their stock of savings by acquiring US capital assets in exchange for goods for current consumption.

From a combined China-US perspective, it is an act of artificial saving. It makes us all worse off, and subsidizes the production of US goods in China (at a time US production is below optimal).

That is so, but only because China sterilizes the capital inflow.  This is a crucial point that is often missed.

Absent sterlization, the massive capital inflow would vastly increase the Chinese monetary base, stimulating domestic demand and inflation.  That would effectively force China's hand and allow the currency to rise to offset the inflationary effect.  By sterilizing the inflow, the Chinese simultaneously keep inflation at bay, suppress domestic Chinese demand, and allow themselves to maintain the peg.  But the net effect internationally - as you point out - is to drain demand out of the world economy and export deflation.

What China is doing is not unlike French policy in the runup to and early stages of the Great Depression - the Bank of France try to stockpile masses of gold reserves by sterilizing the inflow and keeping the franc artificially low.   China already accounts for a greater percentage of world GDP then France did then, and continues to grow rapidly as against the RotW.   

[alfred russel]

That is so, but only because China sterilizes the capital inflow.  This is a crucial point that is often missed.

Absent sterlization, the massive capital inflow would vastly increase the Chinese monetary base, stimulating domestic demand and inflation.  That would effectively force China's hand and allow the currency to rise to offset the inflationary effect.  By sterilizing the inflow, the Chinese simultaneously keep inflation at bay, suppress domestic Chinese demand, and allow themselves to maintain the peg.  But the net effect internationally - as you point out - is to drain demand out of the world economy and export deflation.

And since we don't need deflation right now, and we do need demand, it comes back to the original point--the Chinese are screwing us. There isn't anything we can do about it, so I'm going to be nice to Mono so I'll have a guy on the inside when they take over the world.

[grumbler]

That makes sense, but only to the extent that the US can continue to finance its current account deficit without creating other disruptions.

This is true, but it is not due to China's actions that the US has a current account deficit.  It is because the US has to import oil at such a prodigious rate.  China's actions are harming China (and other low-wage countries even more) than they are the US.

[The Minsky Moment]

That makes sense, but only to the extent that the US can continue to finance its current account deficit without creating other disruptions.

This is true, but it is not due to China's actions that the US has a current account deficit.  It is because the US has to import oil at such a prodigious rate.  China's actions are harming China (and other low-wage countries even more) than they are the US.

In 2008, total petroleum product imports by the US were $453 billion and total petro product exports were $67 billion for a deficit of $386 billion.  This is a very substantial figure but still less than the total deficit of $695 billion in trade in goods and services.

For 2009, the equivalent figures are $204 billion (reflecting lower oil prices and the effects of the recession of consumption) out of a total deficit of $380 billion.

Thus, the US petroleum habit is indeed a significant cause, accounting for more than half of the yearly deficit, but there are other contributors as well.  For example, in 2008, the US suffered a net deficit of over $320 billion in the consumer good trade; in 2009, the figure is over $200 billion - i.e more than the petroleum associated deficit.*  Chinese trade is the most significant part of this deficit (although not the sole cause).

Even at the reduced level of *only* $15-20 billion in net consumer goods imports, there is a significant financing burden on the US.  And since in the short run there is little the US can do to reduce its petro imports or affect the price of oil, the consumer goods trade is a natural point of focus.


*One often hears ganshing of teeth about the decline in the US "industrial base" and claims that the US "does not make anything" anymore.  The data does not bear this out - the US actually runs a trade surplus in non-automotive capital goods, including a slight surplus in industrial machinery.