Comments on the News

Treasury Secretary Tim Geithner’s speech at Peking University last week seems to have been better received there than in Washington. Some currency hawks are lamenting that he saw the need to go to apologize (again) for stating the obvious fact that China has been manipulating its currency for a long time now.

In fact, the speech does not include any apology (though private conversations with official Chinese might have). Nor did it represent what some in the media portrayed as a backtracking from the Obama campaign’s tough line on China. On the contrary, it is a thoughtful, reasoned explanation for the need for China and the US to work closely together to “lay the foundations for more balanced, sustained growth of the global economy once this recovery is firmly established.” The speech should be studied carefully, in my view. The text can be found at http://blogs.wsj.com/chinajournal/2009/06/01/full-text-of-geithners-speech-at-peking-university/.

In fact, I found a lot to admire and agree with in this speech. For example:

§ It rests quite clearly on the expectation that Beijing will start to assume responsibility for the health of the global economy.
§ Geithner made clear that sustainable growth in China “will require a substantial shift from external to domestic demand, from investment and export driven growth, to growth led by consumption.”
§ At the same time, the US will have to increase its savings (i.e. reduce the rate of consumption growth) and should be expected to reduce its current account deficit (the broad measure of borrowing from abroad) as the recovery proceeds.
§ Its global perspective: “China and the United States individually, and together, are so important in the global economy that what we do has a direct impact on the stability and strength of the international economic system. Other nations have a legitimate interest in our policies and the ways in which we work together, and we each have an obligation to ensure that our policies and actions promote the health and stability of the global economy and financial system.”

With respect to the value of the renminbi – a major nexus between Chinese and American growth strategies – Geithner called for a “more flexible exchange rate regime.” There’s not much new in this. Since the days of John Snow, Treasury has used that phrase as code for a stronger RMB. Indeed, only that meaning makes Geithner’s key sentence other than nonsense. He said: “Greater exchange flexibility will help reinforce the shift in the composition of [Chinese] growth, encourage resource shifts to support domestic demand, and provide greater ability for monetary policy to achieve sustained growth with low inflation in the future.” That had to refer to a stronger RMB, not one subject to greater fluctuations.

So, unlike some others. I see in Geithner’s speech most of the elements of a sensible approach to the vexatious currency problem. He has lowered his voice, especially compared to Henry Paulson’s histrionics. He has placed the central issues – sustainable growth strategies for China and the US – on the table for the Strategic and Economic Dialog. He did not back down on the need for a substantial revaluation of the RMB as crucial to a sustainable global recovery.

He’s speaking wisely and more softly. To make the Rooseveltian strategy complete, all he needs is a big stick, some means of compelling Beijing to make politically hard decisions. John Snow at one point told a business delegation in his office that they “should hold our feet to the fire so we can hold the Chinese feet to the fire.” That, I believe, is the most important function of the Currency Reform for Fair Trade Act of 2009 (H.R 2378 and S. 1027). Let’s hope the Secretary will prove willing and able to use it.

Labels: Currency; recovery; China

In the view of the latest issue of The Economist, “inflation is bad, but deflation is worse.“ (See The greater of two evils,” May 9-15, 2009.) An editorial reasoned that “inflation is distant and containable, while inflation is at hand and pernicious.”

It concludes darkly that we might be in for a “malign” form of deflation similar to the 1930s “... because demand is weak and households and firms are burdened by debt. In deflation the nominal value of debts remains fixed even as nominal wages, prices and profits fall. Real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. That undermines the financial system and deepens the recession.”

“Deflation robs a central bank of its ability to stimulate spending using negative interest rates,” the editorial went on. Moreover, using interest rates to combat deflation can slow the reaction of central banks when inflation once again becomes the issue.

By deflation, The Economist correctly means “persistent price declines” rather than passing ones that reflect temporary imbalances in the market. It focuses on the growing gap between the potential for global economic production and actual output as the source of the problem.

That production gap surely stems from other causes that The Economist overlooks. It’s not just debt-burdened households in the US and Western Europe that are not consuming; it’s also cash-rich households in Asia. Deflation surely stems in part from chronic underconsumption and over-reliance on export-led growth elsewhere. At the heart of this syndrome lies mercantilist price-fixing in the form of undervalued currencies.

So, why not go to the source – one of them anyway? Work out a new Plaza Accord with China, Japan and the others with misaligned currencies. This will help them bring their currencies into line with market forces, reduce their overdependence on exports to unwilling or unable consumers abroad, and stimulate demand at home to sop up some of that unused production capacity. That at least would be a step away from a repetition of the 1930s deflation and toward effective international cooperation to put the world economy on a sustainable growth path.

Labels: deflation; recovery; Plaza Accord

On Tuesday of last week, President Obama gave a terrific speech at Georgetown University, explaining and defending his approach to the economic crisis better than at any time to date. His message for Americans was that:

“… each action we take and each policy we pursue is driven by a larger vision of America's future - a future where sustained economic growth creates good jobs andrising incomes; a future where prosperity is fueled not by excessive debt, reckless speculation, and fleeting profit, but is instead built by skilled, productive workers; by sound investments that will spread opportunity at home and allow this nation to lead the world in the technologies, innovations, and discoveries that will shape the 21st century. That is the America I see. That is the future I know we can have.”

For a short while I felt much better about the prospects for a new-style American economy. Obama’s ringing statement was at least the beginnings of the sort of national strategy I’ve been seeking for several years now. Some of what has passed for “stimulus” thus far might not serve the President’s “larger vision.” But this strong statement set forth a real test for future policy – it should promote future investment, economic growth, jobs and incomes. Bravo!

Then the following day (not coincidentally, April 15), the President set an objective for change in a major policy area that left me scratching my head. He directed his Economic Recovery Advisory Board headed by Paul Volcker to come up with recommendations for tax reform by the end of this year. In doing so, he left the impression that he sees the big problem as the “monstrous” complexity of the tax code.

The focus on tax and the sense of urgency are commendable. The code does run to over nine million words. Compliance is a nightmare for average citizens and a challenge even for smart CPAs. It’s full of special-interest gifts and replete with essentially failed social policy (think of the many provisions related to health care, savings, and retirement).

Yet you don’t have to be a cynic to be skeptical about the benefits of tax simplification, particularly as they relate to our central problem: as a country we don’t produce enough to satisfy our needs and pay down our debt to the world. Simplification of the tax code, even if it were to materialize as intended, would not by itself address this problem. Our code is not just overly complex; it rewards the wrong behavior. Alongside simplification, let’s hope that Volcker will broaden the agenda to include:

a) lack of any border-adjustable consumption tax. Such a tax – like a value added tax or a national sales tax – can be rebated when goods are exported and imposed when they are imported. Virtually every US trading country does this, and it’s allowed by international law. The unsurprising result is that we have a persistent, massive trade deficit.
b) relatively slow depreciation rates. The US forces businesses to recoup the cost of investment, particularly major ones, over relatively long periods, thereby increasing the cost of capital. The result is to steer investment away from the US to a more generous country, such as Canada.
c) high corporate income tax rates. In 1986 when the US last undertook an overhaul of the tax code, one objective was to reduce the marginal corporate tax rate to match or overmatch the rates in the OECD area. We succeeded in that, but the world did not stand still. Within a short time, the US once again had the highest marginal rates in the developed world.

Simplification is not the be all and end all of tax reform. If we’re serious about regaining international competitiveness and the long-term integrity of the dollar, we need to aim for more than mere simplification of that monstrous tax code. Let’s get a first-class tax system for now and for the future.

Labels: recovery; tax; Obama

WORKING ON THE RAILROADS

A much ballyhooed element in the Obama stimulus package is the $8 billion dedicated to inter-city rail projects. That’s an impressive sum compared to the paltry investments of the past, and it’s to be complemented by an additional one billion dollars in each of the next five years. It’s an example, say some, of the sort of transformative change that the administration is seeking to bring to this country. Thirteen billion dollars is a big enough pie, reports The Wall Street Journal on April 16, to spark a fierce competition among states from coast to coast to secure a bigger slice for themselves.

Meanwhile, across the Pacific, China has committed to build its own high-speed rail system by 2020. The Shanghai - Beijing link, the longest such line in the world, is almost complete and will cut the trip to five from eleven hours. Even relatively small provincial cities – eleven in Hebei Province alone -- will also be networked together, unleashing a vast potential for development. The cost? A cool five trillion renminbi, or almost $700 billion at current exchange rates, by 2020, most of it planned for the next few years.

Even if construction costs weren’t substantially lower in China, the vast discrepancy in ambition is glaring. My point isn’t that we ought to try to match the Chinese in the scope of our commitment to inter-city rail – though I would love to see that. The payoff of a major commitment to rail transportation is alluring. Lower green-house gas emissions. Less congestion on the highways. An end to a lot of short-haul air travel. Reduced demand for imported oil and gasoline. In short, a big step forward in the greening of America’s transportation system, which is a far greater polluter than our much maligned manufacturing sector.

Instead, what is most striking are the economic benefits that China is already seeing from its commitment to fundamental rather than incremental change in rail transportation. All across China factories are reportedly gearing up to produce steel track, locomotives, rail cars, switches, electronic equipment, and more to satisfy the half-trillion dollar market. The Chinese pie is big enough that investors are eager to produce all that’s needed to supply the burgeoning rail system.

Our incrementally bigger but still woefully inadequate investment, by contrast, is so limited that we will in all likelihood end up importing a good portion of what we eventually do install. That would deliver little of the vision the President laid out earlier this week at Georgetown University of a “future where sustained economic growth creates good jobs and rising incomes.”

In the 19th century, a few thousand Chinese workers were brought to America, to our shame sometimes by duress, to build the transcontinental railroad, using foreign capital and mostly American-made equipment. In the 21st century, more than 100,000 Chinese workers are building their own first-class rail system with their own capital and Chinese-made equipment. We should learn a lesson or two about the multiplier effects of high ambition and get to work on our railroads in earnest.

Labels: recovery; infrastructure; China; investment

Growing up in the 1950s, I learned a lot about scare tactics. In those days, some people imagined a Commie under every bed, as the phrase went. Only in retrospect did I learn
of the many careers derailed and lives ruined from Hollywood to Foggy Bottom by such irresponsible hysteria. These days, it’s not Commies but protectionists – aka fair traders, trade skeptics, populists, nationalists, etc. – who are thought to be crowded into America’s sleeping quarters.

Almost daily, we get new warnings about the dangers of “protectionism.” The WTO, the World Bank, The Economist, The New York Times, The Washington Post, a host of ivory tower academics, and other apologists for the globalization model that helped bring us to the current ruinous conditions, all denounce protectionism wherever they see it – and they seem to see it everywhere.

The common, usually unstated, assumption in this hysteria is that anything that reduces import levels constitutes protectionism and therefore, especially in these troubled times, is to be shunned. In these tirades, illegal actions are indiscriminately lumped together with legal challenges to illegal measures. But, dumping is a beggar-thy-neighbor action; antidumping is by agreement the corrective measure. Subsidies can be trade distorting and injurious; when they are, countervailing duties are by agreement the corrective measure. Violation of any WTO rules surely is protectionist; seeking a remedy under established dispute settlement procedures just as surely is not. But the press and the experts they choose to cite, including the very guardians of the institutions charged with making the trading system work, use such a broad brush that it takes all of them to lift it.

Let’s slow down and think about this for a moment. Any thing that reduces imports is a danger to the trading system? A recession? A new and better product? Investment in expanded production capacity? Increased domestic savings? Obviously not.

Everyone knows that in the 1930s, when the law of the jungle prevailed in international trade, competitive protectionism deepened the depression. The system of trade laws and contractual obligations established since 1933 have reduced the scope for such ruinous behavior. Some, but only some, recognize that competitive currency devaluations were at least as significant an element in the beggar-thy-neighbor race among nations in the ‘30s. If you are opposed to trade-distorting practices – and I am -- you would work to end mercantilist currency policies, a particularly malicious form of protectionism. Persistently undervalued currencies not only create an artificial two-way trade advantage but leave the protectionist governments with a stash of hard currencies – free money, in effect – to use however they see fit. I don’t hear much talk from the average “free trader” about this practice. Yet, unlike trade protectionism, currency protectionism is beyond the reach of current rules and institutions.

So, as we head into the G-20 summit in London this week, let’s be impeccable with our word, clear in our reasoning, and discerning in our diagnoses. Let’s stop sowing distrust, killing dialog with name-calling, and diverting attention from real issues. This international economic system no longer works very well. It can only be remade by a concerted effort of statesmen of high intellect, uncommon inventiveness and profound good will. The constant drumbeat of fear based on false assumptions and hysterical misreading of events hinders, not enhances, their work.


Charles Blum

Labels: Currency Manipulation, Free Trade, Protectionism, Trade

If you thought that monumental greed, unbridled ego, colossally poor judgment, and grossly negligent regulatory “oversight” accounted for most of the financial meltdown, you might be mistaken. At least Steve Forbes wants you to accept a much simpler explanation. “Mark-to-market accounting,” he asserts, “is the principal reason why our financial system is in a meltdown.”

I’m no CPA, but as I understand it, mark-to-market requires a financial institution to reduce the value of an asset on its books when the market value of that asset – what someone else is willing to pay for it at this moment – falls.

This is, of course, highly inconvenient and might have serious consequences for those high-flying financial institutions that threw caution to the winds in pursuit of competitive profits (and fabulous bonuses for certain personnel), even if they existed only on paper. But the solution to their problem is to allow them to invent a more flattering value based on some phony market situation sometime in the past?

Bernie Madoff made up tens of billions of dollars in phony profits and lived the high life. Ramalinga Raju made up a billion dollars in bank deposits and more than 10,000 employees and lived the high life. Both used phony numbers to make their con games work. The longer they were able to keep their scams going the greater the losses their victims had to suffer.

Now Forbes wants the SEC to enable the banks to do the same thing. Only this time it would not be part of the problem, it’s supposedly a major part of the solution. Is he kidding?

If some banks are “too big to fail,” all of them are too human not to fail in some judgments at some point. Why should the government create moral hazard by insuring their losses and, as AIG and others seem to have managed, their bonuses, too? We need less accounting gimmickry, more transparency, constant and effective oversight, and swift and certain justice – and we need all that now more than ever.

Charles Blum

Labels: Confidence, Fraud

There are a few preliminary signs that the Obama administration is preparing to take a fresh look at the trade policy that helped get us into the global mess we’re in. Thus far, nothing revolutionary has emerged, just a hopeful emphasis on enforcing our legal rights and a healthy skepticism about new agreements for agreements’ sake.

In addition, there are signs of fresh thinking being undertaken at the Office of the US Trade Representative, my old agency. This will take time, and I’d urge them to take the all the time needed to get it right.

For starters, though, it might be instructive to reexamine the rhetoric and record of Ronald Reagan. Though sometimes derided as simplistic, Reagan at his best was a principled pragmatist. Nowhere was that more in evidence than in his trade policy.

Reagan believed and publicly argued that “free trade must be fair.” In other words, free trade and fair trade were complementary, not polar opposites.

He made this clear in his radio address of August 2, 1986. (The transcript can be read at http://www.reagan.utexas.edu/archives/speeches/1986/080286a.htm.) In just a few minutes, Reagan laid out three characteristics of his trade policy that are still on point:

• Reciprocity: “Free and fair trade with free and fair traders” was his motto to get the best treatment in trade, a nation would have to give it to others. In fact, reciprocal market access was the essential feature of Cordell Hull’s reciprocal trade agreements that helped lift the world from the Great Depression and later formed a major foundation for the General Agreement on Tariffs and Trade negotiated in 1947. It’s plain wrong to consider reciprocity as a code word for protectionism. In fact, reciprocal trade undid the 1930 Smoot-Hawley tariffs and opened the way to sustained economic growth in the world.
• Respect for Rules: In another context, Reagan famously said “trust, but verify.” That’s why we must not only have trade rules but also be willing to enforce them. Reagan objected to countries that didn’t “play by the rules” and that got an “unfair advantage” by subsidizing their industries. On the other side of the coin, protectionism – transgression of the agreed rules – invited retaliation by aggrieved trading partners and was to be avoided.
• Results-Oriented: A free and fair trade policy was expected to produce fair and equitable results. A key to good results was “toughness.” Reagan said: “We’ve been tough with those nations who’ve been unfair in their trading practices, and that toughness has produced results.”

Reciprocity. Respect for Rules. Results-oriented. Sounds like the making a pretty good trade policy for the Obama administration, too.

Charles Blum

Labels: Free Trade, Trade

According to a Washington Post dispatch today from Shanghai, Chinese exports plummeted by 25 percent in February. Economists reportedly were “shocked” by the news.

Shocked? Like Captain Renault in Casablanca? No, really shocked. Two Merrill Lynch economists called the $64.9 billion export level an “ugly number” and lamented that “the export slowdown has finally come to China.”

Now, wait a minute! One of my intellectual heroes, Herb Stein, said famously that “if a thing cannot go on forever, it will stop.” A mercantilist trade boom predicated on artificially cheap export prices and the recycling of dollars into consumer debt for buyers of the same goods cannot go on forever. It is stopping now. Not a shock. Not even a surprise. A certainty.

Even the New York Times editorial page got it partly right today I opining that China’s leaders “need to understand that export-led growth no longer works for them or the world.” Of course, the Times went on to urge the Obama administration to back off on China’s undervalued currency, one of the pistons driving the country’s export machine.

The China-based economists don’t see everything as lost, however. They credit Beijing for vigorous – one expert calls them ”drastic” -- measures to help the domestic economy. Aside from a 5 percent tax break on small autos, however, much of the stimulus is aimed at more investment rather than more domestic consumption. More investment in production facilities will only add to the burden of overcapacity, deflating prices and creating surpluses that will seek a market outside of China. If that’s what easy credit results in, China’s “drastic” measures might just be making a bad situation worse.

Live by the sword, die by the sword. The current global economic model is broken. Export-led growth won’t work for large economies. As the Times correctly said, neither China nor the world benefits. At least from this time forward, there is absolutely no basis for anyone, not even professional economists and editorial writers, to be “shocked” by perfectly predictable developments.

Charles Blum

Labels: China, World Economy

In his February 1 column in the New York Times, Tom Friedman laments that thus far the government response to the economic crisis is akin to pouring water into a hole, waiting for the sound of it splashing against the bottom, but hearing nothing. I have another image that’s been in my head since as a young boy I saw a Tarzan movie my family’s first TV set – quicksand.

When caught in quicksand, I recall hearing Tarzan urge, you must master your instincts, as struggling only draws you in deeper until you are submerged. Be calm, make a plan, and get the help you need. By all means, stop flailing about.

That seems good advice for the Senate as it considers its stimulus package this week and for the conference committee that will take up the matter soon afterwards. The instinct to do as much as possible may not prove helpful. I cringe when I hear the argument that the biggest danger is doing too little, not too much. Doing too much of costly programs with a dubious stimulative effect and stretching expenditures out over eleven fiscal years simply set up the need for additional, probably quite substantial, new spending measures to help do what this bill is supposed to. The Congressional Budget Office estimates that only $107 billion of the $819 billion approved by the House would actually reach the economy in the fiscal year ending on September 30, 2009. Only $236 billion more would be spent in FY 2010. More than a third of the total would not become available until after October 2010, some of it not until 2019. If the CBO analysis is even remotely correct, we’ll end up sinking deeper into, and being buried beneath, the quicksand of debt as we pile one new stimulus upon another.

A second problem with the stimulus package in its current form is that it aims to do increase in the short run precisely the behavior that we need to cut back on in the longer run. Today, we want to stimulate consumer spending; tomorrow, we want to reduce our over-reliance on consumption as the major engine for GDP growth. Today, we need to borrow from foreign creditors; tomorrow, we have to stop that and start paying our own way again. These and other contradictions between immediate and longer run objectives were neatly summarized last week by Marina Whitman in an op ed piece in the Wall Street Journal.

Those two considerations suggest first that we need to get more public investment into the stimulus package now. In addition to the “shovel ready” highway and transportation projects – a paltry $46 billion of the $819 billion House bill – why not get started on a radical expansion of urban mass transit and high speed inter-city rail links to unclog our streets and air lanes and thereby reduce our fuel consumption and green house gas emissions?

Second, the stimulus ought to provide powerful incentives to private investment, too. It’s clear to all that government spending will not be enough to fund anything like a full recovery of our battered economy. Why not get started right now on a new investment boom by expensing new investment, at least in energy production and transportation, and giving a bonus to those who invest in the next year or two? Why not charter a national infrastructure bank and fund it privately, limiting the government expenditure to a guaranteed annual return? Why not set up a national energy development bank and fund it the same way? Such steps would leverage public expenditures, maximize the role for private capital (foreign as well as domestic), and stimulate real demand for materials, components, finished capital goods, services from engineering to transportation, and labor.

No one expects the Congress to devise a perfect a plan under duress. Time is of the essence. But a little more thought right now might give us a viable exit plan from the fiscal quicksand in which we’re trapped, setting the stage not just for a cyclical recovery but also for a genuine restructuring of the American economy. The whole world is watching and praying that we get it right.

Charles Blum

Labels: recovery; US economy; investment

Many people think the news media are biased. In some cases, I’m sure that’s so. Far more widespread is the problem of unexamined assumptions and beliefs, a mindset maintained over time in the face of obvious changes in circumstances. It’s not so much a question of misreporting as of misunderstanding the reality about which the report is made.

Take the recent reporting on the decline in international trade over the past year. A number of stories have presented this as an alarming development and frequently included a gratuitous warning about “growing protectionism.” The Wall Street Journal, for example, ran a story under the headline “Global Trade Posts Sharp Decline.” Comparing different periods in each case, the article reported declines in imports and exports of 27 percent for Japan, 18 percent for the US, and 11.9 percent even for China. The reporter asserted that a decline in trade was an “unusual development even in a recession.”

For starters, that’s a dubious assertion. When as normally happens in a recession a society consumes less, it needs fewer goods -- whether produced at home or abroad. As recessions are corrections for periods of excess consumption, such a decline is not necessarily a bad thing. Painful, yes, for employers and employees. Uncomfortable, yes, for elected officials. But reduced demand can be a normal part of a healthy process of adjustment.

Next, consider what constitutes a “sharp” drop. Compared to the swift and brutal collapse of steel, aluminum and auto production worldwide – just to cite a few industries -- what’s so extraordinary about a 12, 18 or 27 percent drop in overall trade?

Moreover, those numbers obscure some good news. One reason why trade measured in dollars has fallen is that petroleum prices have plummeted from their heights. Remember $140 going on $300 per barrel prices? Does the Journal really want us to consider that an alarming development? Personally, I’m thankful with every tank full of gasoline.

But the basic problem runs deeper. The unstated assumption of the self-proclaimed “pro-trade” camp is that trade, any trade, is per se a good thing and that more trade is always better than less. Cheerleaders for the current globalization model have for years taken pride in the fact that the growth in international trade has outpaced global GDP growth for several decades. Trade must lead growth, you see? Without faster trade growth, the global economic pie couldn’t possibly grow fast enough to satisfy rising expectations, right?

What’s wrong with this view? Two points bear emphasizing:

A major function of international trade is to smooth out imbalances in national economies. When a country needs more than it can produce in a given period, it imports. When it produces a surplus, it naturally tries to sell the excess goods into world markets. Thus, it’s perfectly normal, acceptable and even welcome when trade helps to smooth out excesses and deficiencies in national economic performance.
To succeed, export led growth depends on growing consumer markets abroad. When Sweden or Singapore follows that path, the world market can easily absorb their net exports. When a giant economy such as China pursues this path, however, the strategy will encounter natural limits. As the US case shows, chronic massive trade deficits – the other side of the same coin – are unsustainable. When that point is reached, massive export-led growth becomes unsustainable, too. And when export-led growth strategies come acropper, it’s a correction, not a tragedy.

So, let’s acknowledge the recent drop in international trade for what it is. First, a sign of the fundamental ill health of the world economy, both in the real and financial sectors. Second, the beginning of a long-overdue adjustment to excessive reliance on export-led growth, especially by larger Asian economies. Third, a warning that surplus as well as deficit countries need to get their macroeconomic policies right if either is to prosper over the long run.

Open trade on fair terms is a good thing. It spurs competition and efficiency, expands consumer choice, and keeps prices moderate. It can help poorer countries grow and develop. But, as we commented recently on China’s massive stash of foreign exchange, it’s always possible to have “too much of a good thing.” All those who write, read and think about international trade should take care, especially in these perilous times, to understand the fundamental realities of the present trading system and leave the ghost of 1929 on the scrapheap of history.

Charles Blum

Labels: Trade, World Economy