Wednesday, January 14, 2009
TOO MUCH OF A GOOD THING
In a remarkably off-kilter story in the January 14 Wall Street Journal (“China’s Capital Outflow Forces Country’s Officials to Try to Rebuild Confidence in Yuan”), Andrew Batson reports sympathetically on Chinese officials’ professed concerns over recent capital outflows and their consideration of a depreciation of its undervalued currency. The article is notable in several ways.
First, it lacks any sense of proportion. After noting that China’s official foreign exchange reserves fell by $25.9 billion in the month of October – a large drop to be sure – Batson writes that they recovered by “only” $5.02 billion in November and $61.31 billion in December. If a $25.9 billion decrease is a large number, then how should an increase of more than double that amount be characterized? Whatever the proper term, the December explosion in reserves was enough to bring the net increase for the quarter to a robust $40.45 billion.
China is hardly running short of reserves. In fact, China’s reserves – by far the largest in world history -- are more than ample to cover its import financing requirements and its modest external debt. China’s reserves are not inadequate, but grossly excessive.
Second, Batson himself notes the notorious opacity of official Chinese data. He might have taken a moment to explain that, even if they are entirely accurate, Beijing’s data on official reserves exclude its sovereign wealth fund (the $200 billion China Investment Corporation), China’s social security investment fund, and dollar holdings by Chinese commercial banks. The total size and composition of these holdings are unknown but probably amount to several hundreds of billions of dollars and other hard currencies.
Third and most important, Batson has apparently accepted the proposition that China needs and is entitled to a perpetual increase in its official reserves perpetually. Anyone with a serious interest in the health of the international monetary and financial system should study the language of International Monetary Fund Article IV. Citing as one objective the “continuing development of the underlying conditions that are necessary for financial and economic stability, ” Art. IV sets forth several obligations of all IMF members. China, of course, is a member, one that wants a bigger say in the governance of the world economy.
Specifically, Art. IV obligates members to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members ….” China has ignored this obligation for years, despite advice to the contrary from the IMF, sometimes strident demands from the US Treasury, and entreaties from other trading partners, developing as well as developed.
The treasury secretary-designate, Timothy Geithner, warned in a speech in June 2007 that the buildup of official reserves in Asia might have gone too far. Asian mercantilism (my word) was resulting in “too much of a good thing” when it came to export-led growth and the amassing of hard-currency reserves. Note that when Geithner made this statement, China’s official reserves were “only” 1.2 trillion dollars. Since that summer, they have exploded by an additional $700 billion.
Why then is the Wall Street Journal continuing to make excuses for illegal behavior by China and other mercantilists? Why does the Journal turn a blind eye to one of the root causes of the global financial instability that now threatens the livelihood and retirement funding of millions of Americans and others around the globe?
Charles Blum
First, it lacks any sense of proportion. After noting that China’s official foreign exchange reserves fell by $25.9 billion in the month of October – a large drop to be sure – Batson writes that they recovered by “only” $5.02 billion in November and $61.31 billion in December. If a $25.9 billion decrease is a large number, then how should an increase of more than double that amount be characterized? Whatever the proper term, the December explosion in reserves was enough to bring the net increase for the quarter to a robust $40.45 billion.
China is hardly running short of reserves. In fact, China’s reserves – by far the largest in world history -- are more than ample to cover its import financing requirements and its modest external debt. China’s reserves are not inadequate, but grossly excessive.
Second, Batson himself notes the notorious opacity of official Chinese data. He might have taken a moment to explain that, even if they are entirely accurate, Beijing’s data on official reserves exclude its sovereign wealth fund (the $200 billion China Investment Corporation), China’s social security investment fund, and dollar holdings by Chinese commercial banks. The total size and composition of these holdings are unknown but probably amount to several hundreds of billions of dollars and other hard currencies.
Third and most important, Batson has apparently accepted the proposition that China needs and is entitled to a perpetual increase in its official reserves perpetually. Anyone with a serious interest in the health of the international monetary and financial system should study the language of International Monetary Fund Article IV. Citing as one objective the “continuing development of the underlying conditions that are necessary for financial and economic stability, ” Art. IV sets forth several obligations of all IMF members. China, of course, is a member, one that wants a bigger say in the governance of the world economy.
Specifically, Art. IV obligates members to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members ….” China has ignored this obligation for years, despite advice to the contrary from the IMF, sometimes strident demands from the US Treasury, and entreaties from other trading partners, developing as well as developed.
The treasury secretary-designate, Timothy Geithner, warned in a speech in June 2007 that the buildup of official reserves in Asia might have gone too far. Asian mercantilism (my word) was resulting in “too much of a good thing” when it came to export-led growth and the amassing of hard-currency reserves. Note that when Geithner made this statement, China’s official reserves were “only” 1.2 trillion dollars. Since that summer, they have exploded by an additional $700 billion.
Why then is the Wall Street Journal continuing to make excuses for illegal behavior by China and other mercantilists? Why does the Journal turn a blind eye to one of the root causes of the global financial instability that now threatens the livelihood and retirement funding of millions of Americans and others around the globe?
Charles Blum
Labels: China, Currency, Currency Manipulation, mercantilism
Thursday, November 13, 2008
APPRECIATING THE RENMINBI
Sometimes a development signifies more than meets the eye and sometimes, less. China took an important step in July 2005 to free up its currency, variously called the yuan or the renminbi (RMB), from its longtime peg to the US dollar. Since then, the RMB has strengthened by a nominal 17 percent. That is, Chinese buyers need to pay fewer RMB for each dollar of imports, and Chinese exporters receive fewer RMB for each dollar of exports.
One would think that such a change would produce substantial effects in the real world. In theory, at least, currency appreciation is expected to reduce trade and current account surpluses and to slow growth in the domestic economy. That’s why overheated economies often seek to strengthen their currencies.
In the case of China, these results have been extraordinarily slow in materializing. In fact, as summarized in the table below, China’s appreciating currency has actually led over the past 39 months to substantially larger imbalances in its bilateral trade with the United States, its overall trade with all trading partners, its current account surplus, and – most shockingly – in the build up of official reserves, which have grown by 168 percent as the RMB was strengthening.
Now by far the largest in the world, China’s reserve position is a matter of concern for the rest of the world. China’s hard currency glut is a destabilizing factor in the shaky world economy. As we discussed in the previous post (“The Mercantilist Menace vs. The Protectionist Peril,” November 11), China’s recently announced stimulus package will not reduce these imbalances unless and until there is a much greater appreciation of the RMB.
Unfortunately, appreciation of the RMB stalled out around the end of July, freezing its value at around 6.85 to the dollar. Since then, foreign money has continued to pour into China by means of its trade surplus (more than $35 billion in October), foreign investment and speculative “hot money.” While the growth in official reserves has tapered off, China is stashing dollars in places not captured by that statistic: the China Investment Corporation (China’s sovereign wealth fund), the Social Security Investment Fund, and commercial banks that are still largely under government control.
When China tries to take credit for its ”stable” currency policy at this weekend’s G-20 meeting, it would be on point if someone would remind China of its obligations under the IMF Articles of Agreement. Article 4 binds China and every other IMF member to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” To maintain an exchange rate that does not reflect market values is to be part of the problem, not the solution.
China may object, but the reality behind these numbers seems to be precisely what meets the eye: Its “stable” currency policy has destabilizing effects for the rest of the world and needs to be abandoned if we are to work our way out of the global financial mess.
Charles Blum
One would think that such a change would produce substantial effects in the real world. In theory, at least, currency appreciation is expected to reduce trade and current account surpluses and to slow growth in the domestic economy. That’s why overheated economies often seek to strengthen their currencies.
In the case of China, these results have been extraordinarily slow in materializing. In fact, as summarized in the table below, China’s appreciating currency has actually led over the past 39 months to substantially larger imbalances in its bilateral trade with the United States, its overall trade with all trading partners, its current account surplus, and – most shockingly – in the build up of official reserves, which have grown by 168 percent as the RMB was strengthening.
Now by far the largest in the world, China’s reserve position is a matter of concern for the rest of the world. China’s hard currency glut is a destabilizing factor in the shaky world economy. As we discussed in the previous post (“The Mercantilist Menace vs. The Protectionist Peril,” November 11), China’s recently announced stimulus package will not reduce these imbalances unless and until there is a much greater appreciation of the RMB.
Unfortunately, appreciation of the RMB stalled out around the end of July, freezing its value at around 6.85 to the dollar. Since then, foreign money has continued to pour into China by means of its trade surplus (more than $35 billion in October), foreign investment and speculative “hot money.” While the growth in official reserves has tapered off, China is stashing dollars in places not captured by that statistic: the China Investment Corporation (China’s sovereign wealth fund), the Social Security Investment Fund, and commercial banks that are still largely under government control.
When China tries to take credit for its ”stable” currency policy at this weekend’s G-20 meeting, it would be on point if someone would remind China of its obligations under the IMF Articles of Agreement. Article 4 binds China and every other IMF member to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” To maintain an exchange rate that does not reflect market values is to be part of the problem, not the solution.
China may object, but the reality behind these numbers seems to be precisely what meets the eye: Its “stable” currency policy has destabilizing effects for the rest of the world and needs to be abandoned if we are to work our way out of the global financial mess.
Charles Blum
Effects of Appreciation of Chinese RMB:
Selected Indicators
Selected Indicators
Labels: China, Currency, Trade
Wednesday, October 29, 2008
REAL MONEY
The venerable New York Times editorial page mangled a basic fact a couple of days ago (“As China Goes, So Goes …,” October 27). I take the time for this nit-picking not just because some of us expect the American newspaper of record Times to get everything right, but because the correction may be illuminating.
Here’s what the Times said: As the rest of the world “tips into recession,” China should give up its “old export strategy” and reorient its economy in the direction of satisfying domestic demand. The Times argued that “by raising Chinese imports and reducing its dependence on exports, it would also help the rest of the world” while reducing its own “overwhelming” vulnerability to changes in world markets. The key is to “unlock the savings of its citizens and encourage them to spend.” To facilitate that, China should step up public works, reduce taxes on housing and rebuild the tattered social safety net. Doing so wouldn’t be that difficult, The Times suggested, because Beijing is “running a huge budget surplus.”
The advice to the Chinese is basically sound and certainly welcome. The basic problem I see with it is that China’s new-found budget surpluses are not “huge.” After years of running budget deficits, China has in the past two years run modest surpluses on the order of one percent of its GDP – about $23 billion of black ink at current exchange rates. Compared to America’ s going-on-one-trillion dollar deficit, that might sound like the promised land. But a social safety net for 1.3 billion people cannot be stitched together for such paltry sums.
What is huge – and I suspect what the Times meant to say – are China’s official foreign exchange reserves. China admits to having over $1.9 trillion, the largest in the world and far in excess of what it or any other country would need. As impressive as that figure sounds, it’s just the beginning of the story. When you include China’s sovereign wealth fund, its social security investment fund, and unknown quantities squirreled away in China’s state-owned commercial banks, the available hard currency surely approaches 2.5 trillion dollars. A trillion here, a trillion there, and pretty soon you’re talking about real money, as Everett Dirksen might say. China could use a portion of these vast sums to build safe schools, rebuild its health care system, accelerate urbanization, clean up its polluted water supply, put scrubbers on every coal-fired power plant – and more.
But it’s not just the size of the funds that matters. Consider the differential economic impact of budget and current account surpluses. A budget surplus is based on tax revenues in excess of expenditures; the government taking out of the economy more than it puts back in. A current account surplus comes from surpluses in trade, foreign investment and other international payments; more local currency goes into the economy than goes out. While a budget surplus is deflationary and helps to cool an overheated economy, the current account surplus is inflationary and helps ensure an excessive reliance on exports and too little domestic consumption – the very problems The Times correctly wants China to solve.
Better advice to China would start with a substantial revaluation of its currency. That would move China’s import and export prices more in line with their real value and allow market forces, as imperfect as they are in China, to reshape its economy in ways that have thus far eluded Beijing’s bureaucrats.
Charles Blum
Here’s what the Times said: As the rest of the world “tips into recession,” China should give up its “old export strategy” and reorient its economy in the direction of satisfying domestic demand. The Times argued that “by raising Chinese imports and reducing its dependence on exports, it would also help the rest of the world” while reducing its own “overwhelming” vulnerability to changes in world markets. The key is to “unlock the savings of its citizens and encourage them to spend.” To facilitate that, China should step up public works, reduce taxes on housing and rebuild the tattered social safety net. Doing so wouldn’t be that difficult, The Times suggested, because Beijing is “running a huge budget surplus.”
The advice to the Chinese is basically sound and certainly welcome. The basic problem I see with it is that China’s new-found budget surpluses are not “huge.” After years of running budget deficits, China has in the past two years run modest surpluses on the order of one percent of its GDP – about $23 billion of black ink at current exchange rates. Compared to America’ s going-on-one-trillion dollar deficit, that might sound like the promised land. But a social safety net for 1.3 billion people cannot be stitched together for such paltry sums.
What is huge – and I suspect what the Times meant to say – are China’s official foreign exchange reserves. China admits to having over $1.9 trillion, the largest in the world and far in excess of what it or any other country would need. As impressive as that figure sounds, it’s just the beginning of the story. When you include China’s sovereign wealth fund, its social security investment fund, and unknown quantities squirreled away in China’s state-owned commercial banks, the available hard currency surely approaches 2.5 trillion dollars. A trillion here, a trillion there, and pretty soon you’re talking about real money, as Everett Dirksen might say. China could use a portion of these vast sums to build safe schools, rebuild its health care system, accelerate urbanization, clean up its polluted water supply, put scrubbers on every coal-fired power plant – and more.
But it’s not just the size of the funds that matters. Consider the differential economic impact of budget and current account surpluses. A budget surplus is based on tax revenues in excess of expenditures; the government taking out of the economy more than it puts back in. A current account surplus comes from surpluses in trade, foreign investment and other international payments; more local currency goes into the economy than goes out. While a budget surplus is deflationary and helps to cool an overheated economy, the current account surplus is inflationary and helps ensure an excessive reliance on exports and too little domestic consumption – the very problems The Times correctly wants China to solve.
Better advice to China would start with a substantial revaluation of its currency. That would move China’s import and export prices more in line with their real value and allow market forces, as imperfect as they are in China, to reshape its economy in ways that have thus far eluded Beijing’s bureaucrats.
Charles Blum
Labels: China, Currency, Recession
Saturday, October 25, 2008
TOY STORIES
The press reported earlier this week that more than half the toy exporters in China -– 3,621 in all -- had gone out of business this year. Last week, hundreds of angry workers protested for three days outside one closed factory in Dongguan in Guangdong Province, the heartland of China’s consumer products industries. Some of them blamed economic conditions in the U.S. for the loss of their jobs. A report by China’s General Administration of Customs issued October 13 also blamed the US credit crisis for what the Chinese see as a slump in their toy industry, still the world’s largest. Certainly, the global financial meltdown and the rapidly deteriorating American economy will bring grief to many Chinese workers in many industries, along with millions in this country. It would be a mistake, however, to leap too far in tying the closure of toy factories in China to sinking US economy.
In fact, the available evidence points to other causes. Most importantly:
• The timing is off. The credit crisis and stock market meltdown erupted in September, too late to affect orders, production and exports in the long toy trade pipeline for this Christmas retail season.
• After a series of product recalls last year, the Chinese government revoked the licenses of 600 exporters at the beginning of 2008. One-sixth of this year’s attrition thus was the result of Chinese government action nine months ago.
• The cost of plastics has risen strongly this year, largely driven by the dizzying spiral in petroleum costs over the first nine months of the year. China’s weak currency compounds the problem by forcing importers to pay extra renminbi for each extra dollar in the world price.
• China’s toy production has actually increased this year. Read the press items carefully: they report that the rate of increase in export sales has fallen (to “only” 1.3 percent over the first eight months of 2008), not the actual sales. Far fewer factories are in fact producing more toys. Overwhelmingly, the closures involve smaller, less efficient, less well run companies that lacked adequate capitalization and could not meet customer or environmental standards. Their disappearance is a sign of progress, not distress.
• The China Customs report speaks of “protectionism,” as a problem. Wait just a minute! Where in the world do Chinese toy exports face increased tariffs or quotas? To refer to product recalls as “protectionism” is unfounded, illogical and destructive of China’s image as a supplier to the world market.
• US imports of Chinese toys did in fact decrease by 5 percent over the first seven months, reflecting shifts in consumer demand (traditional toys like Barbie are declining in popularity) and perhaps some concerns about the quality and safety of Chinese-made toys but not the credit crisis. Moreover, China’s loss of sales to America has been more than offset by increased Chinese shipments to Europe.
• The biggest American toy “makers” – actually marketing companies, first and foremost – have enjoyed a terrific year thus far, despite the looming retail slump. Mattel and Hasbro, which together account for more than 13 percent of the world’s annual sales of toys – are enjoying stronger sales through the first nine months. About half those sales are international. A global recession may leave them with no good market for a while, of course, but thus far they have repositioned themselves quite effectively.
So, let’s not shed too many tears for the 3,500 surviving members of China’s toy industry. In a future post, I’ll address the larger issue of the slowdown of China’s growth. Please keep the instructive story of the toy industry in mind when you read that.
Charles Blum
In fact, the available evidence points to other causes. Most importantly:
• The timing is off. The credit crisis and stock market meltdown erupted in September, too late to affect orders, production and exports in the long toy trade pipeline for this Christmas retail season.
• After a series of product recalls last year, the Chinese government revoked the licenses of 600 exporters at the beginning of 2008. One-sixth of this year’s attrition thus was the result of Chinese government action nine months ago.
• The cost of plastics has risen strongly this year, largely driven by the dizzying spiral in petroleum costs over the first nine months of the year. China’s weak currency compounds the problem by forcing importers to pay extra renminbi for each extra dollar in the world price.
• China’s toy production has actually increased this year. Read the press items carefully: they report that the rate of increase in export sales has fallen (to “only” 1.3 percent over the first eight months of 2008), not the actual sales. Far fewer factories are in fact producing more toys. Overwhelmingly, the closures involve smaller, less efficient, less well run companies that lacked adequate capitalization and could not meet customer or environmental standards. Their disappearance is a sign of progress, not distress.
• The China Customs report speaks of “protectionism,” as a problem. Wait just a minute! Where in the world do Chinese toy exports face increased tariffs or quotas? To refer to product recalls as “protectionism” is unfounded, illogical and destructive of China’s image as a supplier to the world market.
• US imports of Chinese toys did in fact decrease by 5 percent over the first seven months, reflecting shifts in consumer demand (traditional toys like Barbie are declining in popularity) and perhaps some concerns about the quality and safety of Chinese-made toys but not the credit crisis. Moreover, China’s loss of sales to America has been more than offset by increased Chinese shipments to Europe.
• The biggest American toy “makers” – actually marketing companies, first and foremost – have enjoyed a terrific year thus far, despite the looming retail slump. Mattel and Hasbro, which together account for more than 13 percent of the world’s annual sales of toys – are enjoying stronger sales through the first nine months. About half those sales are international. A global recession may leave them with no good market for a while, of course, but thus far they have repositioned themselves quite effectively.
So, let’s not shed too many tears for the 3,500 surviving members of China’s toy industry. In a future post, I’ll address the larger issue of the slowdown of China’s growth. Please keep the instructive story of the toy industry in mind when you read that.
Charles Blum
Labels: China, Currency, product safety
Monday, September 22, 2008
STOPPING THE MERCANTILIST MADNESS
On September 22, the Wall Street Journal editorial page started apportioning blame for the still unfolding bloodbath on Wall Street. It connected some of the dots that we did on our previous posting ("From Mercantilism to the Meltdown," September 21).
In particular, the Journal lashed out at the Federal Reserve. After questioning the validity of the "savings glut" theory of the US trade deficit, the editorial commented: "The savings glut was in large part a creation of the Fed, which flooded the world with too many dollars that often found their way into housing markets in the U.S., the U.K. and elsewhere."
Fair enough. There's no question that the world is awash in dollars. But the Fed didn't decide who would get how many of the excess dollars. That decision was left to oil exporters who fix the price of petroleum and the mercantilists who fix the price of their currencies. In effect, the US policy of malign neglect allowed the modern mercantilists to decide how much to take.
But enough of the blame game. What can be done to stop the mercantilist madness before it consumes us? Here's a simple four-part strategy, the first three steps being matters of urgency:
First, enact legislation to make prolonged currency misalignment actionable under U.S. trade laws. Bipartisan bills have been languishing in each house: H.R. 2942 introduced by Reps. Tim Ryan and Duncan Hunter and S. 796, introduced by Senators Bunning, Stabenow and Bayh. Merge them, pass them and challenge the mercantilists to cease and desist.
Second, armed with the leverage of potential trade law remedies, the Treasury should screw up its courage and, for the first time since 1994, name a country for currency manipulation. In fact, it should name them all -- China, Japan, Korea, Taiwan, Malaysia, Singapore and any others who are piling up massive foreign currency reserves through undervaluation of their currencies.
Third, convene a meeting of all those countries in an undisclosed location and don't come out until a series of coordinated currency corrections has been agreed. This will help restore sanity and confidence to the world financial system and give harried policymakers in the U.S. and elsewhere time to develop thoughtful, workable responses to the meltdown.
Fourth, the next administration should begin planning now to ensure that the global monetary system gets a long overdue and thorough overhaul. The IMF needs to be given the tools it needs to maintain discipline among its members. Moral suasion obviously is no match for mercantilism. For the sake of all its members, the IMF needs to be equipped to play a meaningful role in curbing exchange rate abuses and the excessive expansion of credit by any of its members, regardless of their size. In addition, we need to face up to the fact that neither the United States nor any other single country can afford to run trade surpluses indefinitely. The world needs another, more sustainable source of liquidity to complement the role played for so long by the American dollar. It's not by any means premature to start laying the groundwork for a new reserve currency -- perhaps the long neglected SDRs (special drawing rights) that almost 40 years ago were touted for that role and still exist in limited amounts.
Also 40 years ago, Robert Kennedy would conclude his campaign stump speech with this thought: "Some see things as they are and ask, why? I dream of things that never were and ask, why not?" Given the mess of things as they are, isn't it time for us all to ask, why not?
Charles Blum
In particular, the Journal lashed out at the Federal Reserve. After questioning the validity of the "savings glut" theory of the US trade deficit, the editorial commented: "The savings glut was in large part a creation of the Fed, which flooded the world with too many dollars that often found their way into housing markets in the U.S., the U.K. and elsewhere."
Fair enough. There's no question that the world is awash in dollars. But the Fed didn't decide who would get how many of the excess dollars. That decision was left to oil exporters who fix the price of petroleum and the mercantilists who fix the price of their currencies. In effect, the US policy of malign neglect allowed the modern mercantilists to decide how much to take.
But enough of the blame game. What can be done to stop the mercantilist madness before it consumes us? Here's a simple four-part strategy, the first three steps being matters of urgency:
First, enact legislation to make prolonged currency misalignment actionable under U.S. trade laws. Bipartisan bills have been languishing in each house: H.R. 2942 introduced by Reps. Tim Ryan and Duncan Hunter and S. 796, introduced by Senators Bunning, Stabenow and Bayh. Merge them, pass them and challenge the mercantilists to cease and desist.
Second, armed with the leverage of potential trade law remedies, the Treasury should screw up its courage and, for the first time since 1994, name a country for currency manipulation. In fact, it should name them all -- China, Japan, Korea, Taiwan, Malaysia, Singapore and any others who are piling up massive foreign currency reserves through undervaluation of their currencies.
Third, convene a meeting of all those countries in an undisclosed location and don't come out until a series of coordinated currency corrections has been agreed. This will help restore sanity and confidence to the world financial system and give harried policymakers in the U.S. and elsewhere time to develop thoughtful, workable responses to the meltdown.
Fourth, the next administration should begin planning now to ensure that the global monetary system gets a long overdue and thorough overhaul. The IMF needs to be given the tools it needs to maintain discipline among its members. Moral suasion obviously is no match for mercantilism. For the sake of all its members, the IMF needs to be equipped to play a meaningful role in curbing exchange rate abuses and the excessive expansion of credit by any of its members, regardless of their size. In addition, we need to face up to the fact that neither the United States nor any other single country can afford to run trade surpluses indefinitely. The world needs another, more sustainable source of liquidity to complement the role played for so long by the American dollar. It's not by any means premature to start laying the groundwork for a new reserve currency -- perhaps the long neglected SDRs (special drawing rights) that almost 40 years ago were touted for that role and still exist in limited amounts.
Also 40 years ago, Robert Kennedy would conclude his campaign stump speech with this thought: "Some see things as they are and ask, why? I dream of things that never were and ask, why not?" Given the mess of things as they are, isn't it time for us all to ask, why not?
Charles Blum
Labels: Currency, mercantilism
Sunday, September 21, 2008
FROM MERCANTILISM TO MELTDOWN
Engineers calculate that, for a major accident such as an airplane crash to occur, something like 20 things all have to go wrong. The on-going financial meltdown certainly has multiple causes, too. Greed, bad judgment, mismanagement, lack of effective government oversight, and more certainly were involved. But let’s not overlook the subject of my previous posting (“The Arch Enemy of Free Trade,” September 16): good old-fashioned mercantilism.
For many people, that phrase just doesn’t roll off the tongue, and the connection may not be readily apparent. So, here’s a simple step-by-step connection between mercantilist policies and the currency financial meltdown:
1. Mercantilist countries such as Japan and China use a variety of means to ensure that their currencies are traded at exchange rates well below their true market value.
2. The undervalued (read “cheap”) currency serves as a subsidy to all exports from that country: the exporter gets a bonus of extra home market currency for every international sale. At the same time, an undervalued currency imposes a hidden tariff or tax on all imports: the importer must ante up extra amounts of home market currency to pay for goods from abroad. The result is a chronic trade surplus based on artificial advantages maintained by the mercantilist government. In cash terms, the trade surplus results in an equivalent transfer of funds from trading partners to the mercantilist government.
3. At the same time, cheap currencies induce extra investment. Why? The foreign investor gets more local currency for each dollar or euro. That bonus attracts investment that otherwise would be made somewhere else. So, investment flows are just as distorted as trade flows.
4. The trade surplus and the investment surplus are the main elements in the mercantilist’s current account surplus. Year after year, the cumulative surplus grows. Today, China alone probably has close to 2.5 trillion dollars; Japan, more than one trillion dollars.
5. The problem for the “winners” in this lop-sided current account relationship is to find profitable uses for the money. This has become such a burden that some Chinese openly speak of “unwanted dollars.” They restlessly search the globe for higher returns for their hard currency reserves than mere cash (zero return) or US Treasuries (low risk, low return).
6, That helps explain why Chinese and other foreign investors were easy marks for the Wall Street wizards who churned out new ways to “guarantee” higher and higher returns. Fannie Maes, Freddie Macs, syndicated mortgages – debt was piled upon debt in an elaborate Ponzi scheme that also sucked in pension funds, commercial banks and the proverbial little old ladies like my own mother.
7. In effect, mercantilists, oil exporters and Wall Street wizards got in bed with one another and produced … a huge bubble.
The dots are hereby connected. Mercantilism is not the sole cause of the current crisis, of course, but it one that policymakers around the world have chosen to ignore. Left unchecked, modern mercantilist rigs the game, subverting fair competitive, distorting free markets, and flooding financial markets with funds in search of higher returns.
If monetary authorities in so many countries can cooperate as closely as they have this month to try to stem the tide of imminent financial collapse, why can’t they start cooperating to prevent more, possibly greater, damage from occurring in the future? How to get there will be the subject of my next posting.
Charles Blum
For many people, that phrase just doesn’t roll off the tongue, and the connection may not be readily apparent. So, here’s a simple step-by-step connection between mercantilist policies and the currency financial meltdown:
1. Mercantilist countries such as Japan and China use a variety of means to ensure that their currencies are traded at exchange rates well below their true market value.
2. The undervalued (read “cheap”) currency serves as a subsidy to all exports from that country: the exporter gets a bonus of extra home market currency for every international sale. At the same time, an undervalued currency imposes a hidden tariff or tax on all imports: the importer must ante up extra amounts of home market currency to pay for goods from abroad. The result is a chronic trade surplus based on artificial advantages maintained by the mercantilist government. In cash terms, the trade surplus results in an equivalent transfer of funds from trading partners to the mercantilist government.
3. At the same time, cheap currencies induce extra investment. Why? The foreign investor gets more local currency for each dollar or euro. That bonus attracts investment that otherwise would be made somewhere else. So, investment flows are just as distorted as trade flows.
4. The trade surplus and the investment surplus are the main elements in the mercantilist’s current account surplus. Year after year, the cumulative surplus grows. Today, China alone probably has close to 2.5 trillion dollars; Japan, more than one trillion dollars.
5. The problem for the “winners” in this lop-sided current account relationship is to find profitable uses for the money. This has become such a burden that some Chinese openly speak of “unwanted dollars.” They restlessly search the globe for higher returns for their hard currency reserves than mere cash (zero return) or US Treasuries (low risk, low return).
6, That helps explain why Chinese and other foreign investors were easy marks for the Wall Street wizards who churned out new ways to “guarantee” higher and higher returns. Fannie Maes, Freddie Macs, syndicated mortgages – debt was piled upon debt in an elaborate Ponzi scheme that also sucked in pension funds, commercial banks and the proverbial little old ladies like my own mother.
7. In effect, mercantilists, oil exporters and Wall Street wizards got in bed with one another and produced … a huge bubble.
The dots are hereby connected. Mercantilism is not the sole cause of the current crisis, of course, but it one that policymakers around the world have chosen to ignore. Left unchecked, modern mercantilist rigs the game, subverting fair competitive, distorting free markets, and flooding financial markets with funds in search of higher returns.
If monetary authorities in so many countries can cooperate as closely as they have this month to try to stem the tide of imminent financial collapse, why can’t they start cooperating to prevent more, possibly greater, damage from occurring in the future? How to get there will be the subject of my next posting.
Charles Blum
Labels: Currency, mercantilism, Wall Street
Thursday, June 12, 2008
CURRENCY SWAP
Knee-jerk critics of the WTO might have overlooked an intriguing exchange that took place in Geneva on June 11. If I understand it correctly, the China flipped and the US flopped.
The exchange arose in the course of the annual trade policy review of the United States conducted this week. China challenged the US to explain the “causal link between dollar depreciation and food price hike, and possibly global wide inflation,” according to a text used by the Chinese representative at the June 11 session.
The US took an obdurate stance in response. First, the dollar exchange rate is “wholly market determined.” China didn’t challenge this.
Second, the USTR-led delegation would not comment on activities of the Federal Reserve, referring the Chinese to the Fed’s Web site. The Chinese understandably found this irritating. The spokesman carped: “it has been the practice of the Review Mechanism that leading agency of a Member would coordinate with and seek response from all other relevant authorities, including those in charge of monetary policies.” That seems not only reasonable but essential to any sort of meaningful policy discussion.
Third, China says the US took the position that “international discussion of these topics would occur in the IMF and the WTO is not the appropriate forum to discuss the US monetary policy.” On this point, the Chinese took great umbrage. They noted that “a continuous depreciation of the US dollar … would obviously affect economy and trade of other [WTO] Members, particularly the developing ones.”
Recalling our comment on Steve Hanke’s analysis of the dollar/rice nexus, that point seems entirely fair. But then the Chinese unloaded on the American “double standard,” noting that at last month’s review of Chinese trade policies, the US had insisted repeatedly on tying to draw China into a defense of its currency policy. The US position, he chided, seemed to be that the “WTO is an appropriate forum to discuss monetary policies of other Members including China, but not of the US.” Ouch!
The WTO’s predecessor was sometimes derided as the Gentlemen’s Agreement to Talk and Talk. The Trade Policy Review Mechanism is one of the best features of the Uruguay Round reforms of the GATT. It forces each country to expose itself periodically to world public opinion. That’s not legally binding, of course, but it does have its uses.
In this case, it has helped China abandon its unreasonable position that exchange rates are “internal matters” that “fall within a country’s sovereignty.” Now, perhaps playing to the developing country majority in the WTO, Beijing takes the sounder position that exchange rates do affect commodity prices and trade and as such fall within the purview of the WTO. That is, exchange rates are a trade as well as a monetary issue. The Treasury would be wise to seize on this opening – whether completely sincere or not-- and convene a closed door meeting with China and other countries with undervalued currencies. An acceptable solution can only be found through negotiation. China’s new position has cracked open the door to real progress. Will the US be pragmatic enough to respond positively?
Charles Blum
The exchange arose in the course of the annual trade policy review of the United States conducted this week. China challenged the US to explain the “causal link between dollar depreciation and food price hike, and possibly global wide inflation,” according to a text used by the Chinese representative at the June 11 session.
The US took an obdurate stance in response. First, the dollar exchange rate is “wholly market determined.” China didn’t challenge this.
Second, the USTR-led delegation would not comment on activities of the Federal Reserve, referring the Chinese to the Fed’s Web site. The Chinese understandably found this irritating. The spokesman carped: “it has been the practice of the Review Mechanism that leading agency of a Member would coordinate with and seek response from all other relevant authorities, including those in charge of monetary policies.” That seems not only reasonable but essential to any sort of meaningful policy discussion.
Third, China says the US took the position that “international discussion of these topics would occur in the IMF and the WTO is not the appropriate forum to discuss the US monetary policy.” On this point, the Chinese took great umbrage. They noted that “a continuous depreciation of the US dollar … would obviously affect economy and trade of other [WTO] Members, particularly the developing ones.”
Recalling our comment on Steve Hanke’s analysis of the dollar/rice nexus, that point seems entirely fair. But then the Chinese unloaded on the American “double standard,” noting that at last month’s review of Chinese trade policies, the US had insisted repeatedly on tying to draw China into a defense of its currency policy. The US position, he chided, seemed to be that the “WTO is an appropriate forum to discuss monetary policies of other Members including China, but not of the US.” Ouch!
The WTO’s predecessor was sometimes derided as the Gentlemen’s Agreement to Talk and Talk. The Trade Policy Review Mechanism is one of the best features of the Uruguay Round reforms of the GATT. It forces each country to expose itself periodically to world public opinion. That’s not legally binding, of course, but it does have its uses.
In this case, it has helped China abandon its unreasonable position that exchange rates are “internal matters” that “fall within a country’s sovereignty.” Now, perhaps playing to the developing country majority in the WTO, Beijing takes the sounder position that exchange rates do affect commodity prices and trade and as such fall within the purview of the WTO. That is, exchange rates are a trade as well as a monetary issue. The Treasury would be wise to seize on this opening – whether completely sincere or not-- and convene a closed door meeting with China and other countries with undervalued currencies. An acceptable solution can only be found through negotiation. China’s new position has cracked open the door to real progress. Will the US be pragmatic enough to respond positively?
Charles Blum
Tuesday, June 10, 2008
COMPOUNDING THE CURRENCY PROBLEM
Charles Blum
Monday, March 10, 2008
Valuing the Dollar; Devaluing Our Future
In a thoughtful op-ed piece in the weekend Wall Street Journal, Bob McTeer, former president of the Federal Reserve Bank of Dallas, echoed St. Augustine in wishing for a strong dollar – but not just yet. See Valuing the Dollar.
McTeer makes a strong case that a weaker dollar is part of a solution for the unbalanced US and global economies: “My preference,” he stated, “would be for dollar depreciation to reduce the [U.S.] current account deficit and slow the accumulation of dollar assets abroad. That process has already begun.” He concludes by warning: “A premature strengthening of the dollar would slow needed foreign trade adjustment and neutralize foreign trade as a source of domestic demand as we try to avoid a severe recession.”
This argument is a useful antidote to some of the confused economic logic that often beclouds the vision of Washington decision-makers. Experts are quick to bemoan “unsustainable” imbalances in the world economy, the low US savings rate, and our 35-year propensity to consume more than we produce. Their solution seems to be – get this! – coaxing the American consumer to spend more!
McTeer’s argument is a reminder that the default setting for a market economy such as ours is that persistent imbalances will be corrected through market forces. That’s what the depreciating dollar is doing. It will bring with it higher interest rates, higher exports and – contrary to what McTeer hints at – lower, not higher consumption. McTeer also glosses over the negative consequences of a dollar depreciation for those fools – overwhelmingly American citizens – who continue to hold American assets.
Cheapening the dollar may lead to a fire sale of American assets as foreign holders of dollars cash them in for something of real value at historically low process.
So, if the dollar depreciation runs its course without a major shift in American macroeconomic policy, America’s younger generations can inherit a reduced debt burden – hooray! – accompanied by a lower standard of living, reduced purchasing power, and increased foreign ownership of America’s most valuable assets.
That’s a high price to pay just because America’s political leadership does not take seriously the structural problems of the American economy. For starters, let’s adopt a consumption tax at a rate comparable to those in the rest of the world (say, an 18 percent value added tax). Use the proceeds principally to finance a fundamental restructuring of the rest of the tax system – much lower taxes on corporations and individuals and the elimination of a dozen or more nuisance taxes. Crucial to this is to expense – immediately write off – investments in production capacity.
Unless we change the structure of the American economy so that we can produce more than we consume, the market will achieve that end, however brutal and unfair the process might be. Our longstanding structural problems cry out for effective leadership. If the best that the presidential candidates can do is to argue whether the Bush tax cuts should be made “permanent,” our structural problems just might go on forever and along with it a succession of dollar crises.
McTeer makes a strong case that a weaker dollar is part of a solution for the unbalanced US and global economies: “My preference,” he stated, “would be for dollar depreciation to reduce the [U.S.] current account deficit and slow the accumulation of dollar assets abroad. That process has already begun.” He concludes by warning: “A premature strengthening of the dollar would slow needed foreign trade adjustment and neutralize foreign trade as a source of domestic demand as we try to avoid a severe recession.”
This argument is a useful antidote to some of the confused economic logic that often beclouds the vision of Washington decision-makers. Experts are quick to bemoan “unsustainable” imbalances in the world economy, the low US savings rate, and our 35-year propensity to consume more than we produce. Their solution seems to be – get this! – coaxing the American consumer to spend more!
McTeer’s argument is a reminder that the default setting for a market economy such as ours is that persistent imbalances will be corrected through market forces. That’s what the depreciating dollar is doing. It will bring with it higher interest rates, higher exports and – contrary to what McTeer hints at – lower, not higher consumption. McTeer also glosses over the negative consequences of a dollar depreciation for those fools – overwhelmingly American citizens – who continue to hold American assets.
Cheapening the dollar may lead to a fire sale of American assets as foreign holders of dollars cash them in for something of real value at historically low process.
So, if the dollar depreciation runs its course without a major shift in American macroeconomic policy, America’s younger generations can inherit a reduced debt burden – hooray! – accompanied by a lower standard of living, reduced purchasing power, and increased foreign ownership of America’s most valuable assets.
That’s a high price to pay just because America’s political leadership does not take seriously the structural problems of the American economy. For starters, let’s adopt a consumption tax at a rate comparable to those in the rest of the world (say, an 18 percent value added tax). Use the proceeds principally to finance a fundamental restructuring of the rest of the tax system – much lower taxes on corporations and individuals and the elimination of a dozen or more nuisance taxes. Crucial to this is to expense – immediately write off – investments in production capacity.
Unless we change the structure of the American economy so that we can produce more than we consume, the market will achieve that end, however brutal and unfair the process might be. Our longstanding structural problems cry out for effective leadership. If the best that the presidential candidates can do is to argue whether the Bush tax cuts should be made “permanent,” our structural problems just might go on forever and along with it a succession of dollar crises.
Labels: Currency
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