Now, in 2008, Paul Krugman was granted the Nobel Prize in Economics. In giving the prize, the Nobel Prize committee always cites some specific work or body of work that justifies what they are doing. In Krugman's case, he got it "for his analysis of trade patterns and location of economic activity." Krugman is a recognized expert in the field of international trade, and the Committee, after input from members of the economics profession and deliberation, decided to award Krugman the prize.
The Nobel Prize recognizes important and influential contributions to our knowledge. To pass the bar for the Nobel prize, we have to think of these contributions as truly pathbreaking. The prize-winner must somehow have made us all better off in a significant way. I don't think that anyone imagines that conferring the prize on an individual will make that individual work harder for humanity. What we are thinking is that young economists might see the recognition of a Nobel Prize (and the million bucks too) at the end of the rainbow. In spite of the fact that the chances of getting a Nobel are tiny, perhaps young economists at the top of the profession will all work just a little harder, and the benefits for society will be worth what the Swedish Central Bank spends on the thing every year.
Now, I asked a question in my title, and I mentioned Krugman, so you know what is coming now. We might forgive Paul for his lapses in macroeconomics. He's a trade guy after all, and we don't expect him to be up to speed in modern macro. However, the prize he got was for his work in international trade, and if he is writing about issues in that field, we expect a lot. That's what makes today's NYT column so disturbing. Part of what we do in undergraduate economics classes is to dispel myths, and to show how some basic tools from economic science can shatter ideas that can seem intuitively plausible. Krugman's column takes economic knowledge backward. This is not an attempt to enlighten lay readers by showing them how some simple economics works. It's an exercise in bad economics put forward as mainstream thought, and beyond reproach. If it were in my power, I would love to take the guy's prize away. Of course I can't, and unfortunately no one else can, either.
First, Krugman says this:
China is deliberately keeping its currency artificially weak.First, of course there is nothing "artificial" about China's exchange rate policy. The Chinese government and its central bank are free to intervene as they see fit in financial markets, and those actions are going to have an effect on the exchange rate of the renminbi against the US dollar. Currently, though the Chinese claim that the renminbi/US dollar exchange rate is flexible and market determined, they appear to be essentially pegging it. But so what? A basic principle of international economics is that a country cannot "subsidize" its exports through what are essentially monetary policies determining its nominal exchange rate. The prices of goods sold by China on world markets are determined in world markets in US dollars. There is nothing that Chinese exchange rate policy can do to affect those prices.
The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus.
As to the claim that China's nominal exchange rate policy is "feeding a huge trade surplus," the state of China's current account balance has little to do with exchange rate policy. In China, financial intermediation is very inefficient. Banking in China is dominated by a few large state-owned banks, and those banks are not very good at channeling domestic savings into high-return domestic investment projects. The savings of Chinese households is huge. What happens to that savings? Much of it leaves the country in the form of US Treasury securities and other foreign assets, resulting in lower real interest rates in the rest of the world (than would otherwise exist), as compared to the high domestic real interest rates in China. Some of the savings that flows out of China comes back in as foreign direct investment, but there are barriers to that flow. The result is a current account surplus in China - Chinese national savings exceeds investment. The primary cause has nothing to do with the nominal exchange rate. The Chinese current account surplus would be much smaller if domestic financial intermediation in China were much more efficient - and our interest rates would be higher.
Now, Krugman perhaps is anticipating this criticism:
You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.The big question here is what "undervalued" means. Relative to what? If I can decide what undervalued is, I guess I could make that statement true. The point is, Krugman's last sentence here is not the statement of an empirical fact, so it does not count as evidence.
Then there is this:
And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.Give me a break. Even if what Krugman claims earlier in the piece is true, China could only be accused of selling us stuff cheap, and lending us the funds to do so at a very low interest rate. Somehow this does not look like deprivation.
So what does Krugman want us to do about this "problem?" Well, apparently he wants a trade war. Great idea. Also,
One answer, as I’ve already suggested, is fear of what would happen if the Chinese stopped buying American bonds. But this fear is completely misplaced: in a world awash with excess savings, we don’t need China’s money — especially because the Federal Reserve could and should buy up any bonds the Chinese sell.The world currently has a healthy appetite for US Treasury securities, which in part is why yields to maturity on all these assets are so low now. What happens if the Chinese, or anyone else for that matter, loses interest in our government's debt? Clearly, absent anything else happening, those yields will have to rise. But Krugman suggests that the Fed can buy the Treasuries that the rest of the world is unloading, thus monetizing the debt. This would of course result in more inflation, which would amount to an implicit default on our nominal debt, which I assume is what Krugman wants. This of course would make the world even more skittish about holding our Treasury securities.
Krugman either believes this stuff or he doesn't. In either case it is disturbing. If he doesn't believe it, then what's his agenda? Why the China-bashing? I expect this from politicians, but not from a Nobel-Prize winning trade theorist.