My latest ideas on macroeconomics, monetary economics, economic policy and current events.
Does he really think we're talking about a "tragic investment decision"? Do you?
1. Well, that's what he said, so I guess we should assume that is what he thinks.2. I think he has a point, otherwise I wouldn't have drawn your attention to it.3. What do you think?
I ask whether you believe it because you've previously written that China's policy is a result of their efforts to maintain a fixed exchange rate, which can only be considered an "investment decision" in so loose a sense as to be meaningless.
No, it's full of meaning. As I pointed out herehttp://newmonetarism.blogspot.com/2010/10/what-is-chinese-central-bank-up-to.htmlChina set up something close to a currency board. Most of the liabilities of the Peoples Bank of China (PBC) are backed by what are apparently US dollar-denominated assets, and they fixed their exchange rate in US dollars, which is what a currency board is about. In so doing, they tied their fortunes to ours, which looks to have been a bad bet. It wouldn't seem that it was a good idea for China to tie its caboose to a train for which fiscal policy appears to be out of control, and the monetary authority is experimenting with various interventions which have unknown effects.
So using your previous analogy, the decision to fix California's currency relative to New York's was an investment decision rather than an economic policy. I think we're done here.
No, no. I can keep going indefinitely. There are different ways to fix an exchange rate. One approach is "dollarization," which is just adopting the currency of another country. That's what's going on with California vis-a-vis New York. Obviously no "investment" involved there. A currency board is an entirely different story. The central bank commits by backing outside money one-for-one with assets denominated in a foreign currency. You can see how China is now over a barrel. The central bank's assets are mainly US-dollar-denominated and of course its liabilities are denominated in units of Renminbi. If the Renminbi appreciates, that's bad news for the central bank.
Except you don't get to selectively re-characterize China's action as policy or investment as it fits your current argument. You denounced Geithner's position, saying that China's actions are simply a policy, like the one that binds California and New York. Now you're agreeing with Cochrane that it's just an unfortunate investment mistake.
I'm not re-characterizing anything, and there's no contradiction. China's fixed exchange rate is indeed a policy, and it also is a bad investment. The states in the union made an investment too, but of a different kind. EMU members made an investment in their monetary union, and some Germans may feel like it was a bad one. In China's case, there was straightforward investment in US government debt.
And since you've finally agreed that China's actions constitute a policy, this brings us back around to my original question concerning whether you agree with Cochrane. He writes, "The Chinese government's accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort." A fixed exchange rate policy certainly constitutes a currency-manipulation effort, though it may work to either the manipulator's benefit or to their detriment.
"Currency manipulation" is loaded language, don't you think? All this talk about "artificial over-valuation" and "manipulation" makes it sound like an unnatural act, like bestiality. A government is always doing things that affect the value of its exchange rate. There is no such thing as a null policy (double negative there). Policy always has to be something. If US monetary policy were something other than what it is, then the US dollar exchange rate with other currencies would be different. You want to convince yourself that China is doing something bad here, but I don't see it.
Do you think what France did during the Great Depression was bad? Although perhaps there are different senses in which a country's monetary policy may be "bad".
A lot of people seem to be arguing that Chinese policy is somehow bad for us, but in line with what Cochrane is saying, we should be thanking them. What did France do in the Great Depression?
The PBoC policy of sterilization has reduced growth in currency from what would have been 80% since January 2007 to 40%. So Chinese domestic prices are far below what they would have been without sterilization. This is an "imbalance"; prices would be higher had the PBoC not sterilized. Agreed? Artificially low prices due to sterilization make imports into China less competitive and as such hurt US (and other) exporters. You might say that governments all over the world create imbalances and that China's sterilization is par for the course. Ok, but I'd say its one of the largest of the world's many imbalances.
No, not agreed. Why is the state of the world where the PBC issued PBC bills unbalanced, and the state where they did not balanced? Presumably prices are higher in the former case, but so what? There's nothing artificial about it. Our prices are higher given that the Fed intervened so massively recently, and our exchange rate is lower relative to what would have occurred otherwise. Do we say one state is unbalanced and artificial and the other is somehow balanced and not artificial? If I were advising China, I would be telling them to institute banking reform - get rid of interest rate constraints, allow foreign banks to compete in China, get rid of constraints on capital mobility. That would make the Chinese, and everyone else I think, better off. Forget about these foreign exchange market issues, as that is beside the point.
I'm not making any judgments about China's policy; I'm only trying to understand why you're quoting Cochrane approvingly when you seem to disagree with him. He would like us to believe that the dollar-yuan exchange rate, and hence the trade imbalance, is the result of "a lot of middle-aged [Chinese] workers who need to save for retirement." I (and, if I understand correctly, you) believe the exchange rate is the deliberate result of a fixed exchange rate policy. I would contend that my (and your) position is well supported by the evidence.
"He would like us to believe that the dollar-yuan exchange rate, and hence the trade imbalance, is the result of "a lot of middle-aged [Chinese] workers who need to save for retirement." "This is where you're confused. You have to understand the current account balance in terms of savings and investment, not as something you "fix" by moving around currency exchange rates. From national income accounting, S-I=CA, where S is savings, I is investment, and CA is the current account surplus. Think about that for a while.
By quoting me this accounting identity, do you mean to imply a particular cause-and-effect relationship? Are you, for example, implying that "China's current account surplus is the result of exogenous decisions regarding savings and investment" or some such?
Well, you thought about it for a while, but you seem to have a suspicious mind. Start with the idea that the determinants of savings and investment have to be the same as the determinants of the current account surplus, by virtue of national income accounting. Now, what's the easiest way to think about savings and investment? Forget about monetary exchange, and just do this as a kind of two-period Fisherian model. In a closed economy, the demand for loans is increasing in the real interest rate, and the supply is increasing in the real interest rate. The real interest rate is determined by the intersection of demand and supply. Now, do the open economy version. Treat this as a small open economy with an exogenous world real interest rate. Now, the current account surplus is determined by whatever determines savings and investment domestically. Investment is affected by the technology, the size of the existing capital stock, etc., and savings by wealth, demography, etc. Now, in China's case it's more complicated, as there are many restrictions on intermediation and the inflow of capital from outside the country. We can think of the domestic real interest rate faced by borrowers as being higher than the world real interest rate, and the real interest rate faced by lenders as being lower. However, in spite of the low internal rate of return on savings, Chinese households actually save a lot, and this contributes to the current account surplus. Some people have tried to explain Chinese savings behavior, and one possible explanation that Cochrane alludes to is the absence of a good pension system - savings is high because of self-insurance. In any case, what is going on is that domestic financial intermediation in China is quite inefficient. The high level of domestic savings does not flow into domestic investment, but goes abroad in the form of a current account surplus. Rather than accumulating claims on domestic residents, Chinese savers accumulate claims on the US government. If there is a problem here, it's with restrictions on domestic intermediation in China, and with barriers to foreign direct investment and foreign banking activity in China. Now, notice that monetary factors and exchange rates never entered the story. Why? That would be a side show. These factors are unimportant for understanding what is going on.
France & the Great Depression:http://www.marginalrevolution.com/marginalrevolution/2010/09/did-france-cause-the-great-depression.html
But one can take the same set of facts you relate and interpret them quite differently. I can imagine Geithner saying, Hey look! CA+I=S, so if you know the amount of investment and the degree to which the government is manipulating the current account surplus, you then know what savings has to be. Sure, in your "small open economy with an exogenous world real interest rate" case, CA is determined by I and S, but as soon as you have restrictions and inefficiencies in intermediation, you have to opportunity for government to determine CA.It seems that both views fit the facts, but the theory that has China following a deliberate policy of rapid industrialization strikes me as more plausible than the Chinese-as-really-bad-investors theory.
Well, I tried, but obviously you don't get it. We are really done now.
You gave it a shot. Thanks.
anonymous on France and the Great Depression:Interesting. This came up yesterday when Hal Cole was giving this paper:http://www.ssc.upenn.edu/~colehl/pdf/IntDep.pdfNot sure if he had a newer version - this is the one on his web page. The problem with a commodity standard is that the relative price of the commodity can fluctuate. If the relative price of gold goes up for some reason, you get deflation, which of course is what happened in the Great Depression. I don't know much about gold standard issues vis-a-vis the Great Depression, but it may not be clear that you can blame the deflation on France's "hoarding." There could have been a flight to safe assets. In the recent recession, people seemed to coordinate on US debt as the safe asset. Presumably in the Depression, the safe asset was gold.
"Now, notice that monetary factors and exchange rates never entered the story."Doesn't PBoC sterilization affect interest rates? To sterilize at a faster rate, the PBoC has to issue more bonds, which means sweetening the rate it pays on those bonds.
Scott Sumner has written that a number of people fled to gold when they expected devaluation, and that this increased deflation. But discretionary policy on the part of the French central bank seems to have played a larger role.