Ev Ehrlich's Everyday Economics

Sympathy For The Devil

Before I go to today’s topic – the rush to kick China around over its currency – a few distractions.

First, I’ve wondered about this for a while now, and invite any of you to share your views if you can, simply out of my own personal preoccupation with the question: when dogs bark in movies or on television, what are they saying?

What did you think, that dogs say bow wow wow and it’s completely bereft of meaning?  Shades of Planet of the Apes!  Our own dogs, Eddie (a cairn terrier, a distant relation of Toto and, on the dark-end-of-the-street, down-low, Fala) and Olive (a rescue dog named by my wife because she has a little pit in her), watch television with eager attention when a dog’s on screen, and are obviously getting the message.  What are they hearing?  “This is the twentieth time I’ve done this stupid trick!”  Or, “The actor I’m barking at kicked me when no one was looking!”  (After all, don’t dogs have the right to bitch?)  For that matter, what was Flipper saying when he clicked and whirred to Ranger Rick, or whatever his name was?

Yeah, go find out what Brad DeLong and Paul Krugman think about that.

Next, the Ehrlich blogging dynasty continues, even if it flows up, not down -- cehck out what's going on inValencia, courtesy of ESPN, here.

A third and more important topic is today’s employment report, which came in at 162,000 jobs, the second positive monthly jobs report since January of 2008 (there was a small, positive blip last November), and the largest monthly jobs gain in three years.

About a third of the gain came because the census is now hiring people, and there’s also a bounceback from very bad winter weather in January and February, which artificially depressed reported employment. 

But most importantly, the underlying trend favors jobs – in fact, I thought the number would be larger.  The economy has gone through the most frightening period in our lifetimes.  In the 2008 crisis, the economy was about to enter the equivalent of cardiac arrest – there was or was about to be  no lending to be had in a variety of key markets, including those where businesses got working capital and people could park their liquid savings overnight.

Faced with this unprecedented situation, most firms had to be their own banker, and as I’ve argued elsewhere, a company can raise fast cash in only two ways – selling all the inventory they can and firing everybody they see.  So business did both – in fact, they fired millions more people that you’d expect given how much output fell.  If you don’t buy that explanation, you have to accept that our economy’s productivity is growing at a seven percent annual rate, meaning the amount of stuff the average worker makes is doubling every ten years.  No way.

Look for more gains in the months ahead, and don’t buy the “jobless recovery” and “double-dip recession” arguments.

And now China.  On April 15, the Obama Administration is obligated to report to the Congress as to whether China is a “currency manipulator,” and what it intends to do about it.

Currency manipulation means deliberately keeping your currency – here, the Chinese yuan – below its “real” value in order to make your exports cheaper and the imports you buy more expensive.  Right now, foreigners want to buy yuan for two reasons; first, they want to buy cheap and plentiful Chinese goods, and Chinese producers have to be paid in yuan to pay their costs and make their nut.  Second, many foreign companies want to build capacity in China, and that takes yuan, too, for the same reasons – the crane operator there isn’t going to take your zlotys or riyals to his grocery store. 

So the Chinese accumulate big piles of other currencies – they run trade surpluses with 90 countries, so there’s all sorts of money coming in.  Usually, in that situation, the yuan will go up in value compared to the dollar, because people want lots of yuan to buy Chinese goods and build factories in China than they do dollars.  And when that happens, the situation self-corrects – people demand fewer yuan when its price rises, which leads to fewer Chinese exports, more imports into China, less foreign investment, and so on.

The economists in this debate seem to agree that the yuan, which has already been allowed to rise by 20 percent by the Chinese government since 2005, is still about 25 to 40 percent below where it “ought to be,” as judged by relative labor costs and other measures.  And armed with this calculation, some of them have gone to town.

For example, one estimate has it that the artificially-depressed yuan has cost the U.S. 2.4 million jobs.   More sober estimates still put the number at half of that.  And in response, some very respectable guys – like Fred Bergsten and the aforementioned Paul Krugman -- have called for imposing a tariff on Chinese goods to make up the difference if they don’t stop screwing around with their currency – that is, put a 27.5 percent duty on everything we buy from them if they don’t clean up their act in six months.  That’ll show ‘em.

It’s time to take a deep breath.

First, the 25 to 40 percent figure is true under the current set of conditions in China.  By that, I mean this.  If China were to allow its people to move money freely in and out of the country, there could be an outpouring of funds into higher-paying foreign investment opportunities, which would mean that suddenly people were demanding dollar and trying to get rid of their yuan, which would reverse the current situation.  And while the liberties of Chinese savers are certainly circumscribed by these controls on the inflow and outflow of their money, you can see why China isn’t too enthusiastic about letting its currency move around like that – it invites the kinds of instability and speculation we’ve seen regularly in global capital markets.  So while there’s a cost to these prohibitions, they’re part of China’s attempts to maintain some economic stability.

Second, I don’t buy the jobs numbers for an instant.  There aren’t just two countries in the world, and products move from country to country in stages – stuff that “comes from” China could be made there, or assembled there out of Mayasian or Thai parts and components, or made by U.S. companies in their own facilities there.  If that particular shipment of goods is slapped with a tariff, the assembly could move to Malaysia or Thailand, or the facility itself, or the U.S. firm might decide to set up its operation anywhere else around the world.  And while China is now making higher-end goods, like electronics, as well as lower-end ones, like plastic sandals, it by-and-large doesn’t make stuff that we make. 

The cause of our trade deficit is that we don’t save very much.  If we, as an economy, spend more than we produce and earn, then we have to buy the difference from other countries and borrow their money to pay for it – that’s the only way you can buy more than you make.  There’s just no way around that fundamental identity.  That’s why we have a hellacious trade deficit.  The reason we have a hellacious deficit with China is that China is a cheaper place to make all sorts of things, for both good reasons (cheap labor, hard work, making products that are easy to make) and bad ones (currency manipulation, slave labor).  But acting on Chinese currency without acting on the fact that we spend more than we produce and earn (largely thanks to the budget deficit but also out of our low personal savings rate in general), is like arguing that we can deflate a balloon by squeezing it at one end.

There is then the problem of taking unilateral action against another country because you have “evidence” about bad stuff it’s doing – does this sound familiar?  Letting the dogs of war slip in Iraq was a devastating blunder that seems to dwarf the possible repercussions of slapping import duties on China, but make no mistake – this is just as unilateral.  And that’s particularly true because there are international institutions like the World Trade organization and the International Monetary Fund that have specified role to play in this kind of situation.  Telling the IMF to take a walk and let us handle this is just as disruptive as telling the International Atomic Energy Agency.

The biggest problem with this kind of unilateralism, of course, is that invites a similar response.  Is China going to let this kind of tariff pass without retaliation?  Not in a New York minute.  And China’s other advanced major trading partners will be happy to sell it the aircraft, infrastructure, energy services, and other stuff that advanced nations sell profitably to poorer ones.

Then there’s how China probably sees all of this.  Their primary objective is not to put U.S. workers out of jobs, no matter what a few Senators think.  For most of this decade, the U.S. was happy to let China fill in the gaps in our burgeoning national shopping list and then finance it by lending us the wherewithal to keep it going.  Moreover, going back to the Asian financial crisis on 1997-98, China was the bedrock on which Asia was able to stand – it refused to devalue its currency would there was all sorts of pressure on it to do so, and absent its cooperation, the entire mess would have been catastrophic.  So China’s allowed to feel that the signals are being changed on them.

Finally, China’s leaders probably have the hardest job in the world.  They have 1.6 billion people, an archaic state-controlled economy, tens of millions of people on the edge of rootlessness, enterprises that ought to fail if they haven’t yet, a banking system that survives by not recognizing the worthlessness of many of their debts, and a budding property boom (that would be made worse by a rising yuan, as domestic home buyers would have higher real income).  And they’ve been doing a very good job of keeping all of these balls in the air – compare their mastery at converting their broken down, communist mess when compared to Russia, which went for totalitarianism and poverty to despotism and being broke.  (Reminiscent of the famous dictum – under capitalism, man exploits man, and under communism, it’s the other way around.)

It’s easy to rail against them, particularly if you wave around questionable job numbers , but it takes a more nuanced eye to see what China’s problems are and our stake in helping them make the transition to a market economy.

The good news is that China only recently announced that its President Hu will come to Washington in two weeks – right about when the report on their currency practices comes due.  It’s tempting to read this as a sign that the Administration has come up with a way forward without resorting to starting a trade war or breaching the procedures nations are obliged to follow is their grievances with each other.

What’s really needed is the kind of bilateral policy coordination that we’ve so scrupulously avoided.  The Bush Administration was happy have China pay for its tax cuts and write the rest off to its support of free trade.  The Obama group, having inherited a bleeding mess, has less forgiving sensitivities.  But if it can produce an agreement that balances gradual yuan appreciation with an American commitment to get its deficits – the real source of our trade imbalance – under control, it will have shown remarkable maturity, even if it requires some sympathy for the devil.