Friday, June 25, 2010

Riddle Me This

. Friday, June 25, 2010

If Krugman wants another massive fiscal stimulus package funded by additional deficits, and he does, and he wants the Chinese to stop depressing the value of their currency by buying American debt, and he does, then where does he expect the funds for fiscal stimulus spending to come from? More precisely, if Krugman succeeds in removing the largest purchaser of American debt from the supply side of the funds equation ("$1 billion a day"), then why wouldn't he expect the cost of borrowing to increase massively? And why does he think this will be good for the national accounts?

Then there's this conclusion to his most recent column:

China needs to stop giving us the runaround and deliver real change. And if it refuses, it’s time to talk about trade sanctions.

Is it good for economic recovery to pay more to borrow than we have to, pay more for imports than we have to, and shut off access to a very large and growing market for our exporters by triggering a trade war? Of course not.

Usually when I disagree with anyone, especially someone as intelligent as Krugman, I can at least see where they're coming from. Not this time. I really cannot reconcile his anti-China invective with his pro-Keynes dogma. It just makes no sense.


Wise Bass said...

More precisely, if Krugman succeeds in removing the largest purchaser of American debt from the supply side of the funds equation ("$1 billion a day")

I don't think the Chinese are the biggest buyer of American debt. They're outweighed by private buyers and the Federal Reserve.

Anonymous said...

again, kindred is driven by his hatred of krugman and his attempt to be on the same level as krugman. he obviously falls way short of the latter because he doesn't realize that there are plenty of savings in the world and plenty of buyers of US debt, so interest rates wouldn't change much. even if there are trade sanctions against china (probably moderate sanctions), china would still buy larege amounts of US debt because doing so would still be in China's economic interest.

Kindred Winecoff said...

Wise, I should have written "largest single purchaser" instead. I'm not sure whether the Fed should count for these purposes or not.

Anon, You continue to misconstrue. I love Krugman, love his books, love his textbooks, love his articles. He's a master communicator of econ, and without him I probably wouldn't be studying IPE. Which is why I hate it when he writes silly things in front of large audiences.

You think that if China announced tomorrow that they wouldn't buy any more U.S. debt that wouldn't have an effect on interest rates? Really?

You clearly don't understand what's being discussed. Krugman wants large tariffs, tariffs large enough to make China stop manipulating their currency, which means tariffs large enough to stop China from buying US currency and revalue their currency in a major way. Such tariffs would not be "moderate". Under that scenario, it would not be in China's interest to keep buying dollars, since the only reason to buy dollars is to support exports. If those exports are made impossible by tariffs anyway, then there is no reason to continue doing it.

adam said...

It might actually be a good time to lean on China to absorb some of the re balancing costs that its current account surplus pushes exclusively to the US.

Capital is fleeing Europe at a massive rate, and there's no reason to think that the US is going to have a failed auction any time soon. China is the single largest holder of US debt, and a few years ago it really was buying a majority of new US issuance. But it is only a marginal player now. A Chinese strike on new issuance would have a small, short term effect on US interest rates, but the resulting "flight to safety" should ensure that it's a very small and very short lived.

So the PBoC could dump its holdings, but then the PBoC's technical insolvency (it earns about 1% on its reserves, but once the RMB appreciates, it will earn negative returns) will become a liquidity crisis. The ministry of finance would have to step in to recapitalize the central bank, which is something the central bankers dread more than anything else right now as we go into the 2012 political cycle.

The other option is a trade war, which nobody can win from but the US would loose a lot less than China. The deficit country might be forced to pay higher prices, get some inflation (not a problem right now for US), and consume less. But the surplus country takes a demand a supply hit, and growth will slow much more in China than in the US.

It's not perfect, but it's a reasonable card to threaten right now because there's a realistic chance that the US can take the hit. China needs to step up and correct its twin surpluses much more quickly than they have shown any interest in doing. Krugman is mostly right on this, IMHO.

Andrew Calkins said...

Krugman is off base, you're right. I don't think I will ever understand his China bashing. My biggest frustrating with itthat he views US-Sino relations so narrowly, as if this currency issue is the only dispute, as if it is the only are of concern, as if a policy change in this area is all the US needs from China. It's not.

Threatening or imposing trade sanctions would undoubtedly lead to weak, uncooperative, bilateral relations for years to come.

Julian Swinder said...

Hi All:
I have a basic IPE question, because I'm new at this stuff. How exactly does the Chinese government buy up foreign currencies to keep them high and the renminbi low? Can someone briefly walk me through this process (does the Chinese government use contractionary monetary policy to capture domestic renminbi and then use all of this to buy up foreign currencies on the foreign exchange market?).
Many thanks,

Kindred Winecoff said...

Julian -

That's less of an IPE question than a basic intl econ question. Basically, China accumulates dollars by running a trade surplus with the U.S. They could exchange those dollars for American goods, or sell them for other currencies on the market (with which to buy other countries' goods), but both actions would hurt the value of the dollar relative to the RMB. This would hurt their exports, which would lower employment and economic growth. So they continue to accumulate dollars, and use some of them to buy U.S. debt.

To the previous commenters, I replied to some of your thoughts in another post:

Julian said...

Thanks, Kindred. However, I'm still a little confused. If a bunch of Chinese exporters have a bunch of RMBs, how does the Chinese government take them away in order to trade them for US dollars/US treasuries and other foreign currencies in order to make them stronger than the RMB?

Kindred Winecoff said...

Chinese producers are required by the Chinese government to exchange all dollars for RMB at a state-run bank.

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