The Great Adjustment, or The Way Things Oughtta Be

Matthew Yglesias sums up:

The way this is “supposed” to work is that Chinese people, being poor but growing rapidly, consume more than they produce. The current accounts balance out because savers in rich countries should be investing money in China — building up China’s capital stock and so forth. Investments in capital-poor developing countries “should” offer a high rate of return for developed world savers, and the injection of foreign capital should speed China’s growth. And for “China” you can substitute “Mexico” or “India” or what have you. The world, however, doesn’t actually work like that. Instead, China has been running persistent surpluses. And so have various energy-rich developing countries. So money keeps getting plowed into various US investments. But the US isn’t a poor, developing, capital-poor country. And so a lot of the investment in the United States seems to be going into speculative bubbles — first dot-com stocks, then MBS. Now people are buying up no-interest treasury bonds.

and quotes Brad DeLong:

If it weren’t for the fact that the furshlugginer dollar refuses to fall in value, the answer would be obvious: we will have a boom in import-competing manufacturing (and exports). But then the rest of the world has a long-run problem: if we decide to no longer be the world’s importer of last resort, than what serves as a locomotive to keep it near full employment?

But if the dollar doesn’t fall, then we have a long-run problem. The only answer I can think of is for the U.S. to then become the world’s largest private-equity fund: they lend us their money, and we then invest the money back in their economies–in industries and companies that then have a very high demand for U.S. high-tech goods and for U.S. services exports.

So an adjustment is needed, but we're not getting it. Asian central banks are continuing to buy gobs of U.S. Treasuries which keeps the value of the dollar high. And we're not investing the money back into Asian industries that demand U.S. goods and services. Instead, we're using the money to try to keep the bubble inflated, and so the adjustment is postponed.

Remember When Europe Was Going to Lead the Way?

Germany refuses to enact stimulus until after Obama is elected:

Germany will wait to launch its next fiscal stimulus until it has a clearer view of the economic plan of Barack Obama, who is to be sworn in as US president on January 20, say German officials.

Michael Glos, economy minister, said – after a meeting of government officials and business leaders on Sunday night – the government would decide late next month whether to adopt more measures to stimulate the economy, Reuters reported.

That would mean Berlin would not top up its €12bn ($16bn, £10.7bn) growth-boosting package at an extraordinary meeting of leaders of the governing coalition on January 5, as many economists and international leaders had hoped.

“We will probably know what Obama is going to sign before January 20 but I would be surprised if any decision were made on January 5,” said an official before the meeting.

All indications are that Obama plans to enact a large-scale spending program -- probably in between $700bn and $1,000bn -- to boost economic activity in the short run while improving infrastructure in the medium run. The fact that Germany refuses to move until it gets even more specifics signals that America's standing as the leader of the international financial system has not taken such a great hit after all.

Isn't It Ironic?

Wall Street Journal headline: "France Credits Deregulation for Cushioning Its Economy". Article here for subscribers.

The truth is obviously more complicated than that, and France's economy appears to be decaying just as everyone else's is, but that headline still gives me a chuckle. It's worth keeping in mind when you hear that the days of capitalism are over and gone: the story of this crisis is still being written, and the nature of the causes will be debated for decades. In any case, two things are almost certainly true: so far the crisis has not necessarily been milder for more regulated economies, and there is plenty of blame to be shared by government regulators and market "self-regulators".

Who Says IPE Is Boring?

Brawls broke out in the South Korean legislature over a proposed U.S./S. Korea trade pact:

Scuffles broke out as dozens of opposition members and their aides attempted to push their way into the office. TV footage showed people from both sides shoving, pushing and shouting in a crowded hall at the National Assembly building amid a barrage of flashing cameras.

Opponents later used a sledgehammer and other construction tools to tear open the room's wooden doors, only to find barricades of furniture set up inside as a second line of defense.

Opponents counter that it will cause pain to key sectors in both nations — agriculture in South Korea and automobiles in the United States.

Note that this "free trade" deal is causing a lot of controversy primarily because tariffs aren't the only trade-distorting regulations in the two countries. The opposition party in S. Korea is (justifiably) worried that U.S. subsidies to American farmers will make S. Korean farmers unable to compete if their protections are discarded. They may be right: U.S. agricultural policy is a tragicomedy of perverse incentives, corporate welfare, and inefficiencies. American and European agricultural policies are also killing the agricultural sectors of developing countries, and this has lead to the near-abandonment of the Doha round of WTO negotiations.

America is poised to lose much of its automobile industry anyway; the only question seems to be whether we let it happen now or in a few years when the pill may be easier to swallow. So, without having studied it in depth, this deal looks great for Americans; less good for S. Koreans. Still, I tend to believe than in normal circumstances any reduction in trade barriers will bring a net gain to society, so I'd like to see this pact pass. But it's another reminder that not all "free trade" is truly free.

My hope? Deals like this will eventually force the U.S. and E.U. to abandon their own agricultural subsidies and open their markets to exports from the developing world. This would be helpful on so many levels: it could provide good jobs and strong industries to the countries that need them the most (esp. in Africa and S. America), it could eliminate a great source of waste and inefficiency in American and Europe, it could further the passage of Doha, and give the West more credibility when it talks about markets and liberty to the rest of the world.

Will that happen? I doubt it. But that's what I'd like to see.

UPDATE: Dr. Oatley posted a short video in October that highlights some of relevant points about the politics of farm subsidies. It is here

An Easily-Answered Question

Alex Tabarrok finds this question remarkable: "can market transactions generate institutional arrangements that impair the market economy?" That question was asked in 2006 by Richard Wagner, one of Tabarrok's colleagues at George Mason University. I guess the point was the question foresaw the current financial crisis (Wagner mentioned the securitization of debt earlier in his question), but students of IPE should be well aware of market transactions that can end up causing more damage than good: large volatility in capital flows, especially from the developed to less-developed countries, often generate boom-and-bust cycles that can decimate entire economies. Countries that borrow in foreign currencies sometimes leave themselves open to currency crises that have similarly devastating effects.

I'm not sure why Tabarrok (or Wagner) should be surprised that the result of market transactions can sometimes "impair the market economy". In my mind, a quick glance at history demonstrates that Wagner's question is easily answered in the affirmative.

Italy is so Cheesy!

From Mankiw - 

The WSJ reports:

The world is bailing out banks and car companies. Italy is coming to the rescue of parmigiano cheese.

In an effort to help producers of the cheese commonly grated over spaghetti, fettuccine and other pastas, the Italian government is buying 100,000 wheels of Parmigiano Reggiano and donating them to charity.

Though demand for parmigiano is strong in Italy and abroad, producers have been struggling for years to make money, putting the future of Italy's favorite cheese at risk.

An economist might suggest letting a few producers fail, so supply shrinks, prices rises, and the remaining producers become more profitable. In fact, that same logic might apply to some other industries as well.

Not looking pretty for tomorrow...

Senate abandons auto bailout

Nikkei slides big time on news

It may get ugly in 8.5 hours when the US markets open.

It's Not All Work here on the Hill

The Great Adjustment (a continuing series)

China's exports dropped significantly in November, but their imports fell by an even greater margin, so their current account surplus expanded. This is likely due to the fact that many of China's imports are inputs for production rather than finished goods for consumption. This was reflected by a sharp drop in China's producer price index.

World Bank Report

The World Bank issued a forecast Tuesday. At first glance, the report is pretty pessimistic:

The world economy is on the brink of a rare global recession, the World Bank said in a forecast released Tuesday, with world trade projected to fall next year for the first time since 1982 and capital flows to developing countries predicted to plunge 50 percent.

The projections are among the most dire in a litany of recent gloomy forecasts for the world economy, and officials at the World Bank warned that if they proved accurate, the downturn could throw many developing countries into crisis and keep tens of millions of people in poverty.

Even more troubling, several economists said, there is no obvious engine to drive a recovery.

American consumers are unlikely to return to their old spending habits, even after the United States climbs out of its current financial crisis. With growth in China slowing sharply, consumers there are not about to pick up the slack from the Americans. The collapse in oil prices — a side effect of the crisis — has knocked the wind out of consumers in oil-exporting countries.

The bank forecasts the global economy will eke out growth of 0.9 percent in 2009, down from 2.5 percent this year and 4 percent in 2006. That is the slowest pace since 1982, when global growth was 0.3 percent. Developing countries will grow an average of 4.5 percent next year — a pace that economists said constituted a recession, given the need of these countries to grow rapidly to generate enough jobs for their swelling populations.

Drezner thinks this report is actually an optimistic assessment, and I tend to agree. He gives 6 reasons but in my mind it can be summed up in one: the causes of the crisis are not only not resolved, they seem to be getting worse: credit is still frozen, and current account imbalances all over the world seem to be expanding rather than tightening. "Who adjusts?" is still the relevant question, and so far the answer from every country is "You first". There's a little bit of chicken going on, and the longer that game lasts, the more damage can be done.

Elsewhere, Krugman says (and Cowen agrees):

A scenario I fear is that we'll see, for the whole world, an equivalent of Japan's lost decade, the 1990s -- that we'll see a world of zero interest rates, deflation, no sign of recovery, and it will just go on for a very extended period," he told a news conference.

And that's unfortunately very easy to see happen.