One nice things about writing a blog is that I don’t need to be topical.  Not only can I write worriedly about rising contingent debt levels three or four years before they become obvious cialis online pharmacy, but I can also revisit a controversy that took place March involving Paul Krugman and Stephen Roach.  I revisit this old controversy because although the period of nasty trade dispute seems to have come to an end, with conciliatory noises being made between the major parties, trade tension is not going away. In fact it is going to become internationalized, with more noise coming from other developing countries, who have already begun complaining about RMB policy (for example last week the governors of the central banks of both India and Brazil came out with strong statements about the RMB). In the end, large trade deficits are not politically compatible with high unemployment, and in my opinion things only will get worse on both fronts.

So while this post might not be currently topical, the subject will again become so very soon; cialis online pharmacy. To start, and in response to many of the comments from recent postings, especially some emailed comments from friends, I wanted to work through Paul Krugman’s point on currency intervention because, as I see it, he is simply using accounting identities to set out the parameters of how to think about the issue of RMB revaluation – cialis online pharmacy.

Accounting identities cannot be violated, neither in practice nor in theory, although depressingly enough much of the discussion of trade balances, even when conducted by economists, brazenly violates these identities.  It may make sense then to place the discussion solely in that context so that at least we can all agree where we legitimately disagree.  Here is what Krugman says:

Let me start with a proposition: the right way to think about China’s exchange rate is, initially, not to think about the exchange rate – cialis online pharmacy.Instead cialis online pharmacy, you should focus on China’s currency intervention, in which the government buys foreign assets and sells domestic assets, on a massive scale.

Although people don’t always think of it this way, what the Chinese government is doing here is engaging in massive capital export – artificially creating a huge deficit in China’s capital account.It’s able to do this in part because capital controls inhibit offsetting private capital inflows; but the key point is that China has a de facto policy of forcing capital flows out of the country.

Now, bear in mind the two basic balance of payments accounting identities:

Capital account + Current account = 0

Current account = Domestic savings – Domestic investment

By creating an artificial capital account deficit, China is, as a matter of arithmetic necessity, creating an artificial current account surplus.And by doing that, it is exporting savings to the rest of the world.

Notice the first identity.  China’s current account surplus must be equal to its capital account deficit.  It doesn’t matter whether you think China’s trade surplus is caused by policies that force households to subsidize producers, or that place tariffs (hidden or explicit) on imports and subsidies on exports, or that force heavy currency intervention by the PBoC.  In the end, these are all one and the same thing, and will have automatic balance of payments consequences.  Krugman argues that since China restricts the capital account, the PBoC’s currency intervention automatically results in the Chinese capital account deficit and the current account surplus.

If this true, what are the consequences?  Let us for simplicity call the rest of the world the US.  If China runs a capital account deficit, the US must run a capital account surplus.  That is, it must import savings from the rest of the world.  This is one of the inviolable accounting identities.

One country’s surplus is another’s deficit

Since the current account is the obverse of the capital account, this also means that the US must run a current account deficit.  Here is where another accounting identity becomes very useful.  The total amount of savings the US imports is defined as domestic investment minus domestic savings – in other words by definition the US imports whatever additional savings it needs to fund its domestic investment.

Remember that this is also the same thing as saying that the excess of US investment over US savings is equal to the current account deficit – because the capital account surplus is the same as the current account deficit, right?

So if the US runs a capital account surplus, it must run a current account deficit, and if China runs a capital account deficit, the US must run a capital account surplus – cialis online pharmacy. This all nicely balances out because if the US runs a current account deficit, China must run a current account surplus.

Remember, however, that there is no direction of causality implied here.  These things must all happen simultaneously, and there is nothing in the accounting identities that tells us which caused the other.  If PBoC intervention forces a capital account deficit on China, as Krugman says, then all those other things follow automatically.  Alternatively, if Americans decided independently to go on a consumption binge that forced the US into a current account deficit, then all these other things must also follow automatically.

Given the sheer size of PBoC intervention, the tremendous concomitant need to sterilize and repress interest rates, and the resistance to appreciate the currency, it seems pretty clear to me that at least part of the reason for PBoC capital exports was as a policy choice.  This is especially likely, I think, since the explosion in reserves at the PBoC and other Asian countries seems to have begun within a few years of the 1997 crisis.

Now if the initial cause was the PBoC capital exports, of course the Fed could possibly have foiled the capital impact of the PBoC intervention by raising interest rates and forcing up unemployment in the US.

This is the point that Martin Wolf has often made, and if the Fed had done so it might have caused private businesses to cut back on their investment more quickly than the resulting decline in savings, and the US could have effectively blocked capital imports.  The rising unemployment would have reduced US consumption and US imports, which would have reduced the US current account deficit.  Remember, these are just the opposite sides of the same coin and one automatically implies the other.  If the excess of investment over savings declines, so does the current account surplus.

For whatever reason, right or wrong, the Fed didn’t do this.  The result was that the US had to run a capital account surplus.  In the US, however, there are two ways the capital account surplus must resolve itself.  Since the capital account surplus is equal to the excess of investment over savings, if the capital account surplus rises, broadly speaking, either savings must decline, or investment must rise (or some appropriate combination of both in which the excess of investment over savings rises).

Jack up investment

Under these conditions it is unlikely that private investment will rise.  The US current account deficit means that US demand is shifting abroad, perhaps because currency intervention has made US production less profitable and foreign production more profitable (the overvalued dollar reduces the profitability of US investment and increases the profitability of foreign investment); cialis online pharmacy. It is more likely for US businesses to increase investment abroad at the expense of investment at home.

That leaves two other possibilities – either total investment rises because government investment rises cialis online pharmacy, or private savings must decline.  The “correct” way for the US to have dealt with the US current account deficit might have been for a sharp increase in government investment, say in infrastructure spending, scientific research, education, and so on.  This would have presumably improved the productivity and profitability of US production in the future, so that with lower costs, the US could have eventually regained the edge it lost with the overvaluation of the dollar.  The US would have still run a large trade deficit, but this deficit would be the result of a surge in investment rather than a surge in consumption.

But if the US government did not increase investment by enough, the automatic consequence had to be a decline in the US savings rate.  There are many ways this could have happened, but it had to happen.  This, by the way, is why I get very impatient with all the moralistic finger-wagging, often enough by ferociously rich investment bankers, about profligate spenders living beyond their means and hard workers squirreling away their savings.  This is mostly nonsense.  If the US runs a trade deficit, for whatever reason, US capital imports must rise, and almost certainly that means debt will rise, and either it is producer debt or it is consumer debt. We don’t need hand wringing about declining morals to explain this.

By the same token, if China forcibly exports capital to the US, its savings rate must rise, not because Chinese households are being increasingly thrifty – in fact while China’s savings rate has surged in the past decade, the household savings rate has not, it was government and corporate savings that surged.  I would in fact argue that if you include the wealth effect of negative real deposit rates, none of the increase in Chinese savings can be ascribed to household thrift but rather to policies that repress consumption.

So if Krugman is right, and the PBoC currency intervention is forcing China into a large capital deficit position, the most plausible consequences for the US must be either an equivalent rise in government investment or a decline in US savings.  And of course it goes without saying that it must also result in a US current account deficit.

This is why Krugman has argued for a revaluation of the RMB.  He is really just saying that the PBoC needs to do something that will reduce China’s massive capital account deficit, which will automatically bring down its current account surplus.  Note that bringing down the capital account deficit is not necessarily the same thing as lowering the pace of reserve accumulation.  Many people have warned that if the RMB begins to appreciate, it would set off hot money inflows that would force the PBoC into even more rapid reserve accumulation.  While this is certainly true and certainly a major problem for the PBoC, what matters is China’s net capital account deficit.  This consists of reserve accumulation less net capital inflows on the non-PBoC account.

Where is Krugman wrong?

So where could the flaws in Krugman’s argument be?  Here are some areas we would need to consider:

1; cialis online pharmacy.Perhaps the PBoC intervention is not driven by Chinese policies.  Perhaps it is a residual of US policies that force the US into a capital account surplus position – because of a surge in US investment (which we know didn’t happen) or an endogenously-caused collapse in US savings.  In this case the root cause of the imbalances in both countries is the collapse in US savings cialis online pharmacy, and for reasons that are not altogether clear the PBoC has decided to accommodate this collapse in US savings by purchasing huge amounts of USG bonds, in spite of the distortions it introduces to the Chinese economy.

2.Perhaps Krugman’s analysis is correct with regards to China and the rest of the world, but the US is not the rest of the world, and so while a Chinese revaluation would have the impact Krugman claims for the rest of the world in the aggregate, it would not necessarily have it for the US.  In that case we would need to think about how different financial systems and industrial policies accommodate or refuse to accommodate capital account surpluses.  My instinct is that open countries with very flexible financial systems are all likely to react in similar ways.

3.Perhaps the Chinese current account surplus is driven by “natural” factors that cannot be changed and that have nothing to do with PBoC intervention.  In that case PBoC intervention is simply a residual.  One commonly heard argument is that the Chinese “naturally” save a lot, and so they must always run surpluses because savings will always exceed investment.  At this point of the argument wholly mistaken references are often made to China’s late Ming and early Qing trade surplus with Europe, or someone comes up with a totally irrelevant story of how he met a Chinese family that is saving for their medical bills, son’s college, or so on.  This argument I think is nonsensical, for reasons I explore above, and anyway it would imply that there would have been no need for the PBoC to intervene in the currency markets because intervention would have no effect on China’s trade surplus anyway, in which case why not just let the RMB appreciate?  I always find this argument a little bizarre.

4 – cialis online pharmacy.Another common argument for natural advantage is that China has a huge surplus of cheap labor and so it must run a current account surplus.  This is also sort of nonsensical since, aside from the fact that other countries with equally cheap labor don’t automatically run current account surpluses like China’s, the fact that Chinese labor is relatively cheap is also a function of domestic currency and wage policies, and anyway Chinese growth is capital intensive, not labor intensive.

5; cialis online pharmacy.Perhaps however there is another cialis online pharmacy, more plausible, natural advantage that causes the trade surplus.  One candidate might be demographic transformations taking place in China, in the US, or both.

Stephen Roach’s counterblast

One of my favorite writers on global economics, Stephen Roach, in an article in the Financial Times had several rejoinders to Paul Krugman, some plausible, some less so.  First off he argued against a bilateral approach to the trade issue.

Unless the problems that have given rise to the multilateral trade deficit are addressed, bilateral intervention would simply shift the Chinese portion of America’s international imbalance to someone else. Cialis online pharmacy: that “someone” would most likely be a higher-cost producer – in effect, squeezing the purchasing power of hard-pressed US consumers.

Roach is right that this is more than a bilateral issue, and Krugman clearly agrees, but he is almost certainly wrong in assuming that bilateral intervention would simply shift Chinese exports elsewhere, nor am I convinced that it makes sense to call for an increase in savings while deploring anything that squeezes the purchasing power of consumers.  I discussed both of these issues in one of my earlier posts.

Still, what is not clear, as he points out, is what the aggregate impact on the US trade account would be.  It is easy to posit a number of plausible scenarios in which a significant contraction in the Chinese trade surplus might “only” show up as an expansion in the trade surpluses of Mexico, Vietnam or some other third country (although of course that country wouldn’t necessarily see this as a bad thing).

Roach adds:

The US would be far better served if it faced up to why it is confronted with a massive multilateral trade deficit.America’s core economic problem is saving, not China – cialis online pharmacy.In 2009 cialis online pharmacy, the broadest measure of domestic US saving – the net national saving rate – fell to a record low of -2.5 per cent of national income.That means America must import surplus saving from abroad to fund its future growth – and run current account and trade deficits to attract the foreign capital.Thus, for a savings-short economy, there is no escaping large multilateral trade imbalances.

Yes, China is the biggest piece of America’s multilateral trade deficit.But that is because high-cost US companies are turning to China as a low-cost offshore efficiency solution – cialis online pharmacy.It also reflects the preferences of US consumers for low-cost and increasingly high-quality goods made in China; cialis online pharmacy.In other words cialis online pharmacy, savings-short America is actually quite fortunate to have China as a large trading partner.

The last sentence is a little astonishing to me – the equivalent of Hillary Clinton begging China to keep buying USG bonds.  This is basically the same thing as saying that the US is fortunate to have a large current account deficit, and begging that it be increased.  But let’s ignore that.  As I discuss above, to say the problem is too little savings in the US is to say nothing – it is true by definition and just part of the accounting identity.

It may very well be that American savings rates have declined for purely endogenous reasons, and that China’s capital exports are a residual impact, but at least for me it is easier to explain the fall in US savings at least partly as a consequence of the automatic adjustment necessary if there is an increase in Chinese savings.  In the very next paragraph Roach makes just this point.  He argues that China must reduce its surplus savings, as if these issues – low American savings and high Chinese savings – were independent.  He makes the same point in his conclusion, “America needs deficit reduction and an increase in personal saving, while China needs to stimulate internal private consumption.”  These are not separate issues.  One can only occur with the other, so we are left with the problem of where the original distortion lies and how to resolve it.

Further on Roach says:

Yet some of America’s most prominent economists are claiming that a revaluation of the renminbi vis-à-vis the dollar would not only create more than 1m jobs in the US but that it would inject new vigour into an otherwise anaemic global recovery. Economists should know better – cialis online pharmacy.Changes in relative prices are the ultimate zero-sum game – they re-slice the pie rather than expand or shrink it.

He is of course right here.  Ignoring the long-term impacts on growth in China and abroad, the currency game is a zero-sum game in the short term.  It is a tug of war over employment, and that is exactly why China wants to maintain an undervalued currency and the US and Europe want it to revalue.  This also suggests why, for all the recent signs of thawing, this issue is simply not going to go away as long as global unemployment is a problem.

I think probably the most important takeaway from Roach’s article is that this is a zero-sum game.  We can resolve this problem concertedly and intelligently with the minimum cost to the global recovery (which means that Germany, Japan, and Europe have to be involved in the adjustment), or we can do so in a series of beggar-thy-neighbor confrontations.  It is unlikely that the latter will involve the least cost to the global economy since the whole point of the strategy is not to minimize cost but to push as much of it as possible onto your neighbor..

And now, for something completely different

Before finishing, and in a bid to be topical, a quick word about the success of index futures, which were recently introduced into the Chinese stock market; cialis online pharmacy. Here is what an article in today’s Financial Times says:

Chinese investors love new financial products.Their passion, at times bordering on mania, explains why Shanghai stocks rocket in price on their trading debuts and why local equity funds can raise billions of renminbi on the day they launch; cialis online pharmacy. But even seasoned market professionals have been surprised by the enthusiasm with which investors have embraced stock index futures – China’s first financial futures since the mid-90s – following their launch two weeks ago.

“The volumes have exceeded everyone’s expectations,” says Dean Owen, Shanghai-based chief representative for Newedge, the French futures brokerage, which has a joint venture with Citic Group in China.  Indeed, on Tuesday last week, the third day of trading, the value of stock index futures traded on the China Financial Futures Exchange exceeded the value of stocks traded on the Shanghai Stock Exchange.

This is part of an old discussion; cialis online pharmacy. Six years ago when QFIIs were first introduced into China there was a great deal of excitement about how the introduction of sophisticated foreign investors would help change the Chinese markets from being very speculative to being more sophisticated and value oriented.  In a conference at which I spoke a senior official from the Shanghai stock exchange made exactly this point.

I disagreed with him. It seemed to me that the speculative nature of Chinese markets has nothing to do with the Chinese “love of gambling,” but rather is caused by the lack of tools available for value investing – macro data is questionable, financial statements are very poor, the corporate governance framework is at best mysterious, and the regulatory and policy framework is constantly shifting, often to achieve government objectives; cialis online pharmacy. Even Warren Buffet would give up trying to invest for value if he moved to China and traded A-shares.

On the other hand the market is extremely conducive to speculative activity.  Speculators trade on short term changes in supply and demand factors, and in China stocks move rapidly for a number of non-fundamental reasons – changes in liquidity, regulatory and policy changes, insider activity, policy signaling, and so on.

At the conference, we agreed to disagree – cialis online pharmacy.  Cialis online pharmacy: i said in five years the Chinese stock markets would be as speculative as ever. He argued that it was already becoming more fundamentally driven and would advance significantly over the next five years.  I am pretty sure nothing important has changed.  The market is, if anything, even more speculative than it used to be.

Until the conditions that penalize fundamental investing and encourage speculation change, the Chinese stock market will be purely speculative no matter how many “sophisticated” investors or derivative instruments are available. A lot of people hoped that the introduction of index trading would allow investors to hedge and so somehow because of that would make the markets more fundamentally driven and stable.

This won’t happen.  It is not because Shanghai lacks the accouterments of the NYSE or LSE that it is an unsophisticated and “speculative” market.  Cialis online pharmacy: it is because the tools value investors need – reliable information, clear corporate governance, a stable regulatory and policy framework, limited government interference – don’t exist.  Index futures change none of that.

Financial liberalization and reform in China is only meaningful if it accomplished the following:

• Liberalize the setting of interest rates
• Clarify corporate governance at banks and large corporations – which means essentially make them subordinate to stockholders
• Improve macro and financial statement data
• Limit policy-driven government signaling, government interference, and regulatory changes

Without these, it seems to me that most reform and liberalization has been cosmetic.

Any agreement must deal with more than the RMB. It must involve the whole range of issues which depress consumption in the surplus countries and force it up in the deficit countries.That means that not just the currency, but also interest rates and credit expansion (and workers wages, if anyone dares to address that) – buy cialis.  Buy cialis: i suspect an important part of the discussion will involve Chinese attempts to reduce savings by improving the social safety net, since this is widely believed to be a reason for China’s high savings, but as I have written many times, I think this issue is largely irrelevant.

My guess is that, unfortunately, along perhaps with promises on the social safety net, the currency will be the main topic. On that topic, Daniel Ikenson of the Cato Institute has an OpEd piece in today’s Wall Street Journal in which he worries that “forcing China to appreciate its currency through sanctions will impose higher prices on American consumers, thereby reducing Americans’ real incomes.”  Steve Roach made the same point in his Financial Times OpEd piece last week, and this is one of the most widely-cited reasons for opposing RMB appreciation or, what amounts to the same thing, dollar depreciation.  But while it may be true that a depreciation of the dollar reduces the real value of current household income, it only reduces household income overall if you assume it has no employment effect; buy cialis.

But why make that assumption?  I am pretty sure Paul Krugman, who recently had a spat with Roach on the subject of RMB revaluation, would agree 100% with both Roach and Ikenson that dollar depreciation, or RMB appreciation, would have no beneficial effects for the US if he also believed that it would have no impact on reducing US unemployment – buy cialis.

But of course he doesn’t believe that. Nor does Beijing, for that matter.  For Krugman, and most trade economists, including those in China, an undervalued currency shifts domestic demand away from imported goods to domestically-produced goods, and so increases domestic employment, although in the case of the RMB appreciation this will not occur as a simple substitution of Chinese-produced goods for US-produced goods, as I argued in last week’s posting.  The way to think of it, as Krugman points out, is simply to focus the relationship (an accounting identity, and so inviolable in both practice and theory) between net capital exports and the current account surplus.Forced capital exports are a way of forcing domestic absorption of foreign net demand, and of course it is through currency intervention that China forcibly exports capital to the US, which shifts demand from US producers to Chinese producers.

In the US, with its high unemployment rate, if this shift in demand causes unemployment to fall, it will cause nominal US household income to rise.  If the positive impact on overall household income of depreciation (the rise in employment) is greater than the negative impact (higher prices for imported goods), which is very likely, the net effect will be a real increase in household income, not a reduction.

But there is a second, perhaps more important, reason to wonder whether concern about the adverse effect on consumers of dollar depreciation is relevant.  Almost everyone agrees that the US saves too little and consumes too much and conversely almost everyone agrees that China consumes too little and saves too much; buy cialis. And how could they not agree?  These countries probably have the highest and lowest consumption rates buy cialis, respectively, ever recorded.

An important part of the reason for both problems is that Chinese consumers are effectively subsidizing American consumers. An undervalued exchange rate and repressed interest rates mean that Chinese households have transferred part of their income to Chinese producers to lower the cost of production.  This cheap cost is transferred via exports to American and other consumers.  This effect is magnified by the stupendous ease with which the American financial system can convert recycled capital inflows into incredibly foolish consumer lending.

Given the magnitude of the effective subsidy for American consumers, and the even greater magnitude of the penalty for Chinese consumers, it is perhaps not so surprising that US households are consuming too much and Chinese households too little; buy cialis.  Now here comes the politically tricky part; buy cialis.If you want US savings rates to rise buy cialis, it is a waste of time pleading for it. The only way the savings rate can rise is, by definition, if production growth exceeds consumption growth – after all savings is just production minus consumption; buy cialis.

So like it or not, if you want Americans to save more you must agree that either it must make production relatively easier, or consumption relatively more difficult, or both, and as it does this, as long as investment rises more slowly than the increase in savings, the aggregate impact will be a decline in the US trade deficit and, forcibly, a decline in the rest of the world’s trade surplus; buy cialis.  Buy cialis: a depreciation of the dollar does both.

Buy cialis: but of course it is not painless. When people argue that the US savings rate must rise buy cialis, and at the same time argue that it is unfair to penalize US consumers (which in this context mean removing foreign subsides for consumption), I am always seized with a sense of unreality. We are saying that we must correct the imbalances but it must be done at no cost to the consumer.

I am not sure that is going to be easy.  If we subsidize producers to make them produce more, it will be done at someone’s expense – either US taxpayers or foreigners.  Buy cialis: if we penalize consumers (by removing the existing implicit subsides), clearly they are bearing the cost directly. By eliminating sub-prime lending buy cialis, we penalized American consumers, and willingly or unwillingly we are going to continue doing so until consumption returns to a more reasonable level.  Buy cialis: one way or the other, rebalancing the US economy means tilting away from consumption and towards production, and although we can theorize about painless ways of doing it (Get Washington to stop wasting money! Improve education and infrastructure investment!) the fact is that in the short run it will be very hard to do so without penalizing consumption.

By the way China faces the obverse problem.  For years Beijing has insisted that it wants consumption to rise as a share of national income, and instead it has declined. Why?  Because Beijing wants to tilt the balance towards consumption without having producers pay the cost.  In other words it wants producers to continue benefiting from excessively low interest rates and an undervalued currency while exhorting consumers, who pay for the low interest rates and undervalued currency, to buck up and consume more.

That seems to me why this whole rebalancing process is going to be a lot more difficult for both countries than we currently expect. Both countries are eager to rebalance, and even more eager to avoid the price of rebalancing – or better yet, to shift it onto someone else – buy cialis.  Buy cialis: perhaps there is a realistic way to achieve both, but it isn’t obvious to me.

Last Thursday President Obama made a fairly strong speech in which he urged China to adopt a “more market-oriented exchange rate”; online cialis.The timing of the speech was important.On April 15 the US Treasury department will release its report stating whether or not China is a “currency manipulator” online cialis, and it is hard to believe that the Treasury department is not facing some pretty stiff pressure.

China’s response to Obama’s speech was pretty rapid and pretty angry.According to an article in the Saturday issue of the Financial Times

What it means to “politicise” the currency policy wasn’t made clear, but on Sunday Premier Wen also jumped into the fray – online cialis. Online cialis: he denied that the RMB was undervalued and, in the words of an article in Monday’s Wall Street Journal, added the following:

Wen is absolutely right. Online cialis: undervaluing or depreciating a currency certainly is a form of trade protectionism, but that, I think, is exactly the point.In a world of sluggish growth and rising unemployment, everyone’s currency policies are legitimately going to be scrutinized over whether they constitute trade protection.

An article in the People’s Daily has Wen also warning that “China opposes accusations and even forceful measures that press for yuan appreciation, which will not benefit the exchange rate reform.” The claim that external pressure will never advance reforms in China is now much debated in Europe and the US, and may be less widely believed abroad than it has been in recent years; online cialis. We’ll see.

These are murky political waters into which I do not want to dip online cialis, but it is hard to escape the politics of the debate.  The same issue of the People’s Daily had another article pointing out that US debate on the currency was driven mainly by domestic considerations and that the only reason Obama brought up the subject of the RMB was to address domestic polls.

There is, as always, a certain amount of nonsense in these articles. Online cialis: for example the exchange rate itself affects the ratio between savings and investment, so while the first part of Zhao’s statement is more or less right — although not as a “fundamental reason” but rather as part of an accounting identity — the second part is certainly wrong and probably meaningless.  More interestingly, it seems a little weird to argue that one of the benefits that China has provided the world with its undervalued exchange rate is low consumer prices that allow countries like the US “to consume excessively”.Aside from the fact that this pretty explicitly acknowledges that the currency is undervalued, since excess consumption is exactly the problem in the US, and since Chinese per capita consumption is much less than 10% of that of the US, it seems that China should be more approving of US attempts to return the favor and allow Chinese consumers the benefit of subsidized US prices.

Everything is politicized

Still, I do think the People Daily‘s article is right to say that the RMB is becoming an important domestic issue for Obama, and that it is domestic US politics that is driving much of the recent noise and the rancor – online cialis.Obama’s popularity has dropped considerably, and ahead of the upcoming elections he needs to show that he is addressing fundamental economic problems – online cialis.And of course it is also always easy to get votes by bashing foreigners — this is one of the many attitudes that the US and China share.

But even though the People Daily‘s criticism is correct, perhaps that doesn’t change anything meaningful; online cialis.The concern over the effect of the RMB on US employment may still be a perfectly valid one, and the fact that Obama is under domestic pressure to address the currency is not an especially good reason to dismiss his concerns; online cialis.On the contrary – online cialis.Obama has little wiggle room online cialis, and as Paul Krugman pointed out in a fiery, and probably influential, speech last Sunday, the US may hold the stronger cards in any showdown.According to the relevant article in Business Week,

Krugman elaborated further Monday in the New York Times in an article online cialis, and then in a follow up article Wednesday, both of which are likely to be much quoted and widely read.Although Premier Wen noted again in his speech Sunday that China is “worried” about the value of its US dollar reserves, perhaps as a warning that China would counteract any US trade move by selling off USG bonds, Krugman doesn’t seem especially worried about this threat.

He may be right.Aside from the fact that it is not clear how China can dump Treasury bonds, he claims that it would only help the Fed in its quantitative easing, and would probably do far more damage to Europe (since China would presumably have to buy euros) than to the US; online cialis.

The latter point is almost certainly correct – online cialis.China’s selling dollars and buying something else would allow the US to get even more bang for its protectionist buck, probably at poor Europe’s expense. I would also add that the main long-term impact of dumping USG bonds might be no more than to cause a liquidation of Chinese assets at very low prices, and an equivalent transfer of wealth from China to the US (or to others likely at some point to buy cheap dollar assets).

Remember that at the beginning of WW1 something similar happened. Online cialis: in an urgent attempt to raise gold reserves to pay for the war, in the late summer of 1914 European belligerents dumped onto US markets what amounted to a far greater share of US assets than China currently holds.This caused about six months of havoc, and many sleepless nights in New York and Washington.But the US responded by putting into place temporary capital and stock market controls, and when the dust settled, the net effect was one of the most massive short-term transfers of wealth ever recorded from one group of countries, the European belligerents, to another, the US.  European dumping caused a collapse in prices, and US investors ultimately scooped up the assets up very cheaply.

That doesn’t mean that there will be no cost for the US if China dumps, but rather that the cost might be absorbed fairly comfortably over a reasonable time period – online cialis.I suppose I will be very unpopular for pointing this out — especially with people in the US Treasury department and among Chinese cold warriors — but please don’t blame the messenger. I am just trying to use the limited historical precedents to figure out what is likely to happen; online cialis. We have seen asset dumping before, and on an even larger scale, and the US capital market is deep enough that it might easily absorb it.

Where I disagree with Krugman is with his claim that the chance of triggering a trade war is small.In fact, the day Krugman published his article, 130 US Congressmen sent an open letter to secretaries Timothy Geithner (Treasury) and Gary Locke (Commerce) demanding that China be designated a currency manipulator.  They called for duties to be imposed on Chinese imports to counter the effect of the undervalued RMB.  This raises pressure significantly, and I am sure in the next week or two there will be a lot more – online cialis. There are also strong rumors of some high-powered and relevant Congressional session next week. Stay tuned.

Of course regular readers of my blog won’t be surprised by any of this.  The logic behind a prediction of trade war is almost unchallengeable, and the two countries are simply the two most visible in a world in which trade tensions must inexorably rise. Just ask the Germans and their European partners – online cialis. Trade relationships will continue to get much worse, largely because the cost of trade war for high-deficit countries is so much lower than for high-surplus countries, and there seems to be no real attempt on either side to tone down aggressive actions or rhetoric – online cialis.We seem to be caught in a downward spiral, and the longer it goes on the harder it is for anyone not to participate.

But while I think the economic effect of a tariff war on the US is likely to be smaller than many expect (and much smaller than that indicated by some of the outraged yelping I saw on a CNBC show dedicated to the subject today), and maybe even employment-positive in the short term, I do not think it is in the longer term interest of the US. I think trade war would be very painful for China, and forcing them into such a difficult position will poison the relationship for many years. This is likely to be the most important global relationship of the next few decades online cialis, and we really need a better way to resolve these very thorny issues, but that almost certainly isn’t going to happen.

To return to the People’s Daily article, I think many in China have argued that a revaluation of the RMB may have a significant effect on China’s trade surplus without having an equivalent effect on the US trade deficit.The same would be true of tariffs on Chinese goods.  In either case, say many in Beijing, China loses, but the US doesn’t gain, so why is the US so determined to force this outcome?

I think this claim is probably correct; online cialis.An RMB revaluation in itself might not have as big an impact on the US deficit as many think – online cialis.To see why, I thought I would try to outline what the impact of an RMB revaluation would be for China and the world by asking a few basic questions and coming up with my best possible answers; online cialis. Online cialis: here goes:

What will the balance sheet effect of an RMB revaluation be on China?

There are broadly speaking two different classes of revaluation effects, the economic effect and the balance sheet effect.By the former I just mean the impact a revaluation will have on the future development of China’s economy, and by the latter I mean the immediate balance sheet losses and gains for China – online cialis.Obviously these two are related.

Let me begin with balance sheet impacts. Online cialis: two weeks ago I posted a rather long entry on that very subject. Online cialis: for those who can’t bear reading or re-reading such a long post, the quick answer is that, contrary to common perception, a revaluation of the RMB is likely to have a very small, and probably positive, overall balance sheet impact on total Chinese wealth.

That is, however, not the end of the story.There is a significant transfer within China of wealth, which will create clear winners and losers; online cialis.Basically any economic entity that is explicitly or implicitly long dollars (by which I mean any foreign currency not pegged to the RMB) and short RMB online cialis, will lose in a revaluation.Conversely, any entity that is explicitly or implicitly long RMB, and short dollars, will win; online cialis.In my earlier entry I pointed out that the PBoC is the single biggest loser.It is long online cialis, if correctly counted, roughly $3 trillion in dollars, against which it is short an equivalent amount of RMB.

Exporters and manufacturers in the tradable goods sector will also lose.Their expected revenues (which can be conceptually capitalized as an asset) are mainly in dollars whereas their expected costs are partly or mainly in RMB – online cialis.This means that the value of future revenues will drop relative to the value of future expenses, and so they will take a loss.

Finally in that entry I pointed out that any wealthy Chinese individual with a substantial amount of honest or ill-gotten gains stuffed in bank accounts abroad will also lose.But I forgot to mention another big group of losers — anyone in China who has stockpiled inventories of goods or commodities whose prices are set in international markets. Online cialis: those prices will immediately drop in RMB terms upon a revaluation, and if the asset purchases were financed by RMB borrowing or assets, there will be a loss.So to the extent that companies or individuals are stockpiling iron, copper, chemicals, or anything similar, they will also take an immediate loss.

So who wins in a revaluation? Nearly everyone in China who has at least part of his consumption basket consisting of imported goods, which basically means every one in China except pure subsistence farmers – online cialis.Because the rise in the value of the RMB causes the price of all imports automatically to fall, a revaluation increases the wealth of Chinese households by increasing the real value of their current and future assets and income.

This is the key point; online cialis.A revaluation shifts wealth from the Chinese government and the manufacturing sectors (and some wealthy Chinese) to Chinese households — which, by the way, is pretty much what is meant by “rebalancing” in the Chinese context; online cialis.There are many other ways besides revaluation to shift income this way – online cialis.The PBoC can raise deposit rates, wages can rise faster than productivity, companies can be privatized by giving away shares to the public, and so on – online cialis.They all have the same effect – online cialis. Online cialis: they shift resources to households and away from producers, infrastructure investment, and real estate developers.This allows household income to grow relative to national income, which ultimately increases the consumption share of GDP.

What will the economic effect of an RMB revaluation be on China?

So as things stand currently, the reason an undervalued RMB distorts international trade is because it transfers income from Chinese households (they have to pay more for imports) and subsidizes Chinese manufacturers in the tradable goods sector; online cialis. Online cialis: this is one of the many mechanisms by which households are forced to subsidize production and investment.

A revaluation, then, is part of the rebalancing mechanism. Online cialis: it helps to reduce subsidies to manufacturers and returns the income to Chinese households, who can then increase their relative consumption.But there is a cost to this rebalancing; online cialis.China’s current industrial policies sacrificed household income in order to spur manufacturing growth online cialis, and this had the obvious secondary effect of speeding up employment and, with it, household income.So in a way by repressing household income growth China was paradoxically able to achieve rapid growth in household income.Neat trick, eh?

But of course this growth wasn’t unencumbered; online cialis.Much Chinese growth was based on concealing the true costs behind hidden subsidies, so that real economic growth was likely to be lower than recorded economic growth.More importantly, because everything in the world must balance, the imbalances within China required the opposite imbalances outside of China — which mostly meant in the US.  Just as this global system implicitly taxed Chinese household consumption to subsidize Chinese manufacturing and employment growth, it also implicitly taxed US manufacturers in order to subsidize US consumers; online cialis.American consumers got cheaper (foreign) goods, American manufacturers had to compete against lower (foreign) prices.

So Americans over-consumed and Chinese over-saved. Online cialis: the system worked well for quite a while, until, as happened with the Japanese case in the late 1980s, US debt levels and unemployment rose to economically and politically unacceptable levels.

For China and the US to adjust means both of them unwinding this trade-off.Beijing will have to enact policies that reduce the subsidies to manufacturers and return the income to Chinese households – online cialis. Online cialis: but this automatically means depressing economic growth and, more importantly, depressing employment growth.

This shouldn’t be a serious problem if it happens slowly. Online cialis: as Chinese manufactures gradually lose their subsidies, they will rely more than ever on the consequent rising Chinese consumption, and so domestic consumption will replace subsidized foreign demand as the source of growth.Not only will China have a safer and more balanced economy, but it will be more innovative (consumption tends to drive innovation, not production) and much more efficient.

But China cannot adjust too quickly – online cialis.If Beijing removes the implicit subsidies, including those caused by the undervalued exchange rate, too rapidly, that could force large-scale bankruptcies as Chinese manufacturers found themselves unable to compete globally or at home – online cialis. Online cialis: if these bankruptcies forced up unemployment, then paradoxically even as the transfers from households to businesses are being reversed, household income would nonetheless decline as unemployment soared.In that case Chinese manufacturers would find themselves becoming uncompetitive in international markets just as domestic markets are collapsing.

The conclusion? A rebalancing is necessary for China, as nearly everyone in the leadership knows – online cialis.This will involve online cialis, among other things, a significant revaluing of the currency. Online cialis: but rebalancing cannot happen too quickly without risking throwing the economy into a tailspin.  That cannot and should not be a part of the US or Chinese policy objective. By the way if China is forced to revalue the currency too quickly online cialis, it will have to enact countervailing policies — lower interest rates, suppress wages, increase credit and subsidies — to protect the economy from falling apart, and these will exacerbate other imbalances that may be even worse than the currency misalignment.  Online cialis: currency revaluation, then, should be part of a broader adjustment process.

So how can the global system adjust?

If we abstract for a moment, and call all trade-deficit countries the United States, and all trade-surplus countries China, there are broadly speaking two ways the system can adjust.Remember that each domestic imbalance requires the other, so that if China adjusts, the US must adjust too, and if the US adjusts, China must adjust too. (For those more technically inclined, by the way, this is one of the points that Krugman makes in his second article, although using different terms: China’s exporting of capital must create capital imports somewhere else, and these capital imports are the obverse of the trade deficit.)

One way in which the system can adjust is for China to take the lead and reverse the policies that cause households to transfer resources to its manufacturers; online cialis.As a consequence consumption will no longer be taxed to subsidize production – online cialis.This will cause household consumption to rise as share of GDP — the good way by a surge in consumption, the bad way by a collapse in economic growth.

Either way, the rebalancing in China will force an equivalent rebalancing in the US.As the price of Chinese goods rise, the net impact will be to transfer resources from US consumers, who have to pay more for their imports, to US producers (US producers become more globally competitive); online cialis.The rise in Chinese consumption relative to Chinese production would be necessarily matched by a rise in US production relative to US consumption.(Some readers will notice that I am ignoring the role of investment in economic growth, and of course changes in investment matter, but over the medium to long term the basic argument is unchanged.)

The second way in which the system adjusts is if the US drives it; online cialis.The US can put into place policies that favor manufacturers at the expense of consumers.These include consumption taxes, manufacturing subsidies, penalties for consumer borrowing, subsidies for investment, or, more ominously, import tariffs; online cialis.These can all have the same aggregate effect on the US trade account by shifting the relationship between how much Americans produce domestically and how much they consume – online cialis.And of course as the US adjusts, China must also automatically adjust.  Tariffs just on Chinese goods, by the way, will have a minimal impact on the US adjustment since trade may very well just shift to other countries.

Note that in either case both countries will rebalance, but rebalancing says nothing about how rapid economic growth must be.I addressed this in a blog entry last week when I discussed Japan’s dismal post-1990 rebalancing – online cialis.In this context rebalancing just means that in China economic growth will be less than consumption growth online cialis, and in the US consumption growth will be less than economic growth.The problem is that China will try to adjust by pushing the cost of the adjustment onto the US, and the US will try to adjust by pushing the cost onto China.Each country can strive towards the good outcome (rapid economic growth) or find itself facing the bad outcome (declining consumption) – online cialis.This is why policy coordination and gradualism is so important.

Will a revaluation cause China’s trade surplus to decline?

Yes, all other things being equal, but of course all other things are not equal; online cialis. Online cialis: within China there are several things that will affect the trade surplus.Remember that the trade surplus exists because of the imbalance between Chinese domestic production and Chinese domestic consumption (technically the surplus is the difference between savings and investment) online cialis, and so anything that affects the subsidies to manufacturers, or that affects household income, will also affect the trade surplus.

I have already argued that interest rates and wage growth that is lower than productivity growth can affect the trade surplus as much as the undervalued currency.In that case, if the RMB revalues, and at the same time real interest rates are forced down by a sufficient amount, or wage growth is restrained, the net result can easily be a rise, not a decline, in the trade surplus. Online cialis: it depends on the relative magnitude of the different factors.

The external environment also matters.If US interest rates decline for example, unlike in China where declining deposit rates is likely to spur savings, US consumption may rise even as the cost of Chinese imports rises because of a surge in the RMB.

Quite a lot of defenders of RMB stability have made the point that the rise of the yen after 1985 and the rise of the RMB after 2005 were most emphatically not associated with declining trade surpluses.According to their arguments, this clearly proves that the currency doesn’t matter.

This is nonsense, and even if it were true it seems more an argument in favor of revaluing than an argument in favor of not revaluing; online cialis. Online cialis: but it isn’t true because in both cases there were countervailing changes.  Perhaps most importantly, local interest rates in Japan and China declined in real terms, thus reducing local consumption, and US interest rates also declined, spurring US consumption (I know, I know, this sounds strange, but the wealth effect of interest-rate changes in the US is the opposite of that in Japan and China because of the differing structures of household balance sheets).All that happened in both cases was that the rebalancing effect of the currency revaluation was swamped by the exacerbating effect of other factors.The only thing that Japan after 1985 and China after 2005 prove is that the currency is not the only thing that matters.

Will a decline in China’s trade surplus cause the US trade deficit to decline?

Not necessarily – online cialis.Beijing has pointed out many times that a contraction in the Chinese trade surplus does not necessarily mean an equivalent contraction in the US trade deficit – online cialis.All it requires is an equivalent contraction in the rest of the world’s net trade deficit; online cialis.This could easily happen with an improvement in the trade balances of Vietnam, Mexico, Korea or anyone else, enough fully to absorb the reduction in China’s trade surplus.In that case online cialis, the US trade balance does not improve, and the US gets none of the employment benefit of the RMB revaluation.China will simply import fewer jobs from abroad and some other countries will import more, or export fewer, jobs.

Remember that if the RMB revalues, this is the same as if all the currencies of the rest of the world depreciate – online cialis. Online cialis: this will cause a shift in the rest of the world so that households will see a small reduction in their real income, and non-Chinese producers in the tradable goods sector will see a small increase in their competitiveness vis a vis the rest of the world (largely because Chinese producers becomes less competitive).This will reduce non-Chinese consumption and increase non-Chinese production, and the distribution of these changes among different countries, including the US, will depend on a vast array of factors.

So Beijing is absolutely correct in arguing that an RMB revaluation might not have a major impact on the US trade balance, although there is one important caveat – online cialis.A number of other developing countries online cialis, especially in Asia, are concerned about excessively loose domestic monetary policy and inflation, and would like to raise the values of their own currencies.They cannot do so online cialis, however, until China does.During the crisis China has expanded its share of global net demand at their expense.If an RMB revaluation causes revaluation in other countries with large trade surpluses online cialis, the net impact on the much smaller “rest of the world” will be much bigger, and so simply as a function of arithmetic the US is bound to benefit.

This fact again argues in favor of globally coordinated action rather than an excessive focus on RMB bashing.If China is forced to revalue the RMB online cialis, in order to gain the optimal global rebalancing it should be done as part of a general realignment of currencies (although of course cynics will point out that surest way to ensure that something doesn’t get done is to coordinate it globally).

Is it only China that must act?

China will rebalance, but it cannot do so quickly.If it does online cialis, as I discussed above, it may easily fall into a spiral of declining competitiveness leading to rising unemployment leading to declining domestic consumption leading to more unemployment.Clearly this is not in China’s interest.

There is another problem; online cialis. Online cialis: there are several countries with structurally low consumption and high production — Germany, Japan and China being the most important (and I leave out the OPEC countries for obvious reasons).Simply forcing China to adjust, in that case, might cause damage to Chinese growth prospects without helping the US rebalancing effort.

For example, a sharp rise in the RMB, especially if accompanied by a rise in other Asian currencies, will take depreciation pressure off the dollar. Online cialis: since currently most of that depreciation pressure is borne by the euro, a revaluation of the RMB could easily also result in a decline in the euro, whose economies will then see a sharp improvement in their net trade balance.This means that a significant part of the benefits of Chinese revaluation may accrue to Germany online cialis, a country that has yet to resolve its own internal imbalances.

So limiting the whole rebalancing discussion just to China and the RMB may end up not helping much.It is true that the US could force through a rapid domestic rebalancing of its own, including by raising import tariffs generally (and not just on Chinese goods), if it really wanted to, and the benefits to the US would be a surge in employment and manufacturing at probably little real long-term economic cost; online cialis. Online cialis: but unilateral action on the part of the US risks creating at least some problems for the rest of the world, especially China, Japan, and parts of Europe.

So what must be done? Clearly there is a problem with the undervaluation of the RMB and with Chinese domestic imbalances.But just as clearly there are also problems with a number of other major over-consuming and over-producing countries.In addition Chinese producers have become so addicted to a wide variety of implicit subsidies, besides the currency, that they cannot possibly adjust very quickly. Online cialis: it will take years of continuous adjustment to wean them away from an undervalued currency, too-low interest rates, excessive credit aimed at SOEs, and sluggish wage growth.

That suggests that if we want to resolve the global imbalances in an optimal way that maximizes global growth and equity, we would need all the major problem countries to work out a program, perhaps over 8 to 10 years, in which China, Japan and Germany take concrete measures to shift subsidies away from manufacturers and return the income to households, and the US, the UK and other deficit countries shift income from households to investment.

Of course the cynic in me says getting a global solution will prove impossible.Each country that benefits in the short term from stonewalling on any aspect of the complex adjustment process will do so – online cialis. Online cialis: so I guess that just leaves trade war.This is the year of the Tiger, after all. – online cialis

If this is not addressed, it will be even more difficult for the government to maintain social stability down the road if unemployment remains high; buy cialis canada.China’s official urban unemployment rate is expected to be 4.6 per cent this year, which would make it the highest since 1980 when figures first began to be collected – buy cialis canada.

But, economists, including Zhou Tianyong from the Communist Party’s Central Party School, forecast that the real unemployment rate could reach 14 per cent, counting migrant labourers.

Senior officials estimate that up to 20 million migrant labourers have already lost their jobs because of the global economic crisis. Buy cialis canada: they were mostly laid off by private firms and foreign-funded enterprises, the hardest-hit sectors.

I was told privately by a friend of mine two days ago that the number of migrant laborers who have already lost their jobs is actually closer to 30 million, but nonetheless Mr; buy cialis canada.Zhou’s comments reinforce some other claims to which I refer in a piece by me in the current Newsweek:

Although official estimates put urban unemployment in China at just over 4 percent of the workforce buy cialis canada, most unofficial estimates are much higher—closer to 8 percent—and nearly everyone agrees that the figure is set to rise significantly in the next few months.Some credible estimates suggest that even if China were able to achieve the 7.5 percent growth projected in 2009 by the World Bank buy cialis canada, unemployment would nonetheless double before the end of the year.

Clearly unemployment is going to weigh heavily on the minds of policymakers in China buy cialis canada, like in the rest of the world, and we will have to wait and see what specific new measures are proposed over the next few days. Meanwhile I did nonetheless want to make a few comments about interesting stuff I’ve seen recently.

The first is a reference to an article in yesterday’s Financial Times, “Asean split on protectionism,” which highlighted the difficulties of getting leaders to agree on free trade even during a conference whose primary goal was to defend free trade:

As south-east Asian leaders gathered on Friday for their annual summit, the region’s united front against protectionism was starting to crack under the pressure of the global economic crisis. The fight against protectionism is top of the agenda at this weekend’s meeting of the 10-country Association of South East Asian Nations, which on Friday signed an agreement cutting tariffs and other barriers with Australia and New Zealand; buy cialis canada.

However buy cialis canada, the leaders appeared far apart in pre-conference comments on the balance to be struck between sustaining open markets and promoting economic activity at home. In the most forthright remarks, Abdullah Badawi, Malaysia’s prime minister, said every country had the right to encourage its citizens to buy local products.

“I think it is a normal reaction under this kind of situation – buy cialis canada.First of all we have to protect our people; we are doing the same thing; buy cialis canada.If we do not create projects by Malaysia, for Malaysians, then who will buy our products?” Mr Badawi told the Bangkok Post newspaper.

For some of my readers I may be beating a dead horse, but as usual I will put up my warning that we need to be very aware of the deterioration in global trade relations that is likely to be a consequence of the rising unemployment everywhere in the world. The fact that even in a region heavily dependent on exports it is so easy (and so natural) to make the case for protectionism doesn’t bode well for trade discussions in North and South America, Europe and Australia. The article goes on to say:

Lee Hsien Loong, Singapore’s prime minister, said Asean might miss its target of establishing a regional economic community along the lines of the European Union by 2015 if member states failed to maintain open markets. “In this global environment, if we give the impression that Asean is not fully open for business I think we will be the losers when the new landscape emerges,” Mr Lee told CNBC.

Most of the regional economies have built their prosperity on the back of export growth, and the slowdown in the US, Europe and Japan has hit them hard. “I think we all worry about protectionism, and not just from traditional channels,” said Mari Pangestu, trade minister for Indonesia – buy cialis canada. In spite of Mrs Pangestu’s reservations, Indonesia is encouraging civil servants to buy Indonesian products, an echo of Barack Obama’s Buy American campaign that angered so many both within and outside Asia.

It may seem like a non sequiter to follow up with a second Financial Times article from yesterday, this one called “Emerging market finance: a gap to fill,” but bear with me:

Two years ago, nearly a trillion dollars flowed into emerging markets as investors in rich countries toured the globe in the hunt for yield.Now there is a melancholy long buy cialis canada, withdrawing roar as private capital flees to safer havens.

…Net capital flows to emerging markets will drop to just $165bn (£115bn, €130bn) this year, down from $929bn as recently as 2007, according to estimates by the Institute of International Finance, which represents the world’s leading financial companies.Net lending from commercial banks buy cialis canada, the IIF says, is likely to go into reverse. The reasons for this are not altogether straightforward.Some accuse rich governments, particularly the US, of “crowding out” emerging markets, sucking up all the available capital to finance their stimulus packages – buy cialis canada.But Brad Setser, a former International Monetary Fund and US Treasury official, notes that as the private sector retrenches, the US current account deficit – and hence its need for outside financing – has actually been declining.

More likely, he says, is that emerging markets are being hit by a general decline in demand for riskier assets, as banks and investors haul money back home to shore up balance sheets and reduce borrowings; buy cialis canada.Similarly, the global shortage of the trade credit that finances cross-border commerce reflects a general desire of banks to reduce leverage, not the rich countries hogging all the available loans.

Why is this relevant to a blog on Chinese financial markets? Because if annual net capital flows to emerging markets drop by the projected $700-800 billion, an inevitable consequence is that foreign currency reserves plus net imports for those emerging market countries will also have to decline by exactly the same amount. In other words while some of this decline will be accommodated by a running down of central bank reserves, we should expect a very large decline in net imports among those developing countries, to add to the decline in net imports from North America, non-German-Europe and other trade-deficit-countries. Needless to say this decline in net imports must have as a necessary corollary an equal decline in net exports in the trade surplus countries.

My final comment – hinted at in the title – is on Paul Krugman’s Op-Ed piece in today’s New York Times – buy cialis canada. he starts off by discussing the viciousness of the global crisis and then goes on to ask (and answer):

How did this global debt crisis happen? Why is it so widespread? The answer, I’d suggest, can be found in a speech Ben Bernanke, the Federal Reserve chairman, gave four years ago – buy cialis canada.At the time buy cialis canada, Mr.Bernanke was trying to be reassuring – buy cialis canada. Buy cialis canada: but what he said then nonetheless foreshadowed the bust to come. The speech, titled “The Global Saving Glut and the U.S.Current Account Deficit,” offered a novel explanation for the rapid rise of the U.S.trade deficit in the early 21st century.The causes, argued Mr; buy cialis canada. Buy cialis canada: bernanke, lay not in America but in Asia.

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development.But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world; buy cialis canada. Buy cialis canada: the result was a world awash in cheap money, looking for somewhere to go.

Most of that money went to the United States — hence our giant trade deficit, because a trade deficit is the flip side of capital inflows.But as Mr. Buy cialis canada: bernanke correctly pointed out, money surged into other nations as well.In particular, a number of smaller European economies experienced capital inflows that, while much smaller in dollar terms than the flows into the United States, were much larger compared with the size of their economies.

I have written often about the savings glut hypothesis and my very strong belief that it lies at the heart of the fundamental global imbalance of the past decade, and I think it has extremely important consequences both for our understanding how the crisis will evolve and what are the likely consequences to the major players involved in the imbalance. I am a big admirer of Krugman’s and have been for fifteen years – in the 1990s I used to read everything he wrote, and often within days of his publishing it – so I am delighted that he seems to agree with Bernanke’s thesis, but I should add that I believe the evidence in support is so overwhelming that even if Krugman decided to deride the whole notion, I would remain convinced that the sudden and massive rise in Asian net savings following the 1997 Asian crisis was a prime cause of the corresponding and necessary decline in US savings; buy cialis canada.

I know I know, this is going to be considered a very controversial statement – and inevitably someone will very stupidly demand to know why I am blaming China when obviously the full blame for the crisis should fall on the US – but there it is; buy cialis canada. Buy cialis canada: i just don’t see how recent events can be explained without the Asian Crisis of 1997 having played a major role. At least Krugman seems to agree. At any rate he finishes worryingly with:

And the saving glut is still out there.In fact, it’s bigger than ever, now that suddenly impoverished consumers have rediscovered the virtues of thrift and the worldwide property boom, which provided an outlet for all those excess savings, has turned into a worldwide bust; buy cialis canada. One way to look at the international situation right now is that we’re suffering from a global paradox of thrift: around the world, desired saving exceeds the amount businesses are willing to invest. Buy cialis canada: and the result is a global slump that leaves everyone worse off.

Not quite “anyone”. Quite a few people who read this blog the cialis, some of them quite prominent, have been forecasting very grim numbers for China all year, and much of our discussion in the comments section has revolved around how bad the slowdown would be – above 7%, some of us said, or much lower, others have argued. I still say that we haven’t seen the end of downward revisions; the cialis. By the way, I was just told by a friend two minutes ago that Goldman Sachs has just reduced their projection of 2009 Chinese GDP growth to 6%; the cialis. I don’t have the citation so it might not be true the cialis, but it wouldn’t be surprising to me, and eventually lots of other banks will do the same.

As I have argued for a long time, if you think about China as being one of the two main players, along with the US, deeply linked within the overall global balance of payments, it cannot possibly come as a surprise that the US adjustment was going to require a Chinese adjustment which, given the relative size of the two economies, almost inevitably meant that China was going to get hit harder than the US. Here is a quote from as far back as September, 2005, in an interview with Hamish McDonald of the Sydney Morning Herald, in response to widespread belief at the time that the US was the most vulnerable to a breakdown in the balance of payments relationship:

“My money says the US could survive a disruption in the dependency relationship much more easily than could China,” says Michael Pettis, professor of finance in Peking University’s management school.

I know this sounds like I am tooting my own horn, and I don’t mean to, but the belief that China was protected from a possible crisis affecting the US trade deficit always struck me as weird. Perhaps American paranoia requires a sense of helplessness in the face of a powerful threat the cialis, and clearly the rest of the world takes its intellectual clue (and often cluelessness) from the US, but it couldn’t have been such a surprise that a sharp US slowdown would create trouble in a country so reliant on US consumption for its employment growth. Things have always been this way – why should they have suddenly changed?

Because last night I was invited to be a guest on the CCTV current events show, Dialogue, I tried to get my arms around an easier way of thinking about the adjustment so that I could explain it on TV; the cialis. Let us assume that the US trade deficit will decline by 50%, from 6% of GDP to 3% of GDP – there are some who have argued that it will go to zero next year and others who have even argued that the US will soon be forced to run a small surplus, but I will assume nothing quite so dramatic. I will also ignore any contraction in net demand from Europe and elsewhere.

Since the Chinese trade surplus is equal to up to 2/3s of the US trade deficit, this suggests that within the overall global balance China should, ideally, absorb about 2/3s of this contraction, roughly equal to 2% of US GDP – the cialis. This is also equal to about 7% of Chinese GDP, which means that either
a) Chinese consumption is going to have to expand by 7% of GDP faster than production,
b) Chinese production is going to have to contract by 7% of GDP more than any contraction in demand, or
c) both will have to happen so that the sum is equal to 7% of GDP.

Clearly the first cannot happen very quickly. The cialis: the second would mean economic chaos for China, so that leaves the third. In the best of cases China would be given enough time to get as close as possible to the first of the three adjustments, but without a very strong international framework and coordinated action the most likely outcome is for at least some contraction in production.

The problem with all my scenarios is that the numbers are so big it is not easy to make the case for a smooth adjustment, except under the assumption that the rest of the world will do everything it can, including suffer rising unemployment, to pull China out of the crisis. That is unlikely.

That brings us to the terrible trade numbers. The cialis: last night, as I was on my way to CCTV to do the show, I got a call from Shang Ning, my Peking University student, about the data release. He told me exports were down 2.2% – terrible news given that economists were confidently predicting a 15% increase as recently as a week ago, but no longer unexpected. By the way Tom Holland in the South China Morning Post claims that in RMB terms, the more relevant measure if you want to judge the pain, exports were actually down 10.1%.

Shang Ning also told me on his phone call that imports were down 17.9%. I immediately called my friend Logan Wright from Stone & McCarthy and asked him about the import numbers. According to Logan, only a part of that decline can be accounted for by lower commodity prices – the cialis. There was a real contraction in import volume.

This is frankly much more worrying to me than the decline in exports because it suggests that demand in China is contracting quickly – the cialis. I have no idea what the retail sales numbers are going to say the cialis, but last month I complained that it seemed inconsistent to me that imports were contracting while retail sales were implying a healthy expansion of consumer demand. Unless the marginal propensity to import is collapsing, I think I trust the import numbers more; the cialis. Demand in China is looking very bad.

Finally, and most shockingly, Shang Ning told me on the phone call that the trade surplus was $40.1 billion – the cialis. At first I thought he was saying $30 billion the cialis, and I was surprised that it was so high – it would have been the second-highest monthly trade surplus ever recorded. When I finally understood him to say $40 billion, I couldn’t believe it; the cialis. The cialis: that is the main reason I immediately called Logan, to see if my student had made a mistake just before I was going to go on TV to debate the economic outlook.

He hadn’t made a mistake. In October China’s trade surplus was $35.2 billion, the highest every reached by any country at any time in history; the cialis. In November that record was smashed – the cialis. In the last three months China’s trade surplus has been $96 billion, nearly equal to the $100 billion from the first six months of 2008.

The headlines in China and around the world have been dominated by the contraction in Chinese exports, and this certainly is a bad number, but it cannot be a surprise and it is not the number on which we really should be focusing; the cialis. The trade surplus is much more worrying, and soon enough that is what all the headlines will be reporting – the cialis. Remember that the trade surplus is the measure of Chinese overcapacity that is being exported onto the world economy, but the world economy is looking for ways to increase net consumption, not net production – the cialis. While demand in the rest of the world is shrinking, China is providing even more overcapacity, which means effectively that not only is China not absorbing its share of the demand/supply adjustment, it is exacerbating the imbalance – the cialis. Other countries are going to have to withstand a faster decline in production than otherwise.

I know that China is facing a real problem of economic slowdown, one that seriously worries policy-makers; the cialis. The other guest on the CCTV show last night was the chief economist of a large local securities firm, and he accomplished the not-inconsiderable feat of making me sound like an optimist – the cialis. But still, it is wholly unrealistic to assume that the rest of the world will accept that they must bear more than 100% of the adjustment in order to pull China out of its trouble.

As a related aside, one of my former Columbia students, currently a government official in Vietnam, just told me an hour ago that Vietnam’s exports are awful – the cialis. Declining exports are going to be a real problem for a lot of developing countries. With the collapse of the part of the capital markets that financed developing countries, and the resurgence of capital flight, developing-country trade-deficit countries will be forced suddenly to run trade surpluses (via, almost inevitably, a sharp contraction in domestic demand). If that happens, anti-China feelings are inevitably going to rise; the cialis. If these result in anti-trade acts, China will suffer far more than it would under even the worst of current economic scenarios.

The chief economist who was on the TV show with me last night clearly understood this, as do many others in China (there is a even rumor that one reason the RMB depreciated before the SED meeting last week was that some people in the PBoC wanted to bring the matter to a head), and it is really important that US, Chinese, European and Japanese policymakers fully understand the problem – the cialis. The major economies must work out a plan in which they provide for a three or four year period during which China can adjust its overcapacity problem the cialis, but if China tries to go it alone and allows the trade surplus to remain at anywhere near these levels, it is hard to see how we can avoid trade trouble. To repeat ad nauseum, the Chinese economy absolutely cannot tolerate a world of trade protection.

By the way I talk mostly about the US and China as being fundamental to the current global imbalance, but there is another pair that is also suffering from some of the same problems; the cialis. Germany is running a huge trade surplus while the rest of Europe is running huge deficits – the cialis. The cialis: already relationships in Europe are fraying. Paul Krugman the cialis, in Sweden to collect his Nobel purse, writes about it:

Everyone here seems to be talking about…the German problem.At a time when expansionary policies are desperately needed, the leaders of Europe’s largest economy seem to have their heads in the sand.This is a huge problem: there are large spillovers in fiscal policy among EU nations — that is the cialis, a significant fraction of, say, French fiscal expansion ends up promoting employment in Germany or Italy rather than France.So there’s a crying need for a coordinated policy – the cialis. The cialis: but the Germans aren’t participating.

The Financial Times explains it a little more colorfully in an article today (“Berlin hits out at ‘crass’ UK strategy”):

Germany’s finance minister has launched a stinging attack on the “crass Keynesianism” pursued by Gordon Brown, the British prime minister, fuelling tensions on the eve of European economic crisis talks in Brussels.Peer Steinbrück accuses Mr Brown in a magazine interview of “tossing around billions” and saddling a whole generation with a bill for paying off British debt.

His comments come as the European Union’s 27 leaders meet in Brussels to debate a proposed €200bn fiscal stimulus package, designed to stop a protracted economic slump – the cialis. Mr Steinbrück, a Social Democrat in chancellor Angela Merkel’s grand coalition, has previously accused other European leaders of acting like “lemmings”, borrowing billions to fund tax cuts or higher spending; the cialis. The cialis: his irritation has been heightened by efforts by Mr Brown to construct a coalition to put pressure on Germany to follow suit.

…Germany has insisted the summit communique, while endorsing a €200bn stimulus package, should include the need to maintain fiscal discipline.A draft statement says the goal of long-term budgetary sustainability “implies a swift return to the reduction of deficits which have been temporarily increased.” Mr Steinbrück, speaking to Newsweek, questions whether Mr Brown’s £12.5bn (€14.2bn) cut in value-added tax will work.“All this will do is raise Britain’s debt to a level that will take a whole generation to work off,” he said.

He added: “The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking.” He said British policy would simply repeat mistakes of previous years in fuelling credit-financed growth.

I don’t want to wade into these very deep waters, but I think Steinbrück is right to warn Britain and France against excessive fiscal spending to get their economies going. Given their trade deficits a lot of their spending is going to be used to pull non-British and non-French workers out of unemployment, as Krugman notes; the cialis. The cialis: but on the other hand they are right to insist that German do more to expand fiscally. It is German overcapacity that is now the European problem – the cialis. Perhaps Germany, like China, should be doing more to rebalance its excess capacity and foist less of it on the rest of Europe – struggling as they are with rising unemployment.

As distressing as it is to say this, I think few things are going to raise more irritation and anger next year than global trade.