Sonntag, Juli 24, 2005

Krugman on China (NYTimes)

Krugman, too, raises the question, what happens if China stops buying Dollars. He also has a good explanation or suggestion to the answer why the Chinese government keeps the exchange rate below its value, though I am inclined not yet to buy it. I think there is more to it than sheer angst to change it. China is often very rational in its decision making. A change from Dollar reserves to Euro reserves might be ahead (Yen is not likely given the enimocity of the two nations). But the question remains, what would happen when China "takes away our credit card"? But read for yourself:

China Unpegs Itself

By PAUL KRUGMAN
Published: July 22, 2005
Thursday's statement from the People's Bank of China, announcing that the yuan is no longer pegged to the dollar, was terse and uninformative - you might say inscrutable. There's a good chance that this is simply a piece of theater designed to buy a few months' respite from protectionist pressures in the U.S. Congress.

Nonetheless, it could be the start of a process that will turn the world economy upside down - or, more accurately, right side up. That is, the free ride China has been giving America, in which the world's richest economy has been getting cheap loans from a country that is dynamic but still quite poor, may be coming to an end.

It's all about which way the capital is flowing.

Capital usually flows from mature, developed economies to less-developed economies on their way up. For example, a lot of America's growth in the 19th century was financed by investors from Britain, which was already industrialized.

A decade ago, before the world financial crisis of 1997-1998, capital movements seemed to fit the historic pattern, as funds flowed from Japan and Western nations to "emerging markets" in Asia and Latin America. But these days things are running in reverse: capital is flowing out of emerging markets, especially China, and into the United States.

This uphill flow isn't the result of private-sector decisions; it's the result of official policy. To keep China's currency from rising, the Chinese government has been buying up huge quantities of dollars and investing the proceeds in U.S. bonds.

One way to grasp how weird this policy is would be to think about what a comparable policy would look like in the United States, scaled up to match the size of our economy. It's as if last year the U.S. government invested $1 trillion of taxpayers' money in low-interest Japanese bonds, and this year looks set to invest an additional $1.5 trillion the same way.

Some economists think there is a deep rationale for this seemingly perverse policy. I think it's something the Chinese government stumbled into as it tried to protect itself from the 1997-1998 crisis, and it is reluctant to change because the Chinese economy has been doing well. That is, China's leaders don't want to mess with success.

But pressures against China's dollar purchases are building. By keeping the yuan down, China is feeding a trade surplus that is creating a growing political backlash in America and Europe. And China, which is still a poor country, is devoting a lot of resources to the accumulation of a basically useless pile of dollars instead of to higher living standards.

The question is what happens to us if the Chinese finally decide to stop acting so strangely.

An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs.

But if the Chinese stopped buying all those U.S. bonds, interest rates would rise. This would be bad news for housing - maybe very bad news, if the interest rate rise burst the bubble.

In the long run, the economic effects of an end to China's dollar buying would even out. America would have more industrial workers and fewer real estate agents, more jobs in Michigan and fewer in Florida, leaving the overall level of employment pretty much unaffected. But as John Maynard Keynes pointed out, in the long run we are all dead.

In the short run, some people would win, but others would lose. And I suspect that the losers would greatly outnumber the winners.

And what about the strategic effects? Right now America is a superpower living on credit - something I don't think has happened since Philip II ruled Spain. What will happen to our stature if and when China takes away our credit card?

This story is still in its early days. On the first day of the new policy, the yuan rose only 2 percent, not enough to make any noticeable difference. But one of these days Chinese dollar purchases will trail off, and we'll find ourselves living in interesting times.

More about China

Above is a link to a nice, good discussion of Nouriel Roubini and David Altig on the WSJ website. It will give you a better understanding of what this move by China could mean.

Donnerstag, Juli 21, 2005

Mark this day in your calendar

For two reasons I think this day will show up in history:

1.) German President Köhler dissolved the German Parliament to allow new, early elections.

2.) China lowered the fixed exchange rate from 8.28 down to 8.11 Yuan per Dollar, agreeing to peg it to the Dollar and promised to tie the exchange rate in the future to a currency basket.

Maybe I am overreacting, but German's recent development in terms of government reminds me too much of Weinmarer Republic conditions. The fact that the current Chancellor Schröder is running again is beyond my understanding. If you feel that you don't have the platform to get your reforms through, either means you try to get something done that is not called for or you are not doing your job persuading the public what it needs. The later is too scary resembling Bush's approach of using all means of propaganda to convince people of false facts. In either case, the German democracy seems to be hurt by this decision. It is an indicator of its weakness which again is a sign of its ineffectiveness. Don't get me wrong, I am a convinced fighter of democracy, even if I haven't voted in a German election in a while. Of course, Germans still participate in elections and compared to the USA I still think people are not yet feeling that they can't change anything with their vote.
But when tactics like that are used to get a better result seems more like the statistician that massages data to the point that it fits his/her expectation to what the outcome should be in their opinion, rather than to accept the unbiased result.
I don't get the impression that Angela Merkel is a alternative to Gerhard Schröder, but this is a great gamble for the SPD to get a pink slip with the remark we need a change, no matter what this means in political terms. I will be following this election closely. Most interesting to me will be to find out if their are many swing voters and what the participation and mood of the new/young voters will be. And then there is still the suit before German Supreme Court (Bundersverfassungsgericht) to check the actual constitutionality of this act.

China has been doing so well for a while. But I thought that I remember that China had set is currency below value to ensure tremendous inflow of foreign currency, a modern form of dumping. Revaluation of the Yuan brings its value slightly up. However, it could be and I have to research this a bit more, that the Yuan had appreciate so much over the recent years but could rise due to fixed exchange rate that the lowering of it value actually sets it a its true value. But this still doesn't seem to fit into the picture. So what does that mean for China? It is now less cheaper to invest in China! And it yet remains to be seen how this pegging against other currencies will look like, (Bretton-Woods III?). I am somehow not yet convinced that China will openly let its currency fluctuate on the world market. If this is the first step for China to become more open, great, but then watch out what you asked for. The Chinese have been working on building up to be the next world superpower financially they are certainly on the way to become a force to reckon with. True, they have been already very much an export and import nation, but reserved non the less. I am glad that this is happening, but I skeptical of its sincerity. As an economist I am thrilled, since I don't believe in fixed currency politics, protectionism, or government intervention for the wrong reasons. Long live free trade and open borders!

But like I said, despite skepsis, mark this day in the calendar, it may change the world, even if just a little bit.

Dienstag, Juli 12, 2005

Your deficit counts?

Last night I read in Steven Landsberg's [i]Fair Play[/i] his explanation of deficits. Now I have heard a great deal about pro ond cons of deficits, and in general I welcome deficit spending to boost an economy - in moderation, however. Now, the fact is that deficits are loans paid of in the future, that avoid taxation right now. Though the basis is that model relies on the assumption that the loan has to be paid back some time in the future. An exuberant deficit lowers the expectation that the loan will be paid back or at least increases the risk of defaulting. Now, the general belief is that the USA will never default on its debt due to its sheer mass of assets. When in doubt we can sell Louisiana back to the French and use the money, right? But sometimes, I wonder if this isn't a very easy answer that avoids actually thinking about the chance that other countries may get worried about their investment in the USA. Many of our lenders, and the deficit is largely borrowed money from abroad, are claimed to have a stake in our market to the point that we are large mass consumer of their exports. After all, here we have quite a bit discretionary / disposable income and a high standard of living. But politics is not always based on rational, the USA blocked trades with China for a while, based on human rights issues, induced by the cold war.
What I am trying to say is, that maybe it is not always wise to alienate many nations while holding out the hand to collect a contribution to our wealth. Reminds me a bit of sawing the branch you sit on. Then again, we may have so much more wealth in the next decades that we can pay back the deficit from our petty cash. Hopefully this isn't a sort of risky gambling that ends up costing us our livelihood or we might end up like the bump I met once in Freiburg, who was a former businessman who had lost it all betting on the wrong investment.
Question than remains, is the deficit invested wisely to boost our economy. Education seems no longer a worthwhile investment, nor does public health. Ownership is the new investment, stock market purchases the answer to retirement. But critics say, we have had this type of investment before and it led to the stock market crash of 1929 and the great depression. If we truly foster new innovation, this would be a great investment into the future. However, it seems that in most technological aspects the USA still has not the cutting edge, Asia seems so much ahead, that we see outsourcing in that direction, India, South Korea, China (Japan even looks a bit out dated these days compared to the up and coming economies!). Leaves us with service and consulting, but for those we need education more than anything else or good on-the-job training.

In the end, deficits may come and go. It is just fascinating with what speed the money circulates -- and I don't believe into a Tobin-tax for foreign investment, that is just another barrier for trade. Let people speculate if they want to! You can hardly prevent someone from defrauding others. So we could use a little bit more of ethical behavior when it comes to making money. But that is another story for another day!

Sonntag, Juli 10, 2005

Enlighten Me

Would someone tell why we assume to be in such a growing economy, stable, and in "no crisis" mode, when the latest employment numbers show 25% less then forecasted (146K instead of 195,000). Now 3-5% error, I would consider tolerable, even 10% I could still see as a one time miss, but 25%? I am not convinced that borrowing money from abroad as fast as we do is healthy and sustainable. Where are those deficit reductions that were promised by the administration? The deficit is still growing! Where is the end of this? I hate being so dark, but we have to get our act together! We need some real results and not some phony stuff that catches peoples attention today and is forgotten by tomorrow.