from Follow the Money

Rarely do I agree even a little with Larry Lindsey

April 6, 2006

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But I do think Lindsey correctly highlights why the debate on whether the US economy as a whole benefits from low interest rates courtesy of China's central bank is rather beside the point, at least politically.   Even if the US economy as a whole benefits from taking on external debt to finance consumption and real-estate led growth, China's central bank is helping to determine which parts of the US economy are thriving, and which are not.  Lindsey:

But under an exchange rate fixed by Chinese authorities and not the market, it is the Chinese government that implicitly decides who in America benefits from our trade relationship: consumers or producers, borrowers or lenders.  ...

The matter of principle on which the American political process is now becoming focused is that it is the Chinese government, not our political process or the independent determination of markets, that is determining the result. We are buying more tee shirts, shoes and appliances and living in larger homes than we otherwise would because of a Chinese government decision. We are producing fewer appliances and less agricultural output than the market would have us make as well, thanks to a decision by the Chinese government. It does no good to tell American politicians that if the Chinese want to subsidize us we should let them, because the very fact of their subsidy changes our behavior in a way determined by them, not by us.

Most of Lindsey's oped is devoted to explaining to the readers of the Wall Street Journal - or perhaps the editors of its oped page - why China's de facto peg is bad even if fixed exchange rates generally are good.  The argument is rather ingenious: basically, China's fixed exchange rate reinforced government control over the rest of the economy: "The Chinese autorities are intent on maintaining a fixed exchange rate not to provide discipline to the People's Bank of China, but to maintain state control over the economy."  

It doesn't really matter whether Lindsey's specific argment that China's peg reinforces state control is true; I suspect it is directed at providing a specific audience in the US an argument to use in US internal debates, not at China.   Lindsey is trying to explain why it is OK to think that Argentina should have held on to its peg -- or even dollarized -- back in 2001 but that China should not stick steadfastly to its peg now.  

There is also a strange convergence between Lindsey's proposed Hu/ Bush deal - a targeted rate of appreciation in the RMB - and Thomas Palley's suggestion for exchange rate targets - really target zones.  And I am pretty sure that Thomas Palley is even further apart on the political spectrum from Larry Lindsey than I am.   Target zones are a bit different than a targeted rate of crawl, but both envision steering an exchange rate toward its desired level.   Lindsey views the targeted appreciation as a transition to market exchange rates, Palley views target zones as a constraint on market exchange rates.  But in the near term, both are suggesting a target for the RMB/ dollar.  And an RMB appreciation.

Of course, Lindsey leaves one key thing out of his proposed bargain - any adjustment in US fiscal policy.    And I rather suspect that China would be more inclined to do a deal if the US itself was a bit more committed to take real steps to address its own savings shortage.

But that probably requires a real Treasury Secretary, something the Bush Administration so far has wanted to avoid.

Picking on Treasury Secretary John Snow isn't even fun right now.

Reporters are so desperate to demonstrate that he has done something other than loyally repeat the Bush Adminsitration's party line as he toured the country that some even give him credit for the Bush Administration's evolving China policy. 

Alas, credit here should go to Tim Adams.

And I do think the right word is credit.

Adams has:

  • Broadened the discussion to include China's low level of consumption, not just exchange rates.   That low level of consumption is in part the product of policy decisions - see the ADB
  • Sought to encourage the IMF to take exchange rate surveillance more seriously, and highlighted that China's undervalued RMB affects the world, not just the US.  The IMF even may be listening.
  • Quietly reduced the emphasis on capital account liberalization and put more priority on exchange rate flexibility.   His predecessor put more emphasis on capital account liberalization than exchange rate flexibility.
  • Correctly realized that the Bush Administration's policy on China's exchange rate peg couldn't be "it is China's choice" or "who wouldn't want Alan Greenspan (now Ben Bernanke) to run their monetary policy."   

The Treasury at least needs to be perceived to be taking concerns about China's peg seriously --  the Treasury's domestic hand is a lot stronger if it is trying to encourage China to let the RMB adjust, not defending China's peg.

I basically agree with the steps Adams has taken so far.   The really hard decisions are coming up - the US government may have to decide what it will do if China is not willing to commit to greater flexibility.  I may not agree with the Administration's call on these issues.  But Adams does deserve credit for recognizing a growing problem, and working to address it.

The problem goes well beyond the political backlach against trade with China, or, in Lindsey's formulation, the backlash against China's capacity to pick domestic winners and losers.  If you take the US current account deficit seriously, you also need to take the offsetting current account surpluses seriously.  And - as the ADB's graphs show - China's 2005 surplus is about as big, relative China's GDP, as the US deficit.

My real criticism of the Adams' approach is that it focuses entirely on what other countries should do to facilitate adjustment, and what the IMF should do to encourage other countries to adjust.   It is silent on what the US needs to do as part of the global adjustment process.

Fiscal policy is probably a bit above Adams' pay grade.  But given how he spent 2004, he cannot entirely escape responsibility for the structural gap between US government revenues and expenditures.  That gap is masked by Social Security's cash flow surplus, which helps to finance the rest of the government.  But that surplus won't last forevever.

Nor, for that matter, will the world finance the US forever.   

The Economist now thinks the US will be the last domino to fall ... not the first.   Maybe.

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