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March 15, 2010

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Paul Krugman: Taking on China

Posted: 15 Mar 2010 12:09 AM PDT

Paul Krugman says it's time to take a stand against China's currency policy:

Taking on China, by Paul Krugman, Commentary, NY Times: Tensions are rising over Chinese economic policy, and rightly so: China's policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done. ...
Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. ... This is the most distortionary exchange rate policy any major nation has ever followed.
And it's a policy that seriously damages the rest of the world. Most of the world's large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can't offset.
So how should we respond? First of all, the U.S. Treasury Department must stop fudging and obfuscating.
Twice a year, by law, Treasury must issue a report identifying nations that "manipulate the rate of exchange between their currency and the United States dollar..." ... Treasury has been ... unwilling to take action on the renminbi... Instead, it has spent the past six or seven years pretending not to see the obvious.
Will the next report, due April 15, continue this tradition? Stay tuned.
If Treasury does find Chinese currency manipulation,... we have to get past a common misunderstanding ... that the Chinese have us over a barrel because we don't dare provoke China into dumping its dollar assets.
What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn't change: they're being kept near zero by the Fed... Long-term rates might rise slightly, but ... the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds.
It's true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies... But that would be a good thing ... since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.
So we have no reason to fear China. But what should we do?
Some still argue that we must reason gently with China, not confront it. But we've been reasoning with China for years ... and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation's currency is not undervalued. ... And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies "just for the purposes of increasing their own exports."
But if sweet reason won't work, what's the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it's hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.
I don't propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world's economic problems at a time when those problems are already very severe. It's time to take a stand.

links for 2010-03-15

Posted: 15 Mar 2010 12:01 AM PDT

Shiller: A Crisis of Understanding

Posted: 14 Mar 2010 02:34 PM PDT

Robert Shiller:

A Crisis of Understanding, by Robert J. Shiller, Commentary, Project Syndicate: Few economists predicted the current economic crisis, and there is little agreement among them about its ultimate causes. So, not surprisingly, economists are not in a good position to forecast how quickly it will end, either.
Of course, we all know the proximate causes of an economic crisis: people are not spending, because their incomes have fallen, their jobs are insecure, or both. But ... where and why did it start? Why did it worsen? What will reverse it? It is to these questions that economists have been unable to offer clear answers.
The state of economic knowledge was just as bad in the Great Depression that followed the 1929 stock market crash. Economists did not predict that event, either. ...
Late in the Great Depression, in August 1938, an article ... in The Christian Science Monitor reported an informal set of interviews with US "professors, banking experts, union leaders, and representatives of business associations and political factions," all of whom were given the same question: "What causes recessions?" The multiplicity of answers seemed bewildering, and did not inspire confidence that anyone knew what was causing the deepest crisis of capitalism.
The causes given were "distributed widely among government, labor, industry, international politics and policies." They included misguided government interference with markets, high income and capital gains taxes, mistaken monetary policy, pressures towards high wages, monopoly, overstocked inventories, uncertainty caused by the reorganization plan for the Supreme Court, rearmament in Europe and fear of war, government encouragement of labor disputes, a savings glut because of population shrinkage, the passing of the frontier, and easy credit before the depression.
Although economic theory today is much improved, if we ask people about the cause of the current crisis, we will mostly get the same answers. We would certainly hear some new ones, too: unprecedented real-estate bubbles, a global savings glut, international trade imbalances, exotic financial contracts, sub-prime mortgages, unregulated over-the-counter markets, rating agencies' errors, compromised real-estate appraisals, and complacency about counterparty risk.
More likely than not, many or most of these people would be mostly or partly right, for the economic crisis was caused by a confluence of many factors, the chance co-occurrence of a lot of bad things...
Consider the question of predicting events like the January 2010 earthquake in Haiti, which killed more than 200,000 people....[I]f one went beyond trying to predict the occurrence of earthquakes to predicting the extent of the damage, one could surely devise a long list of contributing factors – including even political, financial, and insurance factors – that resembles the list of factors that caused the global economic crisis.
Indeed, the crisis knows no end to the list of its causes ... in a complicated economic system that feeds back on itself in many ways...
Weather forecasters cannot forecast far into the future, either, but at least they have precise mathematical models ... derived from the theory of fluid dynamics and thermodynamics. Scientists appear to know the mechanism that generates weather, even if it is inherently difficult to extrapolate very far. ... The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. ...
Unfortunately, in 800 years of financial history, there is only one example of a really massive worldwide contraction, namely the Great Depression of the 1930's. So it is hard to know exactly what to expect in the current contraction...
This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.

Amazing - a whole column and not a single mention of his book. But that may be because after arguing that we don't know the cause of the crisis, it's kind of hard to promote a book that explains what caused the crisis:

As George Akerlof and I argue in our recent book Animal Spirits, the current financial crisis was driven by speculative bubbles in the housing market, the stock market, and energy and other commodities markets. Bubbles are caused by feedback loops: rising speculative prices encourage optimism, which encourages more buying, and hence further speculative price increases – until the crash comes.

Part of the confusion is the failure to distinguish between the question of what caused the crisis and the factors that made it much worse once it occurred. But it is rather striking that if you ask a simple question, "what is the single most important factor in explaining why the crisis happened," there is very little consistency in the answers given by economists. I find it a bit disturbing that, even after this much time to figure it out, there is little consensus on what caused the problems. Worse, those that hate government seem to find government at fault, those that think that the deregulation movement that began in the 1970s was an error point to regulatory failures, and so on, and so on.

The fact that the evidence always seems to confirm ideological biases doesn't give much confidence. Even among the economists that I trust to be as fair as they can be -- who simply want the truth whatever it might be (which is most of them) -- there doesn't seem to be anything resembling convergence on this issue. In my most pessimistic moments, I wonder if we will ever make progress, particularly since there seems to be a tendency for the explanation given by those who are most powerful in the profession to stick just because they said it. So long as there is some supporting evidence for their positions, evidence pointing in other directions doesn't seem to matter.

The economics profession is in crisis, more so than the leaders in the profession seem to understand (since change might upset their powerful positions, positions that allow them to control the academic discourse by, say, promoting one area of research or class of models over another, they have little incentive to see this). If, as a profession, we can't come to an evidence based consensus on what caused the single most important economic event in recent memory, then what do we have to offer beyond useless "on the one, on the many other hands" explanations that allow people to pick and choose according to their ideological leanings? We need to do better.

"US Sprawl is not a Market Outcome"

Posted: 14 Mar 2010 12:13 PM PDT

I think John Stossel should be ignored when it comes to economics, he either doesn't know what he is talking about or he is willing to mislead people. For example, he was still claiming that tax cuts pay for themselves long after it should have been clear to any decent journalist that this was a false claim (he went so far as as late as 2007 -- long after the "Bush tax cuts paid for themselves" myth had been thoroughly debunked -- to say he wasn't sure the Bush tax cuts were desirable since the extra revenue the tax cuts generated will allow government to grow larger).

But whether I think John Stossel and his predictable libertarian views should be ignored or not, people are responding to his latest column claiming that urban sprawl is good (because, to a libertarian, it is very rare that government can improve upon market outcomes no matter how bad the market outcome might be). Richard Green explains how zoning laws discourage mixed use development and promote urban sprawl, and how zoning laws are used to keep the poor from locating in certain areas:

US sprawl is not a market outcome, by Richard Green: A discussion is going around the internet about John Stossel's "libertarian" piece on the virtues of sprawl. John Norquist, on the other hand, labels sprawl a "communist plot," and Matthew Yglesias notes how bulk zoning requirements promote sprawl.

A point John likes to make is sprawl is at least in part the result of government housing finance policy. The New York Times this morning:
I.R.S. requirement keeps the agency from acquiring mortgages made in buildings where more than 20 percent of the square footage is commercial — space that is used for, say, a hotel or a doctor's office.
Mixed use development is not going to happen if it can't get financed. Most of Paris, London, large swaths of San Francisco (i.e., some of our best urban places) would not qualify for US housing finance rules. And of course, single use zoning would ban them all.

But most insidious is that zoning is used as a tool to keep low-to-moderate income people out of suburbs. The town next door to mine--San Marino--has zoning requirements so onerous that it is not possible to build small housing there. Even my town, Pasadena, which at least has a bunch of apartments, prevents construction of granny flats on lots smaller than 15,000 square feet. These rules keep out the poor, which reduces expenditures on social services, which makes property values higher, which keeps out the poor, which...

Of course poor people must live somewhere, and so they live in cities with old housing stock that was built before the era of stringent zoning. So cities with old housing stock are placed at a fiscal disadvantage, which induces people with means to leave, which puts them at a greater fiscal disadvantage, etc....

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