Yellow Journalism at the Weekly Standard
Critics of the welfare-warfare state are no fans of the magazine the Weekly Standard. Bill Kristol and its other regular contributors are among the most hawkish of neoconservatives out there. Yet these "right wingers" are also bad on economics too, even though the average person would probably consider them to be laissez-faire.
Of course, there is no real contradiction here: if the federal government (at least with Republicans in control) is good at fixing foreign cultures, then why not use it to improve the economy at home, too?
Today's case study is Irwin Stelzer's recent piece, "Worry About OPEC, Not China." Although international trade can get complicated, especially when fiat currencies are involved, Stelzer manages to pack an impressive amount of nonsense into a fairly short article. I offer this critique to shed some light on these confusing issues.
Strong Dollar Or Weak?
Stelzer opens by calling Treasury Secretary Hank Paulson's December trip to Beijing "mission impossible." Stelzer declares that "if their aim really was to pursue that oft-stated goal of US policy, a 'strong dollar,' the delegation … should have been rerouted to Riyadh."
Quite frankly, Stelzer has things exactly backwards. The Sinophobes are mad because the Chinese government is keeping the dollar artificially strong. This has the effect of, well, why don't I let Stelzer explain:
To the consternation of many politicians, [China's] policy of pegging the yuan to the dollar undervalues the Chinese currency. This gives Chinese exporters a de facto subsidy, and makes made-in-the-USA goods … more expensive in China.
This last quotation is exactly right. (And that's why the entire premise of the article — namely that Paulson was trying to get a strong dollar with his trip to China — makes no sense.) Although jingoes might love a "strong dollar," American exporters actually pine for a weak dollar.
Other things equal — and that's an important caveat — if the exchange rate between the US dollar and the Chinese yuan drops, so that one dollar bill trades for fewer Chinese yuan, then that makes American goods (priced in dollars) relatively cheaper, and Chinese goods (priced in yuan) relatively more expensive. After all, if a Chinese consumer is trying to decide between a domestic or US brand, he needs to be able to convert the prices to a common denominator. The prevailing exchange rate tells him what to multiply the US price tag by, in order to come up with an equivalent number of yuan for the US-made good.
The Chinese government is typical in that it wants to use its power to favor particular domestic companies. One way to do that would be to take China's equivalent of tax revenues and directly hand them over to the politically powerful shareholders. Yet that would be a bit too blatant. A far subtler approach is to use those yuan to buy dollars in the foreign exchange market. This increase in the yuan demand for dollars naturally raises the yuan-price of dollars, i.e., raises the exchange rate between US and Chinese currency. This makes it easier for Chinese exporters to ship goods to the United States, and harder for American exporters to sell goods to the Chinese.
Before moving on, I should underscore the importance of the "other things equal" clause. Suppose the US government decided to double the supply of dollars overnight. This would certainly weaken the dollar against other currencies, as the dollar demand for these moneys would go through the roof.
But does that mean a massive printing of new dollar bills would help US exporters? Not at all. The stated dollar price of US goods would also rise sharply, since people would use the new dollars not merely to acquire foreign goods, but also to bid up the prices of domestic ones. If the dollar generally lost half of its exchange rate against other currencies, US goods and services would generally be twice as expensive (in nominal terms) and thus would be no more attractive than before the inflation.
The Yellow Threat?
Rush Limbaugh uses the term "Chi-Coms" to refer to the ruling class in China. Fox News regularly runs stories on the threat from China. There are plenty of conspiracy theories that the Chinese government is consciously running huge trade surpluses in order to "attack" the dollar at some future point and destroy our economy. For his part, Stelzer too seems worried that the Chinese "have been accumulating dollars at the rate of $200 billion per year"; it's just that Stelzer warns his readers that those wily Arab countries are stockpiling about $500 billion per year.
Let me offer a less alarming explanation for China's behavior. Imagine that you are in charge of the Chinese government. You've admitted that full-blown central planning doesn't work, and so you've over the years been gradually freeing your markets without committing political suicide by publicly praising Milton Friedman. You've got plenty of resources, especially labor, but you need foreign expertise and investment to maintain your astounding growth. Looking at the horrible fate of South American and other developing countries, you absolutely want to maintain a stable currency.
How best to accomplish this? Well, the best course would be to put the yuan on a rock solid 100% gold standard with guaranteed convertibility at any time. But as every ruler knows, that would be a bit too extreme; it's hard to exercise arbitrary power when your hands are tied by gold production. A more moderate aim would be to tie the yuan to something that is relatively stable and known the world over: the US dollar. By convincing the investors of the world that the Chinese yuan can always be converted to US dollars at a predictable exchange rate, the (relative!) success and stability of the US monetary and banking system can be imported to China.
Now, given that you have pledged to tie the yuan to the dollar at a certain rate, how do you actually effect this decree? Do you simply threaten to imprison any currency trader who deviates from the official peg? Of course not. That would simply lead to shortages in the foreign exchange market, and investors would realize the "official" exchange rate was a fiction.
No, in order to convince the world that the yuan really is as "good as the dollar" you need to be ready to exchange US dollars for yuan on the spot. In short, you need to accumulate a vast stockpile of very liquid, dollar-denominated assets. And the more your economy grows, the larger your stockpile needs to be in order to prevent any speculators from "attacking" your currency (i.e., handing over yuan after yuan to get the official number of dollars) because they sense that the peg will fail and you'll have to devalue the currency. The situation is very much like a fractional reserve bank that maintains a certain amount of reserves hoping to prevent a run.
The Trade Deficit
Of course, I don't know for sure that the desire to insource Greenspan's and now Bernanke's policies is really the motivation for the Chinese government's behavior. But what we can say for certain is that the only way China (or other foreigners) can be net investors in the United States, is if the US is at the same time a net importer from them.
This is quite simple, really. If the Chinese government wants to accumulate a stockpile of short-term dollar assets (such as US Treasury bills), what must it do? It must first use its yuan to enter the foreign exchange markets to buy US dollars, and then use those dollars to acquire the bonds from Uncle Sam.
Now what happens to all the yuan supplied to the foreign exchange market? People can either hold them as cash (unlikely), or use them to buy yuan-denominated assets or merchandise from China. If, on the whole, there is more capital investment flowing into the United States from China than vice versa, then simple accounting dictates that there are more goods and services flowing into the US from China than vice versa. In short, if we have a capital surplus with China then we must at the same time have a trade deficit with China.
If appeal to accounting tautologies doesn't reassure the reader, perhaps the following chart will.
As the figure makes clear, the US trade balance generally "improves" during recessions and drops during periods of rapid growth. This is because Americans spend less on goods and services during bad times, and this includes their expenditures on foreign producers. So not only is the trade deficit no cause for worry; if anything it is a sign of economic strength!
Exports Needed For Jobs?
Let us return to Mr. Stelzer. He tells us that Paulson's mission is impossible because:
[T]he Chinese regime's overwhelming priority is to stay in power. That means providing jobs for the 300 million farmers expected to move to the cities in the next 20 years, which in turn means the government will under no circumstances allow the yuan to rise to a level that cuts sharply into exports.
Now in fairness, maybe Stelzer knows that this logic is nuts, and merely thinks the Chinese rulers believe it. However, I don't think that's the case; it seems Stelzer believes Paulson was trying to convince the Chinese government to sell out their own workers and side with US exporters.
We free marketeers get exhausted saying it so many times, but here goes: Foreign imports do not destroy jobs on net. Government interventions against international trade do not promote employment. Everyone can get hired in a free labor market, so there is no issue of "providing jobs." Further, if the labor market isn't free — and it's certainly not in China — then the best way to promote employment is to get out of the way and allow everyone to be as productive as possible. Manipulating the yuan's exchange rate does no such thing.
Indeed, it seems that Stelzer has it exactly backwards here as well. He seems to think that China's implicit subsidies to its exporters hurt the United States and help China. On the contrary, on average they help Americans and hurt the Chinese.
If this seems shocking, change the scenario ever so slightly. Suppose the Chinese government used its yuan (derived from taxes on its people or slave labor) not to buy US Treasury bills, but instead to directly buy products from Chinese exporters. Then, it decided to send these TVs, radios, etc. as free gifts to US consumers. Would Stelzer claim that this tax-and-spend policy created jobs in China? (Well, maybe he would.) Would Stelzer claim that receiving free TVs makes Americans poorer?
The neoconservative writers have horrible foreign policy views. This is no doubt due to their misconceptions regarding military might. But as this article demonstrates, part of the problem may also be their faulty economics.