PK v. JB re $

October 8th, 2014 at 8:09 am

Paul K’s agrees with me on the core aspects of my post yesterday regarding our persistent trade deficits as a barrier to full employment, but disagrees the dollars status as a reserve currency has much to do with it.

Certainly the key part of all this is recognizing the damage done by trade deficits to growth and jobs (particularly among manufacturers), as well as the role these imbalances play in investment and asset bubbles. I’m continuously thrown by analyses which talk about the factors holding back growth and ignore the fact that since 2000, the US trade deficit has averaged 4% of GDP. To be clear, that’s far from the only problem, and it’s certainly possible to offset the growth drag that trade deficits of that magnitude create, but doing so often creates its own problems, as in the bubbles just noted.

But as Paul suggests, one certainly does not need to invoke the reserve currency issue to make the case that we need to do something about this problem, as I did in this earlier piece with Dean Baker.

A few points, however. First, as noted, my thinking on this is influenced by recent work by Ken Austin and earlier work by Michael Pettis (links to all this stuff are in my original post). Austin constructs what I read as a pretty airtight model wherein under conditions like those that prevail today, exchange rate manipulators accumulate currency from reserve issuers ensuring surpluses in the former and deficits in the latter.

No less than Ben Bernanke has made this point as well:

Another factor [driving trade deficits] is the special international status of the U.S. dollar. Because the dollar is the leading international reserve currency, and because some emerging-market countries use the dollar as a reference point when managing the values of their own currencies, the saving flowing out of the developing world has been directed relatively more into dollar-denominated assets, such as U.S. Treasury securities. The effects of the saving outflow may thus have been felt disproportionately on U.S. interest rates and the dollar. For example, the dollar probably strengthened more in the latter 1990s than it would have if it had not been the principal reserve currency, enhancing the effect on the U.S. current account.

As Paul notes, and others have correctly made this point, the dollar is not the only reserve currency. But it is by far the most preeminent one and we therefore face a relatively large adjustment burden, which is a nice way of saying that this setup leads to the exporting of a lot of good jobs.

[Another colleague correctly reminded me—and this is in Austin’s model as well—that the excess savings reserve accumulators export to us don’t automatically have to show up as our trade deficits. The capital inflows could be used by investors to buy foreign assets instead of consumers buying imports. However, given the magnitude of trade deficits in recent years, the empirical record suggests that the Pettis/Austin dynamics apply.]

Do I think we’d run balanced trade if the dollar didn’t hold its reserve status? Of course not: I’ve always stressed other factors are in play. But I’d be very interested in Paul’s take on Austin’s work in particular. I suspect it might nudge him a bit towards me on this.

End of the day, however, not much point in arguing about this reverse point. The main thing is to lower the trade deficit. Dollar, schmollar, as long as he calls his mother. And if reserve currency arguments don’t help in that regard, then they should be put aside.

Here too, however, I wonder if there’s something advantageous to my position that PK is overlooking. To lower our trade deficit, you don’t have to just be willing to allow the dollar to be more competitive in foreign markets (Ezra Klein pointed out to me long ago that “competitive” sounds better than “weaker”), you have to be willing to take action against those managing their currencies to gain a price advantage. And this necessity could be thwarted by arguments about how such actions threaten the sovereignty of King Dollar.

Our policy makers are all a muddle about this. In the morning, our Treasury secretaries pledge their undying allegiance to the strong dollar. In the afternoon they call for China to allow their currency to appreciate against the dollar, i.e., they call for a weaker—oops…”more competitive”—dollar. Perhaps the arguments I and others are putting forth can help clear the way for clearer thinking on this critical issue.

So, let’s hear more from Paul–who knows a little something about international trade–on the substantive case I’ve been highlighting (where are Austin, Pettis, Bernanke getting it wrong?), but let’s not lose sight of the fundamental goals here, as he correctly stresses.

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4 comments in reply to "PK v. JB re $"

  1. Tiree says:

    I agree to a large degree with what is being said, but I have a disagreement regarding manipulation vs. free-market common sense. Given the great disparity of wealth between American and Chinese workers (I use a 2-country example for simplicity, not that there aren’t indirect paths of equalization/imbalance), it seems obvious that American workers can buy a lot more Chinese goods than Chinese workers can buy American goods.

    The best investment for the accumulated export profits is US assets. It’s the right thing to do if you leave everything else to the market forces. Why don’t US investors use the Chinese investments to invest in Chinese assets? Because it doesn’t make economic sense to do so. If it did, the Chinese would just invest directly in their own assets.

    For some reason people believe that it is vitally important that investors be allowed to invest their money anywhere they want to invest it, whether it be domestically or otherwise regardless of the effect upon trade. Why? Investors have no wisdom that is helping the situation. On an individual level, there are reasons for individual companies to invest in foreign assets and vice-versa, but on balance there’s simply no good reason to allow a net flow of capital investment into or out of a nation over the long term.

    I suspect that the Rubin/Summers mindset of the Democratic party has completely clouded the vision on this. They are severely confused about the value of free capital flows. I would never try to convince them of anything. They simply don’t understand the issue.


  2. Tiree says:

    I could state my main point another way:

    International investments should be the slave if international trade, productivity that is. Not the other way around.

    In every capitalist system, there are going to be top investors. Should the top investors dictate how much a country produces and consumes? I say no. It should be balanced, and the investors have to be forced to deal with it.


  3. Peter K. says:

    I wonder if Krugman’s background in international trade makes him overly sensitive to the possibilities of tariffs and trade/currency wars. It’s kind of a dilemma or Hobson’s choice but they see underemployment and slow recovery as better than the hegemon using its power over trade. (Although they push hard on the pro-corporate “free” trade deals.)

    He did makes some noise about China a while back. But nothing has been said about how the Fed bailed out foreign banks during the crisis and they now have access to the trading desk even though they don’t have to follow our marcroprudential rules except those laid out in international treaties. I’m an internationalist and so am not up in arms about this as nationalists would be. I’m looking forward to our one world-Star Trek: TNG, communist government, but these are more costs to holding the reserve currency and being the largest hegemon. And our working poor and middle class are forced to pay the bill.


  4. urban legend says:

    I would guess a huge amount of economic damage to the country can be traced to the framing of the issue as a “strong” vs. “weak” dollar. Remember how the “dollar stands tall” in Reagan’s 1984 campaign?

    In other words, terminology matters, and can matter a whole, whole lot. So I’m going to shift gears to my new hobby-horse, the word “slack” as a description of a labor market with high unemployment (or an economy with weak growth that prevents catching up with potential output). I think the word “slack” should be retired whenever the U-6 is 9.0 or higher — i.e., reserved for 8.9 or below but higher than, say, 7.5%. We have another word which could substitute for it as the standard word: “weakness.”

    I would propose a standard classification such as the following, at least for economists who count themselves as progressive in viewpoint: we know what a strong labor market looks like from the year 2000, when the U-6 actually dipped temporarily below 7.0%, and stayed around the 7.0 level for quite a few months. Anything higher than that, in other words, has “slack,” but at some point that can be argued about, “slack” becomes a term that is actually deceptive because it is deliberately intended — whether intentionally or not, and probably very often not — to hide the real-word pain behind high unemployment. So we should have “somewhat weak” or “some weakness” at 7.5 to 7.9%, “weakness” at 8.0 to 9.9%, “considerable weakness” at 10.0 to 11.9%, “severe weakness” at 12.0 to, say, 14.9%, and “disastrous” or “devastating weakness” for anything 15.0% or higher.

    Why should we be using U-6 instead of U-3 for determining how weak the labor market is? Because people who feel unemployed or underemployed tell us so. U-3 is actually a technical measure with an arbitrary cut-off point: formally searched for work in the last month (which becomes stupid for many unemployed people no longer on unemployment benefits who will still keep their ear to the ground for opportunities). The U-6, on the other hand, tries to count everyone who wants a job, or a full-time job instead of a part-time job (one which likely poorly paid and has no benefits, and therefore is probably perceived as no more than 20 or 25% of a real job). It is a far superior measure of the real feelings of those who are not employed. It comes much closer, too, to tracking with drops and increases in the employment-to-population ratio, a figure that shows many people come out of the woodwork, even more than those counted as marginally attached, to take jobs when they actually are plentiful. Those people coming out of the woodwork vote with their feet to show they prefer working to not working. Even the U-6 doesn’t capture them, but by capturing those who say they want a job it comes a lot closer to reality than the U-3.

    The U-6 and the U-3 have separated more during the Great Recession: before, the U-3 varied from 55% to 61% of the U-6. Now, the U-3 is only 50% of U-6. because of the hisotoric dominance of the U-3 as the official rate, the tendency is to think this calls into question the reliability of the U-6. Actually, because the U-6 is a real measure of what people say and the U-3 is affected by an arbitrary definition, it should be the other way around.

    Bottom line: at 11.8%, the U-6 shows we still have considerable weakness — arguably severe weakness — in the labor market.


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