The Senate yesterday voted to allow a vote on a bill that would try to force China to let its Yuan(or Renminbi) rise-this would be done by imposing sanctions against China and other "currency manipulators." This has led to some polemics. First of all China has declared that this bill's passage would lead to a trade war. It has also led to something of a war of words between Paul Krugman and Scott Sumner who writes The Money Illusion blog.
The offending piece by Krugman that Money Illusion reacts to is here
In the above link, Krugman gives his support to this bill and it is for this that Money Illusion takes issue with. This is his rebuttal http://www.themoneyillusion.com/?p=11201
Though I said it's a "war of words" in fact Krugman has yet to respond directly to Sumner's arguments. Sumner takes issue with Krugman for-to simplify a little bit...-"sounding like a Right winger" in jawboning China and supporting a measure to impose sanctions on it in an attempt to get it to let the Yuan appreciate.
As we noted above, China has already vowed a trade war if it passes. I must say at least in sentiment I tend to agree with Sumner. I don't like the spectacle of jawboning-much less threatening sanctions-against China either.
And yes I do kind of feel like this sounds like Right wing talk. Although it's not so simple to figure out who can claim to be on the "Right" or "Left" in this dust up. For one thing as Krugman notes the Club For Growth has opposed raising tariffs on China's goods because it claims it amounts to a tax hike. Krugman responds to this with "All I can say is that Democrats should welcome this demonstration that antitax fanaticism has reached the point where it trumps standing up for our national interests.
Sumner sees this invoking of "national interest" as more Right wing talk; I don't necessarily agree that it is exclusively Right wing but you have to ask if Krugman is not coming close to using an argument that could be understood as demagoguery as Sumner suggests.(I say "understood as" out of my high regard for Krugman. Sumner shows his regard for him by saying "Krugman is too smart for this argument." Basically even if he is being demagogic here it is very out of character and so I'm reluctant to call it such. ) At the very least this whole argument is against the free market principles that the U.S. always preaches. Krugman himself admits this makes him sound inconsistent:
"Now, some people will ask, didn’t I used to be a free-trader? Yes, and under normal circumstances I still mostly am. But these are not normal circumstances! In an economy that isn’t in a liquidity trap, one can reasonably assume that jobs lost due to Chinese exports will be offset by jobs gained elsewhere, although that may be small comfort to the workers affected. Under current conditions, however, there is absolutely no reason to believe that there are offsetting gains — on the contrary, the losses to import competition are magnified through multiplier effects."
Essentially his argument seems to be desperate times, desperate measures. There are times that appeal may be legitimate although we would still have to be sure that other less desperate measures aren't available and that the desperate measure wont make things worse. The prospect of a trade war with China would seem to be something that could be worse. And Sumner does argue that there are other far less desperate options at our fingertips.
However let's look at Krugman's full argument
"Ask yourself: Why is it so hard to restore full employment? It’s true that the housing bubble has popped, and consumers are saving more than they did a few years ago. But once upon a time America was able to achieve full employment without a housing bubble and with savings rates even higher than we have now. What changed? "
"The answer is that we used to run much smaller trade deficits. A return to economic health would look much more achievable if we weren’t spending $500 billion more each year on imported goods and services than foreigners spent on our exports."
"To get our trade deficit down, however, we need to make American products more competitive, which in practice means that we need the dollar’s value to fall in terms of other currencies. Yes, some people will shriek about “debasing” the dollar. But sensible policy makers have long known that sometimes a weaker currency means a stronger economy, and have acted on that knowledge. Switzerland, for example, has intervened massively to keep the franc from getting too strong against the euro. Israel has intervened even more forcefully to weaken the shekel."
There are a lot of points in these few paragraphs but let's start with the first two paragraphs. First his question: Why is it so hard to restore full employment? He mentions the housing bubble and higher saving rates for consumers. But then he argues that these factors are not sufficient to explain it all. He thinks that China manipulating it's currency has exacerbated things.
"once upon a time America was able to achieve full employment without a housing bubble and with savings rates even higher than we have now. What changed? "
In paragraph two he provides the answer: "The answer is that we used to run much smaller trade deficits. A return to economic health would look much more achievable if we weren’t spending $500 billion more each year on imported goods and services than foreigners spent on our exports."
So what changed is the trade deficit. Still we must go back to the first two factors, housing prices and saving/hoarding money. While it's true that "once upon a time" we were able to achieve full employment without a housing bubble and even higher savings rate than we have now-during the 50s and 60s this was the rule-but the fact is to say that we "lack a housing bubble" understates the case. Certainly you don't need a housing bubble for full employment-and is preferable to get it without one-but it's pretty difficult to do so right now with the level of deflation in housing prices. The housing market is a lot more than simply not in bubble mode, it is in a virulent bear market.
Krugman further argues his case, " some people will shriek about “debasing” the dollar. But sensible policy makers have long known that sometimes a weaker currency means a stronger economy, and have acted on that knowledge. Switzerland, for example, has intervened massively to keep the franc from getting too strong against the euro. Israel has intervened even more forcefully to weaken the shekel."
As far as this goes, Krugman and Sumner have no disagreement, as Sumner will be the first to tell you we need a certain amount of devaluing the dollar-"debasing." No argument at all with Krugman's point that sometimes a weaker currency means a stronger economy. It often seems closer to the rule than the exception. It's what FDR did in 1933 when he got us off the gold standard. Krugman has a great piece that features a video of Keynes celebrating the end of the gold standard.
The question is the means to achieve this. Yes often currency devaluation is in a country's interests. But what about China's interests? They keep the value down for the Yuan for the same reasons we keep down the dollar. As Sumner points out "An appreciation of the Chinese currency is contractionary for China, perhaps costing millions of jobs and slowing growth sharply, just as a strong yuan in 1998 sharply slowed Chinese growth."
So last time China pursued a "strong dollar" policy it went into recession.
Krugman is sanguine about the possibility of a trade war with China, "And the reality of the unemployment disaster is also my answer to those who warn that getting tough with China might unleash a trade war or damage world commercial diplomacy. Those are real risks, although I think they’re exaggerated. But they need to be set against the fact — not the mere possibility — that high unemployment is inflicting tremendous cumulative damage as we speak."
The answer seems to be that there are some risks but these are overblown-does he still say this in light of China's declaration that passage of this bill will mean exactly that?-and in any case,whatever the risks they are worth it measured against the damage of continual high unemployment.
So is Krugman sort of in 9/11 mode on the economy: we don't know what the risks will be and we admit that this won't solve the whole problem or how effective it will be but darn it we have to do something and this is all we can come up with?
He was critical of this attitude in the run up to Iraq and the passage of the Patriot Act. At least according to Sumner we can deal with the problem-both Krugman and Sumner agree with the Irving Fisher analysis that the problem is deflation-without starting hostilities with China.
"even Krugman admits that the fundamental problem is that we don’t use monetary and fiscal policy to boost our own aggregate demand (AD.) So the “harm” being done is only harmful if our policymakers ignore textbook advice to keep AD at an adequate level. Yes, we are ignoring that textbook advice, but I’m having trouble seeing how that’s China’s fault."
Again overall Krugman and Sumner agree on the problem and that the real fault is policy makers are ignoring textbook advice to keep aggregate demand at an adequate level. Maybe Krugman has been driven to despair that they will ever act and figures as we are not going to do the right thing let's at least do something.