Author: R.A. | WASHINGTON

ON THE plane, this weekend, I finally got the opportunity to read John Cassidy’s New Yorker piece on Tim Geithner—the one Treasury handed out to bloggers attending an off-the-record chat with the secretary and other senior administration officials earlier this month. That should give you some sense of the tone of the piece. I tend to like Mr Cassidy’s work, but I found the Geithner piece fawning and unhelpfully uncritical.

Perhaps more disappointing, the piece revealed Mr Geithner to be (or, at least, to appear to be) just as uncritical where the administration’s financial system policy is concerned. He seems as sure of the policy choices made in 2008 and 2009 as ever.

Some measure of a feeling of vindication is justified. Clearly, the proposals rolled out by the adminstration were a part of a response that arrested the cycle of panic and deleveraging afflicting financial markets, and the decline of the broader economy. Clearly, the adminstration’s interventions were nowhere near as expensive as critics intimated that they might be. I defended Mr Geithner and the administration against those calling for nationalisations, and I believe that this was the right call.

But it wasn’t ideal. The administration’s decisions involved some costly trade-offs. Opting for bail-outs and following this up by honouring bonus agreements poisoned the public’s view of intervention efforts and more or less eliminated the possibility of another round of meaningful stimulus. The Economist has defended the use of a one-off 50% bonus tax in Britain as a revenue-raiser, correctly pointing out that as the bonuses were entirely dependent on government bail-outs, the incentive effects of such a levy were benign. Had the adminstration chosen to follow this path, it might have salved some populist anger while raising revenue and creating the political room for more fiscal support for the economy.

Perhaps more important, the decision to opt for explicit bail-outs created a potentially serious moral hazard problem. This problem must be defused by meaningful financial system reform, or the stage will have been set for another large crisis down the road. Risky financial activities at banks with implicit government guarantees must be reined in, and it must be certain that the government is able and willing to wind down failing complex financial institutions in an orderly fashion.

In Mr Cassidy’s piece, one does not get the sense that Mr Geithner is grappling with the imperfect nature of his policy choices, or the potential for disaster to come:

[I]t is worth remembering that he was hired not for his critique of contemporary capitalism or for his abilities as a communicator but for his experience as a financial firefighter. From his time as a mid-ranking Treasury Department official, during the nineties, to his presidency of the New York Fed, from 2003 to 2008, he worked on resolving a series of financial crises around the world. For all the wrath that has descended upon his slight frame, he appears to have succeeded in putting out another inferno. “Why do policymakers screw up financial crises?” he said before I left his office. “They screw up financial crises because the politics are horrible, and that deters action. They are slow and late and tentative and weak because they are scared to death of the politics. But sometimes a policymaker has to say, I’ll take pain now against pain later.”

And most of the time, policymakers immediately become busy with the task of reputation-defending in the wake of major decisions, to the extent that they’re too tentative and weak in addressing follow-up issues. And of course, there would be immediate political pain involved in replacing Mr Geithner with a new secretary uninvested in the policies taken last year (not because Mr Geithner is popular, but because it would be taken as evidence of a White House in disarray).

This is a common problem in crisis situations. It seems impossible to imagine that Ben Bernanke’s involvement in pre-crisis monetary policy has not affected his subsequent decisions to any extent. The desire to paint oneself in a favourable light necessarily influences the way one thinks about issues.

Mr Geithner has put out the fire, but that’s not the end of the job. If he remains unable to sufficiently self-critique, to spot the problems inevitably following on his financial interventions and address them, then he is putting the American economy in a vulnerable position. Driving while staring into the rear-view mirror, we have learned in recent years, is a sure way to land in new difficulties.

TODAY’S big news, of course, is the passage of landmark health insurance reform legislation, which cleared the House of Representatives late last night. A reconciliation sidecar bill—containing tweaks to a number of financial measures in the bill—was also passed by the House and will now go to the Senate, where its reconciliation status means that only a simple majority will be sufficient to get it through. But even if Republicans manage to stymie the sidecar, the difficult job is done. A common bill has made it through the Senate and the House, which means that the most significant overhaul of the nation’s health system since the presidency of Lyndon Johnson is just a presidential signature away.

You can read a summary of the bill that passed here, and The Economist covers the political implications here. Of the legitimate concerns about the bill, two stand out above the others: that the overhaul uses deficit savings to extend coverage rather than address the long-run budget picture, and that the bill does too little to slow growth in health costs. These are both fair criticisms but are worth keeping in perspective. By extending health insurance to 32 million Americans who did not previously have it, the bill achieves a substantial moral and economic victory. While the revenue-raising measures used in the bill might have instead been used to improve the long-run budget outlook, it remains the case that real progress on the long-run outlook is almost exclusively about cost control, and the prospects for cost control under the new framework are likely to be better than under the unsustainable status quo.

But this is not the end of necessary health care reforms. Many of the most difficult decisions remain ahead. Democratic thinkers who have spent decades wondering how to navigate extensions of coverage through Congress must get back to work figuring out why they weren’t able bend the curve more with this bill, and what they’ll need to do in the future—with, in all likelihood, a reduced majority—to make that happen. The game begins again.

HERE‘S something ridiculous:

Morgan Stanley Asia Chairman Stephen Roach said that Paul Krugman’s call to push China to allow a stronger yuan is “very bad” advice and that increased Chinese spending is a better way of reducing trade imbalances.

“We should take out the baseball bat on Paul Krugman — I mean I think that the advice is completely wrong,” Roach said in an Bloomberg Television interview in Beijing when asked about Krugman’s call, characterized as akin to taking a baseball bat to China. “We’re lashing out at China rather than tending to our own business,” which is raising U.S. savings, Roach said.

Two points. First, Mr Krugman’s advice to China isn’t wrong; it’s right. China’s currency is undervalued, and I think everyone (including the Chinese, but evidently excluding Mr Roach), thinks that an orderly appreciation of the renminbi would be a net benefit to China. Where I disagree with Mr Krugman is in his advice to America. The currency issue isn’t a big enough problem to be worth the risks associated with an aggressive American push to get China to revalue.

Secondly, I think it’s very inappropriate to wish violence on anyone, and particularly on a very good economist who is just arguing for what he believes. That’s a poor way to conduct discourse, though it’s probably a good way to get invited back on a television show.

EZRA KLEIN offers a sneak preview of the Congressional Budget Office’s scoring of the Senate’ health care reform bill, which has already passed and which will make up the final health reform law, give or take a reconciliation side-car:

According to a Democratic source, CBO has finished its work and will release the official preliminary score later today. But here are the basic numbers: The bill will cost $940 billion over the first 10 years and reduce the deficit by $130 billion during that period. In the second 10 years — so, 2020 to 2029 — it will reduce the deficit by $1.2 trillion. The legislation will cover 32 million Americans, or 95 percent of the legal population.

It doesn’t strike the blow for cost control for which some had hoped, but that’s not a terrible performance.

MARTIN WOLF became the latest prominent economics writer to warn of the dangers of China’s current economic policy in a widely hailed column published on Tuesday. And I’m afraid that I still struggle to understand the point of view of those declaring that China is among the great villians of the current economic situation.

Begin with Mr Wolf’s title: “China and Germany unite to impose global deflation”. I understand that the world is a what-have-you-done-for-me-lately place, but this strikes me as utterly absurd. Let’s rewind just a bit. Last year, the global economy shrank 0.8%. America’s economy declined by 2.5%, the euro area’s by 3.9%, and long-time net exporter Japan’s by an ugly 5.3%. The only thing preventing an even deeper decline in world output was strength in just a handful of emerging markets. In particular, India continued to grow, at 5.6%. And China acted as the world’s flywheel, growing at an 8.7% pace. This was not an accident. China acted earlier and more aggressively to forestall a serious downturn than any other large economy. It engaged in massive fiscal and monetary stimulus, turned open the lending spigots, and yes, ceased the appreciation of the renminbi against the dollar. Of course, for much of the intense crisis period, a dollar peg meant appreciation against many of the world’s currencies, and so the peg merely meant a somewhat slower strengthening of the currency.

China was not alone in its stimulative efforts. America passed a stimulus as large, and the Fed joined with the Bank of England to engage in stimulative unconventional monetary policy. Other developed nations also chipped in; Germany’s total stimulus, including automatic stabilisers, was the largest among big European economies other than Spain. But there can be no question that the bottoming out of the global economy in early 2009, and the subsequent turnaround in financial markets and in commodity prices, was substantially due to Chinese growth. Impose deflation? China delivered the world from deflation.

But that was then, right? Now that advanced economies are expected to turn in a 2.1% growth performance in 2010, China’s return to double-digit growth, and the resulting upward pressure that places on prices for a range of goods and resources, can be ignored.

Of Germany, Mr Wolf writes:

The core of Mr Schäuble’s argument was not about the mooted European Monetary Fund, which could not, even if agreed and implemented, alter the pressures created by the huge macroeconomic imbalances within the eurozone. His central ideas are: combining emergency aid for countries running excessive fiscal deficits with fierce penalties; suspending voting rights of badly behaving members within the eurogroup; and allowing a member to exit the monetary union, while remaining inside the European Union. Suddenly, the eurozone is not so irrevocable: Germany has said so.

Three points can be drawn from this démarche from Europe’s most powerful country: first, it will have an overwhelmingly deflationary impact; second, it is unworkable; and, third, it might pave the way for Germany’s exit from the eurozone.

Mr Wolf is correct that Germany’s reluctance to intervene with Greece is troubling, and that the exit from the euro zone of either Greece or Germany (which would mean the end of the euro) would be devastating to the global economy. But there is little sign that this is what Germany actually wants. What there is is an indication that Germany wants to foist as much of the cost of a bail-out of southern Europe onto others. That will likely prove costlier to the global economy than an alternative in which Greece isn’t forced into an austerity plan, but that’s not really an option. If Greece were outside the euro, it would face austerity or default. If Greece goes to the IMF, it would be facing austerity. And the costs of Greek austerity, while unfortunate, are nothing like the deflation nightmare that would result from a break-up of the euro. The Greek economy, let’s remember, is pretty small.

Meanwhile, of China, he says:

If I understand China’s declared position correctly, it wants the US to deflate itself into competitiveness, instead, via fiscal and monetary contraction and, presumably, falling domestic prices. That would be dreadful for the US. But it would be dreadful for China and the rest of the world, too. It is also not going to happen. China surely knows that.

Yes! China surely knows that! And other Chinese officials have said as much and recently.

I agree with Paul Krugman and Mr Wolf that actions taken by both Germany and China have been unfortunate. The world would be better off if Germany went ahead and committed to a deal on Greece and if China resumed its RMB appreciation. But I also understand the domestic political constraints those actors face—constraints which suggest that other powers are unlikely to be able to force action. And I believe that both Germany and China recognise what they must eventually do and are prepared to do it.

And I think that the extremely narrow focus on these particular issues, and the increasing willingness to draw a line in the sand over them, is misguided and troubling. Is the RMB peg really the biggest impediment to global recovery? What about economic policy in Japan? What about the conservatism of the ECB? What about the dysfunctional political system in America, where deficit politics is the order of the day while unemployment is near 10%?

There’s nothing wrong with pointing out how Germany and China can do better. But urging leaders to pick a fight over the issue of trade surpluses is not going to be helpful.

WHAT is retail behemoth Wal-Mart up to these days?

Wal-Mart already has “MoneyCenters” in 1,000 of its U.S. stores, and the company said yesterday it plans to to add 400 more by the end of the year. The centers offer services like check cashing and bill pay that are often considered part of the broader “fringe banking” system. […] Lots of those people go to local check-cashing outfits that often charge high fees. So Wal-Mart, which charges $3 to $6 cash a check, can be a good alternative, said Alejandra Lopez-Fernandini, who works for a New America Foundation program that aims to help low- and middle-income people build wealth.

Matt Yglesias notes:

If you’re cashing, for example, a $1,000 biweekly paycheck then $6 is almost one third the price MoneyGram is asking. Nothing too earth-shattering about this, but it underscores the point that a lot of the time the best solution to abusive business practices is to find ways to get competing firms into the business.

Cheque-cashing and payday lending businesses are very common in poor neighbourhoods around the country. They provide the most basic financial services to unbanked customers, at what are typically described as usurious rates of interest—often 400% APR or more. And indeed, the entry of Wal-Mart, which also serves poorer communities, is sure to place significant downward pressure on the rates charged by other lenders. As Mr Yglesias notes, this is Wal-Mart’s general MO, though when the victims are local hardware stores or “mom and pop” grocers (or, indeed, labour forces), its actions tend to receive somewhat less applause.

This just continues to illustrate how interesting Wal-Mart is as a phenomenon and a mirror of American society and culture. Wal-Mart clearly has market power, which it occasionally uses abusively, if not necessarily illegally. But sometimes, it uses its market power to accomplish things government entities are unwilling or unable to accomplish—pressing environmental standards on its suppliers, for instance, or reining in abusive lenders. I just appreciate Wal-Mart’s ability to demonstrate the strangely ad hoc way in which American institutions manage to muddle through. Americans should maybe be taking Wal-Mart’s market power a little more seriously, but hey, so long as its ability to shift the economics in local markets accomplishes goals a dysfunctional federal government is unable to address, well, it may be better to leave well enough alone.

AS SOME economists have pointed out during the course of the recession, there is a slightly troubling incentive effect associated with the provision of unemployment benefits, namely, by making unemployment less painful they encourage the jobless to stay jobless for longer. Now, during recessions, this incentive effect tends to be far less important than the beneficial effects of unemployment benefits. The fact that the newly jobless don’t have to drastically cut back spending prevents pro-cyclical amplification of the downturn, and human suffering is alleviated, given that falling labour demand is driving rising unemployment. But during this recession, Congress has extended benefits for historically long periods. Those out of work can collect benefits for nearly two full years at this point, and for longer in some states.

JPMorgan’s Michael Feroli argues in a new research note that these extensions of emergency benefits—a total of 47 weeks’ worth of which have been passed in this recession—have significantly added to the unemployment rate:

[W]e’ll use a figure of 47 weeks of additional benefits as our baseline…

Based on the widely accepted 0.2 estimate of the responsiveness of average duration to the length of benefit availability, the 47 extra weeks of benefits could be expected to increase average unemployment spells by 9.4 weeks. Since only about half of the unemployed are eligible to receive unemployment benefits (the other half generally have not met the requirements for sufficient prior employment or lost their jobs through layoffs), the total average unemployment duration would be expected to increase by 4.7 weeks.

Starting from an average duration of around 16.5 weeks, this would imply about a 30% increase in the length of unemployment spells. If the generosity of unemployment benefits does not have a major influence on the rate at which firms lay off workers—which seems a reasonable working assumption—this would imply a 30% increase in the unemployment rate. Starting from an unemployment rate before the recession of roughly 5%, this means that increased benefits can account for 1.5%-pt of the subsequent increase in the unemployment rate.

Expect to see that 1.5% figure touted elsewhere in the world of punditry. It’s a substantial number—the difference, probably, between continued Democratic majorities in Congress and the loss of one or both houses to Republicans. But is it right?

I think there’s at least one big problem with Mr Feroli’s calculation. Of the 47 weeks in emergency benefits enacted during this recession, only 20 of them had been passed into law by late 2009, at which point the unemployment rate was plateauing. Since the last 27 week extension, the unemployment rate has actually ticked downward. It therefore doesn’t make sense to argue that emergency unemployment benefit extensions can be blamed for 1.5% of the increase in the unemployment rate from 5% to 10.1%.

Now, as I have been pointing out in recent weeks, the extent to which the fledgling recovery has been jobless is really surprising. It is possible that generous emergency benefits are making workers more patient as they search for jobs, thereby slowing the rate at which labour markets improve. I’m sure that’s taking place to some extent. But there are a few things to say about that.

One is that this dynamic isn’t necessarily a terrible thing. It makes the statistics look worse, and it costs the government, but it may make for better labour market matches and better use of worker skillsets (and increased productivity). Another is that there seems to be a fairly significant structural component to unemployment in this recession—new job growth is coming in places like health and education while the bulk of the job losses occurred in manufacturing and construction. In the absence of generous emergency benefits, what is currently showing up as long-term unemployment (and a higher than expected unemployment rate) would otherwise show up as a decline in the labour force. That would mean a lower unemployment rate (as it reduces the denominator), but it wouldn’t be evidence of more strength in labour markets.

It’s worth investigating these questions, but it’s also important to keep one’s eye on the ball—current high unemployment is overwhelmingly a labour demand rather than a labour supply issue.

SPEAKING of liquidity traps and the zero bound, here‘s an interesting story:

In a bid to shore up a deflation-plagued economy, Japan’s central bank eased monetary policy further Wednesday by enlarging a loan program for banks, setting the country, the world’s second-largest economy, on a path divergent from those of other industrialized nations…

In a 5-to-2 vote at a policy meeting Wednesday, the Bank of Japan’s board decided to double a loan program for banks aimed at increasing liquidity in the Japanese economy, to ¥20 trillion, or $222 billion. The fixed-rate loans are available for three months.

The board voted unanimously to keep the bank’s benchmark interest rate on hold at 0.1 percent.

“The latest step is additional monetary easing,” the bank’s governor, Masaaki Shirakawa, said at a news conference. “We are employing the available tools to contribute to improving the economy and overcoming deflation.”

So there’s that.

PAUL KRUGMAN continues to push back against my criticism of his get-tough approach to the Chinese dollar peg. New posts on the subject are here, and here. The first concerns the question of how much of the world is in a liquidity trap, which is important because:

We’re currently living in a world in which both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment; so it’s a paradox of thrift world, in which anyone who tries to save more reduces demand, reduces employment, and – because investment responds to excess capacity – ends up actually reducing investment. By exporting savings to the rest of the world, via an artificial current account surplus, China is making all of us poorer.

To take this apart a little:

In my analysis, you’re in a liquidity trap when conventional open-market operations — purchases of short-term government debt by the central bank — have lost traction, because short-term rates are close to zero.

Now, you may object that there are other things central banks can do, and that they actually do these things to some extent: they can purchase longer-term government securities or other assets, they can try to raise their inflation targets in a credible way. And I very much want the Fed to do more of these things.

But the reality is that unconventional monetary policy is difficult, perceived as risky, and never pursued with the vigor of conventional monetary policy.

Consider the Fed, which under Bernanke is more adventurous than it would have been under anyone else. Even so, it has gone nowhere near engaging in enough unconventional expansion to offset the limitations created by the zero lower bound.

A while back Goldman estimated that if it weren’t for the lower bound, the current Fed funds rate would be minus 5 percent, and that to achieve the same effect as a further 5 points of Fed funds cuts the Fed would have to expand its balance sheet to $10 trillion; I wouldn’t stake my life on those estimates, but they seem in the right ballpark. Obviously, the Fed isn’t doing that.

Or put it a different way: suppose the real economic outlook were the same as it is — with all indications being that unemployment will stay very high for years to come — but that the current Fed funds rate were, say, 4 percent. Clearly the Fed would feel obliged to engage in a lot more expansion, cutting rates sharply and rapidly. But with short-term rates at zero, the Fed is instead merely on hold — it is not expanding its quantitative easing, and is in fact in the process of pulling back.

And, he says, by this standard much of the developed world is in a liquidity trap. It certainly seems like the zero bound has a constraining effect on monetary policy, if not in theory than at least in the minds of central bankers. Only, I’m not sure that’s what we’re actually observing. The fact is, both the Bank of England and the Federal Reserve engaged in unconventional monetary policy; the Fed is just now wrapping up its purchases of $1.25 trillion worth of MBS, and it also purchased hundreds of billions of dollars’ worth of Treasuries and agency debt.

Now, the Fed might easily have done more, and as Mr Krugman notes, others, myself included, have argued that more action is justified. But the fact that central bankers haven’t done more isn’t necessarily an indication that they’re unable to do more, or lacking the courage to do more. They might just think that more isn’t necessary. Ben Bernanke has said pretty explicitly that additional easing would have created an inflation threat. And while both Mr Krugman and I believe that additional expansion is necessary, fed funds markets appear to expect at least one rate increase by the end of the year. Given Mr Bernanke’s Depression scholarship and his comments through the recession, I believe you can’t ignore the possibility that the Fed eased precisely as much as it wanted to. I honestly don’t think that the Fed would be cutting rates now if it had room to cut rates. If the Fed has policy where it wants it, it’s not in a liquidity trap. And it may well react to additional sources of stimulus by offsetting them.

Meanwhile, Mr Krugman has been using one particular number to illustrate the stakes of this debate:

[B]y running an artificial current account surplus that is 1 percent of the combined GDPs of liquidity-trap countries, China is in effect imposing an anti-stimulus of that magnitude — which plausibly means 1.5 percent of GDP. This is not a small issue.

According to the IMF, China ran a record-high current account surplus in 2008, of $426 billion. Mr Krugman says that “almost all advanced countries” are in a liquidity trap, and adding up their GDPs gets us something like $40 trillion, so it seems that Mr Krugman is declaring that the entirety of china’s surplus is “artificial”. But there is no way that any conceivable RMB revaluation would eliminate China’s surplus entirely, and Mr Krugman provides no real evidence that it would. There are, very clearly, structural issues generating excess savings in China. Even something like a 30% appreciation in the RMB wouldn’t eliminate their effects.

Meanwhile, the list of liquidity-trap afflicted countries harmed by China’s persistent trade surpluses includes a number of persistent surplus countries. In 2008, Germany ran a surplus of $235 billion. Japan ran a surplus of $157 billion. And both of those nations, along with other rich east Asian countries like Singapore and Taiwan, have been running current account surpluses for years. Surpluses aren’t just an issue for China, or of China’s currency. And if China revalued, then those countries would presumably run even larger surpluses, which wouldn’t be helpful to America’s economy. Should we then throw up punitive tariffs on Germany and Japan until they resolve the issues that contribute to their persistent surpluses?

I continue to think that Mr Krugman’s proposed policy is wrongheaded and based on an incorrect assessment of potential benefits. But I also think it’s important to once more point out that it probably wouldn’t work; China doesn’t want to be seen as a weakling to be pushed around by America. Even if it didn’t retaliate, it might just depreciate its currency further to compensate for the effect of the import surcharges. And it might retaliate. It should be clear; this is neither the time nor the way to approach this issue.

GREEN marketing of certain products could potentially have an appreciable effect on human behaviour. Labelling of products as green (assuming the labels are accurate) may influence buying decisions, particularly since consumers may be willing to pay extra to associate themselves with good or green decisions. But those decisions may be offset elsewhere, as consumers seem to keep a kind of mental balance of altruism:

Consumer choices not only reflect price and quality preferences but also social and moral values as witnessed in the remarkable growth of the global market for organic and environmentally friendly products. Building on recent research on behavioral priming and moral regulation, we find that mere exposure to green products and the purchase of them lead to markedly different behavioral consequences. In line with the halo associated with green consumerism, people act more altruistically after mere exposure to green than conventional products. However, people act less altruistically and are more likely to cheat and steal after purchasing green products as opposed to conventional products. Together, the studies show that consumption is more tightly connected to our social and ethical behaviors in directions and domains other than previously thought.

This would seem to point to another advantage for price-oriented environmental policies like carbon taxes. They’re likely to be more effective, because they rely on price signals rather than altruism to generate reductions in the environmental impact of consumer purchases. And because they don’t rely on altruism, consumers may be less likely to compensate for their greenness by being more ethically indulgent elsewhere.

THE latest data on producer prices, for the month of February, has just been released. The headline figure is a decline of 0.6%, but that is mainly due to a 2.9% dip in the cost of energy, which won’t be sustained. Still, core producer prices moved forward at just a 0.1% pace. Pundits may enjoy wringing their hands over an imagined inflation threat, but for the moment, deflation seems as likely (which is why the Fed continues to commit itself to keeping rates low). Here’s where things stand, in chart form:

That’s the 12-month percent change in core PPI. This is what it looks like when analysts say things like “inflation pressures are subdued”.

PAUL KRUGMAN has now put up a substantive response to my criticisms of his column, which I appreciate. But I still don’t quite see the logic of his approach.

Mr Krugman’s post focuses on three different issues: capital export, elasticity pessimism, and then the political economy. Regarding the former, he writes:

Let me start with a proposition: the right way to think about China’s exchange rate is, initially, not to think about the exchange rate. Instead, you should focus on China’s currency intervention, in which the government buys foreign assets and sells domestic assets, on a massive scale.

Although people don’t always think of it this way, what the Chinese government is doing here is engaging in massive capital export – artificially creating a huge deficit in China’s capital account. It’s able to do this in part because capital controls inhibit offsetting private capital inflows; but the key point is that China has a de facto policy of forcing capital flows out of the country…

By creating an artificial capital account deficit, China is, as a matter of arithmetic necessity, creating an artificial current account surplus. And by doing that, it is exporting savings to the rest of the world.

The question here is how much of China’s excess saving can be attributed to the government’s currency policy. The answer is: some. But that doesn’t tell us that much. Remember this chart:

And recall that from 2005 to 2008, the RMB appreciated by about a fifth. Other things equal, a dearer RMB would lead to less exported savings from China and a reduced current account deficit. But that doesn’t mean no current account deficit. China has other, serious structural imbalances, like this:

What is the connection between China’s one-child policy and its savings glut? This column provides a pioneering explanation. China’s surplus of men has produced a highly competitive marriage market, driving up China’s savings rate and, therefore, global imbalances.

Revaluation won’t make that go away.

Mr Krugman elaborates on this point in discussing “elasticity pessimism”, that is, the idea that currency depreciation doesn’t generate trade effects. He writes:

People making these arguments may not know it, but they’re engaged in a modern version of the “elasticity pessimism” that was prevalent in the early postwar years, and used to defend the necessity of continuing foreign exchange controls. Then as now, the claim was that changing currency values would have little effect on trade flows, although back then it was used to argue against depreciations in deficit countries rather than appreciation in surplus countries…

[W]e have lots of experience with currency depreciations – and they have invariably led to a rise in exports and the trade surplus. Consider the smaller East Asian nations in the aftermath of the 1997-1998 crisis, or Argentina after 2001, or even the United States after 2005, when the weak dollar set off an export boom. Is China really uniquely exempt from the rules that apply to everyone else?

I’m not arguing that there has been no effect to the RMB peg, and I’m not arguing that there would be no effect to revaluation. I’m merely arguing that the effect would be relatively small, given the other factors contributing to imbalances. Look, once more, at the chart above, which shows no major shift in consumption’s share of Chinese output despite a major episode of RMB appreciation. Or consider this chart:

China’s top export destination is America, and as I mentioned, the RMB appreciated steadily against the dollar from 2005 to 2008. China’s second most important export destination is Japan. From 2005 to 2008, the RMB appreciated about 25% against the yen. The RMB’s movement against the euro is more volatile; it appreciated against the euro by about 15% from 2005 to 2006, then fell back about 10% (before strengthening strongly during the crisis, thanks to its renewed peg to the dollar, which rose amid the flight to safety). See if you can track the effects of those movements in the chart above.

Or we can focus on the American experience, which Mr Krugman cites. From 2005, the dollar weakened steadily, which did lead to a big increase in exports. And yet, the American trade deficit held steady from 2005 to 2008, hovering around $60 billion.

You can see why. Oil imports surged. So what does this suggest? That even when currency shifts are having their expected effect, other structural issues in the economy can swamp those impacts.

Mr Krugman says:

Finally, don’t make too much of the lack of an obvious relationship between Chinese currency movements over the past few years and the trade balance. China is an economy in the process of rapid transformation – exactly the circumstances in which a real exchange rate that makes sense one year may be way off base just a few years later.

But then what’s the issue here? Just a few paragraphs before, he was writing:

[A] weak renminbi is the mechanism through which China’s capital-export policy gets translated into physical exports of goods.

Is China no longer in rapid transformation, such that currency revaluation will have the expected effect? What has changed? And of course, the real tricky bit to all of this is that China’s trade surplus has dropped over the past year, despite no movement in the relationship between the RMB and the dollar.

The point is that while there is certainly a relationship between China’s capital-export policy and trade imbalances, that’s not the only thing influencing trading patterns.

But still, other things equal, the world would prefer to see China let the RMB appreciate. But what can America do to generate this outcome? Mr Krugman writes:

The final argument I hear about the renminbi is that it’s useless to make demands, because the Chinese will just get their backs up, refusing to bow to external pressure. The right answer is, so?

Here’s how the initial phases of a confrontation would play out – this is actually Fred Bergsten’s scenario, and I think he’s right. First, the United States declares that China is a currency manipulator, and demands that China stop its massive intervention. If China refuses, the United States imposes a countervailing duty on Chinese exports, say 25 percent. The EU quickly follows suit, arguing that if it doesn’t, China’s surplus will be diverted to Europe. I don’t know what Japan does.

Suppose that China then digs in its heels, and refuses to budge. From the US-EU point of view, that’s OK! The problem is China’s surplus, not the value of the renminbi per se – and countervailing duties will do much of the job of eliminating that surplus, even if China refuses to move the exchange rate.

And precisely because the United States can get what it wants whatever China does, the odds are that China would soon give in.

This is a happy world, is it not, when Europe and America slap punitive import surcharges on China and China just sits there and takes it? What if China responds with tariffs of its own? What if it seeks to carve out its own regional trade bloc in Asia? What if it refuses to help America with Iran or North Korea? What if it occupies Taiwan? Where are the careful considerations of all the possible ways China might respond? Certainly we should be very aware of and concerned with these risks.

Especially since it was just one week ago that China central bank governor Zhou Xiaochuan said of the dollar peg that, “These kinds of policies sooner or later will be withdrawn.”

So, to recap. In recent years, exchange rate shifts in China and America have not produced the changes in trade balances one might expect, suggesting that structural issues are an important reason for these persistent imbalances, further suggesting that the benefits of revaluation may not be that big. Meanwhile, despite China’s currency policy, the Chinese trade balance has shrunk. An aggressive campaign to get China to revalue might not generate the desired results, and it might lead to unpredictable and costly retaliation from the Chinese government. And there is recent evidence that Chinese leaders are aware of the problems with the dollar peg and plan to adjust it, even in the absence of American action.

So why roll the dice? I appreciate Mr Krugman’s discussion of the macroeconomic issues involved here, but he hasn’t begun to address why it’s vital to risk international comity over this.

THE ECONOMIST has a new videographic up detailing the behaviour of the German economy over the last decade, in particular the steady persistence of Germany’s trade surplus:

Meanwhile, the Greek endgame seems to be in sight. European finance ministers are saying that they have drawn up plans for a €4.8 billion rescue package, should Greece’s austerity measures fail to convince markets that the country can address its budget problems. The solution, conspiculously, is an ad hoc one.

To learn about Germany’s largest ever investment in America, go here.

LET me make just one more point (you know, for now) about the question of whether or not America should take an aggressive stance with China concerning its exchange rate. Here is one of the top Bloomberg stories at the moment:

China is growing more concerned about Iran’s nuclear intentions, Foreign Minister Yang Jiechi said at a joint press conference with his U.K. counterpart.

The comments from Iran’s biggest trading partner may mark a narrowing of the gap between China and the U.S., U.K., Germany and France in how to tackle Tehran’s atomic program. Iran maintains that it is only interested in civilian uses, while the U.S. maintains the regimes wants to develop weapons.

The United States and its European allies are pushing for United Nations sanctions against Iran to force the country back to negotiations over its nuclear enrichment plans. China holds veto powers as one of the five permanent members of the United Nations Security Council.

Apparently, America could use China’s help to rein in would-be nuclear power Iran. China, as a member of the United Nations Security Council and as Iran’s biggest trading partner, seems to have some weight to throw around, diplomatically speaking. I bet if I thought really hard, I could come up with other areas where America needs a positive relationship with China. Sticking with international threat control, we could talk about North Korea. Or I might point out that China is now the world’s largest emitter of carbon dioxide, and any deal to reduce the damaging effects of climate change must include an agreement with China as a willing partner.

If you’re going to run the risk of alienating a country like China, you’d better have an extremely good reason for doing so. Not a likely-to-be-somewhat-beneficial reason. A really, really, extremely good reason. I’m still waiting to see some explication of why this particular stand is one America has to take—can’t afford not to take. Citing China’s trade surplus figures doesn’t cut it. At present, the case for getting tough with China is riddled with holes.

PAUL KRUGMAN has responded to my disagreement with his column on a “get tough” approach to China regarding its currency policy. Unfortunately, he spends all his energy on the Iraq War analogy:

My case for action is entirely based on dubious claims made by unstable informants with code names like “Curveball”, questionable evidence about things like aluminum tubes, and obviously forged letters allegedly from Niger. The actual, public facts and figures I cited have nothing to do with it.

And the real tell is the fact that I’m closely following arguments made by rabble-rousers like Fred Bergsten and the Institute for International Economics, which, um, is a big supporter of free trade and international cooperation … but nonetheless is just like PNAC.

Oh, and I’m showing disrespect for China’s leaders by not giving them credit for understanding the need for appreciation, even though they consistently say that no change in the exchange rate is warranted. The respectful thing would be to assume that everything they say in public about the issue is a lie.

Ugh. This is extremely disappointing, because it ignores the substance of my criticism and because it so wildly distorts the analogy I drew. I never said Mr Krugman was using false data. I never said he was relying on faulty sources. I never implied anything like that. What I suggested was that he seemed to be ignoring the potential for things to go badly wrong with his plan, overestimating the potential that they may go right, and misreading the net benefit of both of those potential outcomes. His response basically sidesteps all of these issues.

Let me briefly rephrase my argument and see if I can’t provoke a more substantive answer from Mr Krugman. I agree with him that there would be some benefit to China, America, and the rest of the world if China allowed its currency to appreciate against the dollar. But it seems to me that this benefit is easily overstated; both China and America can trace their current account situations to significant structural imbalances, and even without an end to the dollar peg, America’s trade balance with China has improved and continues to improve through the recovery. It also seems to me that an aggressive American push for currency revaluation is unlikely to work, because China’s government does not want to be seen, at home and abroad, as a weakling in the face of American pressure. And there is a not insignificant risk that America’s decision to “take a stand”, and particularly to pursue a series of trade surcharges, would provoke a trade war with China which, given the current feeble state of the global economic recovery, could prove extremely costly. The downside risk to such a policy is quite large relative to the potential upside from Chinese revaluation.

What’s more, I think China understands that it is in its interest to revalue and will do so eventually. Why do I think this? Well, China was more than willing to revalue before the onset of the global recession. Mr Krugman hints that I am the one being disrespectful to China for not taking its leadership at its word when they say that no change in the RMB exchange rate is warranted. But this is par for the course where currency levels are concerned. In America, it’s a time-honoured tradition for leaders in Washington to declare that a strong dollar is warranted, good, right, proper, and so on, despite the fact that this clearly isn’t the case. I suppose we could say that they’re fools or liars, but we generally just note that this is something they say because they feel it is in their interest to do so, for political and economic reasons. Meanwhile, it isn’t as though it’s been ages since a Chinese official hinted that RMB appreciation was just a matter of time.

So there you have it, my view in a nutshell. And Mr Krugman, if the Iraq War analogy troubles you then by all means disregard it. But don’t disregard my argument.

JAMES HAMILTON always has interesting things to say about oil and the macroeconomy. Like:

The surprise to markets in 2008 was that even $100 oil wouldn’t be enough to prevent world demand from growing above 85 million barrels a day, and much more than 85 million barrels a day simply wasn’t going to be produced at that time.

What’s even more interesting is the new paper (PDF) to which he refers, by Joyce Dargay and Dermot Gately, which seems to show that the demand for petroleum has actually become less elastic since the oil shocks of the 1970s:

[C]ompare two decades in which the price of crude oil has quintupled: 1973-84 and 1998-2008. After the price increases of the 1970’s, per-capita demand fell by 19% for the OECD and by 13% for the world as a whole. In the past decade, with oil price increases similar to those of the 1970’s, per-capita demand fell only 3% in the OECD; worldwide it actually increased, by 4%.

Observe:

What I don’t think we know just yet, and what will be very important to see, is how quickly elasticities can adjust given sustained high oil prices. It matters a great deal that real oil prices fell dramatically in the early 1980s and stayed low through about 2003, at which point they began rising toward their 2008 peak. Two consecutive decades of low and relatively stable prices is a long time to build in dependencies. It’s a long period of time through which commutes become longer and vehicles larger and more powerful. The authors of the paper note that:

The factors most responsible for reducing demand since 1971 cannot be repeated. Almost all the low-hanging fruit has now been picked; it cannot be picked again. The OECD has already done the easy fuel-switching, away from oil used in electricity generation and space heating.

Perhaps this is true, or perhaps electric automobiles are much closer than we suspect. Based on the chart above, it looks like we’ll get our answer fairly soon.

WRITING at Triple Crisis, Jayati Ghosh discusses the potential emergence of strong domestic demand in emerging markets, and posts an instructive chart:

Several things to point out. First, China’s household consumption level has long been extraordinarily low, even relative to other emerging markets, currency movements aside. That speaks to the structural issues in the Chinese economy that are contributing to persistent imbalances. A change in the RMB’s value wouldn’t make those issues disappear. Second, notice how similarly consumption patterns in China and India behave over the past decade. Is the RMB peg also holding down consumption in India?

Next, note that between mid-2005 and mid-2008, the RMB steadily appreciated against the dollar while household consumption as a share of output declined. And, there’s no trend break when the RMB begins to appreciate in 2005.

I wouldn’t argue that a floating RMB would have no effect on the Chinese economy; it would be beneficial. But people seem to ascribe a ridiculously outsized role to China’s currency policy in producing China’s trade surplus and America’s trade deficit. The level of rhetoric is simply not consistent with the impact of the peg, and the diplomatic damage some pundits are willing to risk is absolutely out of line with the economic gains that are actually at stake.

ONE part of the Paul Krugman column discussed this morning reads:

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.

That the zero bound on interest rates represents the point at which central banks run out of gas is something that most pundits seem to accept. Not just pundits, really; chief IMF economist Olivier Blanchard recently argued that central banks should consider raising their inflation targets so that policy would hit the zero bound less often. Last spring, Greg Mankiw entertained oddball ideas for ways to make negative nominal interest rates a possibility.

But really, is the zero bound actually a constraint? Scott Sumner has consistently argued that central banks continued to have plenty of options for boosting the economy after the federal funds rate neared 0%. Joseph Gagnon explained very specifically what more the Fed could have done. Ben Bernanke himself seemed to agree. Even Paul Krugman admitted that the zero bound was not actually a bound—not for a determined central bank, anyway.

Need more evidence?

This paper extends the model in Kiyotaki and Moore (2008) to include nominal wage and price frictions and explicitly incorporates the zero bound on the short-term nominal interest rate. We subject this model to a shock which arguably captures the 2008 US financial crisis. Within this framework we ask: Once interest rate cuts are no longer feasible due to the zero bound, what are the effects of non-standard open market operations in which the government exchanges liquid government liabilities for illiquid private assets? We find that the effect of this non-standard monetary policy can be large at zero nominal interest rates. We show model simulations in which these policy interventions prevented a repeat of the Great Depression in 2008-2009.

That’s from a new working paper by Fed economists. Or try this:

The Bank of Canada hit the notorious “Zero Lower Bound” on nominal interest rates (or felt it had). That’s supposed to matter. A central bank that hits that constraint cannot loosen monetary policy enough to offset a decline in aggregate demand. The Reserve Banks of Australia and New Zealand didn’t even come close to the lower bound. So seeing how the otherwise similar Australia and New Zealand did compared to Canada should tell us if the ZLB matters. Australia seems to have done better than Canada, which fits the theory. But New Zealand seems to have done worse.

I am increasingly convinced that it is the commitment of a central bank to continue stimulating that is important, rather than the room that central banker has to cut rates. The determined central banker doesn’t blink at 0%, he or she simply switches policy tools. And if this is right, then perpetuation of zero lower bound idea simply provides cover to central bankers who aren’t willing to continue easing. That’s a decision which should be justified on policy grounds, not chalked up to some imagined constraint.

IT IS fairly well known that over the past decade, real incomes for much of the American workforce stagnated (see this). It is also relatively well understood that one of the reasons for the stagnation has been an increase in the cost of employer-provided health insurance. As in:

It would seem to make sense, then, that part of the recent growth in inequality in America can be attributed to failure to consider health insurance costs as compensation. A new NBER working paper investigates:

A substantial part of the inequality literature in the United States has focused on yearly levels and trends in income and its distribution over time. Recent findings in that literature show that median income appears to be stagnating with income growth primarily coming at higher income levels. But the value of health insurance is an important and growing source of economic well being for American households that is missed by focusing solely on income. In this paper we take estimates of the value of different types of health insurance received by households and add them to usual pre tax post transfer measures of income from the Current Population Survey’s March Annual Demographic Supplement for income years 1995-2008 to investigate their impact on levels and trends in measured inequality. We show that ignoring the value of health insurance coverage will substantially understate the level of economic well being of Americans and its upward trend and overstate the level of inequality and its upward trend.

As I said, this would seem to make sense. I see one potential problem, however: insurance coverage is correlated (PDF) with income. That is, according to the Census, about 8% of households with greater than $75,000 in annual income lack insurance. About 15% of households with between $50,000 and $75,000 in income lack insurance. And nearly a quarter of households with incomes below $50,000 do not have insurance coverage. So if failure to consider health insurance coverage is leading to understatements of wage growth, it would seem to be happening more for households with higher levels of income. Which obviously complicates the argument that inquality isn’t as bad as it looks once insurance is taken into account.

Paul Krugman continues to be very upset with the Chinese government over its currency policy. He has written another column declaring that China’s dollar peg is damaging to the global economy, and that America should get tough with the leadership in Beijing. This still makes no sense to me.

As our Leader points out this week, it is probably in everyone’s interest for China to allow the renminbi to appreciate at this point, though I’m sympathetic to Scott Sumner’s argument that during the depths of the global recession, China’s peg was highly stimulative to the Chinese economy and helped to end the global economic freefall. But while appreciation of the RMB would be good for mostly everyone:

[I]t would not be a magic bullet, either within China or outside. Rebalancing China’s economy will require big structural reforms, from tax to corporate governance, as well as a stronger currency. A stronger yuan would not suddenly bring back millions of jobs to America. Since America no longer makes most of the products it imports from China, a stronger yuan would initially act more like a tax on consumers.

Rebalancing America’s economy will also require major structural reforms. As I have been pointing out, America’s trade deficit with China has been steadily shrinking, and recent growth in the deficit has primarily reflected an increase in America’s petroleum deficit. Mr Krugman tries to illustrate the scope of the problem by comparing current data to 2003 numbers, saying, “The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure.” But from 2003 to 2009, America’s exports to China grew by more (245%) than America’s imports from China (195%). For “the most distortionary exchange rate policy any major nation has ever followed”, it sure doesn’t seem to be preventing the very shift Mr Krugman would like to see.

His view of what ought to be done is perplexing. First, he calls on the Treasury department to label China an official currency manipulator. I’m not sure why he believes that anyone in China or America is confused about what the Obama adminstration thinks of the dollar peg. They’ve been quite clear. I’m also not sure what effect this is supposed to have.

But that’s just the warm-up. Here’s the call to action:

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) 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.

This is really remarkable. Mr Krugman is careful to explain why we shouldn’t fear that China, as a major creditor, has the leverage to punish America, but it seems as though he has given no thought at all to what leverage America has over China. Neither does he seem to pay the least mind to the potential fallout from such a reckless rush to a more aggressive approach to China. Perhaps the decision to impose these surcharges will have the desired effect. Or perhaps, the Chinese government will retaliate, touching off a trade war at the worst possible economic moment. The potential upside to Mr Krugman’s recommendation is trifling; the potential downside is massive.

And Mr Krugman seems entirely uninterested in the domestic political constraints facing China’s leaders. He doesn’t consider for a second the possibility that a bullying strategy on America’s part might make China less likely to do what the administration wants. Why on earth would a nationalistic nation anxious to establish itself as great power want to come off to all observers as a weakling in the face of American bluster? Mr Krugman would paint China into a corner, forcing them to take steps detrimental to all involved.

The general tone of his column—focused on toughness, insensitive to the internal politics of foreign nations, blind to potential negative outcomes, reckless and impatient—is familiar. It looks like nothing so much as the argumentation deployed by the Bush adminstration as it rushed to war in Iraq. Mr Krugman was prescient and prudent in fighting back against that misguided policy. He would do well to stop for a moment, take a deep breath, and think again before urging America to “take a stand”, damn the consequences.

He should respect China enough to know that its leaders understand that RMB appreciation is in their interest. And he should be humble enough to understand that patience and reserve is far more likely to lead to his desired outcome than ill-considered sabre rattling.

UPDATE: By the way, Mr Krugman has responded to this post, and I answer him in a new post here.