James Pethokoukis

Politics and policy from inside Washington

Why we don’t need a currency war, more Fed easing or additional stimulus

October 13, 2010

Great, great stuff from economic analyst Ed Yardeni, busting some myths and taking names:

1. The U.S. will prosper if the yuan appreciates. The number one urban legend today, in my opinion, is that if the Chinese stopped manipulating their currency and let it appreciate by say 20%, then the U.S. trade deficit would shrink and employment would rebound at a faster pace in the U.S. Didn’t the Chinese do that recently without the expected positive impact on the U.S.? Yes indeed. From mid-2005 through mid-2008, they let the yuan appreciate by 20%. It was then pegged again until it was allowed to move a bit higher in recent days. (See Fig. 26 in our China briefing book linked below.) America’s trade deficit with China was $248.8bn during the 12 months through July of this year. The Chinese simply manufacture lots of merchandise that the U.S. no longer produces because labor costs are too high in the U.S. The standard of living of U.S. consumers has improved as a consequence of cheaper imports. If the ones from China were made more expensive through currency appreciation or tariffs, the goods would be made in and imported from other low wage countries rather than made in the USA again. Besides, among the weakest sectors in the U.S. labor markets are construction and local governments. They have home-grown problems that have nothing to do with China. Productivity gains in sectors with high labor costs have cost some Americans their jobs, while they have boosted the real pay of those who remain employed.

Me:  Indeed, a new study out indicates that offshoring (and immigration) has not cost America jobs.

2. The Fed must continue to ease. Another Fed-inspired legend is that since the federal funds rate is down to zero, it means the Fed can’t do anything more to stimulate the economy. There is some bizarre chatter among Fed officials that based on the Taylor Rule, the federal funds rate should be negative! Indeed, FRBNY President William Dudley recently touted the idea that another $500bn in quantitative easing would be equivalent to lowering the federal funds rate by 50-75bps. The problem is that near-zero interest rates are depressing the interest income of many Americans. Americans may also understand that the only real beneficiary of such low interest rates is the U.S. federal government. So, the Fed is enabling the fiscal excesses of Congress. Eventually, such excesses must lead to higher taxes and higher inflation. In other words, Washington’s irrationally stimulative monetary and fiscal policies are getting offset by depressed rational expectations.

Me:  Low rates create more bubbles as investors search for high yields. The stage is not being set for strong, sustainable economic growth. But the lack of sound fiscal policy is pushing the Fed to act.

3. More fiscal stimulus is necessary. Keynesians continue to promote the fiction that government spending can create jobs through the fiscal multiplier effect. A significant portion of the 2009 fiscal stimulus program was directed at protecting the jobs of state and local public employees. Now that the stimulus is wearing off, they are losing their jobs anyway. The problem is that many of them are retiring early with huge pension benefits, making it impossible for state and local governments to hire more workers. The notion that the stimulus program wasn’t enough and that more deficit-financed government spending is required is nutty. What about more government spending on infrastructure? Congress regularly passes bills that purport to do that, yet the money never seems to show up as new roads, bridges, tunnels, and train tracks.

Me:  States need to restructure, and the their fiscal woes are forcing them to take action. Washington should focus on tax and budget reform ASAP.

Comments

Ed Yardeni along with Larry Kudlow are about the only two guys who make any sense. More please.

Posted by Gotthardbahn | Report as abusive
 

I wholeheartedly agree with points 1 and 2, but I think that point 3 is a bit off in that small business and consumers didn’t really see ANY of the first stimulus. If Congress wants to grandstand about the first stimulus, then they should point out exactly where it was spent because I really don’t see it. So – with that in mind – a 2nd stimulus that was transparent and went directly to those best in a position to really trickle it into the economy en masse, then why be against it?

Also, aren’t tax breaks for the rich or big business really just a form of stimulus? Don’t hear you arguing against that… in fact you constantly advocate that very same thing! So in a manner of speaking you are VERY pro-stimulus. I think healthcare and other tax breaks for small business would go WAY farther to help America’s economy than creating dollars for the wealthy that are just chasing return in the market.

Posted by CDN_finance | Report as abusive
 

Also want to add that the whole platform of forcing Yuan appreciation against the USD is not in America’s interests but more for the sake of Japan and the EU who actually are hit quite hard by the peg. Otherwise what we’ll have is the worldwide manipulation of currencies downward, fighting towards what THEY feel are acceptable exchange rates. At least in this process (the ‘currency wars’ hype passing through Washington and in the media), America commands the center seat at the table and can help set favourable, yet fair, terms for all – beats having a splintered global financial situation where no ones knows how far she goes!

Posted by CDN_finance | Report as abusive
 

While it is true that no-one needs a currency war, it is also true that the $US peg is an artificial support of the Chinese exporting economy. Somebody, somewhere isn’t getting a fair deal because of it. Any such arrangement will result in distortions of markets.

Maybe it won’t increase US employment and maybe it won’t result in the full upward revaluation that is predicted… but it would certainly bring things back to a more level playing field.

More quantatative easing is a horrifying prospect, as no-one appears to have a plan for moving interest rates back to “normal” levels without king-hitting markets again. The result is a bond bubble of enormous proportions, and the prospect that it will just get bigger.

Throwing more money to short term traders does nothing to encourage productive investment in the US. It is simply too wide a helicopter drop, and seems a crazy way of balancing the books for the country.

Reducing taxes and government spending may be a grand idea but does the country have the luxury of waiting for a “j-curve” recovery in employment and consumer expectations? Isn’t that simply going to grind the unemployed and underemployed further into the dirt, exacerbating the have/have-not economic polarity?

Aren’t the Irish/Greek experiences proof that rapid moves to austerity measures have a side-effect of killing government revenue and extending the time for a recovery? Wasn’t that the final analysis of the measures taken to deal with the Asian crisis? Surely there is room (as the article suggests) for a better mix of targetted tax change/employment/stimulus action?

And don’t the global figures suggest that defined benefit superannuation pensions are simply too expensive, too leveraged to a growth economy and transfer too much risk to the employer? Immediately implementing a staged movement to defined contributions strategies should at least help reduce the problem for the future. How ridiculous is it that auto companies and entire states can be brought to their knees by pension obligations to retired workers?

Posted by iambemsued | Report as abusive
 

when after the US elections the issues (monetary) that have to be faced will most likely be resolved with worthless dollars, since the staes can’t print their own currency to esolve their problems

Posted by phyll | Report as abusive
 

1. You are ignoring a 60 year cycle. Learn about the Triffin dilemma. The dollar’s status as the reserve currency puts us at a permanent trade disadvantage. We must run continuous trade deficits to stimulate global growth. Keynes knew this when Bretton Woods was being set up and he advised them to put in place an international currency known as the Bancor. The idea was rejected. Friedman thought he would solve the problem with floating exchange rates, which was an $8 trillion mistake.

2. QE is a weak tool & Bernanke has said there needs to be fiscal stimulus. QE cannot solve our problems.

3. You lie when you say the stimulus was a fiction. The stimulus kept those jobs in place and pevented a massive meltdown (do the math). Blaming pensioners is completely political. Why should only the rich have financial security? This isn’t even an issue in most countries. By your logic you should cut your wages and give up your retirement to help Reuters.

The US needs a major upgrade of its communications, electrical and transport infrastructure to remain competitive. This will require government spending over years and will create domestic jobs.

Why is spending trillions on war in the middle east good ecnomically but investing half that money in repairing our roads and bridges wrong? It’s not but political ideologues like you, always attack Americans investing in America as bad.

You should have been drummed out of the financial press years ago for ignorance. If you don’t even factor in the Triffin dilemma, you not qualified to write about internaitonal economics or finance. You’re a dimwit, who has survived by writing sales pap that the financial press loves. You should retire and by the way, you should give your pension funds back to your employers.

Posted by Barts | Report as abusive
 

Why are you trashing the multiplier effect? It works for the private sector. We just went through a massive globale credit bubble that caused tremendous economic growth in America. The growth was irrational because it led to a bubble in housing prices but the growth was real. Except in extreme conditions, credit is always used to expand the ecnomy. Right now price stability is so uncertain and demand is so low, it makes sense to have the federal government borrow to do infrastructure spending.

Posted by Barts | Report as abusive
 

Everything you state will prove to be true but the following idea is allowing China to laugh all the way to the bank and is killing any hopes of returning jobs back to the United States because it is simply not true. Their quality is awful but we will never have the opportunity to compete and demonstrate this until we find a way of throttling down their imports:

“The Chinese simply manufacture lots of merchandise that the U.S. no longer produces because labor costs are too high in the U.S. The standard of living of U.S. consumers has improved as a consequence of cheaper imports. If the ones from China were made more expensive through currency appreciation or tariffs, the goods would be made in and imported from other low wage countries rather than made in the USA again.”

Posted by Rethink | Report as abusive
 

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