James Pethokoukis

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.

What does China’s new currency policy mean in terms of efforts in Congress to pass an anti-China currency bill?  Here is some of what some smart people told me. First Gary Hufbauer of the Peterson Institute for International Economics:

1.  The Chinese decision ratifies the forecast I made a while back — announcement of “flexibility” prior to G20 confabs.

2.  This will take the heat off Geithner and put the Schumer bill on the back burner.  Schumer and Geithner can both claim victory.

3.  Going forward, my expectation is that “flexibility” will translate into RMB apprecition against the dollar of around 0.5% per month, for a cumulative appreciation not more than 15% over the next two years.

4.  As the euro weakens against the dollar, China will claim (rightly) that its real effective XR is also appreciating, and that takes some of the edge off of pressure to appreciate the RMB against the dollar.

5.  My guess is that other Asian countries will appreciate against the dollar as well, but less than China.

Next up is the Philip Levy of the American Enterprise Institute:

1. To me, the puzzle is why they did not do this back in February. The move relieves a great deal of the pressure on the Chiense to revalue and they incur minimal costs in terms of export sector pressure. The only position that really united the bulk of Western critics was that Chinese stasis on currency was unacceptable. As soon as this becomes a debate over the appropriate rate of appreciation, the critics will split.

2. There will certainly be continued criticism. It is highly unlikely that China will appreciate much faster than the 6 percent annual rate they followed from 2005-2008. That’s not going to deliver the millions of jobs that Fred Bergsten, Paul Krugman, and the Economic Policy Institute have been promising. Those critics were talking about a 25-40 percent appreciation all taking place while the United States is in a liquidity trap. I never bought their premise, but if you did, time was of the essence.

3.  I doubt Sen. Schumer or Chairman Levin will be satisfied with a steady but minimal rate of yuan appreciation, but it should certainly reduce pressure on Secretary Geithner to name China a currency manipulator.

4. And, of course, it will be interesting to see whether the Obama administration will take a firm stand. If they threatened a veto, it would be the first time they’d blocked a measure because of anti-trade content within (going back to Buy America and Mexican trucks). My understanding was that Schumer had hoped to attach the provision to must-pass legislation anyways. I would be thrilled to see the Obama administration take such a firm stand, but surprised as well.

Me: Beijing’s currency concession might temporarily defuse Capitol Hill critics who want to limit imports. But it won’t dispel them. With American unemployment high and congressional elections just months away, China is just too convenient an economic scapegoat. Only if PetroChina oil was fouling the Gulf of Mexico right now could China be a more tempting political target. Trade relations are sure to remain contentious.

Allan Meltzer on deficits and the dollar:

The administration admits to about $1 trillion budget deficits per year, on average, for the next 10 years. That’s clearly an underestimate, because it counts on the projected $200 billion to $300 billion of projected reductions in Medicare spending that will not be realized. And who can believe that the projected increase in state spending for Medicaid can be paid by the states, or that payments to doctors will be reduced by about 25%?

While Chinese government purchases of U.S. debt may delay a dollar and debt crisis, they also delay any effective program to reduce the size of that crisis. It is far better to begin containing the problem before the U.S. blows a hole in the dollar and starts another downturn.

A weak economy is a poor time to reduce current government spending or raise tax rates, but we don’t require draconian immediate changes. We do need a fully specified, multi-year program to restore fiscal probity by reducing spending, and a budget rule that limits the size and frequency of deficits. The plan should be announced in a rousing speech by the president. The emphasis should be on reducing government spending.

Me: This could be just like in 2004 when President Bush ordered the Marines to take Fallujah right after the election. Maybe right after the 2010 midterms, Obama will announced a VAT.

This paper make a great case for blaming the Great Recession on the massive influx of cheap labor (and the continued weak yuan) into the global economy. Bad decisions on Wall Street didn’t help, but they are not the root cause:

The common wisdom is that cheap money and lax supervision of financial institutions led
to this financial crisis, and solving that crisis will take us out of the recession. In our view,
the financial crisis is just the symptom. The fundamental cause of the crisis is the huge
labor supply shock the world has experienced, not the glut in liquidity in money supply.

In what follows we argue that this huge and rapid increase in developed world’s labor
supply, triggered by geo-political events and technological innovations, is the major underlying
force that is affecting world events today. The inability of existing financial and legal
institutions in the US and abroad to cope with the events set off by this force is the reason for
the current great recession: The inability of emerging economies to absorb savings through
domestic investment and consumption caused by inadequate national financial markets and
difficulties in enforcing financial contracts through the legal system; the currency controls
motivated by immediate national objectives; the inability of the US economy to adjust to
the perverse incentives caused by huge moneys inflow leading to a break down of checks
and balances at various financial institutions, set the stage for the great recession. The
financial crisis was the first symptom.