The bill to raise the value of the yuan might pass

So reports The Washington Post.  It is worth reviewing (my interpretation of) Milton Friedman:

1. Attempts to stabilize nominal exchange rates, as the Chinese are doing, can in fact be destabilizing, since the eventual adjustment will often come suddenly rather than gradually.

2. Accelerating that adjustment by passing laws aimed at foreign countries is unlikely to be a good idea.  The laws encourage a sudden adjustment now, become a focus on rampant speculation, and the target of the laws is unlikely to react with good grace or feel gratitude. 

3. In the long run a country can peg its nominal exchange rate but not its real exchange rate.  In other words, if the Chinese lower the value of the yuan sooner or later Chinese prices will rise to restore the appropriate terms of trade.  Sterilization of flows (e.g., soaking up Chinese money supply by selling bonds) can succeed for only so long and eventually the problem will cure itself.

4. We might have to actually apply the punitive tariffs.

In other words, this development is really bad news.

Comments

The rosy economic view of economists is not necessarily shared by all
Americans.

The economists' fear of dealing firmly with China is also not shared by
many Americans.

Question: if we require the Chinese to send us safe toys, safe tires,
safe toothpaste with honest labeling and edible food, is that
protectionism? The Bush administration seems to think it is.

"save the rustbelt,"

Developing mechanisms that to ensure that goods are delivered as agreed upon (safe toys, tires and toothpaste) is likely to increase the benefits of trade. However, interference into what should be agreed to between buyers and sellers (tariffs and tinkering with the terms of trade) is not.

1930 in America? Wow. I mean wow. I am without words. That has got to be singlehandedly some of the most hyperbolic agitprop with no basis in reality that I have read in a really long time.

Since we don't make most of this stuff in the US anymore how is forcing the cost of Chinese-made items up going to help the average American consumer?

There are only two outcomes (not mutually exclusive):
1. Prices will rise - people will buy less
2. Prices will rise - people will buy less of something else

What won't happen is that we will suddenly see TV sets being built in the US again, or that Delphi will rehire 10,000 workers to make auto parts and close its Chinese factories.

Just remember it's silly season in Washington with an election looming. Expect to see a lot of what I call symbolic legislation being put forward. Yesterday's example was the new lobbying rules. Requiring naming contributors won't have any affect, lobbyists don't have any shame.

Oooh, Mr. Kotta, Mr. Kotta, I just thought of another reason Rustbelt is so abysmally wrong on trade!

Remember how the anti-traders say that trade will lead to a regulatory race to the bottom? Well, as China demonstrates, they turned out to be wrong! After all, when these scandals over tainted products broke out, we didn't lower our safety standards, China raised theirs.

Left to its own devices, the Chinese company that sold us tainted goods tried like hell to do exactly that, which is why the bribes occurred in the first place.

Er, yes . . . and? I'm not seeing how pointing out that the object of regulation tries to avoid being regulated is in any way a rebuttal of Keith's point. After all, that's more or less the assumption of every regulatory system -- that's why they exist, no? If companies would adhere to safety standards without the threat of fines and punitive action hanging over their heads, we wouldn't need the FDA. And can you possibly imagine that if they could get away with it, companies wouldn't bribe their regulators here in the US? Of course they would -- we have whole reams of laws to prevent it!

China's problem, as I understand it, is that the lack the mechanisms to enforce health and safety regulations on Chinese products across the whole of their economy, in more or less the same way that we lack the mechanisms to enforce our regulations on all imports that come into the country. My hope is that bad PR and U.S. regulatory mechanisms applied to US companies sourcing from Chinese companies will lead to those US companies being more careful about their sourcing, and lead to an improvement in health and safety standards in the Chinese companies, dovetailing with an improving Chinese regulatory climate. And that seems reasonable to me.

The Chinese company that sold defective tires to a NJ retailer ran away when the liability hit the fan.

Expect to see more of that.

"China raised theirs."

It is a little early to judge the results, don't you think?

I'm not anti-trade by the way, just pro common sense. And unlike many on the blogosphere, I've done honest work and do not view blue collar workers as subhuman.

'm not seeing how pointing out that the object of regulation tries to avoid being regulated is in any way a rebuttal of Keith's point. After all, that's more or less the assumption of every regulatory system -- that's why they exist, no? If companies would adhere to safety standards without the threat of fines and punitive action hanging over their heads, we wouldn't need the FDA.

You missed the same point: libertarians/free traders don't think there should be an FDA. The markets police themselves in this beautiful utopia.

fc...is the free market/libertarian idea that there shouldn't be an FDA, or rather that we must realize that the FDA has perverse incentives, and causes a lot of harm? Most of the discussion I'd seen seems to be saying more of "hey, the FDA isn't the Jesus that it's made out to be, so maybe we shouldn't trust it so unquestioningly."

The tariffs are a good idea. B

eyond helping to mitigate what is essentially a subsidy on all Chinese goods, they will also provide a necessary incentive for Americans to save more. This is a process that needs to take place in order to restore trade balance. The sooner it starts the better.

Sorry, the end got cut off and the formatting on that site is a bit screwy:

[ROBINSON] So your view is abolish the FDA..
[FRIEDMAN] Absolutely
[ROBINSON] And what comes up in its place? what comes up?
[FRIEDMAN} It's in the self-interest of pharmaceutical companies not to have these bad things. Do you think the manufacturer of Thalidomide made a profit out of Thalidomide or lost?
[ROBINSON] I see, ok.
[FRIEDMAN] And you have to have..people should be responsible for harm that they do. It should've been possible...
[ROBINSON] So tort law takes care of a lot of this.
[FRIEDMAN] Absolutely, absolutely..
[ROBINSON] Alright, if Lilly or Merck comes up with a drug that does me harm, I go after them, I join a class action with everybody else who's taken that pill and we sue them for billions of dollars and wipe out their share holders equity. Seeing that, they have every interest to be extremely rigorous in testing that drug before they make it available.
[FRIEDMAN] Let me give you a different example. The rules imposed on airlines, for safety. Who has the most interest in preventing airline accidents.
[ROBINSON] After the passenger themselves, the airlines.
[FRIEDMAN] Well it's not even clear that the passengers have more interest than the airlines because included in the passengers are the pilots. [ROBINSON] Right, of course
[FRIEDMAN} Why is the government going to improve airline safety? How are they going to do it? How do they add any incentive to anybody to improve airline safety?
[ROBINSON] Does Milton Friedman really oppose all health and safety regulation? Let me try this one on him- doesn't the public have the right to know about the nutritional content of the food it buys?

(etc.)

I also like how Friedman switches gears and backpedals on the pharm/tort issue. People crucify John Edwards but in this Libertarian world there would have to be a helluva lot more where he came from.

Re: fustercluck:

Milton Friedman disagrees with both of you:

Uh . .

[ROBINSON] So tort law takes care of a lot of this.
[FRIEDMAN] Absolutely, absolutely..

Okay. Yeah. Totally different from what I said.

Fisher-Price to Recall Nearly 1M Toys
Wednesday August 1, 7:35 pm ET
By Anne D'Innocenzio and Natasha T. Metzler, Associated Press Writers

Fisher-Price to Recall Almost a Million Toys Worldwide Because of Lead in Paint

WASHINGTON (AP) -- Toy-maker Fisher-Price is recalling 83 types of toys -- including the popular Big Bird, Elmo, Dora and Diego characters -- because their paint contains excessive amounts of lead.

The worldwide recall being announced Thursday involves 967,000 plastic preschool toys made by a Chinese vendor and sold in the United States between May and August. It is the latest in a wave of recalls that has heightened global concern about the safety of Chinese-made products.

The recall is the first for Fisher-Price Inc. and parent company Mattel Inc. involving lead paint. It is the largest for Mattel since 1998 when Fisher-Price had to yank about 10 million Power Wheels from toy stores.

I fail to see why a US response to Chinese economic manipulation is “really bad news†. Indeed, this is a depressing typical example of how “free traders† undermine the well being of the American people. In my opinion, “free traders† are so hostile to any government action that they refuse to support the basic economic defense of the United States.

Why is it somehow OK for the Chinese government to rig the global economic system against the United States, but sacrilege for the US to do anything about it? Actually, the word “sacrilege† contains the answer embedded in it. For better or worse, “free trade† has become a contemporary religion divorced from the actual merits of trade policy.

It should be clear that China is not practicing “free trade† or anything close to it. No less than Martin Wolf has called it “Foreign Exchange Mercantilism†. See “Will Asian Mercantilism Meet its Waterloo?† (http://www.pc.gov.au/lectures/snape/wolf/wolf.pdf). Of course, China is not alone in this practice. Many emerging market economies have chosen the same direction. The same can be said for Japan as well.

The magnitude of Chinese Mercantilism is vast. The RMB is undervalued by more than 300% on a purchasing power parity basis. Of course, other Asian currencies are undervalued as well. However, that is one of the key reason why the RMB peg must be broken. Other Asian countries won’t allow their currencies to rise against the dollar until the RMB appreciates.

See “Is the Renminbi (Rmb) undervalued in price terms?† (http://www.econbrowser.com/archives/2006/04/is_the_rmb_unde_1.html) for a paper on this subject. Note that the value of the RMB has declined over time. China has actually depreciated the RMB versus the dollar. See http://www.flickr.com/photos/peter_schaeffer/980639059/in/set-797819/ for a chart covering the 1975 – 2003 period.

The consequences for the United States of China’s RMB policy are dire. The US is currently running the largest trade deficit of any nation in history. The current account deficit is in excess of 6% of GDP and shows no sign of shrinking. See http://www.flickr.com/photos/peter_schaeffer/956200486/ for a chart showing how the US has declined in world trade.

To put this in perspective, the US was able to pay for just 55% of its imports of goods in 2006. The US did run a small services surplus of $79.75 billion. However, that was dwarfed by $838.27 deficit for goods.

Perhaps even worse, the US has systematically liquidated its capacity to pay for imports. Since 2000, the US has lost 3.2 million manufacturing jobs. Arguably, those jobs have been replaced by other employment in non-tradable goods. However, that is exactly the point. We have replaced jobs that enable this nation to pay its bills with jobs that don’t.

Would anyone whose income covered just 55% of their outlays think they were doing well? If the other 45% was financed with debt would that be a positive? Of course, not. However, this is supposedly a good thing for the United States as whole†¦ According to the “free traders††¦

The bottom line is that “free trade† amounts to a system where the United States is systematically exploited by countries that know better. Because of the stranglehold of the pernicious ideology of “free trade† our nation is paralyzed in attempting to do anything about it.

Of course, that isn’t entirely true. Certain special interest groups clearly benefit from “free trade†. See “Are US trade politics really driven by the profits US banks hope to earn in China?† (http://www.rgemonitor.com/blog/setser/150535/) by
Brad Setser. A useful quote

“A cynic might interpret the huge windfall gains that China has provided Goldman (and others) as the danegeld that China pays Goldman (and others) to use their political clout to fend of the protectionist hoards in the industrial Midwest. So far, that strategy has worked.

I just doubt a political strategy based largely on rewarding those who already winning from China’s integration into the world economy will continue to work.†

Peter Schaeffer: "Since 2000, the US has lost 3.2 million manufacturing jobs.:

So what? U.S. employment is at an all time high. Technological innovation has been eliminating the need for manufacturing jobs for a few decades.

Peter Schaeffer: "those jobs have been replaced by other employment in non-tradable goods. ... We have replaced jobs that enable this nation to pay its bills with jobs that don’t."

Try these facts, Mr. Schaeffer:

In 2006, U.S. manufacturing output was at an all time high.

In 2006, U.S. exports of goods were at an all time high.

In 2006, U.S. exports of services were at an all time high.

In 2006, the U.S. capital account surplus was at an all time high, as foreign investors and governments demonstrated their belief in the strength of our eoonomy.

The U.S. continues to lead the world in manufacture of aircraft, of medical equipment, of biotechnology, of motor vehicles, and much, much more. In fact, U.S. factories still lead the world in manufacture value added. Why should we care if we no longer make T-shirts and sneakers? or if our workers have better things to do than assemble tiny components in television sets?

I've just learned that my grandchildren have been endangered by possessing the lead coated toys, if only briefly.

Some of those toys we purchased, under the good faith belief that the company was reputable and would not sell dangerous toys (we always screen them for age appropriateness).

Now it is personal, really personal.

John Dewey,

In 2006, the trade deficit was at an all time high. Rising exports don't make a nation solvent if imports are rising even faster. Sadly, that is exactly true.

As for the capital account. Yes, foreign government are willing to finance America's deficits. However, their motives are hardly benign. They are paying for Exchange Rate Mercantilism with a clear goal of strengthening their economies and undermining ours. They are succeeding all too well.

Private investors no longer find the US attractive. Without sovereign capital flows, the dollar would have collapsed long ago.

"Yes, and wages for American workers peaked back in 1973 and have declined substantially since."

Please show me some statistics to support your claim. The BLS data I've seen showed that private sector average hourly wages hit bottom in 1993-1995 and have been increasing since then.

What do you mean when you say "let's not pretend the system is working well"? What system are you referring to?

Peter, do you honestly believe that American households are less well off than they were in 1973? Were you the head of a household in 1973?

Peter Schaeffer: "Private investors no longer find the US attractive"

Really? Not according to the Bureau of Economic Analysis. Foreign direct investment in the U.S. was $161 billion in 2007, higher than any previous year except the bubble years of 1998-2000. Here's some of the industries they invested in:

chemicals............$14.8 billion
computers............$17.9 billion
telecommunications ...$4.7 billion
real estate..........$15.7 billion

John Dewey,

Since around the time of WWI, the United States was a net creditor to the world. Now we are a massive debtor. Worse, we can’t pay our debts because our imports dwarf our exports. How do we keep paying for our trade deficits? More debt of course.

Let me repeat. Foreigners aren’t investing here. At least not on a scale remotely comparable to our trade deficit. Our trade deficit is being financed by foreign governments, not private investors. These governments aren’t “investing here†, they are engaging in “Exchange Rate Mercantilism†.

$161 billion in FDI doesn’t amount to much versus a $838 billion trade deficit. Worse, almost all of the FDI was portfolio investment, not investments in new factories, plants, equipment, etc. in other words, very little of the FDI added to the productive capacity of the United States. Instead we just sold existing assets to foreigners (like the abortive CNOOC acquisition of Unocal). Selling your country to pay for trade deficits isn’t the road to economic heaven.

Peter Schaeffer: "Foreigners aren’t investing here. At least not on a scale remotely comparable to our trade deficit."

Those are two very different statements. I repeat my claim earlier: foreign direct investment in 2006 was higher than any prior year except for the overheated bubble years of 1998-2000.

If China chose not to invest in government T-bills, our current account deficit would still be balanced by our capital account surplus. Either (a) exchange rates would change to reduce the spending power of U.S. consumers, or (b) foreign investors would buy other U.S. assets. As I see it, having the Chinese government hold on to a bunch of T-bills is no worse than either of those scenarios.

Peter Schaeffer: "Selling your country to pay for trade deficits isn’t the road to economic heaven."

That implies that investment is a zero sum game. You seem to be saying that American assets will be reduced if foreigners invest in the U.S. I don't think that's true, Peter.

Peter Schaeffer: "Since around the time of WWI, the United States was a net creditor to the world. Now we are a massive debtor."

First, it certainly made sense for the U.S. to invest Europe and Asia for 15 to 20 years after WW II. Those economies had been ruined by the war. Rebuilding those nations represented very high potential returns for investment.

Second, the U.S. had to be a net exporter of goods after WW II. Again, the industrial capacity of Asia and Europe had been blown up.

I think you are trying hard to tie the debt of the federal government with the current account deficit of the U.S. economy.

We can - and did in either 1998 or 1999 - run a current account deficit even when our federal government spending is balanced with federal government revenues. Can we please get away from this idea that the two are tied together?

Government borrowing is debt that must be paid by future generations. It will still be debt whether we have a current account deficit or a current account surplus.

Correction to my last post: I should have written "the total value of U.S. financial assets is at least $40 trillion dollars".

"I've just learned that my grandchildren have been endangered by possessing the lead coated toys, if only briefly.

Some of those toys we purchased, under the good faith belief that the company was reputable and would not sell dangerous toys (we always screen them for age appropriateness).

Now it is personal, really personal."

Yes, I'm sure you'd make an argument for banning or heavily taxing Made in America products if an American company ever did anything unsafe. And I'd bet you'd make it "personal, really personal."

Look, there are blogs with comments sections where that cheap rhetorical BS flies. This ain't one of them.

Matthew, John Dewey,

The link you provided doesn’t refute any of the wage statistics I provided. Sadly, it supports them rather well. Indeed, the fact that per-capita consumption has grown substantially, while wages have fallen, shows how poorly the system is working. There are many reasons for the divergence between real wages and consumption. Some are mentioned in the web page. I review them below. In addition, the author makes a significant error with respect to housing costs (also discussed below).

The per-capita consumption data would only be germane if it applied to the same population as the real wage data. That is not correct. The real wage data is for “production and non-supervisory workers† as defined by the BLS. The per-capita consumption data is for the economy / population as a whole. The fact that these groups have diverged so badly is exactly the point I was trying to make.

The divergence has many origins. The list certainly includes at least the following.

1. A vastly disproportionate share of economic gains has flowed to the top 10%, 1%, 0.1% and even 0.01%. Actually, Krugman reported that just 25 people hedge fund managers earned $2 billion dollars last year. This is probably a substantial underestimate if anything. Of course, highly concentrated income gains at the high-end raise per-capita consumption while contributing nothing to consumption by wage earners. See “Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income† (http://www.nber.org/papers/w11842) or any of the papers by Piketty/Saez including “Income Inequality in the United States, 1913-1998 (series updated to 2000 available)† (http://www.nber.org/papers/W8467). Another source asserts that “More than 90 percent of the gains from economic growth over this period have gone to the richest 10 percent of the population, with the richest 1 percent alone pulling in more than half†. See “Inequality Without Growth, Pain Without Gain† (http://www.truthout.org/cgi-bin/artman/exec/view.cgi/65/23039).

2. Since 1973 Labor Force Participation has grown substantially, entire from higher female LFP (male LFP has declined). Of course, higher levels of LFP make possible higher levels of consumption. However, this has nothing to do with wages. It is simply a matter of more money (and consumption) for more work. If anything rising female LFP may be (in part) a response to stagnant and/or declining wages.

3. Since 1973 family / household sizes have declined. Of course, this makes possible higher levels of consumption per-capita. However, this has nothing to do with wages. If hypothetically our nation had no children or elderly per-capita consumption could be even higher. Such a statement is meaningless and useless. Worse, some of the trend towards smaller households may be attributable to stagnant and/or declining wages.

4. Since 1973, this nation’s savings rate has declined to zero. Indeed, it may well be negative at this point in time. Conversely, PCE (Personal Consumption Expenditures) have risen to a record percentage of GDP. Obviously, consumption per-capita can be raised by eliminating savings. However, this has nothing to do with real wages. Indeed some the trend towards zero savings may be attributable to stagnant and/or declining wages.

5. Since 1973 real household debt has risen dramatically by every possible measure. Obviously, rising debt make possible higher levels of consumption without any corresponding gains in income (which have not occurred). In this context I am referring to both conventional credit card debt and mortgage debt. In recent years, mortgage debt has been used not just to finance property but directly as a means of financing consumption via MEW (Mortgage Equity Withdrawal). See the (now classic) Kennedy / Greenspan paper for estimates of how large MEW is (trillions in recent years). See “Advance Q2 MEW Estimate† (http://calculatedrisk.blogspot.com/2007/08/advance-q2-mew-estimate.html) for some quite recent data. Of course, consumption financed with debt provides no information about real wage trends. Indeed some the trend towards debt financed consumption may be attributable to stagnant and/or declining wages.

6. Profits, dividends, interest, rents, capital gains, etc. can all be used to finance consumption. Together these financial streams can be called capital income. There is considerable evidence that capital income has grown faster since 1973 than wage income. Indeed, corporate profits are at records levels as a percentage of GDP. Obviously, gains in capital income support per-capita consumption while contributing nothing to consumption by wage earners.

7. The web page web page suggests that “error in measuring housing costs was corrected in 1983† with material consequences. Actually, the reverse is true. Before 1983 housing costs were measured the same way people actually pay them. Housing prices were measured and combined with mortgage interest rates to determine the cost of housing (purchased housing that is). Since then the BLS has used the "owners' equivalent rent of primary residence" method of estimating housing costs. This has resulted in a very large measurement error (understatement) in the CPI. The problem is that rents have not kept pace with house prices, to say the least. At the same time, Americans predominantly purchase home rather than rent them. Basically, the BLS is using a product Americans don’t buy (housing rents) as a proxy for a product Americans do buy (homes). The result is a very large underestimate of inflation. See “House Prices and Fundamental Value† (http://www.frbsf.org/publications/economics/letter/2004/el2004-27.html) for some out-of-date data (the paper is from 2004) showing a large increase in the U.S. Price/Rent ratio. See also “Price Rent Ratio Update† (http://calculatedrisk.blogspot.com/2005/06/price-rent-ratio-update.html).

8. It is certainly true that low-wage immigration has enormously expanded since 1973. Indeed, there is considerable evidence that a considerable proportion of the observed wage stagnation is a consequence of greatly expanded unskilled (legal and illegal) immigration. I would argue that the adverse effects of mass immigration don’t stop with workers (as defined by the BLS) but include much of the middle class via declining housing affordability. However, your argument is that unskilled immigrants have depressed the average wage. Too some extent this must be true even without a supply effect (immigration reducing wages for all workers). However, the effect can not be large. Immigrants are about 15% of the overall labor force. Unskilled immigrants might be half that or 7.5%. Even assuming the they earn 50% as much as natives, the impact on the average can not be large. Note that the supply/demand impact could be much larger of course. However, I question the logic of treating the low incomes of unskilled immigrants as a counterargument. Unless you plan on deporting these folks, they will become part of the population working at below-1973 wages.

It is certainly true that the economy has grown dramatically since 1973. Indeed, per-worker GDP has increased by more than 50% since 1973 (deflating nominal GDP using the GDP deflator, not CPI-U). However, the failure of wages to grow over the same period, and the actual decline that has occurred, demonstrates how dysfunctional the system is.

Peter Schaeffer: "If anything rising female LFP may be (in part) a response to stagnant and/or declining wages."

But it may also be true that wages did not grow as much as you wish they did because women increased the supply of labor relative to the supply of capital.

Peter Schaeffer: "the failure of wages to grow over the same period, and the actual decline that has occurred, demonstrates how dysfunctional the system is."

If the inflation rate has been overstated, as some very bright economists have argued, then real wages have not declined at all.

So how are you proposing that the "dysfunctional" system be changed, Mr. Schaeffer? By government mandated redistribution of incomes? By tariffs that raise the price of goods for all consumers? By raising minimum wages and making American businesses less competitive?

Peter Schaeffer: "There is considerable evidence that capital income has grown faster since 1973 than wage income."

As a small business owner and an investor, Mr. Schaeffer, I don't see increasing returns to capitalists as indicative of a dysfunctional system. When Michigan and Ohio union employees were enjoying outrageous wages and benefits for decades, I was working my ass off to acquire business skills and to build my business while simultaneously working full time for someone else. That the compensation pendulum has now swung away from unions and back to my side doesn't bother me in the least.

Peter Schaeffer: "some of the trend towards smaller households may be attributable to stagnant and/or declining wages."

What in heaven does this mean? That couples are not having children because they perceive they cannot afford them?

A significant portion of the smaller households is due to increases in life expectancy and to the aging of the Boomer population into empty-nester years. Another large factor is the adoption of birth control methods by Catholics.

Peter Schaeffer: "some the trend towards debt financed consumption may be attributable to stagnant and/or declining wages"

How is that going to be possible for the 35 year period you were referring to?

The lowering of interest rates since the 70's has allowed more workers to own homes, and to own more expensive homes. Increasingly sophisticated risk management by lenders has further enabled the expansion of credit to segments of the population that were denied in earlier decades. Those are positive trends, Mr. Schaeffer.

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