Tag: Federal Reserve

Currency Issue Still a Red Herring

Following are some thoughts from a broader analysis of mine on  the state of U.S.-China relations, which will be published in the near future.

Between July 2005 and July 2008, the Chinese RMB appreciated by 21 percent against the dollar.  But over that 3-year period, the U.S. trade deficit with China increased from $202 to $268 billion.  Why, then, do policymakers think revaluation is the key to reducing the trade deficit?  Why do they even care about the bilateral trade deficit, which is meaningless in the context of our globalized economy.  Only one-third to one-half of U.S. imports from China is Chinese value added.  The rest is Japanese, Taiwanese, Korean, Australian, American and other countries’ value added.  The bilateral figures tell us nothing important.

During the aforementioned period of RMB appreciation, U.S. exports to China increased by $28 billion.  But U.S. imports from China increased by $94 billion.  Americans continued to purchase Chinese imports–despite the currency-induced price increase–for two primary reasons.  First, there aren’t many substitutes for the Chinese products U.S. consumers tend to purchase.  Second, Chinese exporters, by virtue of a stronger RMB, were able to reduce their costs of production because many of those costs are for imported inputs (made cheaper because of the stronger RMB), which subsequently enabled them to lower their prices for export to the United States.

There is no compelling reason to think things will be different this time.  Thus, all of the hollering, name-calling, and finger-pointing can only worsen the state of bilateral relations.

There are less provocative alternatives.

If it is desirable that China recycle some of its estimated $2.4 trillion in accumulated foreign reserves, U.S. policy (and the policy of other governments) should be more welcoming of Chinese investment in the private sector. Indeed, some of China’s past efforts to take equity positions or purchase U.S. companies or buy assets or land to build new production facilities have been viewed skeptically by U.S. policymakers, and scuttled, ostensibly over ill-defined security concerns.

As of the close of 2008, Chinese direct investment in the United States stood at just $1.2 billion—a mere rounding error at about 0.05 percent of the $2.3 trillion in total foreign direct investment in the United States. That figure does not come anywhere near the amount of U.S. direct investment held by foreigners in most of the world’s medium-sized economies, nevermind the large ones. U.S. direct investment in 2008 held in the United Kingdom was $454 billion; it was $260 billion in Japan; $259 billion in the Netherlands; $221 billion in Canada; $211 billion in Germany; $64 in Australia; $16 billion in South Korea; and even $1.7 billion in Russia.

In light of China’s large reserves, its need and desire to diversify, America’s need for investment in the real economy, and the objective of creating jobs and achieving sustained economic growth, U.S. policy should be clarified so that the benchmarks and hurdles facing Chinese investors are better understood. Lowering those hurdles would encourage greater Chinese investment in the U.S. economy and a deepening of our mutual economic interests.

Senator Bunning’s Unappreciated Gifts

Sen. Jim Bunning (R., Ky.) blocked “extended” unemployment benefits beyond their scheduled expiration on February 27. That thwarted bill would also have put off, again, a scheduled 21 percent cut in Medicare payments to physicians. Democrats were outraged. But why?

Bunning just wanted to use leftover “stimulus” money to pay for the benefits. Why not? Such transfer payments accounted for over 80 percent of stimulus spending last year.

Besides, as Federal Reserve policymakers noted, the evidence is overwhelming (see here and here) that extending unemployment benefits from six months to nearly two years has raised the unemployment rate by a percentage point or two. I’ve waited since 1991 for someone to prove I’m wrong about that. Nobody has, because nobody can.

If the maximum duration of jobless benefits were trimmed by 13 to 20 weeks (which is all that’s at stake), they would still be far more extended than ever before. But the unemployment rate by the time of this November’s elections would be much lower than otherwise. Would Democrats prefer to go into the elections with an unemployment rate near 10 percent or a rate below 9 percent?

As for Medicare, slashing payments to physicians is the Democrats’ favorite way of paying for expanding Medicaid enrollment and health-insurance subsidies for the non-poor. If they really think that will work, how can they possibly object to saving money sooner rather than later?

[Cross-posted at The Corner]

A New Fed-Treasury Accord

Charles Plosser, President of the Federal Reserve Bank of Philadelphia, gave an important speech last week.  He mounted a strong defense of what is known as Fed independence. “Central bank independence means the central bank can make monetary policy decisions without fear of direct political interference.”

Toward the end of the speech, Plosser admitted the Fed had brought criticism down on itself by blurring the line between monetary and fiscal policy.  In the process, the central bank greatly expanded its balance sheet and substituted “less liquid, long-term assets, such as securities backed by mortgages guaranteed by Fannie Mae and Freddie Mac, for the short-term securities it typically held before the crisis.”

To extricate itself from conducting fiscal policy and get back to doing conventional monetary policy, Plosser called for a new Fed-Treasury Accord.  (He harkened back to the Accord of 1951, which ended the Fed’s wartime obligation to support the prices of Treasury bonds.)  Under the proposal, the Fed would swap out its illiquid assets for Treasury obligations.  Responsibility for public support of housing would revert to Treasury and be subject to Congressional appropriations.

Additionally, and very importantly, Plosser recommended ending or severely curtailing the Fed’s expanded lending authority, which enabled it to balloon its balance sheet and conduct fiscal policy. (That is the section 13(3) authority.) “Never again” is the message of Plosser’s speech.

It was a landmark speech by a high Fed official.

Five Decades of Federal Spending

The chart below shows federal spending in three component parts over the last five decades. It includes Obama’s proposed spending in 2011. Here are a few thoughts on the recent spending trends:

Defense: In the post-9/11 years, defense spending bumped up to a higher plateau of around 4 percent of GDP. But now we have jumped to an even higher level of around 4.9 percent of GDP.

Interest: The Federal Reserve’s easy money policies reduced federal interest payments in recent years. That is coming to an end. Obama’s budget shows that interest payments will start rising rapidly next year and hit 3 percent of GDP by 2015. And that’s an optimistic projection.

Nondefense: This category includes all other federal spending. After a steady decline during the Clinton years to 12.9 percent of GDP, President Bush pushed up nondefense spending to a higher plateau of around 14.5 percent. Then came the recession and financial crisis, and the Bush-Obama tag team hiked spending to an even higher level of around 19 percent of GDP. That level of nondefense spending is almost double the level in 1970 measured as a share of the economy.

Wednesday Links

Popping Bubbles

David Leonhardt’s column today in the New York Times, in reaction to Ben Bernanke’s recent speech at the American Economic Association meetings, asks an important question:

If the Federal Reserve failed to detect the housing bubble when it occurred, why should we entrust it with that role in the future?

But he doesn’t follow the logic of his question far enough and instead embraces a financial equivalent of the National Transportation Safety Board, as if technical solutions exist and could be implemented if politics got out of the way.

In our recent Policy Analysis, Jagadeesh Gokhale and I examine a more complete list of technical and political problems that stand in the way of asset bubble management. Can bubbles be detected using scientific techniques (econometric models) with little controversy? We argue no.

Would stopping bubbles involve the simple implementation of a technical solution such as raising interest rates, or would they instead involve trade-offs with other policy goals? We argue the latter.

Even if bubbles could be detected easily with no controversy and policy solutions involved no tradeoffs, could the Fed maintain political support by stopping booms if the benefits of such a policy (preventing busts after financial bubbles burst) were never observed? We argue no.

And finally, even if all the previous problems were solved, how would raising interest rates reduce the supply of capital to housing markets given that a rate increase would increase the supply of capital to the United States and interest rates for both long-term and short-term housing loans have become decoupled from federal funds rates?

Our reasoning, like Bernanke’s, suggests that the events of 2008 were not the result of “bad” monetary policy. However, we believe that granting additional regulatory authority to the Fed will not prevent similar episodes because of the technical and political difficulties we describe in our paper.