Topic: International Economics and Development

The Wall Street Journal, the Dollar and the Fed

Today’s Wall Street Journal editorial, “The Buck Stops Where?” is the latest in a long series of editorials and articles suggesting the Federal Reserve has been “reckless” to cut interest rates on bank reserves. This story relies heavily on some questionable arguments about the dollar’s exchange rate.

Here are some quotes from the editorial followed by my comments:

  1. “The flight from the dollar has made U.S.-based investments less attractive at a time when the U.S. financial system urgently needs to raise capital.”

    That is almost backwards. It now costs fewer Euros or yen to buy U.S. shares or build U.S. plants than it did a few months ago, which makes U.S. investments more attractive to foreigners, not less attractive. It is true, however, that if the dollar were expected to fall sharply in the future, then risk of exchange rate losses might discourage foreigners from buying dollar-denominated assets and also encourage U.S. investors to buy foreign securities.

  2. “If the dollar had merely retained its value against the euro, oil would be in the neighborhood of $70 a barrel. Dollar weakness explains a large part of the oil price surge.”

    The reason a lower dollar makes oil prices rise is that it makes oil cheaper than it would otherwise be in euro, so Europeans buy more oil than they otherwise would – bidding-up the price (at least in dollars). We can’t be sure what would have happened to oil prices if the Fed had kept interest rates on bank reserves high enough to maintain the dollar’s value against the euro, because higher U.S. interest rates would have had some adverse effects on the world economy (and therefore on industrial demand for energy). If the euro had been stabilized by cutting ECB interest rates, by contrast, the effect on oil prices would have been much different. The oil price is a ratio of barrels to dollars, which means it is partly real and partly monetary.

  3. “Exports in goods are being more than offset by the rising cost of oil imports.”

    Actually, the U.S. current account deficit in fourth quarter was down 12.7% from a year before. Incidentally, purchases of U.S. government securities by foreign central banks were reduced by $148.8 billion last year, while private foreign investments in Treasuries rose by $202.1 billion.

  4. “Import prices have surged nearly 14% in the last year.”

    Import prices were up by 13.6% in the 12 months ending in February only because the price of petroleum imports was up by 60.9%. The price of all other imports was up 4.5%. While it makes some sense to blame rising import prices on dollar weakness, it does not make sense to suggest that petroleum prices are uniquely affected by the dollar, unlike most other imports.

    There is also some reverse causality–with rising oil prices contributing to a lower dollar and not just the other way around. Rising commodity prices lift the exchange rates of commodity-exporting countries like Canada and Australia, which shows up as a drop in the trade-weighted U.S. dollar.

David Malpass of Bear Stearns is an excellent economist who has supported a strong dollar in several Journal op eds. But Malpass does not argue, as the editorial page does, that a weaker exchange rate is necessarily inflationary. Indeed, one of the graphs in David’s December 6 forecast was aptly titled, “Trade-weighted dollar not well-connected to CPI inflation.” Even using 3-year trends, there’s virtually no connection.

On March 14, the Journal’s “Ahead of the Tape” column argued that the Fed is wrong to focus on core inflation, because “inflation is on the rise and energy and food have a lot to do with it.”

Should the Fed raise interest rates when world oil prices go up and lower interest rates when oil prices fall?

That is, after all, what it means to say the Fed should base policy on “headline” inflation, including energy prices (and the impact of ethanol subsidies on food prices).

While he was an academic researcher, Ben Bernanke showed that central bank reactions to oil prices have caused or aggravated virtually every postwar recession.

Recessions eventually cause oil prices to fall and central banks to ease aggressively – years after the recession is over (as in 2003-2004), as I noted in “Interest Rates and Dollar Fundamentals” (WSJ Nov. 15, 2007)

What is different this time is mainly a matter of timing – the Fed easing before recession rather than long after. What also appears different, so far, is that the Fed is acting alone, which largely explains the euro’s recent strength. Yet the ECB has always followed the Fed, after many months, and probably will again.

The Fed may be at risk of overdoing it, but making that case requires looking at some historical variables (or a model, like John Taylor’s) that have a decent track record for predicting inflation.

The trade-weighted dollar has been falling since February 2002, and the price of gold has risen nearly as long. If exchange rates or gold prices could generate reliable forecasts of inflation, then we should have seen escalating inflation for the past six years.

Obama Finds Juche ‘Intriguing’

Another (fictitious) dispatch from my anonymous correspondent on the campaign trail:

LANCASTER, Pa. — Sen. Barack Obama told a crowd of enthusiastic supporters here that the North Korean concept of “Juche,” its stated policy of complete economic and social independence and isolation, is “intriguing” and worthy of further study as a possible antidote to the economic malaise of the state in recent years.

The comment on Juche (pronounced “joo-CHEH”) came as a response to a question from a voter who expressed doubt that a repeal of NAFTA would help the region’s economy. Obama’s remark took the campaign’s message of economic nationalism and support for the weakened manufacturing sectors of the upper Midwest well beyond the rhetoric espoused by his Democratic primary opponent, Sen. Hillary Clinton.

“Trade is not helping the Pennsylvania economy get back its jobs,” Obama told the questioner. “And it may be time to quit tinkering with a system that stopped working a long time ago and get back to the basics.”

“Now we’re talking!” enthused Dean Baker, co-director of the Center for Economic and Policy Research, a D.C. think tank. “Someone finally had the guts to go all the way. Hallelujah!”

A spokesperson for the Obama campaign stressed that the senator was not articulating an official policy position but merely discussing aloud an idea that the campaign’s economic advisers have been contemplating for some time.

Obama said that his one reservation with such an economic system is that North Korea’s economy has struggled a bit in recent years. He attributed those struggles more to execution than policy, along with a rash of bad weather. Autarkic economic self-reliance, he averred, would provide a needed tonic to the U.S. economy and work especially well in the recession-plagued Midwest.

CNN broadcaster Lou Dobbs, a noted critic of U.S. trade policy in recent years, extended cautious praise for Obama’s words. “American economic woes are far more severe than North Korea’s, and we need a stronger dose of Juche than what Pyongyang employs. Pennsylvania would benefit little from a system that merely closes off imports from other countries. To truly help, we need to allow the state to ban imports from other states as well. Obama’s comments were a little timorous for me and revealed how out of touch he and the rest of the D.C. elites really are.”

Obama’s audience seemed quite receptive to the idea. “I’ve never heard of Juche before, but when he explained it a bit I thought it made perfect sense,” said Thaddeus Verhoff, an unemployed sheet welder from nearby Mt. Joy.

Other analysts hailed the proposal as a deft political move. “Rather than continuing to take baby steps around each other, Obama has jumped ahead to the inevitable end point of the debate without giving Senator Clinton any room to get to his left,” said John Cavanaugh, a columnist at Roll Call. “All she can do now is criticize him for being too protectionist, which doesn’t fly in Democratic circles.”

The Clinton team has yet to formally respond to Obama’s comments. A campaign spokesperson did indicate to reporters that Clinton would “stoop to no one” in her defense of state economic sovereignty.

Goliath vs. Goliath?

A further development in the cross-border supply of gambling and betting services broke today when the European Union announced they would launch a formal investigation into the selective (and retroactive) prosecution of European gaming interests by US authorities.

This is yet another twist in the saga first brought to light by Antigua’s case against the United States in the WTO. That case (summarized here and updated here, here, here, and here) sparked a slew of indirectly related skirmishes, a plethora of “David vs. Goliath” headlines, and an unprecedented reaction from the United States to pick up their ball and go home. The various twists and turns of the dispute have provided ample fodder for trade junkies in the form of commercial and systemic issues: Does the WTO dispute settlement mechanism provide effective recourse for big as well as small members? How should WTO members respond when one of their cohorts wants to change the nature of the contracts between the parties? How do members balance their rights and obligations in the context of issues of public morals?

The questions look far from answered because if the EUs investigation proceeds, a new WTO case could be on the horizon. Although the EU and the United States came to a settlement in December over the United States’ wish to withdraw its commitment to open its market to the cross-border supply of gambling and betting services, the details of that settlement are sketchy. And the December deal pertains to compensation for the withdrawal of market access going forward: unless and until that deal is ratified by all WTO members (including those who are asking for compensation of their own), the U.S. obligations stand and so does the ruling that found the United States was in breach of those obligations.

In other words, while the United States might eventually be able to get away with changing its obligations to provide WTO members access to the lucrative U.S. gambling market, in the meantime their (discriminatory?) prosecution of offshore interests leaves them vulnerable.

Bloomberg Columnist Defends Tax Havens

Matthew Lynn of Bloomberg has an excellent column about the Germany-Liechtenstein tax controversy. Lynn explains that the fiscal sovereignty of low-tax jurisdictions should not be hindered just because politicians in other nations are greedy for more revenue. He also explains that competition between nations should be applauded, not persecuted, and he makes the key point that criminals and terrorists prefer to use “onshore” banks (even the United Nations has admitted bad guys avoid so-called tax havens). Key excerpts include:

Over the past few weeks, [Angela Merkel] has been leading an all-out assault on her tiny neighbor Liechtenstein. Its crime? Not cooperating in Germany’s investigation of alleged tax evaders. The tussle between Germany and Liechtenstein is just the overture to a wider battle between the big European nations and the tiny low-tax principalities. Next up: Monaco and Andorra. And yet, the attacks are completely unfair. Places such as Monaco and Liechtenstein have a right to keep banking secrecy and shouldn’t be forced to act as tax enforcers for other countries. Germany should spend more time worrying about why so much wealth is fleeing its borders – and less time picking on places a mere fraction of their size. … You can see why the tax havens are an irritation for the big European governments. In a world of increasing mobility, and better communication links, it has become easier for the wealthy to shift their base to a more tax-friendly environment. Half the British corporate establishment seems to be based in Monaco these days. Plenty of Germans appear to be storing money away in
Liechtenstein. … Germany has a right to set whatever laws it likes for people living in Germany. If it wants to ban its citizens from holding accounts – or setting up trusts and foundations – in other countries, it can do so (and deal with the flight of people and capital). But it can’t harass other countries into changing their practices. If people invest in low-tax countries or in legal structures such as foundations, their tax liability is their business, not the responsibility of the host nation. For most legitimate investors, low-tax principalities provide a useful alternative to the high-tax, big-government consensus that suffocates much of Europe. Lastly, it is ludicrous to say that this kind of tax “competition” is unfair. All competition is unfair. These are small nations entitled to make their living any way they want to. It is no more unfair than Germany’s proficiency at making cars, or the French aptitude at making wine. Should the Germans shut down their luxury-car industry because it makes life difficult for auto workers in the rest of Europe? Of course not. So why should Liechtenstein close its financial-services industry? Naturally, tax havens should make sure they aren’t harboring assets for criminals or terrorists. And yet, that is a red herring. Mounir el-Matassadeq, the only person to stand trial over the Sept. 11 terror attacks in the U.S., operated out of Hamburg, not Liechtenstein. One of the suspected hijackers used accounts in Florida, not Monaco. In reality, terrorists use everyday banks because they attract less suspicion.

Europeans Launch New Attack against Tax Competition

Hoping to get the ability to track – and tax – flight capital, uncompetitive welfare states in Europe are launching a new attack against so-called tax havens. Nations such as France and Germany want to expand the savings tax directive so that financial privacy laws are emasculated and more forms of saving and investment are subject to extra layers of taxation. Fortunately, there are some EU nations that still respect privacy rights, and they are very reluctant to change their policies merely because other nations have bad tax law. Moreover, non-EU jurisdictions such as Switzerland and Liechtenstein are even more likely to resist. The International Herald Tribune reports on the conflict:

Under pressure from Germany, the European Commission will draw up new proposals this year that are likely to widen the scope of legislation on tax evasion - and close a loophole under which trusts and some other savings escape the same controls as cash. …However the newest initiative seems destined to re-ignite the long-running and bitter EU battle over banking secrecy. On Tuesday, Luxembourg, Belgium and Austria hinted that they would resist any moves to force them to provide information to other tax authorities on the savings of nonresident investors. …Germany and Britain want Luxembourg, Belgium and Austria to agree to exchange information so that the EU can apply pressure to the non-European jurisdictions to do the same. Broadly speaking, the tax also is only applied on interest earned on cash deposits, not dividends or the type of trusts that were being used in Liechtenstein. During a meeting Tuesday, the German finance minister, Peer Steinbrück referred specifically to the “spectacular case of tax fraud” emanating from Liechtenstein, according to one official who attended the closed-door discussion. …”German tax payers have effectively been made fools of by high earners using the system to avoid paying tax,” said Steinbrück, who described evasion as a “social and moral issue,” the official added. …”Tax paradises in practice become tax parasites,” argued Anders Borg, the Swedish finance minister. …However the EU is likely to be much more divided about banking secrecy. Jean-Claude Juncker, Luxembourg’s premier and finance minister, made a veiled threat at the Tuesday meeting to stall any potential changes. “I look forward to many years of fascinating, fundamental, discussion,” Juncker said, according to the official. …Kovacs also said that he would escalate efforts to persuade other jurisdictions to abide by the terms of the deal, including Hong Kong, Macao and Singapore.

Conservatives and Free Trade

Robert Lighthizer tries to make the case in this morning’s New York Times that conservative Republicans should all be pragmatic protectionists.

It’s telling that the op-ed column does not present one bit of evidence that trade barriers have actually made America a more free and prosperous country. His argument, rather, is one of name dropping: Many liberals, including Ted Kennedy, have “supported the advance of free trade” while many conservatives, including Ronald Reagan, have prudently deviated from “free-trade dogma.”

Lighthizer paints a misleading caricature of Ronald Reagan’s trade legacy. It’s true that Reagan bowed to protectionist pressure more often than he should have, but in his words and most of his deeds, he came down squarely in favor of free trade. As I noted in an op-ed published shortly after Reagan’s death in June 2004:

Reagan’s heart and head were clearly on the side of free trade. While president, he declared in 1986: “Our trade policy rests firmly on the foundation of free and open markets. I recognize … the inescapable conclusion that all of history has taught: The freer the flow of world trade, the stronger the tides of human progress and peace among nations.’

It was the Reagan administration that launched the Uruguay Round of multilateral trade negotiations in 1986 that lowered global tariffs and created the World Trade Organization. It was his administration that won approval of the U.S.-Canada Free Trade Agreement in 1988. That agreement soon expanded to include Mexico in what became the North American Free Trade Agreement, realizing a vision that Reagan first articulated in the 1980 campaign. It was Reagan who vetoed protectionist textile quota bills in 1985 and 1988.

And Ted Kennedy as a free trader? His trade record is mixed, but on most votes in recent years, he has come down against trade liberalization. According to our new trade vote web feature, “Free Trade, Free Markets,” Kennedy voted against the Central American Free Trade Agreement, the Chile and Singapore FTAs, presidential trade promotion authority, and the 2000 African trade bill. He voted in favor of China currency sanctions, exempting anti-dumping laws from WTO negotiations and the trade-distorting farm bill now making its way through Congress. If that’s the record of a free-trader, then the term has lost any meaning.

Whether a conservative should support free trade ultimately turns on what THAT label means. If conservative means one who opposes change and wants to preserve the status quo, then free trade is probably not the right policy. But if conservative means one who favors individual liberty, free markets, limited government, and a more peaceful world, free trade is a grand slam.

Clinton Promises to Protect Yankees from Unfair Trade Practices

A little ditty from an author who wants to remain anonymous:

NEW YORK — Senator Hillary Clinton vowed Tuesday that if elected president she would enact legislation that would give the New York Yankees a reprieve from what she characterized as the “unfair and exploitive” trading practices of the Kansas City Royals and Pittsburgh Pirates.

Clinton, a self-described Yankees fan, told an audience of supporters that the lower wages paid by the smaller-market clubs give the teams an unfair advantage over the Yankees, who are compelled to pay high salaries for the team’s superstar players. She vowed that upon assuming the presidency she would immediately ask for a “time out” for trades between the Yankees and the so-called “parasite” teams for five years, during which time Congress and Major League Baseball would study the harm done to the Yankees from these trades and construct a remedy that would protect the team.

She suggested that such protection should be extended to other teams as well, with the Dodgers, Mets, and Cubs among the teams that have been victimized in trades by rivals.

Clinton’s proposal was hailed by Yankees fans as a welcome first step toward correcting the imbalances in Major League Baseball that have hindered the Yankees’ efforts to remain competitive.

“Let’s face it, these teams continually manage to steal talented minor leaguers from us, some of whom eventually enjoy moderately successful major league careers,” said Michael Kumar, 26, a florist from Brooklyn. “As a result, we occasionally find ourselves wishing we had the players back that we traded to them. I’m tired of them conniving to weaken our teams in this way. It’s about time someone stopped this.”

Greg Packer, 43, from Huntington, N.Y., a self-described avid Mets fan, echoed that sentiment. “For too long Major League Baseball has allowed the Royals to rip off our teams without doing anything to prevent it. Brian Bannister was our pitcher and now he’s an ace for the Royals. That’s (garbage).”

In her address Clinton noted that the Yankees lost once to the Royals in 2006 and twice in 2007, a trajectory that would have Kansas City sweeping the Yankees in the season series by 2011. “We are giving them the rope to hang us with,” she said. “This must stop!”

An aide to Senator Clinton pointed out that the payroll of the Royals has increased by over 10 percent per year over the past four years, while the Yankees’ payroll has stagnated over the same period. Such a surge has given Kansas City vast resources with which to compete for talent with the Yankees on occasion.

Major League Baseball Commissioner Bud Selig indicated that he will duly investigate the matter and come up with the appropriate prescription that will give the Yankees at least a modicum of relief from the relentless competition that the Royals inflict upon them.

“I am well aware of the myriad advantages that the Royals have over the Yankees, and it is clear to me as a matter of basic fairness something must be done to rectify this situation and protect teams like the Yankees and Red Sox,” he told a reporter in his Milwaukee office.

Selig suggested that the trade “time out” could be phased out over time as the Pirates and Royals increase their attendance and television ratings.

While Senator Barack Obama enthusiastically supported a trade “time-out” as well, analysts have questioned his sincerity after his senior baseball adviser contacted the Chicago Cubs to assure them that if he were elected president they would still be able to make trades.