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Lindsey-squared on China Policy

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Lindsey-squared on China Policy

Former Bush economic advisor Larry Lindsey wrote a great book on taxes , and he helped design the excellent 2003 tax-cuts, right before he was asked to leave the White House. But on monetary policy, Larry Lindsey looks more like famed protectionist Lindsey Graham.
In today’s Wall Street Journal, Lindsey uses the occasion of Chinese President Hu Jintao’s upcoming U.S. visit to make the case for a forced appreciation of the Chinese yuan. Where to begin?
– Lindsey writes that China wants the government to set monetary policy but the U.S. wants “the market” to set monetary policy. This is curious given that our Federal Reserve, not “the market,” has monopoly control over the money supply.
– Lindsey argues that it is China’s too-cheap yuan that allows Americans to “over-consume” Chinese goods and China to “over-invest” in U.S. assets. Lindsey argues that a relatively stronger yuan would reduce American consumption and Chinese investment and thus reduce our trade deficit. But Lindsey ignores one of the fundamentals of classical economics: You cannot change the terms of trade by changing the unit of account.
– Robert Mundell, winner of the 1999 Nobel prize in economics, explains it this way: the U.S. trade gap with China is not a monetary phenomenon. It is a real phenomenon. It is the result of a real competitive shock from the huge Chinese labor supply and rapidly rising Chinese productivity, creativity, and sophistication.
– Lindsey presumes to know how “the market” would value the Chinese currency. “The Chinese clearly undervalue their exchange rate,” he writes. But exchange rates are dependent on the monetary policies of the various central banks that determine the values of currencies. Exchange rates are fluctuating all the time given the policies of governments. Divining a permanently higher value of the yuan is based on what?
– If a decade ago China had fixed its yuan at 4 to the dollar instead of 8.28 to the dollar, there would have been some severe adjustments internally in China back then. But the trade relationships with the U.S. and the rest of the world would be exactly the same today. Repeat, this is not a monetary phenomenon. Pretending that a change in the exchange rate will in any way help the U.S. by reducing our trade deficit is wrong…and harmful because it takes our eye off the ball of important policies that actually could make us more competitive in the global economy.
– Lindsey seems fatalistic about the prospect of protectionist legislation in Congress and says we should make a currency deal now to head off such self-destructive nonsense. But I think this strategy lets Congress off the hook way too easily and continues to give cover to numb-brained protectionists who should instead be ignored or directly confronted.
– Lindsey argues that the dollar-yuan link has reinforced “communist control.” But by greatly expanding commerce inside China and trade with the rest of the world, the stable currency policy has dramatically boosted the private sector in China and thus substantially reduced “communist control.”
– All this said, I wouldn’t mind a 10-15 percent appreciation of the yuan versus the dollar–but NOT for any of the usual stated reasons. It seems to me our Fed is running an inflationary monetary policy, highlighted by the near-$600 price of gold. A slightly stronger yuan would help China fend off some of the inflation they are importing by virtue of their dollar link. But there is absolutely no reason the yuan should forever be “stronger” than it is today. If China fixed to the dollar at much stronger terms, and then the Fed strengthened the dollar, it would push China into deflation, with very bad consequences for them and us. But even after the painful adjustment process, the fundamental trade gap would exist. Dollar stability and yuan stability are the ultimate goals, with or without the dollar-yuan link.
The rise of China is a real economic event. Not a monetary trick. Tricking ourselves into thinking we can solve this non-existent problem through exchange rate manipulation merely diverts us from important economic reforms here at home.
-Bret Swanson