Que barbaridad! Now I really know how Michael Corleone feels about being dragged back by ghosts of the past into business he wants to move away from. I am certain that many IPE Zone readers are not that interested in China-US economics relations. However, our friends at IPE@UNC keep referencing me on the matter, so I believe I'm obliged to respond out of politeness. Hence, I will make this post and try to move on until major developments arise. Recently, the group bloggers at Chapel Hill brought out trade expert Thomas Oatley to chime in on the matter and find little old me culpable of economic ignorance. The good professor faults yours truly for assuming that a large dollar devaluation would reduce America's current account deficit. To begin with, I never said it would. Here I make my defense and urge you, dear readers, to find the defendant "not guilty." I realized at the outset that my nuanced position--neither standard-issue free trader or mercantilist--would not be popular with either camp. Then again, novel proposals are what I think are in order.
(1) Thomas Oatley makes a genuinely interesting find from a 2007 IMF World Economic Outlook (WEO) in which IMF researchers build a model to estimate changes in price elasticity of demand for US imports and exports in response to currency movements (see the results above). In plain English, movements in currency affect the relative prices of imported and exported goods. A dollar devaluation would tend to lessen American imports by making them dearer locally and promote exports by making them cheaper abroad. If imports and exports are responsive or "elastic" enough to price changes, then the US current account deficit would be reduced. Dr. Oatley cites the WEO study for arguing that, for America, devaluation makes little or no sense because the price elasticities of demand for both US imports and exports are low. From p. 95 of the IMF study:
(2) What Dr. Oatley seems to miss is another IPE point I wish to make instead of debating to no end about the IMF model. If the rest of the world becomes unwilling to fund America's CA deficit, then it has little choice other than to shape up. No ifs, not buts. Dollar devaluation will not be the main avenue for correcting global imbalances but rather LDC aversion to footing America's external tab. If capital account flows to the US slow dramatically as China stops piling on reserves and others follow suit, then America will have no choice but to undergo "structural adjustment." Nor am I claiming this will be a painless process. As I am more of an impartial spectator belonging to neither camp of combatants, I am probably more gung-ho on this point than my American counterparts. A reader also brought this point up about price elasticity of demand to which I made a similar reply. Savings are not exogenously determined; others' willingness to foot America's bill matters a lot and is not really considered by the IMF chapter. Simply, price elasticity of demand is a trivial consideration if there is no demand in the first place because China disabuses the US of its exorbitant privilege of cheap deficit financing.
(3) People keep hurling this idea at me that a China-US trade row is the slippery slope that leads to Smoot-Hawley II. Like Vietnam-era domino theory, I do not think this is likely. There is this thing called the WTO now, and LDCs have much tariff water to play with anyhow. I dislike protectionism in general, though I am keen on the possibility of the US initiating boneheaded currency legislation against China that makes the PRC reconsider its poor investment choices. To get things moving, China doesn't have to sell its Treasury stash a la the hyperbole of a "nuclear option." Mainly, it needs to stop buying Treasuries. As I've said, the US should kick China in the 'nads, pronto [1, 2] to get the adjustment process started.
Kindred cites a paper full of game theory in support of his assertion that a US-China trade conflict will lead to an outbreak of competitive devaluation. Aside from the obvious point that these authors are not playing with real numbers, there is no recognition of the real constraints on choice sets imposed by a multilateral economic regime called the WTO. To be fair, I will establish a scenario of how I believe things may play out. Bear with me as I'm all by my lonesome instead of four of them!
* * *
America has given the world an endless dose of courtroom dramas, so the next should be amusing to all re: the case of IPE@UNC vs. IPE Zone -
Judge Trudy: Has the jury reached a verdict?
Foreman George: We have your honor. We find the defendant, one Emmanuel from across-the-pond, not guilty on the count of economic ignorance.
Judge Trudy: The accused has therefore been cleared of all charges and is free to blog. This court is now adjourned [she bangs the gavel...KABLAM!]
(1) Thomas Oatley makes a genuinely interesting find from a 2007 IMF World Economic Outlook (WEO) in which IMF researchers build a model to estimate changes in price elasticity of demand for US imports and exports in response to currency movements (see the results above). In plain English, movements in currency affect the relative prices of imported and exported goods. A dollar devaluation would tend to lessen American imports by making them dearer locally and promote exports by making them cheaper abroad. If imports and exports are responsive or "elastic" enough to price changes, then the US current account deficit would be reduced. Dr. Oatley cites the WEO study for arguing that, for America, devaluation makes little or no sense because the price elasticities of demand for both US imports and exports are low. From p. 95 of the IMF study:The results of the estimation conform to the elasticity pessimism view [of the US trade balance not being very responsive to exchange rate changes]. In particular, the long-run estimates of U.S. import and export elasticities are quite low—indeed too low to satisfy the traditional Marshall Lerner condition (Table 3.2).Yikes! Has that econo-fraud Emmanuel finally been caught out? Well, no. In economics, the Marshall-Lerner condition is a widely-used benchmark for determining whether a currency devaluation has a positive effect of reducing a country's external imbalance. If the price elasticies of demand for exports and imports sum to less than an absolute value of 1, then they ought not have a positive effect on the trade balance and vice-versa. Returning to the table above, the IMF quotation is based on the simulation in red: (-0.69)+(0.02)=-0.67. Fair enough. However, what if certain adjustments are made to the model to make it more realistic? On p. 96:
The U.S. trade equations estimated above represent a basic, “stripped-down” version of the standard empirical trade model [red box]. Several efforts have been made over the years to improve upon this model and find more plausible values for trade elasticities in the long run.It's a technical thing here called "aggregation bias" concerning how the numbers may underestimate price elasticity since differences among product categories are glossed over. What if goods- or sector-specific estimates were used to account for possible bias? Well, you get the results in blue: (-1.45)+(-0.26)=-1.71. Voila, price elasticities galore. As neither of us have the IMF's data set, this becomes a moot point. All I wish to say is that it's not an open-and-shut case of US trade being price inelastic that can be wielded against me. It now degenerates to three-handed economist style arguments which can and do go on ad infinitum.
(2) What Dr. Oatley seems to miss is another IPE point I wish to make instead of debating to no end about the IMF model. If the rest of the world becomes unwilling to fund America's CA deficit, then it has little choice other than to shape up. No ifs, not buts. Dollar devaluation will not be the main avenue for correcting global imbalances but rather LDC aversion to footing America's external tab. If capital account flows to the US slow dramatically as China stops piling on reserves and others follow suit, then America will have no choice but to undergo "structural adjustment." Nor am I claiming this will be a painless process. As I am more of an impartial spectator belonging to neither camp of combatants, I am probably more gung-ho on this point than my American counterparts. A reader also brought this point up about price elasticity of demand to which I made a similar reply. Savings are not exogenously determined; others' willingness to foot America's bill matters a lot and is not really considered by the IMF chapter. Simply, price elasticity of demand is a trivial consideration if there is no demand in the first place because China disabuses the US of its exorbitant privilege of cheap deficit financing.
(3) People keep hurling this idea at me that a China-US trade row is the slippery slope that leads to Smoot-Hawley II. Like Vietnam-era domino theory, I do not think this is likely. There is this thing called the WTO now, and LDCs have much tariff water to play with anyhow. I dislike protectionism in general, though I am keen on the possibility of the US initiating boneheaded currency legislation against China that makes the PRC reconsider its poor investment choices. To get things moving, China doesn't have to sell its Treasury stash a la the hyperbole of a "nuclear option." Mainly, it needs to stop buying Treasuries. As I've said, the US should kick China in the 'nads, pronto [1, 2] to get the adjustment process started.
Kindred cites a paper full of game theory in support of his assertion that a US-China trade conflict will lead to an outbreak of competitive devaluation. Aside from the obvious point that these authors are not playing with real numbers, there is no recognition of the real constraints on choice sets imposed by a multilateral economic regime called the WTO. To be fair, I will establish a scenario of how I believe things may play out. Bear with me as I'm all by my lonesome instead of four of them!
* * *
America has given the world an endless dose of courtroom dramas, so the next should be amusing to all re: the case of IPE@UNC vs. IPE Zone -
Judge Trudy: Has the jury reached a verdict?
Foreman George: We have your honor. We find the defendant, one Emmanuel from across-the-pond, not guilty on the count of economic ignorance.
Judge Trudy: The accused has therefore been cleared of all charges and is free to blog. This court is now adjourned [she bangs the gavel...KABLAM!]
