Don Boudreaux on China, Currency Manipulation, and Trade Deficits
Nov 8 2010

Don Boudreaux of George Mason University talks with EconTalk host Russ Roberts about Chinese exchange rate policy and the claim that China keeps the value of its currency artificially low in order to boost exports to the United States and reduce U.S. exports. Boudreaux argues that regardless of whether China is manipulating its currency, inexpensive Chinese imports are generally good for the United States. He also points out that manufacturing output in the United States has been thriving despite claims that the United States is being "hollowed out." The conversation also includes a discussion of whether Chinese holdings of U.S. Treasuries threaten the United States.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Nov 8 2010 at 9:44am

Creating mal-investment in China due to an artificially weak currency is no different than creating mal-investment in the USA via artifically low interest rates.

It is not healthy for either economy.

Ed Hanson
Nov 8 2010 at 10:02am

At about 17:02, this was said.

“Want to go back to the claim of the worriers. When they complain about this “undervalued”–entered no-man’s land when you talk about a price being “incorrect.” There’s a certain difficulty of making the case that a price should be higher or lower. The value of the yuan is what it is. The Chinese government cannot control what value the yuan exchanges for on foreign exchange markets.”

This statement assumes something that is not true in reality. Simply put, There is no foreign exchange market of any real size for the Chinese Yuan. So, no market, no external economic force telling the Chinese The actual value of the Yuan, thus the Chinese do set the value by their peg.

I am getting old and spend more time than ever looking for things with less success of finding them. Is their a vibrant foreign exchange market for the Yuan out there? And if not, Why?

Nov 8 2010 at 1:09pm

The reason why people complain about Chinese monetary policy is that it is inflationary, whereas US and EU policies are not. China’s inflation has been in the 2-8% region for the last half of the decade(averaging around 5% probably), which would imply that the value of their goods(or at least certain goods) in dollars, given a constant exchange rate, is decreasing.

It’s rather silly when you argue that they peg against $ to ensure price stability. Price stability versus Europe and America, but not price stability within their own country which is what most people understand when the term is used.

Dave Taylor
Nov 8 2010 at 1:17pm

The part of this that I have trouble with is the Irwin Great Depression argument involving accumulation of physical gold in France. It also seems mirrored in the Tim Brooks argument in Vermeer’s Hat (podcast and book) about silver accumulation in China before the collapse of the Ming dynasty. I do not think that either historical event can be dismissed as resulting from simple fear of foreigners or unthinking gainsaying of free trade.

The podcast took a turn I did not expect with the “paper dollars are not the same as gold” discussion. (So – your position is it’s good for the Fed to print up to another trillion dollars this week? What about next week?) Surely, to the extent that US dollars provide a store of value there is more to the exchange problem than this. There also seems to me to be a troubling aspect of a non-instantaneous delay character in the value and exchange adjustment to the currency supply in the background of this whole discussion. (It seemed to me that much of the podcast discussion grew out of assuming a simplistic, instantaneous and linear model and as a result talked down to the listeners in a way that is unusual for EconTalk.)

What I expected was a discussion of the impact of this exchange situation on the dollar as a reserve currency, perhaps with a diversion into history: maybe including bimetalism with gold and silver and the “VERMEER’S HAT” silver experience. Isn’t there some Hayekian world view in competing currencies circulating together that was worth a passing mention?

As someone who has travelled in China, I am curious that the black market exchange rate between Yuan and US Dollars was
not mentioned as an alternative valuation metric. (I suggest that not only do I not know the fair exchange rate of the Yuan with the US Dollar, but also that there are more roadblocks than usual for anyone to know it.)

Whatever value of exchange is set by the Chinese government – either with the US dollar alone or in its role as the world reserve currency – it must have some more consequences than those discussed. I am not sure if anyone can cast them (in the way this podcast did) as intentional or unintentional consequences. But I bet you a beer that consequences will emerge over time.

Steve Fritzinger
Nov 8 2010 at 1:20pm


Can you comment on one additional issue about Chinese exchange rates?

Chinese manufacturers import a huge quantity of raw materials and sub-assemblies. I don’t know if they pay for these goods in yuan or local currencies of their suppliers or dollars, but however they pay, wouldn’t strengthening the yuan make their imports cheaper?

That in turn would reduce their costs and allow them to cut the cost of their exports. And that would at least partially negate any increase we would see in the price of our imports from China

Right? Or am I missing something?

Nov 8 2010 at 1:25pm

Enjoyed this discussion, however, I believe the more salient concern among the general population about international economics and trade is related to jobs. While I completely understand and support aggregate analysis and macro based theories, the reality for most Americans is in the local and regional microeconomic situation. It is not surprising given the local economic reality of many small communities that there is skepticism about the value of complete and total free trade, even if it means paying a little more for things at Wal-mart. There needs to be a well articulated and credible story that connects microeconomic job creation to the value of free trade at the macro level. The ambiguous notion that “if you build it they will come”is not sufficient to garner the support of the masses.

Robert Kennedy
Nov 8 2010 at 2:59pm

Ryan writes:

“It is not surprising given the local economic reality of many small communities that there is skepticism about the value of complete and total free trade, even if it means paying a little more for things at Wal-mart.”

For me, that oversimplifies the discussion. I think it much more than “local jobs” vs “lower prices at WalMart”.

Don did point out early on that a lower valued yuan has impacts beyond lower consumer prices. It also lowers the prices of various inputs into American products & services. When an American business can lower their material input costs, they can lower their prices (goodness), hire more workers (goodness), or pocket the profits (goodness for shareholders). Furthermore, the lower prices of consumer goods allows consumer to spend more money on other things, many of which will result in local employment.

Surely there is evidence of various jobs that were “lost” to overseas suppliers (China or otherwise). But there should also be other evidence of other jobs that were gained from the capital that is freed up from lower prices of various products & services from overseas suppliers. Will those losses & gains be equal? probably not nor would we want it to be.

Nov 8 2010 at 3:35pm


I don’t wish to oversimplify the discussion as I recognize the complexity involved. I live in a small community whose local economy has been in steady decline over the last ten years. I sense a disconnect between the local people I interact with and those in other regions which I believe originates from the natural geographic asymmetries that arise as jobs are created and destroyed through trade. It is my wish that the intellectual free trade community with which I identify (I am an engineer not a professional economist) would work to communicate the abstract yet genuine value in free trade policy concepts those who are personally affected by these policies. The risk of not appreciating the individuals’ role in this creative destruction process is the lack of popular support for the right kinds of policies for everyone.

Nov 8 2010 at 5:02pm

The critique against free trade is that the jobs that are lost(or “lost” depending on your perspective) are the ones that have potential for non-labor cost related productivity growth(manufacturing), whereas the jobs that are created instead do not have this potential(service sector jobs).

Put another way, there were once jobs where technology made the product better and demand for it kept going up so the labor force kept expanding even as each worker was more productive and these jobs were so plentiful that most workers had one of them so life was great. Is this true, or at least an accurate approximation of the 50s-60s? Eh, I’m sure a lot of people THINK it’s accurate, which politically is what matters. Moreover a lot of people think this golden age(+/- ” “) ended because of globalization and free trade, as opposed to a decrease in labor intensive product innovations/market saturation for other industrial products.

Obviously the reality is more complicated. Apple or any of a number of tech companies offer great jobs and a fairly large number of them and would not be able to offer them if the US did not have access to the extremely cheap manufacturing capacity of South East Asia. But they don’t offer as many jobs as GM did at it’s peak. But the products they offer are utterly unique and wonderful for so many people. But some of the people that once worked in a factory and now work in some Walmart can’t afford that product. But but but.

That’s generally how I see the protectionism-free trade back and forth going. I don’t think the approach this podcast took is a legitimate one; ie. I do not believe you can just theorize your way out of this problem, it is, in my view, an empirical question about quality of life for various people. It’s not an easy empirical question but it’s certainly not something you can just day dream about and declare solved.

Lee Kelly
Nov 8 2010 at 5:34pm

Great podcast: it helped clarify some issues for me.

Unless the Chinese are hoarding dollars, it should not be any concern for the Fed. Since the Chinese usually send their dollars immediately back to the U.S. to purchase financial assets, which in turn leads to spending in the U.S., only the composition of income will be altered. To the extent that the Chinese are enabling more U.S. government debt, this is probably a bad thing for the U.S. economy in the long run. But the problem isn’t the Chinese or the trade deficit, it’s the government!

Oh, and when Don said “protectionist malarky”, I heard “protectionist bull!&#*”. I think we all did.

Nov 8 2010 at 7:54pm


“If you believe that the deficit spending is justified–as a lot of people do in this recession–though not in this room, but if you are Paul Krugman, want even more of it–then it is totally inconsistent to bemoan the trade deficit.”

This summarises the discussion.

Nov 8 2010 at 8:16pm

I don’t understand where China as a government gets the money to buy Treasuries, as opposed to the owners of profitable businesses.

Is there some huge tax rate in China?

Then, even so, why buy Treasuries and not today’s output from America.

Some policy in China needs explanation, to make sense of it.

I doubt some sharp trader in China thinks the US is a good place to invest. It’s more like they have to dump the dollars somewhere, and Treasuries seem safe.

I suppose that there’s some strategic advantage if one day the US debt is nearly enough unsustainable so that China stopping buying would drive US debt unstable though a final sudden risk interest rate rise; and that would be a credible threat that might come in handy for the Chinese.

Krzysztof Ostaszewski
Nov 8 2010 at 9:27pm

I am very happy to see that this discussion included the possible national security angle, while the previous, relatively recent, immigration podcast, appallingly, did not. But immigration is affected by low scale asymmetric warfare, while foreign trade relates to standard warfare, and given current U.S. superiority in standard warfare and in weapons of mass destruction, I would suggest the only area where there is any national security angle in trade with China is Chinese government’s efforts to bring in superior technology through moving production facilities there from other countries. U.S. can, and should, respond by lowering taxes to businesses, in order to keep them here, but our politicians prefer to hate businesses.

On the other hand, protectionism also has a national security angle. Allow me to present a protectionist national security horror story. After miraculously (actually, through superior mathematics, i.e., breaking Soviet codes) surviving a massive Soviet invasion in 1920, the government of Poland embarked on a grand strategy of creating domestic heavy industries in 1920s and 1930s to build up its military. They spent massive resources on fixed investment, and ended up not having much left for production and any military construction needed. At the same time the governments of France and Czechoslovakia already had heavy industries building superior weapons, planes and tanks, and with great skills in military construction. In 1938, 1939, 1940, Czechoslovakia and France had superior arms, and France had the Maginot Line, which was impregnable, never conquered by the Nazis. Poland had great will to fight (Poland: First to Fight, was the slogan of Polish refugees in Britain in the period 1940-1945), but did not have enough weapons, and was completely alone against a Nazi-Soviet invasion in 1939. The weapons from Czechoslovakia and France were very useful to the Nazis. Now consider the alternative history in which Poland chose to purchase weapons from Czechoslovakia and France instead of building up its domestic military industry, and also paid the French to build the Maginot Line along the Poland’s Eastern border with the Soviet Union, making the war on two fronts far less likely. Possibly, there would have been no World War II, and tens of millions of lives would have been saved.

Please allow me to stress that the military angle to economics should never be disregarded. Just like the economic angle to military affairs should never be disregarded.

Nov 9 2010 at 1:53am

In Don Boudreaux’s concise description of an undervalued yuan and an over-valued dollar he says this is “good” for the American people and “bad” for the Chinese. Isn’t the unspoken underlying condition: “all things being equal?”

It seems true that it would be bad for the Chinese to get proportionally fewer goods during trade if our total systems were in equilibrium. But they are not and all things are not equal. the Chinese have a relative surplus of labor and a lack of infrastructure. In this is the case by undervaluing their currency the country as a whole can get more total trade from a more productive/sophisticated economy than they would otherwise. This seems good for them, which is fine for us. But I am also not convinced the asymmetry is “good” for us. It is possible that the Chinese are utilizing a large portion of their traded goods to ramp up their development and infrastructure while we are partially spinning our wheels in place to subsidize this transition. Are all goods equally “good?” The fear is the Chinese end up collectively investing their trade in infrastructure while we have seen an artificial shift in our own efforts towards the consumption of low value perishables with relatively less investment in future productive capacity. And of course standard fear is that highly undervalued Chinese labor (due to surplus) reduces the value of human capital in our own economy as the two systems equilibrate.

The hope, as always is that the exchange is not a zero sum. I buy the standard Robert’s view that trade is the source of progress (in general,) but aren’t there exceptions and trade offs in some cases? Isn’t there the possibility that the aggregation of many locally good trades may not be good to the larger economy especially when the entire global system is not homogeneous? Is there conflation between Chinese individuals and Chinese the whole economy?

Overall Boudreaux’s claim seems to beg the question. You can’t just assume that trade is always good and any specific trade relation must also be good else trade wouldn’t always be good.

Otti Eason
Nov 9 2010 at 7:19am

Another great podcast. I’ve listened to almost every single one. Love Munger and Boudreaux’s especially.

Please, if you would, clarify something for a complete novice.

Don made his arguments about the Yuan seem so rational, plausible, and irrefutably sound.

So — my question is — what would Krugman say to counter Don’s claim?

That is to ask: is this a quasi-philosophical opinion that can withstand several view points?

Or is it a matter of simple fact?

And if its a matter of fact —

Well, could you speculate on why someone like Krugman would be wrong on this?

(You both were clear on why politicians would be wrong — either through ignorance or cynicism)

But one would think that an intellectual like a Krugman would be able to see Don’s logic.

Would a Krugman have even a reasonable retort to Don?

Ken from Ohio
Nov 9 2010 at 8:26am

Prof. Roberts usually hits a home run with his podcasts. But today he only hit a double.

The first part of the discussion was related to the Yuan/dollar exchange rate. Prof. Boudreaux described the exchange system as though it was fixed. And all the points he made were correct – related to a fixed exchange system. But the Yuan is not fixed. It is pegged. That means that China keeps the current exchange rate until it decides to change it – based upon its self interest. The exchange rate has been about 6.8 Yuan to dollar for several years. And so it seems “Fixed” as Prof. Boudreax describes. That has served China’s interest (presumably because the dollar has been falling against other currencies). China can and will re-peg the exchange rate when it serves China’s purpose.

Milton Freidman took the position that floating exchange rates are good. Fixed exchange rates are good (providing that one counterparty currency floats). But pegged exchange rates are bad because this system is a method of currency manipulation.

As far as the analogy between China’s current policy and France’s previous policy of gold accumulation – the difference is that France caused trouble because it accumulated gold – but failed to monetize that gold – thus contracting the world’s money supply. But China actively monetizes all of its accumulated dollars into Yuan (that’s how it keeps the pegged rate at 6.8), or it sends the dollars back to the US in terms of portfolio or capital investment. Either way, the money supply is not contracted.

Robert Kennedy
Nov 9 2010 at 9:50am


all good points. Yeah, we need to find better ways to communicate the abstracts here. When a local economy is in decline, the natural tendency is to look for simple explanations, particular explanations that can identify some external villain. Personally, I didn’t understand a lot of dynamics here until I spent time here. Unfortunately, much of the broader concepts are not that simple and won’t fit on a bumper sticker! how about “Thank you China for the capital accounts surplus!”?

Nov 9 2010 at 2:39pm

Great conversation.

I would add that since 2005, the nominal exchange rate for Chinese Yuan has appreciated by more than 20% vs. USD. Some other major Asian currencies such as Singapore Dollar and Japanese Yen, for example, also appreciated more than 20% vs. USD in the same period. Yet, US still runs trade deficits vs. all these countries.

Until Americans start to reduce the net savings deficit, there will always be trade deficits for USA.

See Prof. Ron McKinnon’s article:

Nov 9 2010 at 2:59pm

Other proposed bumper sticker slogans:

Thank you China for buying all those worthless Mortgage Backed Securities.

Thank you China for my Social Security Check

Thank you China for making my car loan so cheap

Nov 9 2010 at 4:24pm

Isn’t China ridding itself of dollars by investing globally in natural resources including gold and oil?

John Wiles
Nov 9 2010 at 6:20pm

Thanks for another insightful podcast Dr. Roberts. I could write pages of praise on this piece but critiques are more fun, so here it goes.

I think you spin a much too positive light on the trade deficit. I see it more as a way of enabling deficit spending by the government, leading to more debt and allowing for expansion of unsustainable entitlement programs. It’d be one thing if this money way returned via productive investment (or even better if it was dropped out of airplanes) and we didn’t have to pay it back. It’s important to say that I don’t blame our trading partners for this malinvestment, but rather our government, for engaging in deficit spending in the first place. Anyways, thanks again for the awesome podcasts.

Nov 9 2010 at 10:39pm


China basically requires foreign exchange earned to be converted into local currency. I can’t export bicycles and then hold onto the dollars myself. Its more complicated than that because I know dollar accounts do exist in China, but the gist is you are forced to convert.

I still don’t get how having lower interest rates than would normally exist due to the actions of a State (China) which can cause mal-investment in housing is somehow “good” for the global economy.

I don’t get how cheap prices from China, while “good” for Americans, is good if it make someone in Bangladesh poorer as they lost out on the business they would otherwise have.

Or am I just to global in thinking, like human right, free trade should be free trade everywhere?

Nov 10 2010 at 6:06am

I understand that US manufacturing is increasing in output, productivity and so forth but in terms of share of GDP and proportion of those employed, it is clearly in decline. If this was offset by an increase in other sectors that one could judge really productive, no problem.. but when it has been offset by increases in financial services and the state, supported by the Chinese etc. accumulation of Treasuries keeping rates lower than they otherwise would be, it is clearly nothing to feel remotely comfortable about.

Nov 10 2010 at 6:27am

Don Boudreaux said that “There are few relations in economics that are
more well-established over the long run between worker productivity
and worker compensation.”

I don’t understand why it should be so obvious that increased
productivity leads to higher wages. I do understand that increased
productivity increases the amount of money available to the company.
This money could go into increased wages, but it could also go into
increased profits. The allocation will depend on the relative
bargaining power of the employers and the employees. Since there are
always many more employees than there are employers, the latter will
have an advantage, unless employees form trade unions. Therefore, I’d
expect wages to increase not when productivity rises, but when more
workers join trade unions.

That’s exactly my experience. I’m a freelancer working for big
corporations. Computers have greatly increased productivity in my line
of work and the result is that hourly rates have fallen, because one
can do more work in a unit of time. It’s the employers that reap all
the benefits. There is absolutely no reason why they should share the
greater pie with me. Hence, the wages are stable.

Nov 10 2010 at 7:03am

What I wrote above about productivity and wages has a bearing on
Chinese-US trade relations. Firstly, a very large share of the imports
from China are products of US companies with factories in China.
That’s not really trade at all. US companies are merely trying to
improve their bargaining position vis a vis US workers by bringing in
cheap, non-unionised, atomised and intimidated workers in China, whose
expectations are very low to begin with.

These maneuvers help increase inequality, and thanks to increased
inequality, the needs of the wealthy few can take even greater
precedence over the needs of the impoverished many.

Bob Layson
Nov 10 2010 at 9:05am

As a matter of libertarian tactics I never let the term ‘protectionism’ go without a ‘so-called’ and then go on to describe protectionist policy as a combination of favouritism to homebased producers and attackism or assaultism as regards homebased consumers wishing to obtain the best value world producers have to offer.

Mike Weeks
Nov 10 2010 at 11:15am

First time listener and the discussion changed my views on this subject matter. I’m the CFO of a manufacturer in Illinois and “economic hobbyist”. While we’ve lost business to China, we’ve developed some successful strategies that actually has brought work BACK from China.
I think the politicians and media assume household economics and international economics are exactly the same, when we know that is not usually true, but it’s simple to make headlines that way.

This was an interesting discussion, but I take exception to 2 issues:
First is the US deficit. The biggest risk to government debt is the pressure to devalue the currency if that government needs to issue more currency to pay it down. In the extreme, no other country would be willing to take it, thus forcing default. So in a time of deep recessionary and/or deflationary pressures, the government would be irresponsible to not create an inflationary pressure to try and stop a deflationary freefall. Society would benefit as a whole. Similar to a young family whose income earners lost their job and can’t afford the mortgage/rent. If a willing relative would help pay the mortgage until the family got back to a better position, wouldn’t the family unit benefit as a whole? If they lost their home, would the children grow up in the streets, become involved in crime, etc, society would seem to take a step backwards.
Second, you seemed to suggest that China was not employing a protectionism by pegging the yuan to the U.S. dollar. As I stated earlier, your discussion changed my view on this and I know understand that by doing this, the U.S. does in fact benefit. However, China doing this should be considered protectionism as they are artifically keeping the value within a certain range to protect the countries economic interests. Whether right or wrong and as you alluded, this is a strategic monetary policy, but it is artificial “meddling” the world economy and it is for the benefit of the “meddling” country, which in this case is China, so I would define that as protectionism.

Russ Roberts
Nov 10 2010 at 12:58pm


Here is a nice discussion of the relationship between productivity and compensation. It is from 2006 but it is a very nice illustration at the very bottom of how sensitive measurement of compensation is to the choice of which CPI deflator to use.

Nov 10 2010 at 2:59pm

Libertarian arguments are unconvincing. If they were right, they’d
have to apply in every case, since no specific conditions under which
they are supposed to apply are mentioned. Yet, at least
sometimes, protectionism is justified, so the general argument must be
flawed. (An example of justified protectionism: any country would do
well to ensure that at least it can feed its people — otherwise,
they’ll end up working like slaves in sweatshops.)

Ricardo was probably as good an economist as David Hume was a
psychologist. However, the difference is that while psychology did
make some progress since the 18th century, Ricardo still appears to have the
last word in economics. Pathetic.

Nov 10 2010 at 3:25pm

Russ Roberts,

Thanks for the link. I entirely agree with your view (which you have
expressed many times in these podcasts) that so-called “hard data”
rarely proves anything. It is often just an effective rhetorical
trick, used to intimidate the opponent.

As you say, “measurement of compensation is [sensitive] to the choice
of which CPI deflator to use.” Someone commented on the page you
referred to that “this is a great demonstration of the validity of
capitalism.” Is there a better example of a non-sequitur and a better
demonstration of your point?

When you are saying that “America’s manufacturing capacity is not
shrinking”, though it’s “hard to measure”, do you mean to say that
it’s hard to measure because of conceptual reasons (maybe different
people define it differently) or because too much data would be needed
to calculate it precisely? (But if we had all this data, everybody
would accept the calculation and agree whether America’s manufacturing
capacity was shrinking or not.) In other words, would it be easy to
measure the productivity of a tiny village as opposed to a huge
country like the US? Or just as difficult?

Nov 10 2010 at 10:11pm

The comments to this podcast have been the most confused I ever remember seeing here.

The basic idea is this: Deficits result from the difference between our (a country’s) saving and need for investment (including government’s need for investment in Treasuries). If saving is lower than investment, trade deficits result becuause we need foreign money for our Treasuries. Right now, U.S. saving is much lower than investment, so the trade deficit is big. Why is U.S. saving lower than investment? Because the budget deficit is a huge “dissaving”; USG needs all our savings plus that of foreigners to do all its spending. Why does this result in a trade deficit? Because foreigners can’t use the same dollars they earn from exporting to the U.S. to buy U.S. goods and also satisfy Uncle Sam’s need for investment, i.e., purchases of U.S. Treasuries. We can’t have it both ways. If our budget deficit went to 0 or into surplus, the trade deficit would collapse.

Another key point is that a cheap Yuan or other foreign currency is great because it makes imports cheap. That’s good not just for consumers buying shirts, shoes and cars but industries using imported parts. All the evidence is that cheap imports create jobs, not the reverse, because a lot of industries use imported parts. And cheap imports leave consumers with $$ to buy domestic services. Why don’t we hear that in pubic discourse? Because domestic industries who compete with imports speak louder than consumers who benefit, especially in Washington, D.C., and industries that benefit from cheap imports have nothing to gain, politically, by crowing about the good deal they’re getting.

Don’s main point, I think, is that it’s stupid to believe (1) you know what China’s or any other country’s currency is worth; and (2) if they’re willing to take T-bonds denominated in depreciating dollars in exchange for goods, both consumers and the USG are getting a great deal.

The argument about jobs is a total red herring, even if beloved of politicians. Trade deficits have been high and higher over the past 50 years, and employment, for the most part, has been rising. The dollar-Yuan exchange rate was lower (cheaper Yuan) three years ago before the crisis than now. Obviously, the level of the Chinese currency didn’t cause our higher unemployment.

By the way, foreigner don’t vote, so they make good scapegoats.

Nov 11 2010 at 12:07am


There seems to be a bending over backwards effort here to defend China’s non-market approach to currency management.

That seems strange given your self-described bias — that liberal market solutions are always the best and government interventions into markets are always terrible.

Does it make any sense to play a game (international business and economics) where the player with the second biggest set of assets plays by their own set of rules? Are we really in a free and open market system of trade if it doesn’t also include currencies as part of that market system? If the answer is “it doesn’t really matter” I’d say the onus is on the person claiming that to prove it. Don never really does that.

Nov 11 2010 at 1:04am

Don & Russ (& Otti Eason),

I must say right off that I am actually rather sympathetic to your position on supposed Chinese currency manipulation.

That being said I am very disappointed in your handling of it. Am I the only one that noticed that Russ for a while kept stating that they would get around to discussing the opposition’s argument… but never did? Eventually Russ even sopped bringing it up.

This is one problem with much so-called “devil’s advocacy.” It can often end up a mere series of straw-man arguments from someone who is either unaware of, or unwilling to present, the opposing argument honestly.

To portray the position Krugman takes (whether you agree or disagree, and currently I disagree with Krugman) as one able to be overturned (as Don puts it) by giving it five seconds of thought is absurd, even if it was hyperbole. Don or Russ, do you really believe that? In fact Krugman discusses almost every argument presented in this podcast very publicly in his blog, column, and talks. To not even raise his rebuttals to your arguments either shows an unwillingness to read his (and I say his because he was mentioned multiple times, although there are others, including other highly educated economists) opposing view, an intentional mischaracterization of the strength and depth of the opposition, insincerity in the claim to be trying to address the opposition (rather than merely state your own), or a serious blind-spot in which, though you are aware, you cannot even bring yourself to articulate the opposing arguments.

Don BRIEFLY touch on some of it (for maybe 2 seconds) when he began talking about sticky wages… that’s it! No more explanation of the argument from the other side!

If people are interested in Krugman’s (and other’s) views who disagree with myself, Don, and Russ on this issue I would recommend reading Krugman’s blog and column (search for yuan, China, Renminbi for topics specifically of this nature) or any other such resource from a respected economist with an opposing position.

If I have enough time I will try to post up soon some of the rebuttals to these arguments soon! (even though I have yet to be convinced by them, they are still worth knowing!! and like most things in life it takes more than 5 seconds to come to a sound or even tentative conclusion)

Russ Roberts
Nov 11 2010 at 7:02am


I have a different memory of the discussion though I have not gone back to listen again.

I pressed Don to discuss the argument against his position, to elaborate on the argument that China’s alleged undervaluation of the yuan is bad for the United States. He kept saying it was just a protectionist argument. We didn’t ignore that argument. We didn’t fail to get to it.

The question is whether the “other side” has something more to say than that. Yes, being a devil’s advocate doesn’t always work at revealing the full argument on both sides. That’s why I try to have guests on both sides of an argument when I can. I’ve invited Paul Krugman on EconTalk many times. Maybe my emails got lost in his inbox. I’m sure it’s crowded in there. But the point is that I would be thrilled to have him on the program.

Here is a column from last March by Krugman that is pretty clear on what he doesn’t like about China. He writes:

Widespread complaints that China was manipulating its currency — selling renminbi and buying foreign currencies, so as to keep the renminbi weak and China’s exports artificially competitive — began around 2003. At that point China was adding about $10 billion a month to its reserves, and in 2003 it ran an overall surplus on its current account — a broad measure of the trade balance — of $46 billion.

Today, China is adding more than $30 billion a month to its $2.4 trillion hoard of reserves. The International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion — 10 times the 2003 figure. This is the most distortionary exchange rate policy any major nation has ever followed.

And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.

He goes on to argue for a 10 percent surcharge on Chinese goods, a tariff.

In my interview with Don, I don’t remember if this precise argument was discussed. But it is certainly in the spirit of what Don discussed–that critics of China argue that by manipulating its currency, China is hurting US exports and thereby hurting the US. To give Krugman the benefit of the doubt, you could interpret his argument as only applying when US interest rates are near zero and unemployment is high–that is, that Krugman is not a protectionist generally, just a protectionist when the economy is struggling. Incidentally, this was Keynes’s position, too. He became a protectionist during the Great Depression.

So again, giving Krugman the benefit of the doubt, we could argue about whether trade deficits particularly hurt the economy during recession. But as Don points out, Krugman has been a forceful advocate for running dramatically larger fiscal deficits. Perhaps he can reconcile that view with his view that it is China that is causing our trade deficit via its currency manipulation rather than US borrowing putting money in China’s hands that is the cause. He is smart and clever and perhaps even correct. But the point is that I have no interest in ducking or hiding from this argument or concealing it from the listeners to this program. It’s pretty straightforward, I don’t think I’m representing it unfairly. And I think it’s wrong. But yes, go read for yourself. And if any of you out there know Paul Krugman and can encourage him to be on the program, please do so.

Nov 11 2010 at 10:43am

Dear Russ and Don,

in my opinion you have tried to view the problem of trade deficit and capital account surplus as a purely monetary or financial phenomenon, completely neglecting the real side of trade.

In the example with Sony computer for 2000$ Don says that he doesn’t owe Sony anything. But this is only true when Sony can swap 2000$ for something valuable, like other goods or services. And dollar in turn is worth something only if one can buy American products. And if America for several years in a row keeps importing more goods than exporting one starts to think that he would never exchange dollars for american output. That leads to the loss of value by dollar, which would in turn make imports for america more expensive. So there potentially is a threat of dollar loosing its value relative to other currencies.

And concerning the political aspects of this conversation, I think that the biggest threat is that China just stops accumulating more Treasuries thus making it harder for the Fed to roll over the the debt.

Also, Russ, I appreciate your attitude towards geopolitical issues, but in reality politicians aren’t as cooperative as you are. And China can potentially start using the advantage of the shift of production from America: they can impose high tariffs for exports causing a substantial rise in price of Chinese goods that can potentially lead to economic problems in the United States. And big army is no help here. Just like the USSR died from economic problems with a huge military sector.

Nov 11 2010 at 12:45pm

First of all, I would like that I enjoy my morning workouts much more thanks to EconTalk. Like one of the previous commenters, I consider myself an economic “hobbyist” that has learned a lot from these podcasts.

However, this week’s conversation frustrated me in many ways. Krugman was appropriately used as a straw man – that you can’t attack China’s policies without coming back to the root cause of the problem, our national debt. However, the Chinese/U.S. relationship is far more complex than monetary policy. To blast the critics of China, and then to simply state at the end of the interview that there are national security concerns that you haven’t addressed, does not provide listeners with the proper perspective. What about, for example, the concerns with China’s ownership of the rare earth metals supply chain?

And just as large as the national security issue, I am surprised that you didn’t provide any time to discuss hunger and poverty. Yes, a strong argument can be made against protectionism in the long term because of the growth benefits of trade. But in the short term the terrible impacts of dislocation are real. Just take a look at the impacts of NAFTA on corn production in rural Mexico to understand the skepticism with free trade. I’m sure that Mexico’s land, people and economic resources will eventually find more productive uses, but the short-term impacts are often unacceptable.

Nov 11 2010 at 10:36pm


Thank you very much for your reply. I apologize if my previous comment was overly vitriolic. As I said, it is not the conclusion that bothered me, but the manner of the discussion. REPEATEDLY it was stated and argued that it would basically take someone born with severe mental defects in order to not immediately see the absurdity of the idea of currency manipulation. And if I knew nothing of this topic I would come away from it knowing virtually nothing of the opposing arguments and basically dismissing them as crack-pots and loonies, not PHD economists who’s delta extensively with trade, as Krugman happens to be.

I happen to disagree with Krugman (albeit tentatively…. which is basically as strong of a belief as I get) about the Chinese currency manipulation issue. So why does Krugman believe something so obviously ridiculous? It’s actually somewhat complex as I see it and deals not only with certain Keynesian ideas, but also monetarist’s ideas.

For one thing Don states that even if currency manipulation is happening it is just making some sectors of the economy less competitive… this is wrong. Because we are talking about currency it would mean EVERY U.S. export was less competitive, similar to putting a % tariff on all US imports.

Krugman in response to something Don said:

“What about the argument that America can offset any effects from China’s policies through looser money? Well, I don’t really get why some commentators can’t grasp the distinction between the proposition ‘quantitative easing is worth trying, and would probably help’ and the proposition ‘quantitative easing will allow the Fed to do whatever is needed, never mind the zero lower bound.’ I subscribe to the first, not the second. And since QE is likely to be helpful but inadequate, China’s artificial surplus adds to the shortfall.”

This argument has to do with Krugman’s belief we are in a liquidity trap, which is DIRECTLY related to his currency manipulation argument. In fact you probably can’t understand one without the other… and yet another reason why you can’t evaluate Krugman’s argument and discount it in 5-seconds.

It would have been nice to here Don’s rebuttal to this argument.

Here is a video of Krugman speaking about MANY of the arguments Don & you made… and arguing against them to why they are not true.

I would have been interested to hear Don & your response to THESE arguments.

In other words Krugman is VERY AWARE of the arguments you are making, but he is arguing why they are wrong… and this podcast did nothing to ACTUALLY address his argument below the surface.

I will try to add more later if I have time. But can you at least begin to see why I am not willing to discount the currency manipulation story before giving it more then 5 seconds of thought? Why I think the opposing argument was not even presented?

And I would LOVE for Krugman to come on your program… sadly I have NO influence. And I still listen to your podcast EVERY WEEK and get great benefit out of it (even listening to much of the back catalogue before I became a regular listener). Have you thought of having Steve Fazzari back on again? I really liked your guy’s discussion… heck even Fazzari & Boudreaux (although that might be a little bit of an ambush ;). Or ANY other Keynesian… just a thought.

JP Koning
Nov 12 2010 at 11:59am

Interesting podcast, but by focusing on the yuan peg Don misses one of the key elements of Chinese monetary policy; sterilization.

A Chinese corporation earning foreign currency through exports is required to repatriate said currency to China. The law requires that x% of the repatriated forex be sold for yuan (some small percent can be retained). The People’s Bank of China (PBoC) prints the yuan to buy this forex (mostly dollars). So the huge buildup in PBoC $US reserves is because the forced repatriation of US dollars is accumulated by the PBoC.

The PBoC prints large quantities of yuan to buy repatriated dollars. This yuan circulates and pushes up prices. Higher Chinese prices *should* render Chinese goods less competitive relative to those elsewhere. These forces *should* encourage a compensating flow of exports from overseas into China; the classic specie flow model.

This doesn’t happen because the PBoC engages in sterilization; it issues bonds to Chinese domestic banks (sometimes coercively) that slurp up the excess yuan. With less currency in the system, prices do not rise to the extent they would were sterilization not engaged in. This preempts the specie flow mechanism from acting, and as a result, Chinese exporters retain the advantage that would otherwise be mitigated were sterilization not engaged in.

The peg is a red herring; sterilization is key.

Russ Roberts
Nov 12 2010 at 2:01pm

JP Koning (and others),

I do hope to do podcast in the near future that focuses more on the mechanisms and nuances of the Chinese currency strategy.

Nov 12 2010 at 2:48pm

Don & Russ (Otti Eason & others)

JP Koning does a great job (better than I could have done) at illustrating another point I was hoping to make that is central to Krugman’s argument.

The Peg does not even relate to the supposed currency manipulation in many ways. Many other’s such as Hong Kong are pegged to the dollar and not accused of currency manipulation. If the peg was the important point why would this be the case?

Short answer, because it’s NOT!

JP Koning helps explain why China is not simply picking a central bank strategy like everyone else, which Russ & Don’s conversation never even addresses. Another reason why I think this podcast NEVER EVEN ADDRESSES CURRENCY MANIPULATION!

This podcast might as well have been called Central Bank strategies or something because it misses EVERY important argument & explanation of what currency manipulation even means and how it relates to the current economic situation.

Russ, excuse the possibly awkward metaphor, but here it goes:

Let’s say there was a debate as to whether it is good to leave arsenic around one’s house. During this debate the commentators constantly attack someone, let’s call him Pugman, for being ridiculous because arsenic is obviously a poison and pets, children, adults, etc. could easily get poisoned. This might seem like a perfectly reasonable argument leading people to ask, what was Pugman even thinking?

Now let’s say what Pugman was actually arguing about was a house Pugman claims is overrun by RATS (a fact the commentators never address) and that he believes arsenic is the best way to rid the house of this infestation.

Now the original commentators could be right, arsenic might STILL be a bad solution to this problem, and in fact Pugman COULD be wrong that their were rats in the house in the first place. This STILL does not change the fact that the commentators NEVER ADDRESSED THE REAL ARGUMENT!

Nov 12 2010 at 3:10pm

a lot of nice give/take in the comments…

ill add briefly, but basically share observation that this was an uncharacteriscally feeble attempt to discuss the china currentcy issue. shame on u econtalk.


the main argument proposed was this:

every sale is a purchase (with a smattering of the seen and unseen): if china sells stuff to us cheap by lowering their currency, then that’s good bc we can use the saved money on other things.

it was kinda tautological.

felt like u didnt really look into the arguments against china’s “monetary” policy. just search voxeu, proj synd or krugman’s site and find some pretty explicit arguments.

such as this:

soros has some interesting things to say here:

there’s a lot of meat there to question and counter argue. no need to spend most of the time just being clever- though that’s good to warm up.

wish there was more detail on the mechanism of how china pegs its currency to the USD, current vs capital accounts, etc.

also there’s a big defference in US monetary policy and china’s:

the FED only intervenes in US treasury markets (until recently of course- but it wasnt like this 3 years ago), yet still only in USD asset markets.

china intervenes in asset markets that r not their own (ie only CNY) as a means of monetary policy. this is different from the swap lines and whatever that the FED has with every central bank in the world and very different from the FED buying US govt debt.

anyway…luv u!

Russ Roberts
Nov 12 2010 at 3:17pm


Who said the peg was important? You’re making a red herring out of a red herring. Look at the Krugman quote–his claim is that the Chinese trade surplus (caused by artificially cheap prices of Chinese goods) is keeping the US in recession and therefore a tariff is in order. I (and Don) disagree. Low prices are not bad for an economy. And I don’t know why Krugman thinks the imposition of a tariff is the end of the story.

Calling for tariffs during a recession is like killing pigs during the Great Depression. Both make us poorer.

JP Koning
Nov 12 2010 at 3:44pm

Russ: “I do hope to do podcast in the near future that focuses more on the mechanisms and nuances of the Chinese currency strategy.”

I look forward to it! Chinese currency strategy is a subject filled with lots of arcane details (heck, all monetary policy is!), but I trust you can distill it for your listeners. By the way, I think your were right to draw a parallel between 1930s France and modern China; they are both short circuiting specie-flow equilibration by sterilizing. Irwin pointed this out: “What happens if the Central Bank gets more gold but decides not to print more money? Then you are really not playing by the rules of the gold standard game. That’s known as sterilization, where you are taking some sort of offsetting action.” China is getting more dollars but not printing.

Nov 12 2010 at 3:47pm

@jp koning:

luv it…was totally thinking something similar during the irwin podcast.

Russ Roberts
Nov 12 2010 at 3:49pm


I read the Krugman and the Soros. They both seem to be saying the same thing: Chinese trade surpluses hurt the US, US trade deficits hurt the US.

This was the focus of Don’s remarks. Trade deficits don’t hurt Americans. Cheap Chinese goods don’t hurt Americans. They help most Americans. The alternative view is called mercantilism. It has not been a respectable view among economists for about 250 years. Of course the economists could be wrong. But I don’t see anything subtle or arcane or complicated about Soros or Krugman.

What am I missing?

Nov 12 2010 at 4:48pm

I had the same question as jp koning: the specie flow model doesn’t work? I always thought this was an important relationship for valuing a currency pairing. Later in the podcast there was discussion about China selling its Treasury holdings. If it did, then what? Would it not then be holding a lot of cash in USD? What can it do with that? If they try to put it to work in China, wouldn’t this upset the peg (they would have to convert it into RMB)? Isn’t this why they need to sterilize?

Since Krugman seems to be somewhat of a lightning rod, I would suggest reading Michael Pettis for some other views about China and trade.

Nov 12 2010 at 7:44pm

Maybe it is an issue of what kind of spending you do rather than having a positive trade balance. If one person/nation/government buys capital assets that produce value, they will be richer in the future than the person/nation/government that buys expendable goods. In fact, it’s even worth borrowing money to buy the capital assets if you’re shrewd enough to manage the assets profitably.

However, the limiting factor is the necessity that someone must buy the products of the capital assets. We need the right balance of spending on consumable goods and investment. Also, we need the right balance of saving and investment.

If one group saves more and consumes less, and the second group consumes more and saves less, the group that saves more at first will end up with a greater claim against future profits.

Nov 12 2010 at 9:26pm


HA! funny cuz soros cites m pettis in that article. feel like ur right about that lightning rod thing. it’s so strange.


sounds like the krugman post, not soros.

my reading of soros was that chinese intervention was bad for all their trading partners and global econ in general. for what it’s worth, “dollar” appears on only 3 occasions.

soros takes global focus, saying that chinese market distortion ripples thru all currency markets and nominal trade balances cuz chinese econ is a much bigger factor than 10 yrs ago (especially after the crisis). hence, the “responsibility” mantel they must assume by letting the CNY appreciate via natural market forces.

krugman did say it was bad for the US- which makes sense cuz US and china r each others’ largest trading partner.

but i think the cool thing about the post was his depiction of the market distortion. it clearly frames the chinese intervention.

besides, isnt top-down market intervention/planning to b viewed with healthy skepticism?

dont interventions almost always redistribute from/to someone, somewhere, while introducing inefficiencies?

r we to assume china is redistributing gifts of low cost goods to trading partners? r the partners just lucky?

china CNY policy is a massive market intervention. everytime they loosen their control, markets only and always revalue CNY higher vs USD.

how does this lead to a somewhat blithe critique of CNY policy when major elements of central planning r present in huge amounts?

…so confused, maybe missing something.

n e way…china will appreciate CNY. itll just happen slower than markets would have it.

luv u!

Nov 13 2010 at 1:54pm

Russ and Don,

It is refreshing to hear you endorse price fixing by government bureaucrats. For that is what pegging the yuan (actually renminbi) is.

And to do so, they are much more interventionist than merely following a monetary policy like any other central bank, as you portray. As other comments have indicated there policy includes sterilization of the interventions. In addition, not mentioned in the podcast, is a very tight set of capital controls dictating what can and (mostly) cannot be done with the currency.

Just this week, Bloomberg reports ”
The State Administration of Foreign Exchange will tighten management of banks’ foreign-debt quotas and introduce new rules on their currency provisioning, the regulator said in a statement on its website. The government will also regulate Chinese special-purpose vehicles overseas and tighten controls on equity investments by foreign companies in China”

Read more:

You often come across dogmatically against government intervention. I would be delighted to hear you expand on the reasons you think it is desirable in this case.

Nov 13 2010 at 3:46pm

yuan : renminbi :: pound : sterling

Nov 13 2010 at 5:28pm


I think your giving the benefit of the doubt characterization is pretty accurate from Krugman.

Here is another quote for Krugman:

In normal times, you could argue that this policy provides benefits to the rest of the world, by reducing borrowing costs (although given what we did with those capital inflows, maybe not). But these aren’t normal times. We’re currently living in a world in which both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment; so it’s a paradox of thrift world, in which anyone who tries to save more reduces demand, reduces employment, and – because investment responds to excess capacity – ends up actually reducing investment. By exporting savings to the rest of the world, via an artificial current account surplus, China is making all of us poorer.

Nov 13 2010 at 6:09pm

Here is another relevant post

“The bottom line in all this is that we don’t need the Chinese to keep interest rates down. If they decide to pull back, what they’re basically doing is selling dollars and buying other currencies — and that’s actually an expansionary policy for the United States, just as selling shekels and buying other currencies was an expansionary policy for Israel (it doesn’t matter who does it!).”

Nov 13 2010 at 6:53pm

My problem with the podcast is not that it was bad, it’s that we already had this exact same podcast. If you aren’t going to update any of the arguments and actually respond to the new arguments that may apply to our current situation, why repeat the podcast? That’s pretty disappointing.

Also, I am SO sick of GMU economists, referring to Paul Krugman as a “once good economist.” It’s is so petty.

Can we PLEASE have Gary Gorton on? Pretty please?

Nov 13 2010 at 7:37pm

As someone else pointed out, I was a little surprised at around 52:30 when Don said he thought the yuan peg to the dollar was a win-win for China and the rest of the world, compared to a freely floating exchange rate. I could understand the argument that if China is holding down the exchange rate it is providing “artificially” cheap goods to the U.S. and supporting its own exporters, but there are costs to this policy as well, for example on its own citizen’s consumption. Does Don favor fixed exchange rates only in this case (and please elaborate), or in general?

Nov 13 2010 at 7:38pm


What I think you are missing is that Krugman most likely agrees with you that mercantilism is an outmoded point of view. Krugman is responding to a very particular set of circumstances in which he believes that liquidity problems plus massive government distortion of the currency market leads to an issue which should be address in a way that at other times would seem counter intuitive to most economists. I find it funny that you are appealing to the fact that most economists discount something as an argument, especially considering Don made it seem as if the currency manipulation was common wisdom.

Also saying something is mercantilist and not supported by economists is not really an argument. For one thing there are plenty of economists who hold this view, and for another labeling something “mercantilist, Keynesian, monetarist, Austrian” says nothing about THAT PARTICULAR ARGUMENTS merits or fallacies.

I’ll start by pointing out what I believe are simply a couple of mistakes and possible confusion on Don & yours part. I think this might be more helpful as it directly address your argument rather than presenting the counter-argument (which I hope to follow with… and with all this devil’s advocacy I might end up sympathizing with Krugman’s view rather than rejecting it :).

As I am not an economist I would greatly appreciate if you could tell me where I have gone wrong, as I am sure I have made at least a few mistakes.

Part One:

1) First Don states that when an American person or company buys something from China it must FIRST convert its currency into Yuan. I believe this is backward, normally US dollars go to China and the Chinese Central Bank holds onto them and gives the Chinese company Yuan in exchange.

Normally these dollars would be sold back on the exchange market in return for Yuan for the Central Banks reserve, which would have the effect of devaluing the dollar (by increasing the supply) and appreciating the Yuan (by reducing the supply). China does not do this in order to keep the Yuan low and Dollar high. I believe most contras hold SOME dollar reserves, just no where near the extent of what China holds. This is part one of answering why it is not awkward (as you seemed to feel it was) to say that it was lowering the value below what it otherwise would be.

This first issue is somewhat technical and although I think it is necessary to understand does not serve as an argument in and of itself. The next one does however (I believe) cut down one of Don’s major arguments.

2) Don also stated that printing Yuan and keeping it devalued (if true) would hurt the Chinese, not help them, because excess money supply leads to inflation.

This statement almost leads me to believe Don does not know what people like Krugman are arguing. This is exactly the point. Devaluing the currency DOES lead to inflation on the FOREIGN EXCHANGE and SHOULD lead to inflation in the DOMESTIC markets, but it doesn’t because of capital controls. The Chinese government has used various tools, such as capital controls & interest rates, WITHIN China to keep inflation down domestically. Therefore the Yuan is only inflated to OTHER COUNTRIES not WITHIN China! This seems to undermine Don’s argument that it would hurt China through inflation, does it not?

Russ also stated at this same time that another problem with this was the Chinese were getting “less goods per unit of output.” As you can see this would be true on the foreign import market, but not domestically. In other words, yes it DOES raise the price of imports, but does not effect goods produced domestically (other than indirectly through possibly higher material costs, etc.). Does this hurt them greatly? It certainly helps domestic production in domestic markets as well as internationally. Although it does hurt import markets and does nothing to “stimulate” greater demand.

3) Don states that it is a “subsidy on our consumption.” Yes, and it is also a drag on our production by lowing the dollar supply and making it more expensive to export and hindering (in Krugman’s view) the stimulation of demand the increased dollar supply helps encourage. Don – “The payers of that subsidy are the Chinese people” as I argued above, not through inflation as Don postulated.

4) Don says that China for “strategic reasons pegged the value of the Yuan to the Dollar.” For its general stability and international reputation of sorts. Don does not mention that there are other countries who have done this and not been accused of currency manipulation. Hong Kong, like China, did not suffer the severe contraction many in the west did. Because Hong Kong’s dollar is pegged to the US dollar Hong Kong has experienced inflation because the Fed has increased the money supply under the monetarist idea that this will help fight the contractionary pressure on the US economy. Hong Kong, not having the contraction, only receives the inflation… China does not (domestically at least).

Also pegging the for stability or export competitiveness aren’t mutually exclusive, both could be reasons. AND Don’s story doesn’t explain why China would go through so much trouble to inflate internationally and contract internally.

5) Don – “It’s not as if the Yuan is plunging in value.” THAT’S THE POINT!! It should be APPRECIATING (according to the argument)! But China is keeping it from appreciating abroad while fighting inflation domestically! And keeping it from appreciating hurts the US’s attempts to stimulate domestic demand as well as balance the current account.

6) Don – by pegging to the dollar it is reducing concerns about inflation.

Reducing concerns by whom? Domestically each contries inflation rate is related not only to the money supply (as we’ve found out recently) but also to the macroeconomic conditions. Printing money during a boom quickly leads to inflation and over-valued assets, during a contraction it helps mitigate negative effects… at least according to Milton Friedman and the Monetarists. Hence Hong Kong’s inflation, but not ours.

Don and you are right internationally, however.

John Hoge
Nov 14 2010 at 4:06am


I listened to this podcast from Weihai, China and beg to differ with one of the fundamental points, that the undervalued Yuan gives the Chinese inferior terms of trade.

One only has to visit a Chinese supermarket to see that this isn’t true. Far from the bare communist shelves of a decade and a half ago, a Chinese supermarket, at least in a city, looks more like a Whole Foods today. There is a huge selection of wonderful pre-prepared goods, as well as an exotic “foreign foods” aisle with favorites from around the globe.

Chinese housing, which once made East Germany look luxurious, is now quite opulent. New developments in Weihai (which is on the periphery of the Chinese boom) resemble Tuscan villas or botanical gardens.

I believe that this stems from one obvious omission in trade theory – that technology is never measured in the balance of trade. Ten years ago – even five years ago – Chinese firms were clearly behind much of the world in many areas of technology and thus specialized in low wage, low value added labor. That’s not the case anymore. I don’t think that is relevant to talk about “advance nations” and “developing nations” anymore. Technology is now almost equal in much of the world.

Everybody’s got IPads, broadband, mobile phones and CAD software. This is a development whose consequences cannot be overstated. And it’s pretty clear that a cheap RMB makes it worthwhile for a western firm to transfer technology to China in return for a brief period of cheap products. The cheap prices won’t last, but the technology transfer is permanent. So I wouldn’t worry too much about the Chinese consumer suffering from inferior terms of trade due to the RMB valuation.

Nov 14 2010 at 10:43am

dont push back too hard people, or ull get called “mercantilist”. it’s been discredited for 250 yrs, you know, which means ur comments r too.

the irony is that it’s china that is pursuing mercantilism and by pointing this out one gets painted with that brush too.

here’s more mercantilist thought from formally trained international trade economists of the peterson institute (not a left wing outfit):

CNY policy may cost US 300k to 700k jobs

here krugman cites an IMF paper and does a quik/dirty calculation that says it might b shifting 1m to 1.4m jobs out of the US.

i guess mercantilism hasnt really died out or maybe something like it is just called international trade now….i dont know.

Russ Roberts
Nov 14 2010 at 4:33pm


I brought up mercantilism to emphasize that as far as I can tell, the currency issue is a red herring– it is just a version of the standard protectionist argument. As I said, it could be right, but my general view is that it is hard to get rich by choosing to pay higher prices.

Nov 14 2010 at 5:07pm

“I brought up mercantilism to emphasize that as far as I can tell, the currency issue is a red herring– it is just a version of the standard protectionist argument.”

This is such an odd statement. Can you really not tell the difference between Krugman’s argument and standard protectionist arguments? I mean, it seemed like you did understand it when you posted about it (although, it’s less obvious that either of you understood the argument during the podcast). This is the reason many of the more informed commentators think the podcast was so bad. You lumped together standard protectionist arguments with that of a Nobel prize winning international trade theorist’s as if they were the same. This particular trade theorist has been a vocal advocate for free trade (read Pop Internationalism). Maybe your audience should have been given an opportunity to consider his argument.

You guys could have just ignored him completely, and you just would have looked out of touch, but to bring him up without differentiating his argument from standard protectionism was very bad form.

Don Boudreaux
Nov 14 2010 at 5:44pm

Here is my stab at responding to some of the (many good) criticisms posted here of my statements in the podcast:

Don Boudreaux

Nov 14 2010 at 5:52pm

I would like to see Russ and Don address Krugman specifically too, but Krugman sure sounds like a standard protectionist — the only difference seems to be that if we’re in a liquidity trap, anything goes (and many people do not agree that we’re in a liquidity trap). Throwing out a bunch of job numbers because you just assume it is equivalent to a lack of government spending with a certain multiplier is not convincing even if you have a Nobel Prize — for one thing, does this include jobs due to foreign investment and cheaper imports (which include inputs to production)? And as Don pointed out, isn’t China financing government spending that Krugman wants more of?

Russ Roberts
Nov 14 2010 at 6:01pm


Don’t mean to beat a dead horse. But I quote Krugman above and have read what he has written on the topic. His position is that when times are bad, it’s bad to pay low prices for foreign goods because that hurts our exports which in turn hurts aggregate demand which in turn makes times worse.

I understand your point that he isn’t an out-and-out protectionist. It’s not “standard” protectionism because it invokes the special circumstances of the recession. Maybe we should call this Keynesian protectionism. Or Keynesian mercantilism. Here’s the end of the quote you cite above:

so it’s a paradox of thrift world, in which anyone who tries to save more reduces demand, reduces employment, and – because investment responds to excess capacity – ends up actually reducing investment. By exporting savings to the rest of the world, via an artificial current account surplus, China is making all of us poorer.

I confess that I have trouble understanding how China investing in the US (exporting savings) makes the US poorer in good times or bad times. But you’re right, it isn’t a straightforward protectionist argument. If I suggested otherwise, I apologize to the man. I’ll stick with Keynesian protectionism as my favorite term for now and hope to someone on the program in the future to discuss these issues again.

Nov 14 2010 at 6:27pm


fair enough, but prefering a more market based exchange rate is hard to characterize as protectionist (or mercantilist).

even if CNY policy appears to benefit US now (which is disputed), what about the unintended consequences of such an intervention of this scale?

US is far from perfect here, but if the topic is china CNY policy, then it looks like a bad idea.

it looks like chinese govt is selling chinese labor cheaper than it would b. im not sure what the implications of that r, but this labor pool is increasingly becoming a more important part of the global economy (foreign debt markets, forex, flow of goods, etc)

i dont know either, but it doesnt look good.

Nov 14 2010 at 8:47pm

I am re-listening to this podcast.

Did I hear correctly that China’s policy of pegging the Yuan to the US dollar is somehow good for investors?

I thought market prices included very important signals and information for investors. Now I am informed that instead, fixed prices are a boon!

Is an investor in China served when they open a labor-intensive textile operation at 8.1 and then in a few years it suddenly becomes 6.7? Is the Yuan undervalued or overvalued? No one knows because its not allowed to float freely, thus investors also don’t know if China is the better location or Bangladesh is for the textile plant.

Also, if this is such a great idea, then why not implement wage and price controls on everything? Imagine the peace of mind when the steel plant investor in the USA knows what the wages, raw material costs, and final product prices will be in perpetuity!

Nov 14 2010 at 8:57pm

JP Koning mentions sterilization. After listening to a LSE podcast, the claim was that US housing interest rates were 1% lower than they would have been due to Chinese government purchases of US bonds. They own approximately 800 billion of Fannie and Freddie bonds. I am sure the Chinese people completely approve of investing upwards of $800 / capita in US housing market, but you have to wonder how much that forced 1% lowering increased the intensity of the housing boom.

Nov 15 2010 at 8:41am


feel like the claim that deficits/surpluses r benign is only true (or likely mostly true) under conditions of a floating exchange rate.

Nov 15 2010 at 10:48am

This was a brutal listen for me. The Chinese “yuan” is actually pronounced like the United Nations acronym “UN” and not “you-on”. I’ve only recently begun training myself to say it the correct way and hearing Don and Russ say it the more intuitive, yet incorrect, way undermined my progress! 🙂

Otherwise it was, as usual, an entertaining and informative listen. Thanks!

Ricardo Cruz
Nov 15 2010 at 1:45pm

The wheat-cars metaphor.

Prof Roberts and Boudreaux discussed who had come up with the wheat-cars metaphor to trade.

I am pretty sure it was David Friedman in his 80s textbook “Price Theory”. The relevant chapter (search for “growing hondas”):

Another great podcast btw !

Charles Stampul
Nov 15 2010 at 5:54pm

The idea that if China became net sellers of U.S. Treasuries the value of the Treasuries they still held would plummet, overlooks the obvious fact that while the price of their Treasury holdings would drop, the price of whatever they would move into, most likely gold, would soar. If China began selling their U.S. bonds tomorrow, all they would lose are markets for their exports, which they are becoming less and less dependent on.

If an oil exporting country such as Saudi Arabia sold it’s stock of U.S. Treasuries, demand for their oil would crash, and with the gold they’d purchase in exchange, they could continue there current level of spending, and keep their oil in the ground.

Nov 16 2010 at 3:55am

Some more thoughts generated by this podcast and the comments, mainly about IP issues:

1. China is not the only low-wage, export driven economy. There are plenty of other SE Asian nations that have a similar strategy; clearly China is outperforming them, but China is also extremely different than them. Let’s see what we think in 10 years when Vietnam will be well on the way towards a Chinese-style switch to free trade and capitalism.

2. Trade discussions really should address a common distinction in peoples’ minds between various types of products(manufactured goods, services, food, raw materials).

First, can an economy thrive without some kind of balance between services(ie. intellectual goods’) and material goods’ production? The VERY recent history of the OECD would suggest that yes it can, but in fairness it’s an awfully short period of time to be drawing any strong conclusions. This issue touches with national security concerns(how much do you really want to offshore the production chain for your military supplies? do you want your nuclear missile chips made in China?).

Second, how do you deal with the incredible dependence on IP right enforcement that you are now developing. Clearly if your economy depends on innovation and essentially intellectual production on the international trade arena you are putting yourself completely at the mercy of foreign nations. How do you enforce IP rights in China? How many iPods sell in China? How many knockoff iPods? It’s great to talk about the innovation driven economy, but honestly that works when the norms, because let’s face it international law does not truly exist, governing the global consumer market respect non-material property. Right now the US deals with such patent/IP infringements by not allowing knock offs to be imported/sold. Great, that works because the US is a fat chunk of the global consumer market. But what happens in 50 years if OECD nations, now more slivers than chunks in the trade pie-chart, are the only ones still imposing these trade barriers/enforcing IP laws in that manner? Will Europeans and Americans pay $200 for an iPod while Chinese and Indian buyers pay $20(already available price for old models if you’re buying in mainland China)? Or is the automatic assumption that, of course, the market structures/rules/norms that exist here will slowly be adopted by the developing world?

There’s some interesting tie in here with Wallerstein’s world systems theories but it’s way too late and this post is way too long.

Richard Taylor
Nov 18 2010 at 3:02am

I am in two minds about this argument. On the one hand, I remember that during the 70’s and 80’s, there was great outcry against Japan for following a similar mercantilist policy. Japan appeared to keep the value of the Yen low and ran a large current balance of trade surplus against the rest of the world, particularly the US. Yet no one is complaining about Japan now. Similarly, the outcry against China may be short lived.

On the other hand you did not explicitly discuss the role of the dollar as a reserve currency. Many countries, China included, use the dollar as a benchmark and try to keep their currencies exchange rate stable with respect to the Dollar. In this sense the Dollar has taken over from Gold as the benchmark of a currencies value. To do so, the countries central banks buy and sell Dollar and other assets to keep their countries currency exchange rate stable. As the US runs a large current account deficit with China, the Chinese central bank buys Dollar assets to offset that trade imbalance. As it happens, the Dollar assets that the Chinese buy are US Treasury bonds. Whether this is currency manipulation with a little ‘m’ (good) or Currency Manipulation with big ‘M’ (bad), it is currency manipulation.

The problem with the Dollar as a reserve currency is that it allows the US to run a large balance of trade deficit without affecting the value of the Dollar. Normally, if a country ran a large balance of trade deficit, the value of that countries currency would fall, however because the Dollar is a reserve currency that effect does not happen. When the British Pound was a Reserve currency, Britain ran a similar large current account deficit for a very long time without it affecting the value of the Pound, and when the Pound ceased to be a reserve currency, it had a big effect on the value of the Pound.

Joe Brown
Nov 18 2010 at 10:25am

Thank you for this podcast. It is easy to get lost in the world of talk and “spin” by both sides of the political aisle. This podcast helped clarify some of the misconceptions, myths and fears associated with China.

topology of the mind
Nov 18 2010 at 9:07pm

Your best podcasts are the ones where you interview someone of an opposing viewpoint, worst when you interview fellow GMU staff. Most of this podcast was predictable.

The best part was deconstructing the other side’s rhetoric about “unbalanced” trade — when in fact the countervailing currency flows must balance every trade. That was new and, I think, would be effective to point out in a discussion with someone who’s never taken Econ 101.

topology of the mind
Nov 18 2010 at 9:51pm

A couple things you guys ignored at the end:

  • The Chinese can get ahead by trading with other countries besides us.
  • It’s not necessarily their ability to raise interest rates but their ability to do so SUDDENLY.
  • Pace Don’s point that they’ve allowed extra Pentagon spending — what if the Chinese have secretly been amassing military power beyond what we understand, and decide they want to fight us? Stabbing the US Treasury with a delta wave would be an effective precursor to an attack.
  • The other side’s point about the Chinese winning the race is about jobs, not cost-of-living.

I would also have loved to hear more about how if you take benefits into account, the entire Krugman story about 30 years of stagnant real wages disappears. Probably worth a whole podcast!

Nov 18 2010 at 10:34pm

First, let me say that I am a huge Econtalk fan, I’ve been making my way through the archives over the past year or two and it’s been a joy. In fact I will admit that I’ve even been known to refer to you as “Uncle Russ.” That said, I was really disappointed in this one. I’m not a trade economist, but I am an economics professor who teaches a trade economics class, and it seemed to me that you guys are way, way off on some pretty basic things here. I guess what bugged me is that you guys took the views that a) China’s currency is undervalued and b) the trade deficit with China is something to be worried about, and cast those as ignorant views that only dummies, protectionists, and Paul Krugman would agree with. But the truth is, I’m sure that at least half of all trade economists would agree with those views, and I would bet that it’s actually more like 90% of all trade economists. There may be reasonable counter-arguements, but you guys didn’t present them very well and I really think you did mischaracterize the debate.

A couple of points where you went wrong: first of all, Don tries to counter the notion that the Yuan is undervauled by arguing that the reason it’s pegged to the dollar is to maintain stability. But that doesn’t make sense- the issue isn’t whether the Yuan is pegged to the dollar, it’s whether it’s pegged to the dollar at a rate that is systematically lower than what the market would bear in the long run, i.e., not the market clearing rate.

Secondly, you rightly point out that a trade deficit isn’t necessarily a bad thing. But that’s only the case if it’s either a) being financed by productive foreign investment or b) it’s temporary. One quick look at the data shows that neither is the case here. China has been piling up US treasuries, not building factories in the US. The US has maintained a negative savings rate, and systematically imports way more than it can afford to pay for. If that doesn’t convince you that the Yuan is undervalued, what would?

I totally agree with Brian Caplan’s take that most people seem to be susceptible to a knee-jerk anti-foreign bias. But I think you guys are being just as susceptible here to a knee-jerk anti-knee-jerk anti-foreign bias(!). For sure, China’s undervaluation of its exchange rate is perfectly understandable, it’s something that has been enormously successful for them and has worked for other developing countries as well. And it’s sommething that under normal circumstances we don’t need to be very worried about. But there are very, very good reasons to be worried about it now, and none of them have anything to do with some suspicion that China is pernicious or sneaky or whatever. We need to seperate the issues of a) whether or not the Chinese government has malicious motives, and b) whether the US-China trade situation is something to be worried about.

Russ Roberts
Nov 19 2010 at 11:06am


You make a lot of points–let me try to respond to some of them. I wouldn’t use a vote among economists to decide whether something is true. But yes, if you’re right that most economists or most trade economists are worried about these things, they shouldn’t be dismissed as lunacy. I certainly agree that the views of others should be treated respectfully and taken seriously. Having said that, I don’t think “most trade economists” think that deficits are bad per se or that they prove an exchange rate is misvalued.

China has invested in real productive resources in the US, but you’re right, especially lately, much of their investments have been in US Treasuries. I am not a Keynesian, but if you (as Krugman and many economists are), this is good–it allowed the federal government to stimulate the economy. It tells us nothing btw, about whether the yuan/dollar exchange rate is “correct.” As was discussed in the podcast, most US states run deficits or surpluses with every other state. The trade in goods and services between one state and another is never in balance. That is not caused by exchange rate issues, obviously.

Where I think there is a consensus in the profession is over sudden changes in trade balances. The US trade deficit with China can be sustained for many years indefinitely and I still don’t see why that deficit per se is harmful to the US. But if China suddenly stop buying US assets, be they Treasuries or factories, that could lead to adjustment costs that are painful. That is not the issue in the news these days.

Nov 19 2010 at 7:31pm


Thanks for the response. I would think about in these very simple undergrad econ textbook terms, maybe you can tell me where/if I’m going wrong? Let’s imagine a graph where we’ve plotted the supply and demand curves for Yuan on the world market. We’ll define the Yuan exchange rate in terms of a trade-weighted basket of foreign currencies and put that on the Y-axis (unit foreign currency/Yuan).

My claim is that actual Yuan exchange rate is not the same as the what the market clearing exchange rate on this graph would be. Instead, the exchange rate is below the market clearing rate, such that the demand for Yuan is greater than the supply. In other words, foreigners want lots of Yuan to buy cheap Chinese imports, but there isn’t enough demand from Chinese firms and consumers for foreign currency to allow the market to equilibrate at this low price we see in the real world. The Chinese government purposefully keeps the Yuan at a rate lower than the equilibrium rate by systematically buying up foreign currency in order to shift the supply curve to the right. It is doing this on purpose, in order to make the tradeoff of higher rates of employment and growth for lower levels of consumption (note that I’m not saying that is bad, just that it is true). It is in this sense that the Yuan is undervalued.

Do you disagree? If so, how?

Nov 19 2010 at 8:04pm


I’m sorry, I’m just an amateur economist (musician by trade) but you simply seem to be making TONS of mistakes on this issue.

You keep saying that there being a trade deficit between the United States and China isn’t bad… but NO ONE IS ARGUING THAT! I am pretty sure Ben and others are talking about the U.S. trade deficit with ALL of its partners. In other words the United States is spending more money on imports, etc. than it is taking in. In my experience if I am spending more than I am taking in as income, it is a bad thing. So why is it good for the U.S. to be spending more money on imports than it is taking in? You could say because the current/capital accounts will have to balance out so that money will come back to the United States through investments in factories, etc. but as Ben and MANY other economists point out, that’s not happening!!!

AND if you actually READ what Krugman has to say about this (not just SOME Krugman but A LOT of Krugman and others) he IS NOT worried about China dumping treasuries and DOES wish they were spending more money investing and stimulating the private economy.

So once again you seem to not be understanding what the opposing view is arguing. Every rebuttal I have seen seems to be a simple misunderstanding of the issue and you arguments seem not to address any of the real issues!

I’d suggest re-reading Ben, mine, Krugman, and other’s comments MUCH more closely!

Again, no one is arguing (as far as I know) that deficits with China are a bad thing.

Krugman WOULD RATHER China not by treasuries and invest in the “real” economy as far as I can tell.

And one more thing DETAILS DO MATTER!!! You and Don can’t act as if you have covered everything important and all the stuff you didn’t cover is somehow unimportant and doesn’t effect the over-all argument. SPECIFIC arguments require SPECIFIC counter-arguments.

Russ Roberts
Nov 20 2010 at 7:59pm


I appreciate your interest and devotion to the topic at hand. Unfortunately, while I certainly do make tons of mistakes, I don’t agree with your assessment of what the issues are here. Let’s agree to disagree and I’ll try to get a China-worrier on Econtalk and discuss the issues directly.

Nov 21 2010 at 2:06pm


Sounds good! The funny thing is that I don’t even agree with Krugman in this instance 🙂 although my reasonings slightly different.

Tim Vlamis
Nov 22 2010 at 12:31pm

Hi Russ,

I too am a devoted fan of EconTalk. I too was disappointed with the tone of the podcast. I often describe EconTalk to others as an objective “exploration” of different topics related to economics including history, society, finance, and trade. I’ve listened to this podcast three times now and it’s more of an argument why others who don’t agree with you are wrong rather than an objective exploration.

Here are a few observations related to the topic that I didn’t hear and haven’t seen others address.

1. The policy of “pegging” the Yuan Renminbi to the dollar was largely based on Hong Kong’s very successful pegging strategy. It worked great when it was initially introduced when China’s economy was relatively small, but is now proving to be impractical given the size of China’s economy. The Chinese value stability more than anything else (i.e. the power position of the party) and unlike many in the west, do not chase the “new strategy idea of the week” in a series of fads (see the business section in the local Barnes and Noble bookstore). Rather, they tend to stick to what works. Both approaches have advantages and disadvantages, but in the scale of macroeconomics, sticking with strategies over a long period of time tends to work well. They peg because they pegged in the past and it worked. The Chinese government will have a hard time coming off their currency peg because they won’t trust another strategy. When they do, we should all take notice that the new approach will be viewed by the Chinese government in a competitive framework, not a cooperative one.

2. China’s economy does not operate the same as other economies with convertible currencies. In many ways, large parts of their economy operate on the dollar, not on the Yuan (commodity purchases, contracts with suppliers, etc.) Not all incoming money is exchanged into Yuan and then reexchanged into dollars for purchases. Please invite some experts in international banking and finance to a future podcast who can address how businesses actually function in China. Don’s characterization of how flows function is not accurate in my experience.

3. The growth in direct foreign investment over the past many years has had an enormous influence on the Chinese economy. Growth can hide a number of sins (Ponzi schemes look very successful until they collapse). It is disingenuous to look at the Chinese economy as being predominantly about comparative advantage. It is a story of growth and self-reinforcing patterns. In effect, it is non-linear in its mechanics and cannot be analyzed successfully through linear systems (traditional exchange algorithms) except in narrow, specific situations.

4. The government has distorted many traditional “input” prices. For example, energy costs in China have not been “market based” for many years. Some firms get sweetheart deals on coal or electricity. Talk with some operators in China and ask about energy costs, what they pay for different commodities, what they paid for raw land, etc. There are deals all over the place. Obviously, over time these start to fall apart and indeed, the Chinese government has been reigning in the most egregious examples. It is still important to note that there is a fair degree of difference along dimensions of region in China, closeness (and involvement) with party officials, and industry vertical. The Chinese economy operates with different “rules” that are there to protect those in power and extract the maximum in money, information, and power from foreigners.

5. The size of markets in foreign exchange (somewhere north of $2 Trillion per day) far outweigh the need to exchange tangible goods and services (a tiny percentage of the market). Why would you rely on model that addresses only a sliver of the mass? These issues are enormously complex and additional models from psycho-economics and behavioral finance should be addressed when exploring foreign exchange.

Thank you for all you are putting into EconTalk and your blog(s). You are appreciated!

Thomas Stanley
Dec 3 2010 at 6:08pm

I don’t think everyone would find the example of trade imbalances within the United States to be innocuous. There seems to be a fair amount of political interest in protecting specific industries within various states. An example that is probably familiar to Russ Roberts is the concern of Maryland horse breeders with the unfair restrictions on horse racing in Pennsylvania. While this isn’t a case of trade imbalance across all industries, it’s certainly an example of the sort of interstate resentment that would probably be triggered by the widespread publication of trade imbalances within the United States.

Of course, it’s also a classic example of a struggling industry seeking to solve its woes (among which Pennsylvanian Protectionism is a minor sorrow) by appealing to regional loyalties and requesting government subsidies.

Clinton Weir
Dec 6 2010 at 11:23am

Something can only be undervalued or overvalued. Because of the nature of the reals, it is all but impossible for something to be valued exactly right.

A central bank can undervalue their currency forever. If I have $10 and I want to buy RMB, and the market says $10 is worth 100 RMB, but China’s central bank says they will give me 150 RMB, I am going to go to China’s central bank. Thus the market can either sell RMB at the $10=150RMB rate or the market will be empty.

A central bank can not overvalue their currency (at least not for long). If I have $10 and I want to buy RMB, and the market says $10 is worth 150 RMB, and China’s central bank says they will give me 100 RMB, I am going to go to the market. On the other hand, the market will gladly sell their RMB to China for dollars – but China can not print dollars. So as soon as China overvalues their currency, they will run out of dollars.

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Podcast Episode Highlights
0:36Intro. [Recording date: November 3, 2010.] China, America's trade relationship with China, and China's currency, the yuan. A lot of people claim that China manipulates its currency to hurt us; that they deliberately pursue a policy of undervaluing its currency. What's the argument there? Do people who are worried about that--what are they worried about? It's actually not very complicated. For Americans to buy things from the Chinese, Americans first have to convert their dollars into the Chinese currency, the yuan, or sometimes called the ren min bi. If the price of the yuan in terms of dollars is low, then Americans get more yuan for any given amount of dollars; and that means that because Americans have more yuan, they can buy more Chinese goods. Or chits to buy their stuff. And on the reverse side, it makes it more costly for the Chinese to buy American goods, because they need a greater amount of yuan to buy any given amount of American dollars. Or put differently, their amount of yuan gets them fewer and fewer American dollars. So they can buy fewer and fewer American goods. So the idea is that if the yuan is undervalued, American exports to China are too low. The Chinese are not buying as many as they would otherwise buy of American goods, and American imports from China are too high: We are buying more Chinese goods than we would otherwise buy if the value of the yuan were higher. And is that a worrisome thing? If you are a mercantilist, that is, if you think that prosperity comes from exporting--and you always have to be careful in these kind of issues not to ignore other effects--other prices that can change, other prices that can interact, and the ramifications of those changes. But just sticking narrowly to this issue, should we be worried that as Americans, we are buying, getting more--essentially what it says is the veil of money that if we swap goods, our goods for their goods, we get more goods than we otherwise would. Is that a correct way to say it? That's exactly right. Our terms of trade improved. We get more for less. There's nothing wrong with that. A good thing. Why do people say it's a bad thing? What are they thinking? This is just one element of the larger species of protectionist misconceptions. One of a wide variety of areas in trade where protectionists get things wrong. You allude to a protectionist thing, that exports are the benefit from trade and imports are the price we have to pay. So we can make stuff for other people. Or they go with the notion that tariffs will save jobs here--save jobs in those industries that are protected by the tariffs; it reduces the number of jobs and wages in other industries that might export or not. This is just a species or element that protectionists often have. Protectionists are world-champions at looking at only half the argument. It is true that a lower-priced yuan makes it more difficult for some American producers to compete. But it also releases--and this is the other part of the story, the part that you so beautifully referred to in The Choice, by the way--it also releases resources and labor to produce things here in America that we might not otherwise be able to produce. We get more for less. A lower priced yuan--let me back up for a minute--I'm assuming for this part of the discussion for the purposes of discussion that the yuan is undervalued. I do not think it's undervalued. But assuming it's undervalued, a lower-priced yuan helps America. It doesn't hurt America. A lower-priced yuan by allowing us to get more valuable goods, both direct consumer-goods and inputs into products that American manufacturers and service suppliers produce, makes us wealthier, in the same way that if suddenly there was a change in the atmosphere and cell phones started falling down from the sky free of charge. We wouldn't be made worse off. Cell phone manufacturers and their workers--but society would be made wealthier. The people who should be concerned about the undervalued yuan are not Americans, but the Chinese people. This is another part of the story that the folks who are concerned about China's allegedly undervalued currency miss. Part of the story--broader narrative about how the Chinese are very cleverly using monetary policy and industrial policy to outcompete us--they are going to overtake us in the future and all these terrible things, and we should be doing the same thing; we should be engaging these mercantilist and protectionist policies along with broader industrial policies. We'll get to this point a little later. If the Chinese yuan is undervalued, then inflation is being created in China. The only way the Chinese authorities can undervalue the yuan is by increasing the supply of yuan relative to dollars. That causes inflation in China. Inflation has a whole host of problems, everyone is familiar with. That inflation makes the Chinese people worse off. That's only part of the harm to them. Aren't they also getting fewer goods in return? Just like we are getting more goods per unit of output, they are getting fewer goods per unit of output. Yes. The mix of those two depends on the details of how the undervaluation is taking place. But there is no question that if the yuan is undervalued, it is a subsidy to Americans for their consumption; and the payers of that subsidy are the Chinese people. So they are being hurt, and we are being helped.
7:58Let's talk about the mechanics of that monetary policy for a minute before we get into the issues of the harm and benefit. The people who are complaining about this strategic policy on the part of the Chinese--they are implying that the Chinese government is--coming back to your story of a second ago--they are creating more yuan than they otherwise would. Not quite sure how to word that. Sufficiently so that the rate of increase of their currency exceeds the rate of inflation in the United States, thereby cheapening their currency relative to ours. Is that accurate? It's close, except the actual facts are--and here I think we can't avoid the actual facts of what's going on--the Chinese, and I don't know exactly when it started several years ago, made a strategic decision. And by strategic, I'm going to defend it. I think the Chinese were wise to do it. They made a strategic decision to peg the value of the yuan to the dollar. Just before coming into your office for the podcast, I actually looked at recent yuan/dollar exchange rates going back to 2005-2006. It's very, very stable. There have been a few periods where the value of the yuan has actually risen a little bit against the dollar. But it's very, very stable. Right now it's about 6.8 yuan to the dollar. So, it isn't as if every day the value of the yuan is plunging. Sucking more. May fall a little bit today, may rise a little bit tomorrow. The Chinese government, Chinese Central Bank, have made a decision to peg the value of the yuan closely to the dollar, and lets its value against the dollar change only within a very narrow range. Now, why do the Chinese do this? Of course, the mercantilist story, and the story everybody seems to know is true, although I think it's not true, is so it makes Chinese exports artificially inexpensive for Americans, and makes American and other world imports artificially expensive for the Chinese consumers. I think a more plausible explanation is that the Chinese government wanted to commit itself to a stable monetary policy, and that dollar, relatively speaking, is still the world reserve currency. For now. Well, that's right. The Chinese have said--and I'm speculating, haven't read the minutes of the Chinese Central Bank meetings. There is a Chinese Allan Meltzer, if you will, some day. The Chinese by pegging the value of their currency to the world reserve currency, the U.S. dollar, have done two things, at least two things. Number 1, they've made a commitment, and by living up to this commitment, the more time expands, they prove the commitment is meaningful--saying: Look, we are not going to engage in reckless inflation. You can trust the value of our currency. The second thing they've done, which is related to the first, is by keeping the value of the yuan closely to the value of the dollar, it reduces investor uncertainty. A lot of the uncertainties that often arise because of exchange rate fluctuations are gotten rid of. For an American, or even a Chinese investor. Enough uncertainties in the economy as it is. The Chinese have virtually gotten rid of one of them--investors don't have to worry about the value of their investments. Foreigners investing in China--and a lot of investments are calculated in terms of dollars--they don't have to worry about the value of their investments in China plummeting just because of some uncontrollable exchange rate fluctuation. The pegged exchange rate reduces the uncertainty that investors face, both directly by reducing the variability of exchange rates between the dollar and the yuan, and more indirectly by reducing the risk of inflation. The Chinese Central Bank has committed to keeping the yuan pegged to the dollar. Correct a piece of that: would have thought that they have not actually gotten rid of the risk of inflation. What they have said is: We're going to take the inflation rate of the dollar--the dollar is going to be a relatively stable currency and I think they are willing to accept that. Yes; I didn't mean to imply otherwise. What they've said is: You don't have to worry about us being more inflationary than the U.S. Federal Reserve Bank (the Fed). More importantly, for people transacting in the global economy in dollars, which would certainly include American investors--and by American investors I mean American corporations making an investment, not somebody buying Chinese stock. You're saying to those folks: You're not going to have any extra uncertainty transacting in our backyard than you have in your own backyard. You're going to have to deal with inflation also, but the differential rate of the Chinese inflation rate is going to be eliminated. Think about someone in New York investing in Tennessee. A lot of uncertainty, things could happen, but one thing you don't have to worry about is the value of your investment in Tennessee plummeting dramatically just because it's denominated in a different currency. The Chinese do that with the American dollar. Look, I'm not a sinologist or whatever they're called, but I don't think it's too much of a wild speculation to say the Chinese government knows they are not looked upon with great trust in the world. They certainly have liberalized many of their markets--liberal policies which the United States would adopt. But it's still an authoritarian state. Authoritarian states have a terrible reputation for doing arbitrary authoritarian things. More generally, governments that have fiat currencies have a terrible historical record of using inflation to get out of trouble when they get into trouble. So, it does seem to me that the Chinese government is interested in having the Chinese economy integrated in a genuinely productive way more heavily into the world economy; so by saying we are pegging the value of our currency to the U.S. dollar--they are saying: You can trust us, yes we are Communist thugs but our monetary policy is basically being conducted by U.S. Fed policy. Like that story; don't think they talk about that publically. That would be a good story to tell. Do they tell that story? That's a good point. I don't know. My impression--I'm not a sinologist either--should be someone who studies trigonometry ['sign-ologist'], but it's somebody who studies China. My impression is they are quite discreet and don't comment much about adopting the Federal Reserve policy; philosophy of less is more. One thing you have to explain is that your story is not just that this is benign, but beneficial for the United States. This part of the story is also beneficial for the Chinese people. Unlike the other part--pay a price in worse terms of trade.
17:02Want to go back to the claim of the worriers. When they complain about this "undervalued"--entered no-man's land when you talk about a price being "incorrect." There's a certain difficulty of making the case that a price should be higher or lower. The value of the yuan is what it is. The Chinese government cannot control what value the yuan exchanges for on foreign exchange markets. Well, the way it can control it is simply by adjusting the supply of yuan. So, it's conducting monetary policy. It chooses to conduct monetary policy in a certain way. That way has certain consequences about the value of the currency. The Federal Reserve is just as arbitrary in conducting monetary policy. It chooses a certain monetary policy; some people think one is good, another might be worse--but whatever it chooses results in a certain market value for the dollar. Quite amazing to me that American politicians will berate the Chinese for conducting a particular monetary policy while we do the same. That's how they choose to do their monetary policy. And, it's one I think, all things considered, in this imperfect world we live in, given that we don't have free banking and competitive currencies, one that I believe is beneficial both to the Chinese people and to the world as a whole, including Americans. Raise a question: You read sometimes that people make a similar claim about the U.S. dollar--not a similar claim that we are doing something sinister, but: The value of the dollar needs to change; it needs to be higher, or lower; the dollar is overvalued, undervalued; the Central Bank needs to do something about it, needs to change the value of the dollar. Why would there be any unambiguous impact for good or bad from arbitrarily moving the value of the dollar from what it is now? When people make those claims, what do they have in mind? What are they saying when they say the dollar is overvalued? They are arguing implicitly that if we pursued a different monetary policy than we are doing now, that somehow we would change the price of American goods relative to other goods, as if 1. all other currencies would do nothing in response, and 2. as if prices wouldn't adjust to offset the so-called benefits of having that other policy. Find that totally mystifying. When I get interviewed in the media--and I don't get interviewed very much on this, you'll see why in a second--they say: Do we need to raise the value of the dollar? I always say: I have no idea. Why would you presume to think you know what the value of the dollar is? Not a very good sound bite, so I don't get called very often. Or they say: The value of the dollar just went up; is that good or bad for America? I always say: I don't know why it went up, and if I don't know why it went up, how can I presume to predict what the impact is, since there's supply and demand. I don't get it. Am I missing something there? No, you're not. The best way to explain those kinds of claims would be from a quasi-Keynesian perspective. Oooooh. Not justifying it. If you take as one of your starting points that prices of goods and services or especially wages are rigid downward, then you might want inflation--to make the value of the dollar to fall--to make those nominal prices that won't fall, make them lower in real terms. That's a very different argument from what should the value of the dollar be on international markets, or what should the value of the yuan or euro be on international markets. Going back to the Chinese issue: the people who don't like the value of the yuan--instead of trying to get the Chinese to do something, which is a different country, why don't they just get the Fed to fix this problem? Because it just doesn't suit protectionist claims. There is--and despite the fact that even Paul Krugman, who was once a good trade economist, very good trade economists, has now jumped on this anti-Chinese bandwagon--there is nothing more sophisticated in this argument at its root than simple protectionism. The argument that the yuan is undervalued is being spread around as an excuse for Americans to impose higher tariffs on Chinese goods. This whole currency issue is not well-understood by people. By me--you can tell. Well, by the general public, even less well-understood than comparative advantage or more fundamental issues in economic trade. It sounds to a lot of people: We'll just trust the experts; they say the Chinese yuan is undervalued. By saying it's undervalued, it sort of implies that its value is something it shouldn't be; well, it should be what our experts say it should be--higher. Congress--protectionist Congress--want to protect their constituent producers from having to compete with the Chinese. It boils down to that. This is an excuse to ram through protectionist policies that will be accepted by the American public as legitimate. They are not legitimate--they are simple protectionist malarkey.
24:09Let's talk about the source of the concern. Since there isn't a book where you can look up the "correct" value of the yuan--you can't say it should be 7.3 and it's 6.8; no place to look that up. What I assume people are reacting to is the expansion of Chinese manufacturing capacity and the reduction of U.S. manufacturing capacity, with the implication that they are cheating. If our exports to China are small and our imports from China are large--if our manufacturing sector is shrinking and theirs is expanding--then obviously they are cheating. Right, but the first point to make is that America's manufacturing capacity is not shrinking. It's expanding. Not surprisingly it fell a little bit during the recent recession; it's picking up again. In 2007, it hit an all-time high in real terms. This fact is so little known, often quiz students, journalists, others I talk to. It's a really important fact. Have to issue a caveat, which is: it's hard to measure. You are adding up Boeing 747s and chips for computers, so what we're really talking about is the dollar value. You have to aggregate that, so there's issues of aggregation there. But those exist across the whole world. The point is that U.S. manufacturing output is massively larger than it was 30 or 40 years ago--double or triple. In real terms. Corrected for inflation. We are not being hollowed out. We are a giant in manufacturing. However, employment has been falling steadily as a proportion of total employment. Manufacturing employment; and even in absolute terms in recent years. So, since 1950, for the last 60 years, we've produced a lot more with a lot fewer people and we call that productivity. That doesn't stop the concerned people. This is of a piece with the concern of people over the value of the Chinese yuan, in the following sense: these myths get out there and they are very convenient falsehoods for the protectionist cause. Just keep repeating that the Chinese yuan is undervalued or the U.S. manufacturing capacity is being hollowed out, moreover it's going to China. We don't make anything any more; we flip hamburgers and sell cosmetics--that's simply not true. But it's so ingrained that when you tell that to some people they just don't accept it. Like the Catholic Church refusing to believe that the earth is not the center of the universe. Galileo comes along with his evidence and he's not believed. This is not difficult data to discover. You can go to any government website that publishes data on manufacturing output. We have several posts on Cafe Hayek that present these data. But Don, what about all those factories that get shut down, that move to Mexico or China, all the production that we've lost? There are factories that shut down, but there are factories that open up. More importantly even the factories that exist, that are not shut down, are used ever and ever more efficiently. Not only do you have more output per worker, but--I'm pretty sure, though I haven't seen data on this--you have more output per factory. The machines in the factory are more efficient. It's not just better worker skills, deeper division of labor, more powerful, reliable machines that increase manufacturing productivity. It's some things people never think about. Improvements in packaging material increase manufacturing productivity. Means there is less and less damage done to goods in transit. As communications technology improves, manufacturing firms are better able to coordinate supplies and shipping their outputs to retail markets. A wide variety of things cause American manufacturing output to rise. The fact is, it is rising. Despite the fact that there are many things we don't make here in the United States that we used to make here because it's not profitable to make them here any more; more profitable to make them elsewhere. But we continue to make lots of things here. Can't resist; this is what you call in The Choice the roundabout way of production; what Steve Landsburg in a brilliant blog post--actually I think it was in his 1993 book, The Armchair Economist--described the Iowa car crop: Americans produce cars by growing corn, shipping corn over the water and in return we get cars. A beautiful way, very efficient way to get cars. No different than producing cars in a factory, just more efficient. But the issue of the Chinese currency being devalued, being undervalued, the issue of manufacturing being hollowed out, the issue of American workers making no gains over the last 40 years, the issue of the World Trade Organization (WTO) unjustly eating into American sovereignty--all these and many more are just convenient myths trotted out by those seeking protection. Because it requires a little bit of effort to think about and check, a lot of people don't do it. On the topic of this podcast, I just do not believe it's true that the Chinese yuan is undervalued. It's value is what it is, and it reflects the monetary policy choices of the Central Bank in China. Want to mention, by the way, that that Iowa car crop metaphor--I first saw it, I used a similar metaphor in The Choice--I first saw it in James Ingram, former professor of mine at the University of North Carolina in one of his books going back almost 50 years ago when he first wrote it, maybe 40-something.
31:34So all that's true, but--and here's the but that I think is the sticking point for the average American who is worried about equality, fairness, justice, a level playing field: it remains true, and this is a fundamental fact, that we import more from China than they import from us--in goods and services. We've already talked about why that might be a good thing. But a lot of people hear that and say: That's an imbalance, and that must mean they are not playing fairly. You and I talk all the time about--there's a lot of trade imbalances between the states in the United States of America. I guarantee Idaho doesn't import the same amount from California as California imports from Idaho. Any two states have trade imbalances. They share the same currency, so obviously there can be reasons for imbalances that have nothing to do with currency manipulation. But I think a lot of people see that "imbalance" and say: That's unfair; they are artificially rigging the system so that they are--was going to say getting more stuff from us--giving us more stuff than they are taking from us. Why considered unfair or bad? Listed a bunch of myths earlier; perhaps there's no myth in international trade arena that is more pernicious and more widely misunderstood than that of trade deficits. We had a whole podcast on trade deficits. It's always good to take another crack at that issue. There is nothing at all in economic theory, as you know, that suggests that in a world, a globe, of nearly 200 different nations, that trade between each and every pair should be "balanced." It would be freakish if that happened--where the amounts the Americans buy from the Chinese are equal to the amounts the Chinese buy from the Americans; same between Brazil and China. That would have to be manipulated, to bring that about. There is nothing at all bad or unusual about any two nations having so-called imbalanced trade. Want to quickly insert here, the whole term "balanced" is nuts. Trade is always balanced. At least from a global perspective: when America's running a global trade deficit, current account deficit, with all other countries that it trades with, then that means all those other countries are investing in American assets, so we have a corresponding capital account surplus. When you put it that way, it's a net inflow of capital in America--what's wrong with that? Think the press does it out of ignorance. The very fact that the politicians who do it both out of ignorance and out of manipulativeness always talk about the trade deficit, never mention the capital account surplus--unless it's maybe the Wall Street Journal--is further evidence that there is a kind of almost perverse demand to scare Americans about the alleged dangers of foreign trade. There's nothing about the trade deficit--neither a global trade deficit and certainly not a trade deficit with an individual country that warrants alarm.
35:43Let's talk about that capital account for a minute, and the implications both for the United States and China. The image I like to think of is boats are going from the United States to China filled with stuff and boats are returning to the United States from China filled with stuff, and the value of the stuff that goes to China is less than the value of the stuff that comes to the United States. That's what it means to run a trade deficit. But there are other things on the boat besides the goods. There are services--not a lot, but some services: financial consulting, financial advice, legal services, tourism, education. But the most important part that's missing when you look at the boats is there are also little pieces of paper on the boats going from the United States to China--because as you point out, trade is always going to be balanced worldwide--they send us a bunch of stuff, we send them a bunch of stuff; but if we are running a trade deficit it means we are also sending them claims on American assets. Or on future American goods. That's the right way to say it. It's not IOUs--it's not debt. It can become debt. And some of it is debt--some of it is American Treasuries, issued by the government. Some of it is corporate debt, bonds issued by companies raising capital for new investment, which is very different from the U.S. government borrowing money, typically. And it's also equity--pieces of paper that give Chinese investors, either the government or individuals, a share of future American profitability--that may or may not materialize of course. Some of those bets may turn out to be worthless, in which case we got "stuff" for pieces of paper, and that's a pretty good deal. It could be foreign direct investment--spending the dollars building a factory. So, giving the critics their due: if they are arguing that the yuan is artificially low, making U.S. goods artificially expensive, what they are doing though is they are fundamentally buying American assets with that money, in addition to the American goods. Or they are using the dollars for other things, and those investors in other countries are using the money to buy American capital. Why are they doing that? Again, taking the argument that this is unnatural, that there is some strategy here. And we know the Chinese are accumulating large amounts of U.S. Treasuries. What do you think they are doing? Especially when you bring in U.S. Treasuries, hard--now we have a whole mare's nest of other issues. Try to untangle the mare's nest. Let's start with the U.S. Treasuries. The trade deficit can be a symptom and I think often is a symptom in the modern world of fiat currencies of something good: foreigners' willingness to invest in your economy. It can, however, be a symptom of some malady. In the case of the United States, I think it's still mostly the former, but increasingly the latter, and the malady is: excessive debt accumulation by Uncle Sam--excessive deficit spending. Congress spends way too much; it has to borrow to finance this spending, and foreigners are among some of the people who are lending Uncle Sam the money. To that extent, and if you believe that the deficit spending is unjustified, as I do, then the trade deficit is a symptom of a malady. Now, here's an irony. If you believe that the deficit spending is justified--as a lot of people do in this recession--though not in this room, but if you are Paul Krugman, want even more of it--then it is totally inconsistent to bemoan the trade deficit. Because foreigners are helping us to fund it. It's particularly hypocritical for members of Congress, who vote for budget deficit spending with one breath and with the very next breath criticize the Chinese for running a trade deficit with America. Finish thought on this. Even to the extent that today's trade deficit is a symptom of the malady--excessive government budget deficit spending, the trade deficit itself is still not a bad thing. I would prefer, and I think every American should prefer, that as many people around the globe be willing to help Uncle Sam fund his debt than not. If Uncle Sam had to depend only on Americans to fund that debt, interest rates would be a lot higher, because the Chinese are willing to buy some of that debt; not just the Chinese but other foreigners. Some American funds that would otherwise go to fund government debt are now released to go into the private sector. Given whatever level we have of government budget deficit finance, I'm delighted that foreigners want to help us pay for it. Saw an estimate recently--NBER paper, new paper I wanted to tell you about, "Has the Fed Been a Failure?" by our colleague Larry White as well as George Selgin and they found that from 1977 to 1997, the willingness of foreigners to buy U.S. Treasuries has brought interest rates down a full percentage point--one percentage point. That's a lot. I would prefer that Uncle Sam not have a budget deficit; if he got rid of it, no doubt the trade deficit would fall; but the good thing in that story would not be the falling trade deficit. That would just be a symptom of the good fact that the government budget deficit has fallen.
43:12Some people argue that that's all well and good, but it's not sustainable. What's not sustainable? This capital surplus/trade deficit. May be. But their argument is: We are systematically selling off America, and there's a limit to how much foreigners can invest here and therefore this policy can't continue--this "imbalance." This ties in with the myth that the trade deficit is the same thing as debt. By the way, even John Cochrane, who is a very good economist--he had a very nice piece last week in the Wall Street Journal--even he slipped in thinking carelessly into the error. He actually wrote in a way that indicated the trade deficit is necessarily debt. And it's not. Claim that somehow we are living beyond our means. And that's just not true. Example I like to give: If I buy--and I'm an Apple guy now--but years ago I was a Sony guy and I bought a Sony computer. I paid $2000 cash for the Sony computer, made in Japan. The Sony corporation, headquartered in Japan, got $2000. I don't know that the Sony corporation did with those $2000. Let's say it just stuck it in its cash register and forget about it. Or let's say it invested it in land in Texas. Then that means that the U.S. trade deficit with Japan--with the world--rose by $2000. But there's no debt. I don't owe Sony anything. But the standard argument is that when they buy U.S. Treasuries, certainly we will owe them money in the future. We may end up inflating and paying them back with less, but putting that to the side: the part that drives me crazy is if an American corporation's stock is purchased by a foreigner, that that's debt. It's not debt at all. It's an expectation of future productivity. It may come to be, and there's a promise there--there's a claim on future productivity. Well, but no, equity is not even a promise. Well, it's a share of the future productivity. Yes, but if that corporation declines in future profitability then the loss in that case is borne by the foreigner and not by the American. The issue of foreigners buying U.S. debt--it is true; we have to pay them. But the problem is that taxpayers in the future are going to be burdened, going to have to pay the debt. The problem is not the identity or the place of residence of the debt holder. The problem exists even if all Americans hold the debt, or if all foreigners hold the debt. Jim Buchanan, his first great book, in fact I think it was his first book as opposed to a collection of essays, 1958, Public Principles of Public Debt, one of the myths Jim exposed in that book is the idea that the national budgetary debt is no problem if we owe it to ourselves. Makes no difference who you owe it to. The problem is having to service the debt. All this concern about we owe it to foreigners--they are going to get the money, and then what? As if they are going to then hoard it and not use it to stimulate our economy. Let's say they do hoard it. Let's say all the debt is owned by foreigners. We pay it off; then they decide to hoard the money. Well, great! They are not coming back to us demanding our resources and goods--leaving more to us. If of course they do spend the money in America, that's what these protectionist people wanted all along. Just want to emphasize the point that the identity, the nationality, the issuer of the passports of the people who hold U.S. Treasuries is irrelevant. What's relevant is the size of the debt burden and the interest of principal has to be paid off in the future, meaning higher taxes or higher inflation to pay that off. On the issue of equity: when foreigners buy real estate, it's accounted for in the capital account, so it adds to the current account deficit when they buy equities, when they buy an investment firm or doing green field investment--all of those things increase the U.S. current account deficit; none of those things increases U.S. debt. All of them bring capital to America. More to work with. Makes us more productive. Protectionists claim to be concerned about the wage rates that American workers earn. There are few relations in economics that are more well-established over the long run between worker productivity and worker compensation. You raise worker productivity, you raise worker compensation. You lower it, you lower worker compensation in real terms. Just for the record, a lot of people claim that relationship has broken down in recent years, but make that claim by looking at wages, not at benefits. By looking at compensation. If you look at full compensation, you'll see that relationship is fairly steady.
49:03Would like to look at question that came up in recent program with Doug Irwin. Irwin argued that going back into the data, which he did very effectively, that in the late 1920s and early 1930s, France pursued a monetary policy that brought a lot of gold in from the rest of the world. They became a significant holder of the world's gold stock. And the implication of that was that they had an enormous inflow of gold, which meant that the rest of the world had an outflow of gold, which meant that because of the gold standard of its day and the implicit, sometimes explicit, promises, that nations had made for their currencies relative to gold, that their currencies experienced deflation. What essentially happened was that France, by hoarding gold, imposed a deflationary spiral on the rest of the world. Reduced the monetary base of the rest of the world. And therefore played a role in bringing on the Great Depression. When we had that podcast, some people said: Well, isn't that what China is doing today? Aren't they pulling in U.S. dollars by their trade policy, either because it's this sinister thing that people are worried about, or simply because, if you are correct, it's just the way their policy has turned out. There certainly have been inflows of dollars into China because of their trade policy. Isn't that harmful to the rest of the world the way France was? No, and look, the big difference here is dollars are not gold. The very virtue of the gold standard, which in this case turns into a problem of the gold standard--but the underlying virtue of the gold standard is that gold--the world supply of gold--cannot be increased arbitrarily. Or quickly, yes. Dollars can be increased as quickly or as much as you want. As we are about to find out here in the United States. If it's true--if the Fed really is worried, rightly or wrongly, about the Chinese causing deflation in America by absorbing U.S. dollars, then we don't have to jawbone or take punitive steps against China. We just increase the supply of dollars. It can be done immediately, as much as we want. There's no problem with gold there. Again, I don't think that's what's going on. I listened to the great podcast with Doug, by the way. I don't feel I know enough about the French situation to make any definitive comments about it. But I do know enough about gold and dollars to know that they are very different. I don't know what ultimately the French policy-makers were thinking of or not thinking of, what the policy-makers in other countries at the time were thinking of or not thinking of, but I do strongly feel that the yuan pegged to the dollar is a win-win for China and the rest of the world--compared to a freely floating exchange rate between the dollar and the yuan.
52:45The other issue that's related that we have just barely touched on is the accumulation of securities--Treasuries in particular by the Chinese. I've never understood this argument so maybe you are not the right person because maybe you don't agree with it either: this argument that somehow we are at their mercy because they are holding all these U.S. Treasuries. Aren't they at our mercy? Aren't they at risk, and they've talked about it publically, that if there's large inflation in the United States, which many people are now expecting, that the value of the promises we've made to them to repay the Treasuries that they bought, that what they buy will be worth less than when they bought them? I don't think it's a sinister plan to hurt the United States. Why are they holding so many U.S. Treasuries? Any thoughts? Store of value is a standard thought, but anything else as well? I don't know and I don't want to speculate on what the Chinese government is thinking on that front. This whole foreigner versus non-foreigner thing--so the Chinese government holds a lot of U.S. Treasuries. Now, what can they do? These Treasuries are term, so it's not like the Chinese government can say: Okay, I want to be repaid right now. Can't hurry it up. What they can do is sell them. In order to hurt America, if they think: Dump a lot of them in the market, that would dramatically lower the price of the Treasuries, dramatically raise the interest rate that Uncle Sam has to pay. To borrow additional money. They'd be competing with the Chinese Treasuries on the market. One thing says that this would just be a natural consequence of an irresponsible fiscal policy followed by the U.S. government. Suppose people around the world, Americans and non-Americans assessed U.S. policy and said: Well, let's sell U.S. Treasuries. That would be a market signal that fiscal policy was unsustainable. In the case of the Chinese, the concern is not that they are following the markets, but they just want to be mean to Americans--maybe they have some diplomatic or strategic thing: U.S. government, you want to interfere with our relationship with Taiwan, and if you do, we're going to dump Treasuries. The argument is the Chinese will sacrifice their own economic advantage in order to impose an economic harm on the United States. Well, okay, they might do that; but notice that they would suffer. They can't, they have a huge stock of them, by the way. By starting to sell them off they are diminishing the value of what they have left. If in fact the market value--well, let's hold on a second. We can agree that the market value of these things would fall for a long time if China decided to divest itself of all its U.S. Treasury holdings. Then one has to ask, still: Uncle Sam can choose to behave in a non-economically rational way, just like the Chinese were doing. Back up. You need something like the U.S.-Chinese-Taiwanese issue to make any sense of this story at all--for the hell of it going to dump Treasuries to hurt the United States. They would only threaten to do that, and carry out that threat, to achieve some other non-economic end. The worry is the United States, because of this economic threat, will succumb. Well, if the Chinese government is capable of putting aside its economic welfare for some non-economic end, the U.S. government is capable of doing that to. The U.S. government could say: Well, look, we don't care what you do to our interest rates; we will still protect Taiwan. I don't see that the U.S. government is in a worse position than the Chinese government. And keep in mind, all along the way up until now, the Chinese government has been making it easier for the U.S. government to accumulate weapons of mass destruction because buying all these Treasuries has made it easier for bread-and-butter stimulus spending--I don't know what that means--but more Pentagon spending, too. I think at the root of all this is a view that economic activity is a race rather than a cooperative endeavor. People have this paranoia, I think, that China is going to get ahead of us. Let's take the standard argument you hear that their economy is going to surpass ours. They're way behind us but they are growing so fast. My view is--I have no idea how fast they are growing, I have skepticism about our economic statistics, so let's take that and multiply it times 7. My 5-year-old niece is growing faster than my 13-year-old son. Well, there's that, too. Let's suppose it's true. Let's suppose their economic data are accurate; they are starting at a low level so they can grow very fast as they modernize, as they accumulate capital outside China, as they convert non-monetary production at the household level on farms and the household level to urban, measured economic activities--there's a whole bunch of reasons they are thriving. And I say: Bless them. There's a lot of poverty, but their people are thriving; it's a wonderful thing they are doing better than before. And the key point is that their thriving takes nothing away from us. On average. It does--Americans who have to compete with the Chinese have had challenges--but there are enormous gains to other Americans that dwarf that. Microsoft growth takes something away from Apple, but clearly both of them can grow and we don't regret Microsoft's growth or Apple's growth just because it happens to take something away from some competitor. But often it just creates something for both sides, and the part that I always find strange is this idea that China is going to get ahead of us in this race, which I think is the totally incorrect metaphor, but that China is going to get ahead of the United States by selling us a lot of inexpensive stuff. Of course, if they do that, we get ahead an enormous amount as well, because we don't have to spend an enormous amount of money on this stuff! So, if that's what you are worried about--if you think the American way of life depends on our being Number One, which to me is absurd and bizarre and I'd be thrilled to be Number Two if by being Number Two we have a much better life and live longer and had richer experiences about human beings--but if for some reason you care explicitly about our ranking, the only way they can get ahead is by improving us. So, I never understood this argument that they have some sinister plan, say to punish us by dumping Treasuries, whatever it is. Most of their economic fortunes are tied to us. They help us by doing better. We are still far and away--America is, to the extent you want to talk in these kinds of aggregates--the world's largest economy. We may have this huge market here, and the Chinese have to sell to it, and get supplies and entrepreneurial ideas from it and capital from it. If the Chinese really want to grow economically, then the idea--you are right--the idea that they'd somehow want to hurt us in any absolute way is ludicrous. Good rule of business: Don't shoot your customer. Don't debilitate your customer. Don't pick his wallet. If they are not doing that, they are making us richer. I think it's a sign of an intellectually-infused argument--of course protectionism is just a tissue of an intellectually-infused argument--which is that they are hurting us by making us better, so let's show them; let's hurt us even more. And then will them down. Crazy. I don't know where people get their economics from. Reading op eds by Pat Buchanan, books by this silly William Greider guy. Perpetuates all sorts of myths that may sound acceptable to someone who doesn't want to think more than 5 seconds about the issue, but to anyone who wants to think 6 or more seconds about the issue, definitely doesn't make any sense. And they could always read The Choice. Or Globalization, by Don Boudreaux, which we'll put links up to. But in closing, there are other issues--military issues, foreign policy issues; you and I are not experts on those issues; we don't pretend to be. What we are talking about here, though, are just the economics. Well, let me mention one thing, we can put a link up to it, Liberty Fund just published it. There's a beautiful 1954 monograph by my teacher at Auburn, Leland Yeager, that Liberty Fund put up a year or two ago. It's got "free trade" in the title. It's a really, really excellent overview of the issues. Even though it's in 1954, it's not dated at all. At the very end he deals with the national security issue. He recognizes that it's different from the more traditional economic issues, but he actually makes a strong case for why even that excuse for protectionism is often overblown.

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