Econ 101: Erdogan’s Turkey

President Erdogan believes that by cutting interest rates on the Turkish lira the resulting depreciation of its exchange rate will cheapen Turkish goods and thus increase their exports and promote growth (the China model, he thinks). Accordingly, he has replaced four central bank governors who could not bring themselves to accede to his demands. “Revolving door-Turkeys-last-four-central-bank-chiefs”

In an earlier disastrous cycle, the Central Bank of Turkey (CBT) reduced its policy rate from 24% in 2019 in steps to 8.5% in mid 2020 only to raise it again to 19% in March 2021 until the latest cuts started in September of this years. In November, “The Monetary Policy Committee (MPC) has decided to reduce the policy rate (one-week repo auction rate) from 15 percent to 14 percent.” “Press Releases/2021/ANO2021-59”  

When I was part of the IMF team in 2000-1 working with the Turkish authorities to regain control of inflation (which ranged from 60 and 100 percent between 1980 and 1999) and clean up the banking sector (they closed 13 banks in 2000), the CBT policy interest rate was briefly raised to 100% (ala Paul Volcker in the US). Inflation declined rapidly to single digit levels (until the last four years) with interest rates quickly following.

The dollar price of the Turkish lira has fallen in half since February of this year (i.e., a dollar will buy twice as many lira–one lira cost 0.14 dollars in February and 0.061 dollar on December 17).  Erdogan seems to think he is choosing to benefit workers (exporters) over consumers (importer), though they are generally the same people.  If the lira depreciates, the rest of the world can buy lira more cheaply and thus (according to Erdogan) will buy more cheaper Turkish exports. This should increase the demand for Turkish good and the jobs that produce them and increase the growth of the Turkish economy.

As any economist can explain to Mr. Erdogan, depreciating the exchange rate with lower interest rates in Turkey than in the rest of the world is achieved by printing more money with which to buy foreign currencies. Broad money (M2) increased almost 48% in November 2020 from a year earlier and 24% from a year earlier this November. But such a rapid increase in the money supply will increase prices in Turkey over and above the increase in the price of imports from the lira’s depreciation. “Turkey-central bank-Erdogan”

Inflation in Turkey has risen from single digits between 2004 to 2016 to “21.3%” in November 2021 (annual rate from a year earlier). According to the Central Banking Journal “Official figures show Turkish inflation reached 21.31% year-on-year in November, but there is considerable controversy over whether these figures are accurate. Several well-informed observers, have told Central Banking that they believe the official figures understate actual inflation.”  “Turkey’s currency hits new low after further rate cut”  Steve Hanke reports the actual rate at around 100%  “Steve Hanke’s estimate of Turkey’s inflation rate”

In short, Mr. Erdogan’s crazy policy of reducing interest rates has not made Turkish goods cheaper for the rest of the world. As the lira became cheaper for foreigners (depreciation), the lira price of those goods became more expensive (inflation). The real effective exchange rate (which takes account of both) is not being significantly reduced because Turkey is experiencing higher and higher inflation along with the lira’s depreciation. Monetary policy works in Turkey the same way as in every other place.  The CBT’s inflation target, by the way, is 5%. “Turkey-Erdogan currency crisis”

Where Does Senator Josh Hawley Stand?

Upon what basis should we make our decisions to do or not do something? Upon what basis should the government take the right to make decisions for us? The quality of our individual choices depends on the values and principles that guild us. These profoundly influence the quality of our lives in our given or chosen societies.  I have discussed this issue before:  “The great divide-who decides” 

The issue of Covid-19 vaccination mandates and related issues are currently providing vivid and noisy examples of these questions. A few of my reactionary libertarian friends (in contrast with more thoughtful libertarians) insist that it is their right to decide whether to get vaccinated or not. Perhaps, but it is not their right to knowingly infect others (the freedom to swing my fist ends at your face). Specifically, the unvaccinated do not have the right to be where they are not wanted or permitted by private establishments. Businesses (restaurants, theaters, sports events, etc.) should have the right to determine who they serve (subject to the sometimes problematic limitations imposed by the 1964 Civil Rights Act Virtually all such businesses wisely go out of their way to reassure potential customers that they are save places to visit. This generally takes the form of mandating that their employees and customers are vaccinated for Covid. In my opinion the government, in addition to collecting and disseminating the best possible information on Covid risks and how to minimize them, should protect the freedom of businesses to make Covid policies they consider appropriate to their own business and should mandate that all of the government’s own employees be vaccinated. Only specific health issues should qualify for potential exemption. Religious and other beliefs should not.

Sports, and the Beijing Winter Olympics in particular, also raise the issue of who decides to participate in the face of serious Chinese human rights violations. I generally think that sporting competitions should not be influenced by politics. So, should athletes participate in the upcoming winter Olympics and who should decide?

In his December 9 column in the Washington Post Josh Rogin makes a strong case for each of us to speak out against violations of our principles: “Enes Kanter Freedom takes bold stance on China” “’We must always take sides,’ Holocaust survivor Elie Wiesel said while accepting the Nobel Peace Prize in 1986. ‘Neutrality helps the oppressor, never the victim. Silence encourages the tormentor, never the tormented. Sometimes we must interfere.’”

President Biden recently declared a diplomatic boycott of the China games, meaning that the U.S. government will have no representatives there, though the American Olympic teams and individual athletes are free to make their own decisions. The Economist reported that “France will not join the partial boycott that America, Australia, Britain and Canada are calling against the Beijing Winter Olympics in protest at China’s treatment of its Uyghur minority and of Peng Shuai, a tennis star. President Emmanuel Macron complained that the Anglophone countries’ merely withholding diplomatic representation—while their athletes compete—is not an effective way to alter China’s objectionable policies.” “The Economist Morning Brief”

“Sen. Josh Hawley, R-Mo., [also] ridiculed the Biden move, echoing Hagerty’s claim that the diplomatic boycott did not go far enough.  ‘A diplomatic boycott of the Beijing Olympics is a joke,’ Hawley told the Daily Caller Monday. ‘China doesn’t care if Biden and his team show up. They want our athletes.’”  In short, Hawley wants a presidential mandate forbidding participation of American athletes in the Beijing Winter games. “Republicans blast Biden apos diplomatic”

On the other hand, Sen. Hawley opposes President Biden’s proposed mandate that every eligible person must receive an approved Covid-19 vaccination.  “Senator Hawley-Biden vaccine mandate shows contempt for religious liberty”  In this area the good Senator puts “choice” over “life.”  With regard to abortion Senator Hawley sides with “life” over “choice.”

“U.S. Senator Josh Hawley (R-Mo.) issued a statement in support of Missourians who traveled to Washington, D.C., today to participate in the 46th Annual March for Life. The group of nearly 3,000 Missourians represented all ages, from high schoolers to retirees and came from all over the state including Cape Girardeau, Jefferson City, Kansas City, Sedalia and St. Louis.

“’It’s incredible to see people of all ages and backgrounds, from Missouri and across the country, who have made the trek to our nation’s capital to speak their hearts, their minds, their faith – to tell their elected leaders that this nation was founded on the dignity of every person and that every life is worth fighting for,’ said Senator Hawley. ‘I am proud to stand for the right to life. Always.’”

“Senator Hawley commends missourians participating in march for life”

Where is Senator Hawley coming from and where is he going?  Regarding health and vaccination against Covid-19, Hawley is “pro choice” rather than “pro life.” Regarding the abortion of non-viable fetuses, Hawley is pro (potential) life rather than pro choice.  What are the principles guiding when he is one and when he is the other (beyond political expediency)? When should government mandate our choices and when not?

Which is it for gas prices?

“President Biden on Wednesday called on the Federal Trade Commission to launch an investigation into oil and gas companies, alleging that their “anti-consumer” behavior has led to higher gas prices…. ‘The bottom line is this: gasoline prices at the pump remain high, even though oil and gas companies’ costs are declining,’ Biden wrote in a letter to FTC Chair Lina Khan.” “Biden-FTC-gas-prices–Washington Post”

On the other hand, the Whitehouse website states:

“The United States has set a goal to reach 100 percent carbon pollution-free electricity by 2035,… America’s 2030 target picks up the pace of emissions reductions in the United States, compared to historical levels, while supporting President Biden’s existing goals to create a carbon pollution-free power sector by 2035 and net zero emissions economy by no later than 2050.”  Whitehouse fact sheet: President Biden sets 2030 greenhouse gas pollution reduction target

Which is it?  Does Biden intend to replace oil and gasoline (and coal) with carbon free energy, which would increase oil and gas prices (ultimately to infinity), or does he want to keep oil and gas prices low?

A market approach to phasing out petroleum products would be to increase their cost via a carbon tax–an approach that I support.

Broadband for All

The just passed Infrastructure Investment and Jobs Act provides $65 billion for high-speed internet to make sure that every household can access reliable broadband service. This raises, or should have raised, the question of the most cost-effective way of providing it. Many rural areas enjoy high speed internet access from satellites. These can easily be expanded to cover the entire country and are significantly cheaper than running cables to remote areas. But the other approach is for families wanting such high-speed internet access to live in areas that provided, e.g., cities.

When I taught at the University of Virginia, I choose to live ten miles out of Charlottesville on Piney Mountain. I did have electricity but no water or sewage disposal for which I had to drill a water well and dig a septic tank and system. That was an understood part of the deal of living in a semi remote area and a factor in its cost. Should everyone who chooses to live in remote areas be entitled to electricity, water, sewage, broadband, or whatever other modern convenience comes along or should those wanting such convenances have to live where they are efficiently provided?

Econ 101: Inflation –Temporary or Longer Lasting?

Prices of many goods and services have increased in recent months. Are these increases permanent or temporary or will they continue rising in the future? Before exploring those questions, it is important to understand the measures of inflation we are considering. What is the current rate of inflation in the United States? U.S. inflation in September was 3.0% (Compound annual rate of change for Consumer Price Index without food and energy prices over the month of September), or 4.0% (percent change from a year ago) or 5.4% (percent change from a year ago including food and energy prices). What does it mean if this is temporary or long lasting?

If prices remain where they are today after the 5.4% increase from a year ago, inflation going forward would be zero even though the cost of living would be permanently higher. If inflation is long lasting it means that prices will continue to rise for some time (years). What are the factors that influence the future behavior of prices? What should we expect in the U.S.?

The price of a good or service increases when its demand exceeds its supply and similarly for prices in general (when aggregate demand exceeds aggregate supply). As prices are measured in a country’s currency, supplying too much of the currency (generally when the money supply grows more rapidly than the supply of goods and services) causes its value to fall (i.e., prices in the country’s currency to rise).

On the cost side, firms will hire workers and pay them a particular wage (and related benefits) when it adds more to the company’s income than it costs, which includes the cost of the tools they use (capital). Workers will accept a job when its benefits (pecuniary and nonpecuniary) are the best they can find. The inflation expected by the employer and the employee over the period of the wage contract is an important factor in determining what will be offered and what will be accepted.

Because of changes in consumer demands, worker preferences, halving of work visas for immigrants, and supply chain disruptions, labor markets are temporarily in turmoil. September unemployment in the U.S. was 7.674 million while there were 10.4 million job vacancies. Employers are raising wages in an effort to fill those vacancies. As reported by Scott Lincicome: “Goldman Sachs analysts saw a ‘perfect storm of factors that have significantly reduced the supply of workers who are currently looking for jobs at the same time that labor demand—as measured by job openings—has risen to an all-time high.’ This includes… state and federal benefits, early retirements, severely restricted immigration, a switch to self-employment, fear of COVID, and a geographic mismatch between unemployed workers and available jobs. Combined, these factors account for most of the missing workers out there.”  “What if the labor shortage isn’t transitory?”

In short, the labor force has shrunk just as the demand for output is increasing. This excess demand for workers is driving up labor costs and thus pushing up output prices. If the 5 or 6 percent price increase experienced over the present year is expected to be temporary, i.e., if prices are expected to return to their level a year ago, because the supply of labor returns to its pre-pandemic level, wage increases should be temporary as well, falling back to their pre pandemic level and growing thereafter on average with labor productivity plus the 2% inflation target of the central bank once there is full employment and better labor market balance.

More likely, if the inflation is expected to be temporary, i.e., the current 5 to 6 percent inflation stops but prices remain at their increased level, wages will remain at the increased level, but their real (inflation adjusted) value will fall back to their original level. In other words, if these higher prices are expected to be “permanent,” the nominal wage increases now being experienced will not result in any increase in real wages and the worker short fall might remain.

While some of those who withdrew from the labor force will probably return, it is not likely to fully satisfy the demand for various reasons (early retirement, fall in immigration, etc.). Filling (or attempting to fill) the remaining labor shortage will require additional wage increases (unless the public’s demand for goods and services falls–see below). In that case, firms will plan to pass on their higher cost of labor to their customers. If we, the customers, can continue to pay the higher prices, the inflation will continue. Expectations of higher prices and or inflation will be realized.

The Covid-19 pandemic caused a sharp fall in output and thus to most people’s incomes. The government provided extraordinary financial support to temporarily fill the resulting income gap. Such support did not increase the output of goods and services or even prevent their decline but rather temporarily redistributed income from those saving it to avoid hunger and defaults on rents, mortgages, and other financial obligations by those who lost it.  “The new covid-19 support bill”  Because personal incomes were substantially maintained while actual output fell, personal savings rates increased dramatically and continue to be well above pre pandemic levels.

The Federal Reserve pitched in by buying up huge amounts of the resulting government debt increasing its balance sheet from $3.5 trillion in February 2020 to $6.3 trillion in August 2021 (measured by the monetary base, M0). This fueled an increase in board money (M3–M0 plus bank deposits and similar liquid assets of the public) from $15.5.0 trillion in February 2020 to $20.8 trillion in August 2021. This increase, though substantial, was significantly less than the increase in M0 (which almost doubled) because the Fed paid interest to banks for keeping the new base money with the Fed (excess reserves) rather than lending it to the public, by paying banks interest on all bank reserves kept with the central bank.

Historical experience is that the public will not be willing to hold these larger amounts of money for ever. They will eventually attempt to spend them down to their traditional (normal) levels, thus adding to aggregate demand for goods and services (and inflationary pressure).

Eventually, the demand for goods and services (aggregate demand) must fall to match real output, or output must rise to match demand. But if the Federal Reserve continues to print money faster than its real value is being inflated away, the inflationary process will continue or accelerate. Similarly, if the government continues to redistribute income from those with a lower propensity to consume (generally higher income families with a higher savings rate) to those with a higher propensity to consume (generally lower income families that save little), aggregate demand will remain excessive perpetuating inflation.

Historically, hyperinflation episodes invariably exploded in the collapse of the currency.  “Hyperinflation in Zimbabwe”  Turkey has come closest to a high inflation “equilibrium.” From the mid 1980s to the end of the 1990s Turkey’s inflation rate varied between 80 and a 120 percent. A high inflation “equilibrium” would be characterized by nominal interest rates and wage rates that fully incorporate the ongoing expected rate of inflation in order to preserve the appropriate real (inflation adjusted) rates. Interest rates in Turkey in this period generally exceeded 100%, as did wage growth.

In its most recent World Economic Outlook, the International Monetary Fund stated that: “In settings where inflation is rising amid still-subdued employment rates and risks of expectations de-anchoring are becoming concrete, monetary policy may need to be tightened to get ahead of price pressures, even if that delays the employment recovery.” “World Economic Outlook-October 2021

As stands out clearly from the increasingly but unevenly rising inflation in the 1970, the process of increasing inflation is not linear (see the chart above).  As inflation increased, the Federal Reserve tightened monetary policy (raised interest rates to slow monetary growth) to slow inflation, causing real output to slow or decline. Policy then eased prematurely, and inflation and the expectation of higher inflation took off again, each time reaching a higher peak (until Paul Volcker stepped on the breaks and ended the game in 1979-80–the exciting year I worked at the Federal Reserve Board).

The Federal Reserve is smarter today than it was in the 1970s and has the tools to prevent the acceleration of inflation and the unhinging of inflation expectation. But the excess money balances and personal saving are very large and the government’s seeming willingness to run up unprecedented deficits create a powerful inflationary head wind. The tightening of monetary policy that will be needed (sooner rather than later in my view) will reduce the Fed’s purchases of Treasury debt and increase interest rates. Higher interest rates will increase government spending for debt service on its very large stock of debt, which will further increase government borrowing and debt or require cuts in spending for other programs. This must be added to the economic challenges of confronting climate change, the continuing recovery and adjustments from the Covid-19 pandemic, the deepening and destructive partisan divide that is stifling Congress, and the growing lack of public trust that drives it.

Whether our current inflation is temporary or longer lasting depends on how quickly and decisively the Federal Reserve tightens monetary policy and how quickly people go back to work. Whether the U.S. economy and the government’s large stock of debt continue to enjoy safe haven status around the world depends heavily on whether our government brings its spending and tax policies under better control.

Our Right to be Free

Our country was founded and has prospered on the proposition “that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” We jealously guard our individual liberty. We are free to decide what we want to do and how we want to do it. This liberty is subject to two major conditions: we must live with the consequences of our choices and actions, and our actions cannot interfere with the same exercise of freedom by others. We never fully live up to these high principles, but they do define the goals we continue to and should continue to aim for.

When our actions or circumstance fail to sustain us, we do step in to help those in distress, whether from family obligations or friendships or a government administered social safety net. We continue to debate and refine its features.

Determining the boundary between those actions I am free to choose, and those that unacceptably affect others is not always easy. Walking in public naked is not acceptable in most societies (except at designated nude beaches). While this would not infringe on the freedom of others to behave as they want, it would “force” them to see something they do not want to see.

I chose this example because it does not fall neatly into something purely private that I have a right to do (walking around my home naked) or something clearly and obviously damaging to others that I do not have a right to do (driving my car through my neighbor’s garden).  In the realm of social norms, I can walk in public dressed in many ways depending on the society I am in.  A man might freely walk around in a dress (if he chooses the neighborhood carefully) without getting knocked down in some societies but not in others. Such social norms are important in defining and guiding acceptable public behavior and they vary across societies and over time. Such norms are continuously debated.

But clearly my freedom to swing my fist ends where your face begins. If you are infected with a contagious disease, you do not have the freedom to walk around potentially infecting others even in the most libertarian of societies (e.g., lower Manhattan). I assume that anyone sick with Covid-19 knows that she must isolate/quarantine herself.

But what about someone who doesn’t feel sick but hasn’t been vaccinated?

Any establishment has the right to require that only vaccinated people work or shop there and/or wear face masks. And I certainly have the right to attend only those performances or eat in those restaurants that impose these requirements. These are implications of freedom.

Surely everyone understands and accepts these propositions.  So why is there such controversy over wearing masks and getting vaccinated? I don’t know the answer to this question but will suggest a few factors that I think are important. That such health issues have become so politicized is almost more distressing than the fact that in the United States 728,000 people have died from Covid-19 by October 10, 2021.

One reason is that some people are pushing back on being told what to do by the government. Such behavior is common in freedom loving children but rather unseemly in adults. Another is that vaccines were developed with miraculous speed and their effectiveness and potential side effects are not yet fully known. None the less the evidence is overwhelming that being vaccinated significantly increases your prospects of living and surviving the infection compared to those who are unvaccinated. Another is that during the Trump administration medical policy and advice became quite politicized. Many of us, often with good reason, stopped trusting the messages from the CDC and FDA. And to this day government messaging remains poor. Rather than offering advice based on the most recent evidence (which can change over time) and the reasons for those recommendations, government pronouncements are often confusing and sometimes sound like demands. Many of us have lost trust in the government’s pronouncements. Unfortunately, some people have put their trust in unreliable sources of information and even, in some cases, in deliberately malicious sources (and we can’t always blame Russia). 

Where our choices and actions affect only ourselves, we should be free to do as we like and benefit (or suffer) from the outcome. Where our actions affect others, more or less directly, social norms and government rules should limit our choices. In societies where its citizens live by the golden rule and respect these norms, beneficial behavior is followed voluntarily — enforcement is not a serious problem.  We must determine the sources of information that we trust carefully and based on such information we must treat our neighbors with the respect we expect from them.

Protecting our freedom is critical but it is not enough. We must also exercise it virtuously. The “fusion” of freedom and virtue has been (most of the time) the basis of American success. We seem at risk of losing both. Get vaccinated now for everyone’s benefit. Please.

China and the United States

“Biden describes the China challenge as a global, ideological struggle between democracies and autocracies…. Any event from the pandemic to the Olympics will occasion commentary, particularly in the United States, of who “won,” China or America, and what it means for the epic struggle for global supremacy.” “There is no unified front against China”

I am not sure what it is that we want to win. We don’t seem to mind selling planes and bombs to other autocracies (Saudi Arabia, Qatar, etc.). Anything to keep the defense industry’s profits flowing short of yet another war seems a (relatively) good deal. And why might “global supremacy” matter?

Winning things sounds to me like rooting for our own basketball team and cheering when it wins the championship. How do we go about striving to have the best basketball team? First, we recruit the best basketball players we can find and hire the best coach to train them. Everyone must play by the agreed rules, and we win by playing the best game. In short, our efforts go into being the best team possible, not into poisoning the drinking water of the other teams.

But sporting contests are zero sum. One side wins and the other losses. Global cooperation and trade is win–win. The goods we produce and sell (for example) to China, with which to pay for the goods we buy from China make us and China both richer. The citizens of both countries benefit from this exchange. Win–win. Sharing information on the source, nature, and potential cure of a virus (which knows no borders) benefits all of us. Win–win.

The world’s output is maximized when our productive assets (labor and capital) are allocated to their most productive uses globally. That requires that market prices reflect the true productivity and value of each activity. Thus, the world as a whole benefits from rules governing government interferences in market prices and allocations. The World Trade Organization is the forum for agreeing on these rules of fair trade and enforcing them. “Econ 101- Trade in very simple terms”

The airplanes built by Boeing and Airbus benefit from government support of one sort or another. For years they have fought one another over whether this support conformed to fair trade rules. A settlement has finally been reached. “Boeing – Airbus settlement”

Trade restriction in the name of national security, while potentially legitimate, can easily cross the line into wealth reducing protectionism. Does the use of Huawei 5G equipment really threaten U.S. national security or U.S. business interests (protectionism). Some of these cases are hard to call but we must look carefully at narrow business interests in protecting their markets to the detriment of the rest of us. “Huawei ban could crush US aid efforts”

Global supremacy suggests that we would set these rules. To be successful the rules of international trade must be very broadly followed. Thus, their formulation must be a collective undertaking. It is fine for the U.S. to exert influence in setting these rules, but unfortunately, we have a poor record of even following them. We have caused the demise of the WTO dispute resolution body. We have strangely and counterproductively withdrawn from the Trans-Pacific Partnership (TPP), which was then replaced by the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). These set high standards for more open trade that China will hopefully have to meet to join. The self-image of supremacy has corrupted U.S. behavior. Former President Trump’s protectionist tariffs on trade with China, EU, Canada, etc., which President Biden has so far failed to remove, have further reduced U.S. and world income. “Trade protection and corruption”

So, what should our policy be toward China? China has no intention or interest in attacking the United States. They care about their own economies and their own neighborhoods. We should keep our nose and military home to look after our own neighborhood. We should work with China (and Russia and others) to formulate win-win rules for international interactions and behavior. We should apply the mechanisms of the WTO and other international bodies, and diplomacy more generally, to hold China (and others) to the agreed rules. But we must abide by them as well. The rule of law is not just for others.

We should fix the problems in our own economy. We should work to make our domestic rules of commerce fair and efficient so that our economy will be the best in the world. We should work with other countries, including China, to maximize the productivity of their resources because we and everyone else will benefit (win-win).

The United States was founded on principles that have served us well providing a model that the rest of the world would do well to follow. The idea that we should (or can) impose our principles on others rather than provide an example like “a shining city on a hill,” is a violation of those very principles. We have repeatedly failed to uphold those principles, but we keep trying. We must continue trying and must try harder.

Econ 101: Tony Judt on Trade

I just finished listening to the Audible version of Thinking the Twentieth Century, a discussion between Tony Judt and Timothy Snyder, recorded just before Judt died in 2010. Judt was a British-American historian, essayist and university professor who specialized in European history. Snyder is an American author and historian specializing in the history of  Central and Eastern Europe and the Holocaust.

I found Judt to be a very insightful in his area of political and social history expertise but generally off base on economic issues, which is not his field. I fear that his misunderstanding of trade is widely shared so I will set out some important basics as a contribution to better public understanding. “Science” doesn’t dictate policy, but a correct understanding of the economics of trade is essential if one’s value preferences are to lead to policies that produce your desired result.

Judt describes the increase in American wages for manufacturing workers along with their health and pension benefits over the past several decades leading manufacturing firms to outsource their production to the cheaper labor in (for example) China and thus hollowing out American manufacturing.  Almost everything about this description is wrong.

For starters manufacturing output in the U.S. is at an all-time high (prior to Covid shutdowns). Off shorting some of it has not hollowed out U.S. manufacturing.  Because manufacturing output has grown more slowly than the economy overall (the upper line below), its share of GDP has fallen (the lower line). Moreover, because of increased labor productivity in manufacturing, fewer workers are needed to produce this increased output (second chart) thus freeing labor to work in other areas and increasing our overall standard of living.

U.S. manufacturing output

Billions of US $ and Percent of GDP

Data Source: World Bank
MLA Citation: <a href=’https://www.macrotrends.net/countries/USA/united-states/manufacturing-output’>U.S. Manufacturing Output 1997-2021</a>. http://www.macrotrends.net. Retrieved 2021-08-16.

But let’s take a closer look at Judt’s statement. If the U.S. shifts some manufacturing offshore, it must pay for it. Instead of paying American workers it must pay Chinese workers, and firms and shipping companies. Fundamentally, a country’s imports must be paid for by its exports (or by capital inflows from the exporting country). Let’s look carefully at each possibility. To simplify, let’s initially assume that there are no capital flows (cross border investments from one country in another) so that trade in goods and services must balance (i.e., pay for each other).

For starters whether labor is cheaper in China than in the U.S. cannot be determined without considering the exchange rate of the dollar for the Chinese Yuan. If exchange rates (not mentioned by Judt) are flexible (determined freely in the market) the fact of an increase in U.S. imports from China (i.e., the offshoring of U.S. manufacturing to China) will depreciate the dollar/Yuan exchange rate. As U.S. manufacturers sell dollars to buy Yuan with which to pay for the goods they now want to buy from China, Yuan will become more expensive (a depreciation of the exchange value of the dollar). The dollar’s depreciation will have two effects. It increases the cost of Chinese labor to U.S. companies and thus will reduce the cost advantage of Chinese labor and reduce the demand for it by U.S. firms. And it will lower the cost of U.S. exports thus making them more attractive in China. While the adjustments will take time, the dollar depreciation will continue until American exports increase and its imports from China moderate until trade balances–our increased exports pay for our increased imports.

If the exchange rates are fixed, as they were in gold standard days, the adjustment in the real effective exchange rate needed to balance trade takes a different form.  The initial increase in the demand for Chinese products (outsourcing to Chinese workers) are paid for with dollars. But to preserve the fixed exchange rate, the PBRC (Chinese central bank) must buy these dollars with newly created Chinese currency. This increase in the Chinese money supply will lift prices in China making Chinese exports more expensive in the U.S. and U.S. goods cheaper in China. In short, the real exchange rate adjustment needed to balance imports and exports in this case results from a higher inflation rate in China than in the U.S. while in the first case of flexible exchange rates it results from adjustments in the nominal exchanges rates themselves.

A third possibility is for China to take the extra dollars being spent in China and invest them in the U.S. (or elsewhere) This is the capital flow case in which trade itself does not balance.  This was the policy followed by China in the 2000s through 2014. The PBRC would buy the dollars being spent for outsourced Chinese labor (U.S. manufacturers payments to Chinese workers rather than to American ones for the goods they needed) and would invest them in the U.S. If the increase in the Chinese money supply resulting from those dollar purchases was more than was consistent with stable prices in China, the excess money would be sterilized–so called sterilized foreign exchange intervention (the PBRC would create Yuan to buy dollars and would repurchase some of those Yuan back with domestic Chinese securities owned by the PBRC).

To some extent this foreign exchange market intervention by the PBRC was the result of its desire to build up its FX reserves (a kind of insurance policy for exchange rate shocks). However, much of it was to prevent an appreciation of the Yuan that would reduce its exports (it was following an export led development strategy). This policy was much criticized abroad as currency manipulation and ended in 2013-4.  Thus, China has financed a significant part of the U.S. governments fiscal debt. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

Thus, when someone says that something is cheaper to make in China, remember that it must also be that from China’s perspective, something must be cheaper to make in the U.S. in order to pay for what China sends to us. Both sides benefit and the world grows richer.

A shift in monetary regimes?

By Warren Coats[1]

This Sunday, August 15, is the 50th anniversary of President Richard Nixon’s closing of the gold window as part of the “Nixon Shock.” “Fifty years later Nixon’s August surprise still reverberates”  He announced on that day that the U.S. Treasury would no longer redeem its dollars for gold at $35 an ounce. Over the subsequent few years, the world moved from national currencies whose values were anchored to the market value of gold, to currency values determined by central banks’ regulation of their supply relative to the market’s demand. The value of one currency for another floated in the foreign exchange market. Central banks have deployed various approaches to determining the supplies of their currencies and most have now settled on targeting an inflation rate (often 2% per year) in one way or another.

With the rapidly increasing interest in cryptocurrencies, some have asked whether we are on the brink of another monetary paradigm shift? Specifically, might the dollar be replaced as the dominant international reserve currency. To explore that question we need to understand how the existing monetary systems work and how the widespread use of cryptocurrencies might add to or change these systems.  

In describing the existing and potential future monetary systems, we need to distinguish “money” from the “means of payment.” Money is the asset that people accept in payment of debts or for the purchase of goods and services. The U.S. dollar and the Euro are “money.” The means of payment refers to how money is delivered to the person being paid. Do you personally hand dollar bills and coins to the Starbucks cashier, write out a check (bank draft) and put it in the mail, or electronically transfer “money” from your bank account to an Amazon merchant via eWire, Zelle, Venmo, PayPal, or some other digital payment service? Or perhaps you purchase goods and services with borrowed money (Visa, MasterCard, American Express) that you pay back at the end of each month or over time. Or if you don’t have a bank account (a form of digital money) you might hand-deliver physical currency to a Hawala dealer or a MoneyGram or Western Union office to be electronically transferred to their office nearest to the person you are sending it to, potentially anywhere in the world. If you are paying in a currency that is different than the one the payee wishes to receive, your currency will be exchanged accordingly along the way in the foreign exchange market.

Discussions of cryptocurrencies include both the latest and evolving means of payment (digital payment technologies) as well as new, privately created moneys such as bitcoin, Ethereum, or Ripple.  Private currencies vary enormously with regard to how their value is determined. By private currencies I do not mean privately created assets redeemable for legal tender, such as our bank accounts. When we speak, for example, of the U.S. dollar, we invariably include dollar balances in our bank accounts, dollar payments made via our Visa card, etc. These are all privately produced assets that are ultimately redeemable for Federal Reserve currency or deposits at a Federal Reserve Bank. They are credible claims on the legal tender of the United States. Most U.S. dollars are privately created.

The value of all money is determined by its supply and demand. The demand for money arises from its acceptability for payment of our obligations and the quantity of such obligations (generally closely related to our incomes). Within each country, its legal tender money (e.g., the U.S. dollar in the U.S.) must be accepted by payees. In particular, it must be accepted by the government in payment of taxes.  Truly private currencies (those not redeemable for legal tender, of which there are over 11,000 at last count) have a serious challenge in this regard. Very few people or businesses will accept bitcoin, or any other such private cryptocurrency. As a result, the demand for such currencies for actual payments is very low. The demand for bitcoin, for example, is almost totally speculative–a form of gambling like the demand for lottery tickets. Such private currencies are more attractive in countries whose legal tender is rapidly inflating or has unstable value (e.g., Venezuela). 

The acceptability of a currency in cross border payments raises special challenges. My currency is not likely to be the currency in general use in other countries. Someone in Mexico paying someone in Germany will generally have Mexican pesos and the recipient in Germany will want Euros. The pesos will need to be exchange for Euro in the foreign exchange market. It would be very costly for dealers in the FX market to maintain inventories of and transact in every bilateral combination of the world’s 200 or so currencies. It has proven more economical to exchange your currency for U.S. dollars and to exchange the U.S. dollars for the currency wanted by the payee. The dollar has become what is called a vehicle currency.

The economy of a so-called vehicle currency can be illustrated with languages. Two hundred and six countries are participating in the 2021 Olympic Games in Japan. To communicate with their Japanese hosts participants could all learn Japanese. It is unrealistic to expect the Japanese hosts to learn 205 foreign languages. But what about communicating with their fellow participants from the other 205 countries. For this purpose, English has become the default second language in which they all communicate. Unlike more isolated Americans, most Europeans speak several languages, but one of them is always English. English as the common language is the linguistic equivalent of the dollar as a vehicle currency.  

The rest of the value of money story focuses on its supply. Bitcoin has the virtue of having a very well defined, programmatically determined gradual growth rate until its supply reaches 21 million in about 2040. The supply today (Aug 2021) is 18.77 million. See my earlier explanation: “Cryptocurrencies-the bitcoin phenomena”  The other 11,000 plus cryptocurrencies each have their own rules for determining their supply, some explicit and some rather mysterious. The class of so called “stable coins” are linked to and often redeemable for a specific anchor, sometimes the U.S. dollar or some other currency. The credibility of these anchors varies.

The highly successful E-gold (from 1996-2006) is an example of a digital currency that had well-defined and strict backing and redemption for a commodity at a fixed price. “E-gold”  The supply of such currencies is determined by market demand for it at its fixed price–what I have elsewhere called currency board rules. I describe how currency board rules work in my book about establishing the Central Bank of Bosnia and Herzegovina:   “One currency for Bosnia-creating the Central Bank of Bosnia and Herzegovina”

The dominance of the U.S. dollar in cross border payments reflects far more than its use as a vehicle currency. Many globally traded commodities, such as oil, are priced in dollars and thus payments for such purchases are settled in dollars. Pricing a homogeneous commodity trading in the global market in a single currency makes that market more efficient (the same price for the same thing).  Making cross border payments in dollars (or any other single currency) also avoids the costly need to exchange one for another in the FX market. The dollar is most often chosen because its value is relatively stable, and it has deep and liquid securities markets in which to hold dollars in reserve for use in cross border payments.

So, what are the chances that current cryptocurrency developments might precipitate a shift from the dollar to some other currency and means of payment. Several factors of U.S. policy have heightened interest by many countries in finding an alternative.  Specifically, from my recent article in the Central Banking Journal on the IMF’s $650 billion SDR allocation:

Cumbersome payment technology. Existing arrangements for cross-border payments via Swift are technically crude and outmoded.

The weaponization of the dollar. The US has abused the importance of its currency for cross-border payments to force compliance with its policy preferences that are not always shared by other countries, by threatening to block the use of the dollar.

The growing risk of the dollar’s value. The growing expectation of dollar inflation and the skyrocketing increase in the US fiscal deficit are increasing the risk of holding and dealing in dollars.”  “The IMF’s 650bn SDR allocation and a future digital SDR”

Most central banks are upgrading their payment systems. But the Peoples Bank of the Republic of China (PBRC) is one of the most advanced in developing a central bank digital currency (CBDC), the e-CNY. However, it has little potential for displacing the dollar for several reasons. The Federal Reserve is also modernizing its payment technology, including exploring the design of its own CBDC, and can match China’s payment technology in the near future if necessary. More importantly, China’s capital controls, less developed Yuan financial markets, and less reliable rule of law make the Yuan an unattractive alternative to the dollar. These latter impediments do not apply to the Euro, however. “What will be impact of China’s state sponsored digital currency?”

Rather than looking for another national currency to replace the dollar, there are several advantages to using an international one. These include greater ease in making cross border payments and the reduced risk of political manipulation, or a national currency’s domestic mismanagement.  Bitcoin, for example, can make payments anywhere in the world without being controlled by any one of them. The serious drawbacks of Bitcoin’s blockchain payment technology might be overcome with one or another overlaid technology. But to become a serious currency, bitcoin must be dramatically more widely accepted in payment than it is now. Widespread acceptance in payments could generate the demand to hold them for payments, which would tend to stabilize its very erratic value. This seems very unlikely. A digital gold-based currency, such as the earlier E-gold, would enjoy the advantage of an anchor that is well known and that has enjoyed a long history. However, gold’s value has been very unstable in recent years. Aluminum has enjoyed a very stable price and elastic supply and will be the anchor for Luminium Coin to be launched in the coming weeks: https://luminiumcoin.com/

But the world has already established the internationally issued and regulated currency meant to supplement if not replace the dollar, the Special Drawing Rights of the International Monetary Fund. The IMF has just approved a very large increase in its supply.  “The IMF’s 650bn SDR allocation and a future digital SDR”  The SDR’s value is determined by the market value of (currently) five major currencies in its valuation basket. While all five of these currencies have a relatively stable value, the value of the basket (portfolio) of these five is more stable still. The rules for determining the SDR’s value and supply, as well as its uses, are well established and transparent and governed by the IMF’s 190 member countries. In short, the SDR is truly international. However, it can only be used by IMF member countries and ten international financial institutions such as the World Bank and the Bank for International Settlements.

While the SDR has played a limited useful role in augmenting central bank foreign exchange reserves, it has failed to achieve a significant role as an international currency because of the failure of the private sector to invoice internationally traded goods and financial instruments (such as bonds) in SDRs and the absence of a private digital SDR for payments. If the IMF is serious about making the SDR an important international currency it should turn its attention to encouraging these private sector uses of the unit. “Free Banking in the Digital Age”

In the long run the IMF should issue its official SDR according to currency board rules and anchor its value to the market value of a small basket of commodities rather than key currencies: “A Real SDR Currency Board”


[1] Warren Coats retired from the International Monetary Fund in 2003 where he led technical assistance missions to the central banks of more than twenty countries (including Afghanistan, Bosnia, Egypt, Iraq, Kazakhstan, Kenya, Kyrgyzstan, Serbia, South Sudan, Turkey, and Zimbabwe). He was a member of the Board of the Cayman Islands Monetary Authority from 2003-10. He is a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  He has a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago.

Eviction Moratorium

Many people who lost their jobs because of Covid are not able to pay their rent until they return to work. What should we do about it?  Most landlords will work out an arrangement for deferred rent with tenants that are otherwise trustworthy. Most overdue debts are handled this way. But a case can be made, and has been made, for temporary government assist. Where you think the money should come from to bridge the income gap tells a lot about your general attitudes toward our market economy. When renters lose their incomes and stop paying their rent, they are passing on part of that loss to their landlords.  

But landlords are people with financial needs as well.  As noted by George Will: “As of June, landlords were owed $27.5 billion in unpaid rents. Almost half of landlords, who include many minorities, own only one or two rental units. They continue paying mortgages, property taxes, insurance and utilities while the CDC requires them to house nonpaying people or risk jail. Landlords can plausibly argue that the moratorium is a “taking.”  https://www.washingtonpost.com/opinions/2021/08/04/eviction-moratorium-exacerbated-americas-institutional-disarray/

The income supplement to out of work renters can come from the general taxpayers (us) or from landlords.  Investing in real estate is one of the primary ways in which lower middle-income families build wealth and move up the ladder. They should not be the ones to bear the cost of this assistance.  The CARES Act and subsequent programs was meant to share this burden more fairly, but its disbursements seem to have been slow.  The eviction moratorium, in addition to being illegal, is immoral.