Pearlstein: Steering U.S.-China economic relations toward a new normal

Jun 30, 2010

Washington Post columnist Steven Pearlstein hosted a discussion on Wednesday, June 30 at 12:00 ET on U.S.-China economic relations.

Dear Mr. Pearlstein: If the United States adopts the policies you've proposed, what do you anticipate would be the Chinese reaction?

They'd make a huge stink. They'd cancel some contracts. They'd slap on some tariffs of their own. They'd launch an appeal with the World Trade Organization. It would not be costless to us -- getting into fights never is. But after a year, once they saw we were serious, they would find a way to begin accomodating us in significant ways, and if we respond with a positive tit for tat, things could finally improve. They've been testing us for years and what they discovered was that we were easy to push around. So guess what -- they pushed us around.

What should be the thing the US should be most concerned with as China's economy continues to expand and the standard of living in China rises?

We should welcome and celebrate their rising standard of living, and the rising productivity of their workers, and the relative size of their economy. Global economics is not a zero sum game. Let me repeat that: global economics is not a zero sum game. What we should be concerned with, however is if that growth is the result of a fundamentally imbalanced and unfair trading relationship that limits us from selling into this booming market, so that some of those dollars they earn selling us electronics and sneakers and everything at Wal-Mart can be recycled back not in Treasury bills but in purchases of American goods and services. THAT would be balanced trade.

Is this column a marked departure from your previous wisdom on trade and China? It seems so to me. But some of us did foresee this back in 1996 or whenever that was, some of us saw exactly the traits in China that you decry today and were certain that China would not change their ways. Why would they, after all, when they could get rich doing things in their standard authoritarian way? Given that the optimism that China would join the free market world was unwarranted and China maintains policies destructive of our own interests, is it time to place less faith in the WTO and its provisions, which seem so clearly inadequate to address recalcitrant nationalists/imperialists such as China? If WTO cannot within its framework adequately solve this issue, are we then still much as we were before, a community of individual nations with their own self-interest? And should not that self-interest take precedence over "international norms" when nations act in ways harmful to other nations?

You make good points except one: I've actually been critical of the China WTO accession deal from the beginning, and in favor of managed trade with managed economies. So there has been no siginficant change in my position.

In terms of recent years, there is general consensus that the dollar peg artificially depressed the Chinese currency, which has boosted their exports to the US. We have not had the opportunity to deflate our currency as a means to balance trade. But considering their national debts, idiosyncratic state/private enterprises, and a worrysome real estate bubble, what if it turns out soon that the renminbi would soon float downward instead of up?

If it does it does -- I have no doubt where the longterm trend would be. You have to remember, however, that because China has a closed capital account, and parties outside China can't hold yuan, and parties inside China can't trade them for foreign currency at will, this isn't exactly a free currency market as far as yuan-dollar is concerned. So that presents a problem. As long as those features exist in China -- and I'm not saying the Chinese are wrong to maintain them -- then they may have to continue managing the currency. And what the economics would dictate (their productivity growth rate is much higher than ours) is that their currency would move up relative to ours.

So if the US got what it wanted, a revalued yuan of up to 40 percent, what would that do to the massive amount of debt that China buys back? If the answer is that it would decrease the amount of borrowed money the US would have, do we really believe that the US could survive being put on a limit (there is no limit now, at least according to Krugman), or that they really want to?  I'm thinking this is more smoke than fire. Also, what are the ramifications if Europe and the US decide, in tandem, to inflate away their debts? At whose detriment would this be? Thanks for answering my questions.

Yes, the implication of a more balanced relationship is that they don't send us so much cheap credit with which to live beyond our means. Interest rates go up. The value of their Treasury holdings goes down. Interest rates that are artificially low because a trading partner wants to manipulate its currency are NOT a good thing in the long run, even for the debtor country. Why? Because they encourage us to take on more debt, to live beyond our means, and because they cause us to use this cheap borrowed money to bid up the price of real estate and financial assets to levels that are not supported by the underlying economic -- bubbles, in other words.

    As for Europe, although its complicated, let's say that because of the rigidity of the dollar-yuan exchange rate, the "burden" of adjustment has fallen indirectly on the euro, meaning it has pushed up the value of the euro as well, slowing those economies as well. Europe, like the rest of the world, would benefit if the yuan were allowed to float freely and China would open its capital accounts.

Your column in spot-on about the economic dimensions of this issue, but what about human rights? When trade normalization and WHO membership were being debated 20-something years ago, proponents argued that engagement would give us more leverage to campaign for human rights. Why don't we use it?

Not my issue. I generally don't think we should tie these two things together.

I confess, after reading your article, I am upset. I now realize I have a trade deficit with the Washington Post. And my supermarket. And the gas station. And my doctor. And on and on. I purchase their services but they don't return the favor! On the positive side, I have a trade surplus with my employer. On a more serious note, trade imbalance between China and the US is not real. The Chinese sell Americans goods; we pay with dollars; the Chinese then use many of these dollars to buy IOUs issued by Uncle Sam. Although the result is a measured U.S. current-account deficit with China, there's no more any economically meaningful "imbalance" in such a result than there would be if, say, Texans lent a lot more of their dollars to Uncle Sam. The real imbalance is the gargantuan deficit created by the government. That's what I would really worry about. Talk of imbalances in trade diverts attention from the real problem: Uncle Sam's gargantuan debt. That fast-accumulating debt is a huge problem. It is caused not by trade with China but rather by Washington's lack of fiscal discipline.

Very clever. But, alas, not very original. In general, bilateral trade imbalances are not the story -- what matters is a country's overall trade balance. And in our case, of course, it is whoppingly negative. China and the China bloc are a big part of that problem, along with Middle East oil suppliers who also peg their currency to the dollar. So in this case it is relevant to talk about the bilateral relationship because it is so big.

    Now you are right that a big part of our living beyond our means is the federal budget deficit. But it is not the entire story.  And one reason that we have a big federal deficit is because somebody (guess who) is willing to finance it at 3.25 percent interest rate. There is a way all of these macro pieces fit together, which you well understand, in a general equilibrium kind of way. The causalities work in both directions at the same time. So its not so cut and dry that the current account, or trade, deficit is caused by the budget deficit, nor is it clear that simply cutting the deficit by cutting government spending on education and health care and public safety and public infrastructure(none which can't be imported) will lower the trade deficit or, in fact, make the private sector more competitive in world markets. 

Do we have the political courage to admit that our blind faith in the markets has yet again proved illusory? Until we do so, I can't see any sort of progress. Yes, the Walmarts of our economy have strong lobbying powers, but they work against our cultural background of "trust the markets" and "the markets will solve all our problems." The right-wing marketing organizations like Cato, Heritage, AEI, Competitive Enterprise Institute, Mercatus Center and the rest are so successful that many Americans actually believe that gov't regulation caused the financial crisis. Books like Judge Posner's "A Failure of Capitalism" don't make a dent in public perception. Look at the success of the tea baggers and their anti-gov't rhetoric. I see no way Washington will be able to take the steps you correctly advocate.

You know, this notion that the right wing think tanks have been so successful and taken over the minds of policy makers and voters is so ludicrous that I don't know where to begin refuting it. We have a vibrant civil society in this country and people have access to all sorts of information and opinions -- and as we know very well, those choices and how people get information is changing very rapidly now because of technology and generational changes in preferences. But liberals have to get something clear:  the reason they lost a lot of arguments in the last 40 years is because their arguments were tired, or contradicted by experience or ran against the grain of fundamental American values. It's not because they weren't able to get their ideas across or that the corporate side used its money to brainwash America. Sorry, I don't buy it. Yes, I'm sure they meant it to be a conspiracy, but that doesn't mean that is the only reason it worked. It worked because government got bloated and ineffective and certain interest groups got piggy and uncompromising and certain swing voters came to a different conclusion about what was in their best interests. So let's have a bit more faith in democracy and each other, shall we? After all, we just elected a liberal black guy whose name is Barack to be president of the United States, and we have old-fashioned liberals in charge of the U.S. House of Representatives, and a couple of pretty liberal-minded women are about to take two of the nine seats on the Supreme Court, and we finally have established health care as a universal right (as well as a responsibility) in the United States.  So let's tone down the right wing conspiracy stuff, shall we?

Mr Pearlstein, I'm happy to see your advocacy of tariffs to address the issued of currency disparity. Thousands (if not millions) of jobs have been lost and perhaps tariffs will provide some modicum of relief. It seems to me, however, the problem goes much deeper. In countries such as China (but many others as well), competition for employment keeps wages extremely low (by conventional US standards) permitting those countries to manufacture and sell goods to us for far less than we can do so for ourselves. Even though our productivity measures indicate our productivity is among the highest of the developed countries, there is no way for us to be competitive with the likes of China. Are we not then faced with one of two alternatives, either let the standard of living for the majority of our populace continue to decline (and I believe perhaps on a steeper and steeper downward slope), or, on the other hand, become increasingly protectionist? I have to add that the economists standard answer, education, will at best make only a small difference. Just look at the numbers of college graduates either not employed or greatly under employed.

I share some of your skepticism that education is the only answer, but the data on this is pretty compelling and we have been falling behind. The percentage of the workforce that completes college has been flat for nearly twenty years now after generations of steady increase, and that's not a good thing. Some of that represents lack of demand, which won't be solved by more supply. And some of it is the result of lack of the right kind of graduates, which means graduates with skills in science, engineering, technology.  So I agree that just giving everyone a college education won't, by itself, solve the problem if we can't get access to foreign markets to sell them the goods and services that would support our high wages.  On the other hand, to continue to be a high wage country, we need to do the kind of work that justifies such wages and that usually means higher-skilled work.

Everyone gets so up in arms because the Chinese "manipulate" their currency to be artificially low. However almost no one gets up in arms about our own currency manipulation. The Federal Reserve, in the name of quantitative easing (money printing) has purchased a trillion dollars of treasury bonds and may potentially buy a few trillion more. I agree with those actions and, in fact, want more, but let's not throw stones when we clearly live in a glass house. The Chinese have amassed $900 billion is treasuries over a few decades. The Fed did more in less than a year. Why is China constantly demagogued and the Fed praised for the same actions?

Sorry, there is no parallelism here, not in the least little bit. The Chinese have a long-term strategy of pegging their currency to the dollar despite huge trade imbalances and big differences in productivity growth rates. That is distorting. The fact that the Fed might be printing money might well depress the value of the dollar against other currencies, except that at the moment it doesn't have that affect because of the general economic slowdown and deflation and deleveraging. In fact, the dollar is going up because of the flight to safety of US Treasury bonds and other financial assets.  This is complicated, I realize, but nobody suggests that what motivates the Fed is mercantilist currency manipulation, if for no other reason that the dollar is up, not down.

If tee-shirts from China become too expensive, how about getting them from Haiti? Isn't it in our interest to support economies physically closer to us than China's?

Yes, if the yuan rises against the dollar, production may well shift to other developing countries. And if markets are working correctly (and, by the way, they often do), then those countries will use their dollars to buy some of our stuff since many of them are not set up in a way to be ruthlessly mercantilist like China.  There are some industries, like T shirts, that will never come back here. That's okay -- not a lot of high wage jobs in T shirts anyway. Or shoes. Or ironing boards. Or even low-end computer chips. The point here is to let markets work the way they can, which is to allocate production to those places that enjoy comparative advantage -- in other words, let every country do what it does best.

What do you think of the idea of a grand bargain with China where we agree to formally link the yuan to the dollar in exchange for China making its currency convertible and opening its capital markets? This would allow older Americans who need to save to lend to young Chinese who would like to borrow but don't have access to capital markets. This would also be a huge incentive for the Chinese to lower their saving rates because they would have much less uncertainty over their currency. David Goldman and Reuven Brenner laid out these ideas a couple months ago.

My brain isn't big enough, and my understanding of macroeconomics isn't complete enough, to be able to evaluate your idea. One problem with the analysis is that the Chinese don't really need our capital -- they have plenty of savings that they can lend to each other if they want. I would say that you are right to point out that opening the capital account is as important as unpegging the currency in allowing the markets to really find a suitable equilibrium.

I don't mean to say there's a vast conspiracy from the right, but rather a very successful marketing effort. Prof. Gratez of Yale examined just such a marketing effort to repeal the estate tax. See his book "Death By A Thousand Cuts." I still think we will have to undergo a cultural change before we can deal successfully with China.

The campaign against the estate tax is an example of a small group of very rich people using their money to buy influence among key lawmakers. But it may also be true that the estate tax is simply too blatantly redistributive for Americans. Obviously most Americans don't pay the estate tax and they would benefit from collecting the revenue. They understand that, and their reluctance to sock it to the rich therefore is contrary to interest. But you can't just jump to the conclusion that the only reason people don't act in their economic self interest is because they have been brainwashed by an effective marketing campaign. Its quite possible -- indeed I would say probably--that there is some core belief or value there that drives their opinion.  That's why I've suggested scrapping the inheritance tax entirely, and require estates to pay the capital gains tax on all unrealized gains before the proceeds are distributed. The studies show you can raise pretty much as much money as the inheritance tax, and the politics of it are much, much better. The big liquor distributors and other funders of the anti-estate tax lobby hate my idea, by the way.

Steven Thanks for today's chat. I have a question on the ongoing debate over the extension of unemployment insurance - in your opinion, does the short-term benefit of putting money into the pockets of unemployed Americans outweigh the addition to the national debt on a long-term basis? I ask because it seems that the GOP has put an interesting line in the sand by arguing the addition of any debt is a non-starter. In other words, if they don't want to add debt to extend UI, what items ARE they willing to add debt for?

This is just the right thing to do -- the burden of rebalancing our economy is falling disproportionately on the 15 percent of Americans who are unemployed and under-employed, so it is the duty of the rest of us to help them out. Now you can pay for that with borrowed money, in which case there is fiscal stimulus, or you can pay for it by taxing the rest of us a big higher, which involves no fiscal stimulus. But one way or the other, we need to do that.

     I would say, however, that its not unreasonable to begin to reduce the monthly checks after a year. That may sound cruel. But there is a general tendency for people who are unemployed to refuse to consider taking jobs that pay less than they are used to,  and it may be that they need a gentle nudge to do so.  That's not to say that there aren't plenty of people who do take lower paying jobs. But there are also lots of people who are very reluctant to.

Steven: Are the Keynesians right? Will the European and U.S. austerity measures to cut deficits only result in strangling the recovery and sending us into a rerun of 2008? I read a piece in the New York Times about how austerity measures in Ireland, which have been implemented over the past two years, have done nothing to arrest the economic downturn. Granted, Ireland's economy isn't that of the U.S. or Germany, but is it a portent? Thanks.

There aren't any hard and fast rules on this. Much depends on Ireland's ability to borrow and at what cost, since "stimulus" is by definition done with borrowed money. Greece is in no position to stimulate, and I suspect Ireland isn't a whole lot better off. The problem with the way you set the question up is that it assumes there is a solution that prevents the country from suffering a painful period of decline in its standard of living. And the truth may be that there is no way -- and that the choices are between different versions of pain that have different distributional consequences and play out over a different time horizon.

That's it for today, folks. "See" you next week.

In This Chat
Steven Pearlstein
Steven Pearlstein is a business columnist for The Washington Post. He won a Pulitzer Prize in 2008 and is co-moderator of the On Leadership discussion site.
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