stats and forecast; interest rates and wage inflation

The importance of CBO’s new interest rate projections by Nick Bunker

In its 2013 long-term budget projections, CBO forecasted that the long-run average annual interest rate would be 3 percent. This year’s forecast has lowered that projection to 2.5 percent. This new projection is not only lower than previous forecasts but also lower than the average range of 3.1 over the period of 1990 to 2007. Thankfully, CBO goes through the different factors that influenced their lower projected interest rates. And these factors are interesting in their own right.

NYT Says 12.4 Percent Growth in China Is "Sputtering" by Dean Baker

"Some economists inside and outside the government say China has a choice: slow down lending and accept steady declines in economic growth each year, or continue heavy lending and risk a sharp drop in economic growth someday when the financial system begins to teeter. But nobody knows when that might happen." 

If that sounds very scary then it's worth reading through to the last paragraph: 

"Retail sales are growing strongly, up 12.4 percent in June from a year earlier, according to the government figures released Wednesday, nearly matching a pace of 12.5 percent in May." 

As the article explains, real wages for factory workers are rising at more than an 8.0 percent annual rate. If that pace of real wage growth continues, the country should not have to worry about a lack of demand in the years ahead.

It's always everywhere a dilemma. The possibility of other solutions is foreclosed.

Trade

Coppola agrees on the problem with Baker.

"The US trade deficit is pretty intractable largely because the two major surplus countries - China and Germany - do not have currencies that float with respect to the USD. Germany uses the Euro, which does float, but the Euro is persistently undervalued relative to fundamentals in Germany because of the presence of weaker countries in the union. If the currency cannot adjust, then neither the trade deficit nor the capital surplus can correct unless unit labour costs fall, which means very significant falls in wages and employment costs. This is what is happening in the Eurozone periphery: it has not happened in the US thus far because of the US's willingness to borrow and the world's willingness to lend to it. 

However, there is a cost. As Philip Booth points out, China will not be able to suppress inflation forever if its currency is under-valued. Germany, too, faces high inflation relative to others in the Eurozone if its economy is  out of equilibrium: the ECB's tight money policies keep German inflation below 2%, but this forces weaker countries into outright deflation. "

Makes sense as ruling class policy: keep the labor market loose and increase the capital share and incentivize Germany to ally with us against Russia and to pay off China.

And yet she sees Baker's solution as unlikely: "This is why devaluing the dollar would not necessarily reduce the US's trade deficit, as Dean Baker thinks: China would simply adjust the yuan to maintain its desired exchange value, and Germany would tighten fiscal policy to stop a fiscal deficit developing as a consequence of a falling trade surplus in a low-demand economy. The only way to resolve the currency problem is for China to allow the yuan to float and Germany to abandon austerity. Hell might freeze over first. "

Inflation should be building in Germany and China.

China and job creation

China's Central Bank Announces Job Creation Program for the United States by Dean Baker

That may be a bit of an overstatement, but the comments from Yi Gang, a deputy governor at China's central bank, deserved much more attention than they received. According to Bloomberg, YI announced that the bank would no longer accumulate reserves since it does not believe it to be in China's interest. The implication is that China's currency will rise in value against the dollar and other major currencies.

This could have very important implications for the United States since it would likely mean a lower trade deficit. Since other developing countries have allowed their currencies to follow China's, a higher valued yuan is likely to lead to a fall in the dollar against many developing country currencies. A reduction in the trade deficit would mean more growth and jobs. If the deficit would fall by 1 percentage point of GDP (@$165 billion) this would translate into roughly 1.4 million jobs directly and another 700,000 through respending effects for a total gain of 2.1 million jobs.

Since there is no politically plausible proposal that could have anywhere near as much impact on employment, this announcement from China's central bank is likely the best job creation program that the United States is going to see. It deserves more attention than it has received.

Standard of Living Is in the Shadows as an Election Issue by Leonhardt

Better Ways to Deal With China by Eduardo Porter

China and Protectionism: It Ain't Quite as Simple as They Tell Us by Dean Baker

Housing Was a Huge Headwind; Now It’s a Small Tailwind by Jared Bernstein

Bernanke not coming back

The End of China Bashing: Toward a Serious Discussion of the Trade Deficit by Dean Baker

Paul Krugman and Ezra Klein both say, following Joe Gagnon, that the time for criticizing China for "currency manipulation" has passed. This is partly true in the sense that China's currency has risen substantially in real terms against the dollar over the last few years. However this does not mean either that the relative value of the dollar and the yuan is now at a sustainable level or that China is not continuing as a matter of policy to prop up the dollar against its currency. 

Thoma and DeLong seem to agree with Krugman and Klein. Is this a reaction to Romney's China bashing during the debates as the Presidential race tightens?

You can't blame them in that this election is very important.

Who will be the next Fed Chair (Applebaum piece) or Treasury Secretary (Sorkin piece) According to Sorkin: "If Mitt Romney wins the presidency, he has already pledged he will replace Mr. Bernanke, whose term as chairman ends in January 2014, in just over 15 months. However, Mr. Bernanke has told close friends that even if Mr. Obama wins, he probably will not stand for re-election."

Or Supreme Court judge?

minutes later, however, it became clear that while the court had rejected an expansive view of the Constitution’s commerce clause (which the administration had argued gave Congress the power to make people buy health insurance), it had in fact upheld the health care law on grounds that the individual mandate fell under Congress’s broad power to levy taxes.

Oceania, Eurasia and Eastasia

Euro Counterfactuals (Wonkish) by Krugman

Via The Irish Economy, a new paper (pdf) from the IMF looks at how, exactly, massive current imbalances emerged within Europe, with Germany running huge surpluses and the GIPSIs running huge deficits. 

The paper shows that there were indeed huge capital flows from the European core to the periphery, in Spain largely taking the form of lending to banks, presumably by other banks:

[chart]

The surprising result in the paper is that much of the rise in imbalances within the euro area involved trade with non-euro nations. Germany sharply increased exports to Asia and Eastern Europe, which had strong demand for German durable manufactures.  Meanwhile, southern Europe saw a sharp increase in imports from low-wage countries.

Emphasis added. So basically the U.S. dollar is undervalued relative to China which has a trade surplus. Germany in turn has a trade surplus with Asia (right?). Southern Europe increased its imports from low-wage countries (China?).

Is the Euro undervalued versus the dollar? Why is Germany and not the U.S. supplying Asia with durable manufactures?

Drama

Also Simon Johnson and Tim Duy have been playing up the budget troubles of Japan. Krugman and Yglesias  have been highlighting the problems with Europe and the Greeks and Spainairds revolt against austerity.

Fear-of-China Syndrome by Krugman

How is it possible that we’re borrowing much less from foreigners when the government deficit has gone up so much? The answer is that the private sector is deleveraging, having moved into massive surplus as consumers try to pay down debt and corporations hold back on investment in the face of weak consumer demand. All those government deficits have only partly offset this move, so that overall national borrowing from overseas is down, not up. 

But what would happen if the private sector stopped deleveraging? The answer is, we’d have a strong economic recovery, which would among other things greatly reduce the budget deficit. A side implication of this point, of course, is that for the time being that deficit is a good thing, helping to support the economy while the private sector unwinds its excessive leverage. 

So who’s actually financing the US budget deficit? The US private sector. We don’t need Chinese bond purchases, and if anything we’re the ones with the power, since we don’t need their money and they have a lot to lose. In fact, we don’t want them to buy our bonds; better to have a weaker dollar (a point that the Japanese actually get.)

The last hyperlink sends one to:

Chinese Bond Purchases by Krugman

September 10, 2010

Regular readers may remember that I’ve spent more than a year trying to knock down the idea that the United States dare not get tough with China, because we need them to keep buying our bonds; as I wrote way back in May 2009, given the fact that we’re in a liquidity trap, a decision by China to buy fewer of our bonds would actually be doing us a favor — it would weaken the dollar, and help our exports. 

I’ve failed, despite repeated attempts, to get through with this point here — but the Japanese get it. They’re complaining to China about its purchases of yen-denominated bonds, which they argue — correctly — hurts Japan by strengthening the yen. 

Quick update: I should also link to this post, and quote Dean Baker again: China has an unloaded water pistol pointed at our head.

Price Data Suggest Specter of Deflation in China

Sino-Americana by Perry Anderson

Should The U.S. Take A Harder Stance On China's Currency? (Part II) by Joe Gagnon

Federal Reserve Chairman Ben Bernanke recently said that Chinese currency manipulation "is blocking what might be a more normal recovery process." In fact, the problem goes beyond China to include many other emerging economies and even a few advanced economies. All together, governments in these economies are spending about $1.5 trillion per year on currency manipulation.

Currency manipulation occurs when governments purchase foreign currency in order to hold up its value relative to their own currency. Manipulation makes a country's exports cheaper and imports more expensive, artificially raising the trade balance. The evidence suggests that currency manipulators jointly have increased their trade balances by about $1 trillion relative to where they would have been in the absence of manipulation. Europe and the United States have suffered the corresponding decline in trade balances.

(via Thoma)

American Republicans (and Fed board members like Lacker), the Chinese Communist Party, and German conservatives are the Axis of fools, all denying the American economy full employment and adequate demand to close the output gap. Germany however is mostly damaging Europe, though. The Chinese are screwing their consumers.

DeLong gives an early sketch of the Brookings paper he's working on with Larry Summers, titled "Fiscal Policy in a Depressed Economy".

Persistent high transitory cyclical unemployment is transforming itself into permanent structural unemployment as the labor market recovery continues to delay its appearance.

Government polices by the American, Chinese and German governments are actively delaying its appearance. Its not choosing to be fashionably late itself.

Revised GDP figures offer hope for final three months of 2011 by Neil Irwin

The revision, however, stemmed from businesses running down their inventories by $8.5 billion, which means that the nation’s factories may need to ramp up output to meet demand for their products. Revised figures for final sales, which reflect growth excluding inventory fluctuations, remained the same as originally estimated.

Fed plans second stress test for big banks by Neil Irwin


Taking No New Action, Fed Hopes for More Policy Mileage From Clearer Communication by Binyamin Appelbaum

The minutes from the Nov. 1-2 meeting were released.

While the economy remains weak and more than 25 million Americans cannot find full-time work, the Fed has taken only small steps to stimulate the economy since June. And the minutes — actually an extended description of its Nov. 1-2 meeting rather than a transcript — make clear that a broad majority of the 10 voting members of the committee does not support more drastic action at the present time.

Emphasis added.

“Participants generally agreed that, even with the positive news received over the intermeeting period, the most probable outcome was a moderate pace of economic growth over the medium run with only a gradual decline in the unemployment rate,” the minutes say.

I'd replace "gradual decline" with "glacially slow decline."

The document also notes that events in Europe could undermine the health of the domestic economy.

Only one of the committee’s 10 voting members dissented from this logic. Charles L. Evans, president of the Federal Reserve Bank of Chicago, reiterated his public position that the high rate of unemployment required more immediate and forceful action by the central bank. He said the Fed should commit to maintaining low interest rates until unemployment drops below 7 percent.
...

There is less agreement about proposals to formalize rules for the management of monetary policy. Some Fed members, including its chairman, Ben S. Bernanke, have long favored the idea of formalizing a long-term inflation target of 2 percent. Others, including Mr. Evans, are pushing for temporary targets for unemployment and inflation to clarify the Fed’s near-term objectives.

The committee dismissed the idea of adopting a new benchmark, like a commitment to pursue stimulus until the nation’s economic output recovers from the recession. Such an approach is favored by a vocal chorus of outside economists, but has little support inside the institution, because of concern about the consequences of accepting more rapid inflation.

The verdict was reported in the Fed’s typically understated style: “Participants agreed that it would not be advisable to make such a change under the present circumstances.”

West's Economic Slump Catching Up With Asia

China depends on the U.S. consumer market -Europe has a trade surplus with the U.S. as well. Another way to put is that China depends upon the aggregate demand supplied by the United States.

"The sense of entitlement carried by savers in our society would put any welfare queen to shame."
(or a Balance of Payments Problem / Global Savings Glut)


Krugman blogs about a Randy Waldman post and they are both getting at what I've been trying to describe by way of a Grand Unified Theory (GUT) of "late capitalism." Krugman writes:

He then argues that the”natural” real rate of interest — the interest rate that would match savings and investment at full employment — has been negative for quite a while, and that we’re only seeing this now because various bubbles and deregulatory schemes have masked the reality.

What he doesn’t say, but immediately strikes anyone who knows some of the history here, is that this amounts to a return of the “secular stagnation” hypothesis that was popular in the early postwar years; the hypothesis was that there was a fundamental excess of desired savings over desired investment, and that this would require government intervention on a sustained basis to achieve full employment.

That hypothesis proved wrong at the time, but that doesn’t mean it couldn’t be true now. And I’m somewhat sympathetic to the view that it might indeed be true.

Waldman goes on to suggest that high income inequality is what’s driving this — he has a little parable involving bakers and bread that ultimately comes down to the rich being satiated while the poor cannot afford to buy.

OK, I like little parables. But I have a problem with this one, for one simple reason: any such story, basically an underconsumptionist story, would seem to depend on the notion that rising inequality has led to rising savings. And you just don’t see that. Here’s private saving as a share of GDP:

Obviously it jumped up after the housing bust, but until then it was actually declining, and even now it’s below historic highs. I just don’t see how to make the underconsumption story work.

But then the question is, why do we find it so hard to achieve full employment even with saving somewhat low by historical standards. And the answer seems clear: it’s the trade deficit. America in the 70s and 80s could have high savings, not hugely strong investment, but still have full employment because trade deficits weren’t as large compared with the economy as they are now.

And this in turn means that the savings glut possibly making the natural real rate negative is actually originating abroad, not at home.

Do you sort of see why I’m a hawk on China policy?

A Note on the U.S. Comparative Advantage in the Sale of "Political Risk Insurance" by DeLong

China Reigns in Liberalization of Culture 

Whether spooked by popular uprisings worldwide, a coming leadership transition at home or their own citizens’ increasingly provocative tastes, Communist leaders are proposing new limits on media and Internet freedoms that include some of the most restrictive measures in years.

The most striking instance occurred Tuesday, when the State Administration of Radio, Film and Television ordered 34 major satellite television stations to limit themselves to no more than two 90-minute entertainment shows each per week, and collectively 10 nationwide. They are also being ordered to broadcast two hours of state-approved news every evening and to disregard audience ratings in their programming decisions. The ministry said the measures, to go into effect on Jan. 1, were aimed at rooting out “excessive entertainment and vulgar tendencies.”

Maybe they're trying to head off the coming "reality show" onslaught and prevent a Chinese Jersey Shore craze.

The End of Cheap Chinese Goods by Floyd Norris

The End of Cheap Chinese Goods by Floyd Norris

China, Driver of World Economy, May Be Slowing

America's Chinese disease by Krugman

I really like Fareed Zakaria's optimism. Take this piece on how the lessons of Iraq paid off in Libya. He gives the reader a sense that the glass is half-full.

I hope he is right about China and Europe in his newest piece, titled "How China can Help Europe Get out of Debt."

Facing a similar crisis in 2008, then-Treasury Secretary Henry Paulson talked about the need for a bazooka, a weapon large enough to scare markets into submission. Europe doesn’t have one. Even Germany — which has a debt-to-GDP ratio of 83 percent — can’t credibly bail out Italy and Spain. Together they need to roll over 600 billion euros of debt before the end of next year. Who has that kind of money*

Today, $10 trillion of foreign exchange reserves are sitting around across the globe. That is the only pile of money large enough from which a bazooka could be fashioned. The International Monetary Fund could go to the leading holders of such reserves — China, Japan, Brazil, Saudi Arabia — and ask for a $750 billion line of credit. The IMF would then extend that credit to Italy and Spain but insist on closely monitoring economic reforms, granting funds only as restructuring occurs. That credit line would more than cover the borrowing costs of both countries for two years. The IMF terms would ensure that Italy and Spain remained under pressure to reform and set up conditions for growth.

What’s in it for the Chinese, who would have to devote at least half the funds and who have already politely demurred when approached by the Italians? China invests its foreign exchange reserves looking for liquidity, security and decent returns. It isn’t trying to save the world. Premier Wen Jiabao made slightly encouraging noises this week, hinting that he would increase bond purchases and asking in return for greater market access to Europe. That’s classic Chinese diplomacy: cautious, incremental and narrowly focused on its interests.

The time has come for China to adopt a broader concept of its interests and become a “responsible stakeholder” in the global system. The European crisis will quickly morph into a global one, possibly a second global recession. And a second recession would be worse because governments no longer have any monetary or fiscal tools. China would lose greatly in such a scenario because its consumers in Europe and America would stop spending.

Of course, China would have to get something in return for its generosity. This could be the spur to giving China a much larger say at the IMF. In fact, it might be necessary to make clear that Christine Lagarde would be the last non-Chinese head of the organization.

In a world awash in debt, power shifts to creditors. After World War I, European nations were battered by debts, and Germany was battered by reparation payments. The only country that could provide credit was the United States. For America, providing desperately needed cash to Europe was its entry into the councils of power, a process that ultimately brought a powerful new player inside the global tent. Today’s crisis is China’s opportunity to become a "responsible stakeholder."

Would (will?) China be an enlightened, responsible stakeholder? I'd think human rights, democracy, and civil rights will be low on their list of priorities as well as environmental and labor regulations, such as they are. Still the Chinese Communist Party enacted a sizable fiscal stimulus after the financial crisis of 2008. This demonstrated they have much more wisdom and macroeconomic know-how than the American Republican Party.

Update: A New York Times news analysis on the European Central Bank says:

The E.C.B. can stop this crisis in a minute if they want to,” said Guntram B. Wolff, deputy director of Bruegel, a research organization in Brussels. The bank, he said, could simply overwhelm bond markets by buying huge quantities of debt from Greece, which is effectively insolvent, as well as other countries that have come under attack, like Italy. End of crisis.

Some economists have argued that the bank could buy more than $1 trillion in sovereign debt if it needed to.*

But such an action would provoke howls from Germany and countries like Finland,** where the bank is seen as having gone rogue because of its relatively modest purchases of debt from a list of countries that also includes Spain, Portugal and Ireland. In those beleaguered countries, meanwhile, the bank is regarded as insufficiently supportive.

------------------------------
* Apparently the ECB has that kind of money.
** Finland?

Dean Baker's entire post on the "currency wars" is excellent, so I'll repost the entired thing.

The NYT had a piece on the recent decline in the value of the dollar and effort by other countries to offset its impact. The article noted in particular developing country efforts to reduce capital inflows that are raising the value of their currency.

It would have been worth noting that in standard economic theory, developing countries are supposed to be borrowers. The logic is that capital is relatively scarce in the developing countries, which means that it gets a higher return. Capital therefore should flow from relatively to slow growing rich countries to more rapidly growing developing countries.

This was the direction of flows until the East Asian financial crisis in 1997. The harsh conditions that the IMF imposed on the East Asian countries led developing countries throughout the world to focus on building up reserves so that they would not have to deal with the IMF. This reversal coincided with the "high dollar" policy touted by then Treasury Secretary Robert Rubin. It helped to lay the basis for the imbalances associated with the stock and housing bubbles.

To a large extent, the decline in the value of the dollar would effectively reverse the distortions to the world economy resulting from the IMF-Rubin policy of the late 90s. It is also worth noting the recent decline in the dollar is largely just reversing its run-up as a result of the financial crisis in 2008. Money flowed into the U.S. as a safe haven, pushing the dollar well above its pre-crisis levels. It is now falling back toward the level it was at before the crisis.

What would you call the reasonable reaction of China and others to the harsh conditions imposed by the IMF in the wake of the 1997 crisis? It would be the opposite of morale hazard. Once can be too indulgent and too harsh or strict.

This New York Times piece argues that England's current austerity measures are partly due to memories of the IMF bailing them out in the 1970s.

Competitive Nonappreciation*

Geithner Call for Global Cooperation on Currency by Sewell Chan

As finance officials from around the world gather here this weekend for the annual meetings of the I.M.F. and the World Bank, American officials are concerned that the degree of cooperation in the recent financial crisis is eroding. In particular, the Obama administration is looking to the I.M.F. to help bring about what months of negotiations have failed to achieve: greater exchange-rate flexibility by China.

Instead of the "competitive devaluation" of the 1930s, which exacerbated the Depression, the world faces a threat of "competitive nonappreciation," Mr. Geithner said, citing a term coined by Edwin M. Truman, a former official at the Treasury and the Federal Reserve.

That was a reference not only to China but also Japan and Brazil, which have taken steps recently to prevent their currencies from rising in value.

I'm pretty sure the competitive devaluations of the 1930s helped ameliorate the Depression.

Financial Shock and Awe by Barry Eichengreen

(via Mark Thoma and Brad DeLong)

First, it is a misunderstanding to believe that the policies pursued by the BOJ, the Fed, and the Bank of England come at one another's expense. What we are seeing, in all three cases, is not exchange rate manipulation but what is known as quantitative easing, actual or incipient. The evolution of BOJ policy makes this clear. What two weeks ago started as a modest foreign exchange market intervention has now turned into an explicit program of purchasing 5 trillion yen of Japanese treasury bonds and bills, commercial paper, exchange traded funds, and real estate securities. The Bank of England has made no bones about its continued commitment to quantitative easing. The Fed is moving slowly, slowly in the same direction.

This, of course, is precisely what is needed in a world where deflation has again become a problem and fiscal policy, for better or worse, is off the table. It is not a "beggar thy neighbor race to the bottom." If anything it is a race to the top.

Eichengreen sees the Fed employing "shock and awe" methods in the data, but wishes they would be more explicit. (Krugman notes that the markets appear to believe in QE2) He hopes China sees reason as well, but I doubt they will.

 The Fed needs to stop dithering and make precise the extent of the quantitative easing it intends. Uncertainty about whether it will move in increments or adopt a policy of shock and awe is contributing to the erratic behavior of the dollar exchange rate.

Not only would more clarity help that exchange rate settle down, but in addition it would make it easier for other central banks to calibrate their own policies. In particular, a Fed policy of shock and awe which, recent data increasingly suggest, is what is called for will make it easier for China to calibrate an appropriate response. With China experiencing inflation rather than deflation, looser credit conditions are the opposite of what it needs. Its challenge is to continue to modestly cool off its economy. Delinking from Fed policy by delinking from the dollar is the obvious way of achieving this result.

 Eichengreen believes the European Central Bank is still fighting the last war, but will eventually come around.

The ECB, for its part, needs to start planning for the next battle instead of incessantly fighting the last. If it ends up with an exchange rate of $1.50 to the euro, the European economy tanks, and in the absence of growth the Greek, Irish, and other fiscal austerity programs will collapse. It will only have itself to blame.

Here's a prediction: Contrary to what the markets currently assume, the ECB will eventually join the quantitative easing bandwagon. The only question is whether by the time it does it will already be too late.

 --------------------------------------------
* what often happens in marriage. Spouses compete on who can not appreciate the other the most. (sad trombone sound - wah wah)

A reciprocity requirement: The easy and legal way to stop currency manipulation by Daniel Gros

Overall it seems that the rest of the world with free capital markets can do little to stop the Central Bank of the People’s Republic of China to continue "steering" its exchange rate by accumulating more and more international reserves - it does not matter whether these are US or Japanese. The US, Japan, or the ECB cannot do the same because China has capital controls and there are simply no significant renminbi assets that foreigners are allowed to invest in.
...
But there is another way. The US (and Japan) could easily prevent the Chinese Central Bank from continuing its intervention policy without breaking any international commitment. The US and Japan only need to invoke the principle of reciprocity and declare that they will limit sales of their public debt henceforth to only include official institutions from countries in which they themselves are allowed to buy and hold public debt. Instead of the "moral suasion", tried in vain by the Japanese, the Chinese authorities would just be told that they can buy more US T-bills Japanese bonds only if they allow foreigners to buy domestic Chinese debt.

Imposing such a "reciprocity" requirement on capital flows would be perfectly legal - although the US (and Japan and all EU member countries) have notified the IMF that they have liberalised capital movements under Article VIII of the IMF. Yet, in contrast to the area of trade, there are no legal constraints on the impositions of capital controls.

This "reciprocity" measure would of course be equivalent to a very specific form of controls on capital inflows. Capital controls are always somewhat leaky, but not in this case because the Chinese Central Bank would find it difficult to hide its huge investments going through western financial institutions. No reputable financial institution would dare to become a hidden intermediary for the Chinese given that no institution bidding for hundreds of billions of T-Bill would take the risk of secretly fronting the Chinese government or central bank as it would have to certify that the beneficial owner is not from a country in which foreigners cannot buy and hold public debt instruments.

As a practical matter the introduction of the reciprocity requirement should provide a grand fathering of the existing stocks of Chinese official assets abroad (already above $2,500 billion). However, the Central Bank of China would still not be able to continue its interventionist policy - and that is what counts for foreign exchange markets.

(via Mark Thoma)

China does have capital controls unlike other countries. If the US blocks China and they in turn buy from Japan who has to in turn buy from the US, then we can block Japan also.

It's important to point out that the world economy is working under exceptional circumstances as Krugman continuously points out. There's too much savings and too much unemployment and not enough demand. China and Germany are exacerbating the problems with beggar-thy-neighbor policies.

Stephen Roach argues that China should adopt policies to boost its consumer spending. 

China’s gross domestic saving rate is 54 percent of national income, the highest in the world for a major economy. But its consumption share of G.D.P. is only about 36 percent, the lowest for a major economy and about half the 70 percent ratio in the United States.

I would therefore urge China to opt for aggressive and immediate pro-consumption structural policies. Stimulating domestic consumer demand would be a far more direct - and potentially a far less destabilizing - way of reducing saving and trade imbalances than a currency realignment would be.

These policies should include an expanded social safety net, with a public retirement program, private pensions and medical and unemployment insurance. China should also provide major support for rural incomes through tax policy and land ownership reform, as well as enhanced initiatives to encourage rural-urban migration. And it should encourage the creation of service-oriented jobs in industries like retail and wholesale trade, domestic transportation, leisure and hospitality.

China's Currency Manipulation

David Leonhardt

Dean Baker

Paul Krugman