more on the Swiss Peg

Switzerland drops its currency peg by James Hamilton

Reply to Tyler Cowen by Scott Sumner

Chaos in the Currency Markets by John Cassidy

Switzerland ends its peg fest

Sokrates and Friends in Davos, or, the SNB and the Berne Whale: The Honest Broker for the Week of January 18, 2014 by DeLong

If you do it they will believe by Scott Sumner

trade deficit

Dean Baker: 

The $500 billion trade deficit, coupled with a standard multiplier of 1.5, translates into $750 billion of lost annual output (roughly 4.5 percent of GDP). This in turn would come to about 6 million jobs. That is close to enough to get us back to full employment. That would give workers enough bargaining power to secure real wages. So yes, trade is a big deal.

Investment in Equipment (and Software): What Are Neil Irwin and Tyler Cowen Thinking? Tuesday Focus: July 22, 2014 by DeLong

Plaza Accord

Plaza Accord

Background

Between 1980 and 1985 the dollar had appreciated by about 50% against the Japanese yen, Deutsche Mark, French Franc and British pound, the currencies of the next four biggest economies at the time.[citation needed] This caused considerable difficulties for American industry but at first their lobbying was largely ignored by government. The financial sector was able to profit from the rising dollar, and a depreciation would have run counter to Ronald Reagan's administration's plans for bringing down inflation. A broad alliance of manufacturers, service providers, and farmers responded by running an increasingly high profile campaign asking for protection against foreign competition.

Major players included grain exporters, car producers, engineering companies like Caterpillar Inc., as well as high-tech companies including IBM and Motorola. By 1985, their campaign had acquired sufficient traction for Congress to begin considering passing protectionist laws. The prospect of trade restrictions spurred the White House to begin the negotiations that led to the Plaza Accord.[1][2]

The justification for the dollar's devaluation was twofold: to reduce the U.S. current account deficit, which had reached 3.5% of the GDP, and to help the U.S. economy to emerge from a serious recession that began in the early 1980s. The U.S. Federal Reserve System under Paul Volcker had halted the stagflation crisis of the 1970s by raising interest rates, but this resulted in the dollar becoming overvalued to the extent that it made industry in the U.S. (particularly the automobile industry) less competitive in the global market.
Effects[edit]

Devaluing the dollar made U.S. exports cheaper to purchase for its trading partners, which in turn allegedly meant that other countries would buy more American-made goods andservices.

The exchange rate value of the dollar versus the yen declined by 51% from 1985 to 1987. Most of this devaluation was due to the $10 billion spent by the participating central banks.[citation needed] Currency speculation caused the dollar to continue its fall after the end of coordinated interventions. Unlike some similar financial crises, such as the Mexican and the Argentine financial crises of 1994 and 2001 respectively, this devaluation was planned, done in an orderly, pre-announced manner and did not lead to financial panic in the world markets. The Plaza Accord was successful in reducing the U.S. trade deficit with Western European nations but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural conditions that were insensitive to monetary policy, specifically trade conditions.

The manufactured goods of the United States became more competitive in the exports market but were still largely unable to succeed in the Japanese domestic market due to Japan's structural restrictions on imports.

The recessionary effects of the strengthened yen in Japan's export-dependent economy created an incentive for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s. The Louvre Accord was signed in 1987 to halt the continuing decline of the U.S. dollar.

The signing of the Plaza Accord was significant in that it reflected Japan's emergence as a real player in managing the international monetary system. Yet it is postulated[3] that it contributed to the Japanese asset price bubble, which ended up in a serious recession, the so-called Lost Decade.

trade deficit

The Trade Deficit: The Biggest Obstacle to Full Employment by Dean Baker

trade and currency policy

DeLong:

Ryan Avent: Secular Stagnation: Glut Busters: “A particular view about the macroeconomics of the pre-crisis period seems to be coalescing…. Since we haven’t solved the underlying savings glut, the American economy now has three options, according to this view: 1. Suffer through the same low growth (“secular stagnation”) that was characteristic of the early 2000s. 2. Use monetary policy to raise demand through higher asset prices and credit growth, restoring decent growth but creating a risk of new bubbles. 3. Use deficit-financed fiscal policy to absorb excess savings and boost demand, without relying on rapid growth in private credit. Certainly, parts of this story are correct. But is this really the best way to describe what was taking place?… One might… argue that the problem in the 2000s was not that the Fed haplessly created a bubble in order get the economy going again…. The problem was that it… ought to have done… was intervene aggressively in foreign-exchange markets to dampen the dollar’s rapid appreciation…. Doug Campbell… [and] Ju Hyun Pyun…. Now obviously, direct intervention in foreign-exchange markets is not the sort of thing America is supposed to do…. But this is a taboo that needs rethinking. Depreciations have historically been the most effective way to lift expectations for growth and inflation…. The Fed will not do any of the above autonomously. The decision to change the global monetary system will be political, just as it was in 1933 and in 1971, when American presidents made the necessary policy shift. Such decisions only tend to be made when the status quo is clearly untenable or when large political majorities demand a different course. Unfortunately, America’s secular stagnation mess does not seem likely to test either limit for some time to come.”

trade deficit

Taking Aim at the Wrong Deficit by Jared Bernstein and Dean Baker

currency policy, exchange rates, exports, and trade deficit

If the Dollar Stopped Being the Preeminent Reserve Currency It Would Mean More Jobs and Growth by Dean Baker

The Fed, Inequality and Accounting Identities by Dean Baker

However, a little income accounting here would go along way in helping this discussion. The country has an output gap of around 6 percent of GDP. This is due to the plunge in residential construction following the collapse of the housing bubble and also the lost consumption that resulted from the loss of $8 trillion in housing equity. Standard measures of the housing wealth effect imply that a reduction of $400 billion to $560 billion in annual consumption. 

There are a limited number of channels to fill this lost demand and thereby make up the 9 million jobs deficit we now face. One route is large government deficits, either from increased spending or tax cuts. That is probably the quickest and surest way to make up the demand gap, but the Serious People insist that we can't run large deficits. 

Another obvious route, and probably the best long-term solution, is to get the dollar down. This will improve the international competitiveness of U.S. goods and bring the trade deficit closer to balance. Unfortunately this has not been a high priority for the Obama administration. There are powerful interests like Walmart, many large manufacturers, and the financial sector which benefit from an over-valued dollar. As a result, getting the dollar back to a more sustainable level has not been a priority for the administration. 

When these routes are excluded there are not many other options to increase growth and create jobs. Low interest rates will help by allowing homeowners to refinance their mortgages and free up money for other spending. However this effect will be limited. Even if all $8 trillion in mortgage debt were refinanced at a 1.0 percentage point lower interest rate that would only free up $80 billion. And, this is offset by the fact that those lending the money will have less to spend.

Robert Samuelson Mostly Right on Over-Valued Dollar by Dean Baker

The part of the story that Samuelson misses is that the over-valued dollar is a relatively recent phenomenon, not something that dates from the U.S. becoming the world's leading reserve currency. The dollars soared in 1997 as a result of the U.S. government and IMF"s mismanagement of the East Asian bailout from the financial crisis.

The conditions they imposed on the countries of the region led developing countries around the world to begin to accumulate massive amounts of dollars as a cushion so that they would not ever be in the situation that the East Asian countries found themselves in 1997. This means that the imbalances of the last 15 years can be directly attributed to the failures of the Greenspan-Rubin-Summers team (a.k.a. "The Committee that Saved the World") that directed the bailout.

Trade Deficits and the Dollar by Dean Baker

In prior posts I have often referred to the run-up in the dollar engineered by the Clinton-Rubin-Summers team in the 1990s as being the root of all evils. The point is that their over-valued dollar policy led to a large trade deficit. The only way the demand lost as a result of the trade deficit (people spending their money overseas rather than here) could be offset was with asset bubbles. 

To fill this demand gap, the Clinton crew gave us the stock bubble in the 1990s and the Bush team gave us the housing bubble in the last decade. In both cases the bubbles crashed with disastrous consequencees, the latter more than the former. (It took us almost 4 years to replace the jobs lost in the 2001 recession, so that downturn was not trivial either.) 

Anyhow, my take away from this story is that, using the advanced economics from Econ 101, we need to get the dollar down. I have made this point in the past and readers have often commented that trade does not appear to be responding as would be predicted from a falling dollar. I would argue otherwise. The graph below shows the non-oil trade deficit measured as a share of GDP against the real value of the dollar.


Source: Bureau of Economic Analysis and the Federal Reserve Board. 

This picture looks pretty much like the textbook story. The dollar has fallen nearly back to its 1995 level and the deficit as a share of GDP has fallen almost back to is 1995-1997 level as well. (There are lags, so trade does not adjust immediately to changes in the dollar's value.) Before anyone starts jumping up and down about pulling oil out of the picture, let me explain.
Oil prices have more than quadrupled over this period causing us to have a much larger deficit from oil imports. (Sorry, I have not deducted oil exports because they were not available from the same table.) Demand for oil is relatively inelastic. This means that when oil prices go up, if nothing else changed, we would expect our trade deficit to rise as the increase in the price of oil more than offsets the decline in quantity. 

The textbook response to the increase in oil prices and the rise in the trade deficit would be that the additional outflow of dollars would cause a further decline in the value of the dollar. This decline in the dollar leads to reduction in imports and an increase in exports, which effectively allows the country to pay for higher priced oil. 

In other words, if we followed the textbook story, we should expect to see a somewhat lower valued dollar today than in 1995 as a result of higher oil prices. This would cause us to have a reduced deficit, or even trade surplus, on non-oil products. This would mean that the dollar has to fall somewhat more than it already has in order to bring our trade deficit back to its mid-90s level. 

It looks to me like the intro textbook story is still doing pretty well.

Monetary Stimulus Is About Domestic Demand Not Exports and "Competitiveness" by Yglesias

Currency Wars

Draghi Seeks to Ease Talk of Global Currency War

Over the last few years, emerging-market countries like Brazil have openly accused slow-growing advanced countries like the United States of unfairly pushing down the value of their currencies with their aggressive monetary policies. And, for years, the United States has accused export-reliant emerging economies, in particular China, of manipulating their currencies, too. 

More recently, in Japan, stimulus programs backed by the newly elected prime minister, Shinzo Abe, have kept interest rates near zero and flooded the economy with money, which has reduced the cost of Japanese products around the world.

China has capital controls which prevent inflation and "hot money." It has a trade surplus. It intervenes in foreign exchange markets by buying U.S. Treasuries. That's manipulation. This article neglects to mention this info.

The U.S. has a trade deficit and a large output gap. It's reasonable to try to stimulate the economy after a financial crisis. A stronger U.S. economy will be able to buy more exports from countries like Brazil.

mommy-daddy wars continued (or Martin and Malcom)

Krugman can play the insider though. (see last post). He was for Hillary over Obama. He pushes the Clinton-years-were-awesome / Bush-years-sucked-partisan-theory-line.

The Great Dollar Decline by Krugman

What you see right away is that the dollar fluctuates a lot, so impressions of big decline depend a lot on your starting point. Think of it this way: maybe the question isn’t why the dollar fell so much during the Bush years, but rather why it was so strong during the late Clinton years. (The tech boom/bubble is an obvious answer).

Baker would say Rubin/Clinton had a strong dollar policy. Krugman knows governments can have policies regarding the strength of their currencies.

So: the euro was extraordinarily weak in the early 2000s (which I remember from a wonderful bike trip in Burgundy), reflecting teething troubles with the new currency. It recovered, and has stayed strong despite the crisis because of the refusal of the European Central Bank to match the easing of other central banks. Canada, meanwhile, saw its currency rise along with a great commodity boom.

Did Bush have a weak dollar policy?

I believe Krugman is correct regarding MMT.

Gavyn Davies provides the link. Davies fails to mention Professor Bernanke on Japan. And Waldman may be right that we'll be at the ZLB for a long time.

Not dead yet: Currency Management and the Need for a More Competitive Dollar by Josh Bivens
(via DeLong)


What's Really Dragging Down the U.S. Economy by Dean Baker

Wow, that isn't what the Commerce Department is telling my spreadsheet. I get that the average share of consumption (all categories together) in GDP was 67.3 percent in the years from 1985 to 2005. I get that it was 70.8 percent in the most recent quarter. This means that consumption was 3.5 percent higher than its longer period average as a share of GDP. This means that consumers are not hanging onto their wallets at all. In fact, they are spending at very ambitious rate. (Boys and girls, you can check this one for yourself by going to the National Income and Product Accounts and clicking up Table 1.1.5.) 

This is consistent with the data showing that consumption is higher than normal relative to disposable income. (The adjusted consumption line has to do with the treatment of the statistical discrepancy in the national income accounts.) This means that consumption is not holding back the economy, it is actually unusually high.

...
The other error along these lines is that imports should be expected to rise relative to GDP as the economy moves back toward its potential. If GDP were to rise by 6 percent to bring it back in line with its potential then imports would rise by roughly 20 percent as much or 1.2 percentage points of GDP. This would make it more clear that the biggest factor that is out of line with our historical experience is the trade deficit. That would be even more clear if we took a longer period as the basis of comparison that was not so distorted by asset bubbles.
Of course given the Washington Post's unabashed celebration of recent trade agreements its reporters are probably not allowed to call attention to such facts.
 

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.

NYT Tells Readers that President Obama's Economists Don't Believe in Economics When it Comes to Trade by Dean Baker

On the one hand, it notes the view of Ron Bloom, who had been the president's senior advisor on manufacturing policy, that the U.S. should take steps to push down the value of the dollar in order to make manufacturing in the United States more competitive. It then contrasts this view with that of Lawrence H. Summers, formerly the top economic adviser to Obama. The piece tells readers: 

"along with many economists, Mr. Summers argued that an overly aggressive trade stance could hurt manufacturing — by, for instance, pushing up the price of imported steel used by carmakers — and over time, drive companies away. " 

Actually, standard economic theory would argue that a lower valued dollar is exactlythe mechanism through which the trade deficit should be brought down. In a system of floating exchange rates, the excess supply of currency on world markets from a deficit country like the United States is supposed to bring down the value of its currency. This makes its goods more competitive in world markets, reducing the size of its trade deficit. 

The expected drop in the value of the currency is not taking place today with the dollar because a number of countries are buying up large amounts of dollars in order to prop up its value against their own currencies. By keeping the dollar over-valued they are able to sustain their trade surpluses with the United States.

currency exchange rates

The Value of the Yen, the Dollar, and Generational Issues by Dean Baker

Remarkably, while the value of the currency is apparently a hotly debated issue in Japan (at least according to the NYT), it is rarely mentioned in the United States. This could be due to the fact that more powerful interests than retired workers support an over-valued dollar in the United States.

The financial sector typically supports an over-valued currency since it reduces the risk of inflation and it makes them bigger actors overseas. Also, major retailers like Wal-Mart have established extensive supply networks overseas that rely on being able to buy goods cheaply. Most major manufacturers have also established subsidiaries in China and other countries with low wages.

These powerful interest groups would strongly resist any effort to lower the value of the dollar and thereby make U.S. goods more competitive in world markets. This could explain why the value of the currency is debated in Japan, while the NYT tells us that is only a matter of historical concern (the 1980s) in the United States.

Mitt Romney's Big Polish Idea: Let's Debase the Dollar! by Matt O'Brian

Pole's Apart by Krugman

Monetary Expansion Works: Poland Edition by Yglesias