“Huge foreign demand for Treasuries”. Via Across the Curve, here’s the Wall Street Journal:
The global hunger for U.S. government debt is intensifying as investors seek better returns from the negative yields and record-low rates found in Japan and Europe. On Thursday, an auction of 30-year Treasury debt attracted some of the highest demand ever from overseas buyers…
Thirty-year bonds typically attract a specialized audience, largely pension funds and other investors trying to buy assets to match long-term liabilities. There are few viable alternatives for such buyers around the world. The frenzy of buying has sparked warnings about the potential of large losses if interest rates rise. …
One auction is hardly dispositive, but that huge foreign demand is worth keeping in mind when we think about the US fiscal and external deficits. A point that Ryan Cooper also makes well.
You get the debt, I get the cash. When I pointed out Minsky’s take on Trump on this blog a few months ago, there were some doubts. How exactly, did Trump extract equity from his businesses? Why didn’t the other investors sue? In its fascinating long piece on Trump’s adventures in Atlantic City, the Times answers these questions in great detail. Rread the whole thing. But if you don’t, Trump himself has the tl;dr:
“Early on, I took a lot of money out of the casinos with the financings and the things we do,” he said in a recent interview. “Atlantic City was a very good cash cow for me for a long time.”
Unto the tenth generation. If you are going to make an argument for Britain leaving the euro, it seems to me that Steve Keen has the right one. The fundamental issue is not the direct economic effects of membership in the EU (which are probably exaggerated in any case.) The issue is the political economy. First, the EU lacks democratic legitimacy, it effectively shifts power away from elected national governments, while Europe-wide democracy remains an empty shell. And second, European institutions are committed to an agenda of liberalization and austerity.
From the other side, we get this:
I wish I knew where this sort of thing came from. Maybe Brexit would reduce employment in the UK, maybe it wouldn’t — this is not the sort of thing that can be asserted as an unambiguous matter of fact. Whether it’s EU membership or taxes or trade or the minimum wage, everyone claims their preferred policy will lead to higher living standards than the alternatives. Chris Bertram seems like a reasonable person, I doubt that, in general, he wishes suffering on the children of people who see policy questions differently than he does. But on this one, disagreement is impermissible. Why?
I like hanging out in coffeehouses. Over at Bloomberg, Noah Smith offers a typology of macroeconomics:
The first is what I call “coffee-house macro,” and it’s what you hear in a lot of casual discussions. It often revolves around the ideas of dead sages — Friedrich Hayek, Hyman Minsky and John Maynard Keynes.
The second is finance macro. This consists of private-sector economists and consultants who try to read the tea leaves on interest rates, unemployment, inflation and other indicators in order to predict the future of asset prices (usually bond prices). It mostly uses simple math, … always includes a hefty dose of personal guesswork.
The third is academic macro. This traditionally involves professors making toy models of the economy — since the early ’80s, these have almost exclusively been DSGE models … most people outside the discipline who take one look at these models immediately think they’re kind of a joke.
The fourth type I call Fed macro…
It’s fair to say a lot of us here in the coffeehouses were pleased by this piece. Obviously, you can quibble with the details of his list. But it gets a couple of big things right. First, the fundamental problem with academic macroeconomics is not that it’s a study of the concrete phenomena of “the economy” that has gone wrong in some way, but a self-contained activity. The purpose of models isn’t to explain anything, it’s just to satisfy the aesthetic standards of the profession. As my friend Suresh put it once, the best way to think about economics is a kind of haiku with Euler equations. I think a lot of people on the left miss this — they think that you can criticize economic by pointing out some discrepancy with the real world. But that’s like saying that chess is flawed because in medieval Europe there were many more knights than bishops.
The other thing I think Noah’s piece gets right is there is no such thing as “economic orthodoxy.” There are various different orthodoxies — the orthodoxy of the academy, the orthodoxy of business and finance, the orthodoxy of policymakers — and they don’t agree with each other. On some important dimensions they hardly even make contact.
Merijn Knibbe also likes the Bloomberg piece. (He’s doing very good work exploring these same cleavages.) Noah follows up on his blog. Justin Wolfers rejects basically everything taught as macroeconomics in grad school. DeLong makes a distinction between good and bad academic economics which to me, frankly, looks like wishful thinking. Brian Romanchuk has some interesting thoughts on this conversation.
Are there really excess reserves? I’ve just been reading Zoltan Pozsar’s Global Money Notes for Credit Suisse. Man they are good. If you’re interested in money, finance, central banks, monetary policy, any of that, you should be reading this guy. Anyway, in this one he makes a provocative argument that I think is right:
Contrary to conventional wisdom, there are no excess reserves – not one penny. Labelling the trillions of reserves created as a byproduct of QE as “excess” was appropriate only until the Liquidity Coverage Ratio (LCR) went live, but not after. …
Before the LCR, banks were required to hold reserves only against demand deposits issued in the U.S. … As banks went about their usual business of making loans and creating deposits, they routinely fell short of reserve requirements. To top up their reserve balances, banks with a shortfall of reserves … borrowed fed funds from banks with a surplus of reserves… These transactions comprised the fed funds market.
Under the LCR, banks are required to hold reserves (and more broadly, high-quality liquid assets) not only against overnight deposits, but all short-term liabilities that mature in less than 30 days, regardless of whether those liabilities were issued by a bank subsidiary, a broker-dealer subsidiary or a holding company onshore or offshore …
The idea is this: Under the new Basel III rules, which the US has adopted, banks are required to hold liquid assets equal to their total liabilities due in 30 days or less. This calculation is supposed to include liabilities of all kinds, across all the bank’s affiliates and subsidiaries, inside and outside the US. Most of this requirement must be satisfied with a short list of “Tier I” assets, which includes central bank reserves. So reserves that are excess with respect to the old (effectively moot) reserve requirements, will not be to the extent that they are held to satisfy these new rules.
Pozsar’s discussion of these issues is extremely informative. But his “no one penny” language may be a bit exaggerated. While the exact rules are still being finalized, it looks like current reserve holdings could still be excessive under LCR. Whie banks have to hold unencumbered liquid assets equal to thier short-term liabilities, the fraction that has to be reserves specifically is still being determined — Pozsar suggests the most likely fraction is 15 percent. He gives data for six big banks, four of which hold more reserves than required by that standard — though on the other hand, five of the six hold less total Tier I liquid assets than they will need. (That’s the “max” line in the figure — the “min” line is 15 percent.) But even if current reserve holdings turn out to be more than is required by LCR, it’s clear that there are far less excess reserves than one would think using the old requirements.
Liquid assets as a share of short-term liabilities, selected banks. Source: Credit Suisse
Pozsar draws several interesting conclusions from these facts. First, the Federal Funds rate is dead for good as a tool of policy. (I wonder how long it will take textbook writers to catch up.) Second, central bank balance sheets are not going to shrink back to “normal” any time in the foreseeable future. Third, this is a step along the way to the Fed becoming the world’s central bank, de facto in even in a sense de jure. (Especially in conjunction with the permanent swap lines with other central banks, another insitutional evolution that has not gotten the attention it deserves.) A conclusion that he does not draw, but perhaps should have, is that this is another reason not to worry about demand for Treasury debt. There are good prudential reasons for requiring banks to hold government liabilities, but in effect it is also a form of financial repression.
This is also a good illustration of Noah’s point about the disconnect between academic economics and policy/finance economics. Academic economists are obsessed with “the” interest rate, which they map to the entirely unrelated intertemporal price called “interest rate” in the Walrasian system. Fundamentally what central banks do is determine the pace of credit expansion, which historically has involved a great variety of policy tools. Yes, for a while the tool of choice was an overnight interbank rate. But not anymore. And whatever the mix of immediate targets and instruments will be going forward, it’s a safe bet it won’t return to what it was in the past.
W. Arthur Lewis, The Evolution of the World Economic Order
This little book may have the highest insights-per-page density of any economics book I’ve read. This isn’t an unmixed blessing — what you’re getting here are the distilled conclusions of a lifetime’s work in development economics, without any of the concrete material that led to them. The central theme — among many fascinating side-trips — is a basically Ricardian vision of a three-class society in which conditions in agriculture fundamentally determine the possibilities for capitalist development, and landlords are the great enemies of progress.
Among the book’s many virtues is the way it demonstrates how Ricardo’s theories of trade has much more radical implications than the free-trade-is-good bromides it’s usually deployed in support of. As Lewis points out, the Ricardian model clearly shows that it is in the interests of the rich countries that poor countries develop their capacity to produce goods they are already specialized in (i.e. follow their comparative advantage). But it is in the interest of the poor countries themselves (except for the landlords) to develop their capacity to produce the goods currently produced by the rich countries.
Charles Sellers, The Market Revolution
Originally I’d picked up some other history of the pre-Civil War United States. It referred dismissively to the idea that resistance to wage labor and to production for profit had been important to political and social developments in the early United States, and referenced The Market Revolution as the leading example of this now-discredited view. Ah, I thought, that’s the book I should be reading. I was not disappointed. The transition from use-value production by family units to market production by wage (and slave) labor turns out to be a very effective tool for organizing a general political and social history of the US from the end of the War of 1812 to the 1840s.
Richard Dawkins, The Ancestor’s Tale
I’d had this sitting around for ages and for some reason picked it up when I was unpacking a box of books. It’s a history of evolution, told through the conceit of a pilgrimage from modern humans back to the origins of life. Each pilgrim represents the last common ancestor of us and some other group of organisms. It may not be obvious at first but there is a definite number of such meeting points, no more than a few dozen, though obviously there is quite a bit of uncertainty about the more distant ones. It’s a very effective device for telling the story of evolution in an unfamiliar way, and, thankfully, Dawkins’ cranky politics are confined to a few footnotes.
Richard Werner, Princes of the Yen
Someone recommend this book to me in comments on this blog. It’s an original retelling of the story of Japan’s long postwar boom and long post-1980s stagnation that puts monetary policy at the center of both.
The basic argument is that the distinctive features of Japanese capitalism are a product of wartime mobilization, not some ancient features of Japanese culture; Werner’s claim that 1920s Japan was as liberal as the US or UK on most economic dimensions is consistent with other things I’ve read. The central feature of wartime planning that was preserved after 1945 was direct allocation of credit by the state — not officially, but via “window guidance” to banks on the desired volume and direction of lending. Initially this was controlled by the Ministry of Finance but in the 1980s, Werner argues, the Bank of Japan became increasing independent, and the key decisionmakers there — the “princes of the yen” of the title — saw their control over credit as a tool to dismantle the distinctive features of postwar Japanese capitalism. His claim that the crisis was deliberately provoke and prolonged in order to push through a broader agenda of liberalization is highly relevant as a precedent for what’s happening in Europe today — though I have to admit that his evidence for it is more suggestive than dispositive.
Ray Madoff, Immortality and the Law
I stole this from Mike Konczal when I was visiting him last year; he was using it for a piece in The Nation. It’s a fascinating discussion of a question I’d never thought about much before — the legal status of dead people.
The argument is that the US is an outlier, in that it grants dead people no rights over their bodies — instructions about the disposal of remains have no legal force — but grants wealthowners almost unlimited freedom to dispose of their property however they wish. In most European countries, by contrast, children and other family members are entitled to a substantial share of the estate regardless of the wishes of the deceased. Piketty, incidentally, is critical of these rules, on the grounds that they reinforce inherited wealth, but the US has its own ways of maintaining fortunes across generations. As Madoff points out, the “rule against perpetuities” now exists only in law school classrooms. While at one time it was possible to leave wealth in trust only for named individuals, it is now perfectly possible to set up a trust to benefit your decendents unto the last generation. Even better, you can keep your property itself in the trust, allowing your heirs only an income, or the use of it (as with a house); this protects it from the taxman, your children’s creditors, and their own spendthrift ways. Of course the law is not the whole story here; whether the US has the norms and institutions to actually maintain such perpetual wealth remains to be seen.
Elizabeth Kolbert, The Sixth Extinction
If you’ve read Kolbert’s pieces on climate change in the New Yorker then you know what this book is like. It’s a good, readable summary of what we know about the mass extinction currently underway. There’s nothing really new here, but one thing I did learn from it is how much of what’s happening is due to factors other than warming per se. Ocean acidification is responsible for the extinction of coral, which may be completely gone by the end of the century; invasive species and the dissemination of pathogens is the main factor in the decline of bats and amphibians. No matter how familiar you think you are with this stuff there’s always something that hits you. I remember my fascination and disgust as a child when I learned there were frogs that swallowed their eggs and hatched the tadpoles in their stomachs. It turns out there aren’t anymore.
Christopher Boehm, Moral Origins: The Evolution of Virtue, Altruism and Shame
The central claim of Boehm’s previous book is that all the small bands of foragers we know of — the closest analogues to the societies that existed for 99 percent of human history — are strictly egalitarian, with no one (among adult males) allowed to assume authority over anyone else. This contrasts with the modern world of kings, cops and bosses, and even more so with the rigid dominance hierarchies of our nearest primate relatives. And yet there is a striking parallel between the alliances that dominant chimpanzees form to defend their top spot, and the alliances that entire groups of human beings form to prevent anyone from occupying the top spot in the first place.
Boehm’s idea — which I like a lot, though I don’t have any expertise — is that the same basic behavioral patterns, presumably with the same genetic underpinnings, can produce dramatically different kinds of society. An intense dislike of having people above you, plus the ability to form alliances against anyone who tries to move up in the ranks, are the ingredients for a world of chimpanzees, baboons, mafiosos and orcs, where everyone is jealously guarding their spot in the hierarchy and ready to violently retaliate against usurpers who try to cut ahead of them. But the same vigilance against anyone trying to put themselves above you can equally give rise to the absolute democracy of hunter-gatherer bands, or today to political movements like Occupy Wall Street.
The main thing the newer book adds to the story is a more explicit argument that egalitarian norms arose through natural selection, along the same lines as people like Bowles and Gintis. I am not sure this evolutionary turn is a step forward. Like all evolutionary psychology, this consists largely of speculative just-so stories. And it loses one of the most interesting ideas in the earlier work, that the same behavioral building blocks can give rise to both hierarchical and egalitarian forms of society.
As for fiction, I’ve recently read:
It’s a Battlefield, by Graham Greene
Q, by Luther Blissett
The First Bad Man, by Miranda July
The Lists of the Past, by Julie Hayden. (See Laura Tanenbaum’s review here.)
The Member of the Wedding, by Carson McCullers
The Progress of Love, by Alice Munro
Going after Caciatto, by Tim O’Brien
The Hunters, by James Salter
Cities of Salt, by Adulrahman Munif
Crow Fair, by Tom McGuane
My Brilliant Friend, The Story of a New Name, and Those Who Leave and Those Who Stay, by Elana Ferrante
I liked all of them a lot, would recommend them all. Maybe I’ll write mini-reviews in an another post. Or maybe not.
Roosevelt Institute has a new roundup of policy advice for the next administration. There is a lot of useful stuff in there, which perhaps I’ll post more on later. My own contribution is on international trade. Here’s the summary:
It is natural to look to measures to improve the trade balance — through a weaker dollar, or through tariffs or other direct limits on imports — as a way to raise demand and boost output and employment. While the U.S. has done little to boost net exports in recent decades, there is increasing public discussion of such measures today…
We argue that while the orthodox view is wrong about trade being macroeconomically neutral, measures to improve the U.S. trade balance would nonetheless be a mistake. All else equal, a more favorable trade balance will raise demand and boost employment. But all else
is not equal, thanks to the special role of the U.S. in the world economy. The global economy today operates on what is effectively a dollar standard: The U.S. dollar serves as the international currency, the way gold did under under the gold standard. In part for this reason, the U.S. can finance trade deficits indefinitely while most other countries cannot. For many of our trade partners, any reduction of net exports would imply unsustainable trade deficits. So policies intended to improve the U.S. trade balance are likely to instead lead to lower growth elsewhere, imposing large costs on the rest of the world with little or no benefits here.
We do not deny that the trade deficit has negative effects on demand and employment in the U.S., but we argue this is only a reason to redouble efforts to boost domestic demand. The solution to the contractionary effects of the trade deficit is not a costly, and probably futile, effort to move toward a trade surplus, but rather measures to boost investment in both the public and private sector.
There were a couple figures that didn’t make it into the final piece. Here is one, showing the stability of the international role of the dollar over the past 20 years.
The dotted line shows the share of central bank reserves held in dollars (source). The heavy line shows the share of foreign-exchange transactions that involve the dollar (source). About two-thirds of foreign exchange reserves are held in dollars, and close to 90 percent of foreign-exchange transactions involve the dollar and some other currency. These shares have not diminished at all over the past 20 years, despite continuous US trade deficits.
In my opinion, the international role of the dollar makes it exceedingly unlikely that the US could face a sudden outflow of foreign investment. (And given that US liabilities are overwhelmingly dollar-denominated, it is not clear what the costs of such an outflow would be.) It also makes it highly unlikely that the US can achieve balanced trade through conventional measures, unless we come up with some other mechanism to provide the rest of the world with dollar liquidity.
Deliberately. The IMF has released its new Debt Sustainability Analysis for Greece. Frances Coppola has the details, and they are something. Per the IMF,
Demographic projections suggest that working age population will decline by about 10 percentage points by 2060. At the same time, Greece will continue to struggle with high unemployment rates for decades to come. Its current unemployment rate is around 25 percent, the highest in the OECD, and after seven years of recession, its structural component is estimated at around 20 percent. Consequently, it will take significant time for unemployment to come down. Staff expects it to reach 18 percent by 2022, 12 percent by 2040, and 6 percent only by 2060.
Frances adds:
For Greece’s young people currently out of work, that is all of their working life. A whole generation will have been consigned to the scrapheap. …
The truth is that seven years of recession has wrecked the Greek economy. It is no longer capable of generating enough jobs to employ its population. The IMF estimates that even in good times, 20 percent of adults would remain unemployed. To generate the jobs that are needed there will have to be large numbers of new businesses, perhaps even whole new industries. Developing such extensive new productive capacity takes time and requires substantial investment – and Greece is not the most attractive of investment prospects. Absent something akin to a Marshall Plan, it will take many, many years to repair the damage deliberately inflicted on Greece by European authorities and the IMF in order to bail out the European banking system.
For some reason, that reminds me of this. Good times.
The core countries of Europe are not ready to make the economic reforms they so desperately need—and that will change, alas, only after a diabolic economic crisis. … The sad truth is that voters are not yet ready to swallow the nasty medicine of change. Reform is always painful. And there are too many cosseted insiders—those with secure jobs, those in the public sector—who see little to gain and much to lose. … One reason for believing that reform can happen … is that other European countries have shown the way. Britain faced economic and social meltdown in 1979; there followed a decade of Thatcherite reform. … The real problem, not just for Italy and France but also for Germany, is that, so far, life has continued to be too good for too many people.
I bet they’re pretty pleased right now.
Polanyism. At Dissent, Mike Konczal and Patrick Iber have a very nice introduction to Karl Polanyi. One thing I like about this piece is that they present Polanyi as a sort of theoretical back-formation for the Sanders campaign.
The vast majority of Sanders’s supporters … are, probably without knowing it, secret followers of Karl Polanyi. …
One of the divides within the Democratic primary between Bernie Sanders and Hillary Clinton has been between a social-democratic and a “progressive” but market-friendly vision of addressing social problems. Take, for example, health care. Sanders proposes a single-payer system in which the government pays and health care directly, and he frames it explicitly in the language of rights: “healthcare is a human right and should be guaranteed to all Americans regardless of wealth or income.” … Sanders offers a straightforward defense of decommodification—the idea that some things do not belong in the marketplace—that is at odds with the kind of politics that the leadership of the Democratic Partyhas offered … Polanyi’s particular definition of socialism sounds like one Sanders would share.
Obamacare and the insurers. On the subject of health care and decommodification, I liked James Kwak’s piece on Obamacare.
The dirty not-so-secret of Obamacare … is that sometimes the things we don’t like about market outcomes aren’t market failures—they are exactly what markets are supposed to do. … at the end of the day, Obamacare is based on the idea that competition is good, but tries to prevent insurers from competing on all significant dimensions except the one that the government is better at anyway. We shouldn’t be surprised when insurance policies get worse and health care costs continue to rise.
It’s too bad so many intra-Democratic policy debates are conducted in terms of the radical-incremental binary, it’s not really meaningful. You can do more or less of anything. Would be better to focus on this non-market vs market question.
In this context, I wish there’d been some discussion in the campaign of New York’s new universal pre-kindergarten, which is a great example incremental decommodification in practice. Admittedly I’m a bit biased — I live in New York, and my son will be starting pre-K next year. Still: Here’s an example of a social need being addressed not through vouchers, or tax credits, or with means tests, but through a universal public services, provided — not entirely, but mainly and increasingly — by public employees. Why isn’t this a model?
The prehistory of the economics profession. I really liked this long piece by Marshall Steinbaum and Bernard Weisberger on the early history of the American Economics Association. The takeaway is that the AEA’s early history was surprisingly radical, both intellectually and in its self-conception as part of larger political project. (Another good discussion of this is in Michael Perelman’s Railroading Economics.) This is history more people should know, and Steinbaum and Weisberger tell it well. I also agree with their conclusion:
That [the economics profession] abandoned “advocacy” under the banner of “objectivity” only raises the question of what that distinction really means in practice. Perhaps actual objectivity does not require that the scholar noisily disclaim advocacy. It may, in fact, require the opposite.
The more I struggle with this stuff, the more I think this is right. A field or discipline needs its internal standards to distinguish valid or well-supported claims from invalid or poorly supported ones. But evaluation of relevance, importance, correspondence to the relevant features of reality can never be made on the basis of internal criteria. They require the standpoint of some outside commitment, some engagement with the concrete reality you are studying distinct from your formal representations of it. Of course that engagement doesn’t have to be political. Hyman Minsky’s work for the Mark Twain Bank in Missouri, for example, played an equivalent role; and as Perry Mehrling observes in his wonderful essay on Minsky, “It is significant that the fullest statement of his business cycle theory was published by the Joint Economic Committee of the U.S. Congress.” But it has to be something. In economics, I think, even more than in other fields, the best scholarship is not going to come from people who are only scholars.
Negative rates, so what. Here’s a sensible look at the modest real-world impact of negative rates from Brian Romanchuk. It’s always interesting to see how these things look from the point of view of market participants. The importance of a negative policy rate has nothing to do with the terms on which present consumption trades off against future consumption, it’s about one component of the return on some assets relative to others.
I’m number 55. Someone made a list of the top 100 economics blogs, and put me on it. That was nice.
My dinner with Axel. Last fall, Arjun Jayadev and I had a series of conversations with Axel Leijonhufvud at his home in California; videos and transcript are now up at the INET site, along with a collection of his writings. I’m very grateful to have had this chance to talk with him; Leijonhufvud is one of two or three economists who’ve most influenced my thinking. He’s also a charming and delightful storyteller, which I hope comes through in the interviews. I’ll be writing something soon, I hope, about Axel’s work and its significance, but in the meantime, check out the interview.
The mind of Draghi. This speech by Mario Draghi offers a nice glimpse into the thinking of central bankers circa 2016. The fundamental point is the idea of a long run “real” or “natural” rate of interest, which policy cannot affect. This idea, and the corollary that the economic world we actually observe is in some sense a false, unreal, artificial or “distorted” sublunary version of the true ideal, is, I think, the central site of tension between economic ideology and economic reality today. But there are other particular points of interest in the speech. First, the frank acknowledgement that the big problem with zero rates is that they reduce the profitability of financial institutions. (By the same logic, Draghi should want to do away with public education since it reduces the profitability of private schools, and with law enforcement since it reduces the profitability of private security firms.) And second, the claim that one reason for the problem of low interest rates is … excessive government debt!
A temporary period of policy rates being close to zero or even negative in real terms is not unprecedented by any means. Over the past decades, however, we have seen long-term yields trending down in real terms as well, independent of the cyclical stance of monetary policy.
The drivers behind this have been, among others, rising net savings as ageing populations plan for retirement, relatively less public capital expenditure in a context of high public indebtedness, and a slowdown in productivity growth reducing the profitability of investment.
Yes, for years we have been warned that excessive government debt is that interest rates will get too high, increasing borrowing costs for the government and crowding out of private investment. But now it turns out that excessive government debt is also responsible for rates that are too low. Truly, to be a central banker in these times one must be a Zen master.
Business cycle measurement ahead of theory … or heading in an entirely different direction. I’m very excited about a series of posts Merijn Knibbe is doing for the World Economics Association. They are on the incompatibility of the concepts used in the construction of national accounts and other macroeconomic data, with the concepts used in macroeconomic theory. I’ve wanted for a while to make the case for a consistent economic nominalism, meaning that we should treat the money payments we actually observe as fundamental or primitive, and not merely as manifestations of some deeper “real” economy. Knibbe is now doing it. The first installment is here.
Kaminska on “deglobalization”. Izabella Kaminska is always worth reading, but this piece from last week is even more worth reading than usual. I particularly like her point that the international role of the dollar means that the US is to the world as Germany is to the eurozone:
the dollarisation of the global economy … has created a sort of worldwide Eurozone effect, wherein every country whose own currency isn’t strong or reputable enough to be used for trade settlement with commodity producers is at the mercy of dollar flows into its own country. Just like Greece, they can’t print the currency that affords them purchasing power on the global market.
The logical corollary, which she doesn’t quite spell out, is that the US, thanks to its willingness to run trade deficits that supply dollars to the rest of the world, has fulfilled its international role much more responsibly than Germany has.
1. A bank in rich country A makes a loan of X to the government of poor country B. Let’s say for concreteness that A is the United States, B is Nigeria, and X is $1 billion. So now we have a liability of $1 billion of the Nigerian government to the US bank, and deposit of $1 billion at the US bank owned by the government of Nigeria.
(Nigeria might just as well be Egypt or Mexico or Argentina or Greece or Turkey or Indonesia. And the United States might just as well be Germany or the UK. )
2. The deposit at the bank is transferred from ownership of the government to ownership of some private individual. It’s easy to imagine ways this can be done.
3. The residents of Nigeria, via their government, still have a liability of $1 billion to the bank, obliging them to make annual payments equal to the interest rate times the principal. In this case, let’s say the interest rate is 5%, so debt service is $50 million.
4. The payments can be met by running an annual export surplus of $50 million. As long as this $50 million annual payment is maintained, interest payments can be made and the principal rolled over; the debt will remain forever.
5. The private individual from step 2 moves from Nigeria to the United States, eventually becoming a citizen there.
The result of this: a family in the United States has wealth of $1 billion (plus whatever they already had, of course). Meanwhile, the people of Nigeria make payments of $50 million each year to the United States forever, in the form of uncompensated exports. In their important book Africa’s Odious Debts and related work, Boyce and Ndikumana demonstrate that this story describes much of sub-Saharan Africa’s foreign debt. It applies elsewhere in the world as well.
I wonder how various people evaluate this scenario. Do we agree there is something wrong here? And if so, what, and what is the solution?
The orthodox view, as far as I can tell, is: what’s the problem? People should pay their debts. Nigeria (or Argentina etc.) is a person, it has borrowed, it must pay. The fact that some private individual chooses to hold their wealth in one country rather than another has nothing to do with it.
More generally, the dominant view today is that the ability to carry transactions like those describe above is an unmixed blessing; in fact it’s the whole point of the international system. The three pillars of the European union are free movement of people, free movement of goods, and free movement of finance. Argentina’s Macri is hailed as a hero — by Obama among others — for removing capital controls. If you are committed to capital mobility, then it’s hard to see where the objection would be. Third World governments and New York banks are consenting adults and can contract on any terms they choose. And of course the fact that a possessor of wealth happens to be located in one country cannot, in a liberal order, be an objection to them owning an asset somewhere else.
Maybe it’s the last step that is the issue? Outside of Europe, the free movement of people does not have the same place in the economic catechism as the free movement of money or goods. And even in Europe it’s a bit shaky. Still, most governments are happy enough to welcome rich immigrants. (A few months ago, my FT dislodged a glossy pamphlet, a racially ambiguous woman in a bikini on the cover, advertising citizenship by investment in various Caribbean countries.) This post was provoked by a Crooked Timber post by Chris Bertram; I’d be curious what he, or other open-borders advocates like my friend Suresh Naidu, would say about this scenario. Does an unrestricted right of human beings to cross borders imply an unrestricted right to transfer property claims across them also?
If the solution is not limits on movement of people, perhaps it is limits on cross-order transfers of financial claims, that is, capital controls. This used to be common sense. It’s not entirely straightforward where capital controls would operate in the sequence above; the metaphor of “capital” as a substance that moves across borders is unhelpful. But in some way or other capital controls would prevent the individual in country B from coming into possession of the bank deposit in country A.
There are two problems with this solution, one practical and the other more fundamental. The practical problem is that many routine transactions — payment for imports say — involve the creation of bank deposits in one country payable to some entity in another. It is hard to distinguish prohibited financial transactions from permitted payments for goods and services — and as Boyce and Ndikumana document, capital flight is usually disguised as current account transactions, for instance by over-invoicing for imports. Eric Helleiner [1] quotes Jacob Viner: “Because of the difficulty of distinguishing between capital account and current account transactions, capital controls could be made effective only by ‘censorship of communications and by crushing penalties for violation.'” [2]
The more fundamental problem is that these transactions — and capital flight in general – may be perfectly legal by the rules in force when they take place. Or if formally illegal, they are usually carried out by high government officials and/or members of the country’s elite. So the government of the poor country is unlikely to aggressively apply any restrictions that do exist. A subsequent government might well feel differently — but what claim do they have on a private bank account in a foreign country?
The problems with making capital controls effective were recognized clearly in the runup to Bretton Woods. In White’s 1942 draft for the agreements — again quoting Helleiner — “governments were required (a) not to accept or permit deposits or investments from any member country except with the permission of the government of that country, and (b) to make available to the government of any member country at its request all property in form of deposits, investments or securities of the nationals of the member country.” Even this wouldn’t be enough, of course, in the case where the wealthowner ceases to be a national. And it might not help in the case of a corrupt government that doesn’t want to repatriate private funds — though it might, if (as was also discussed) countries with balance of payments problems were required to draw on foreign exchange in private hands before being granted official assistance. In any case, it seems challenging to impose effective capital controls without granting the government control of all foreign assets — which will often require the cooperation of the country where those assets are held.
Needless to say nothing like this was included in the Bretton Woods agreements as signed. The US government would not even accept its allies’ pleas to assist in repatriating flight capital to help with the acute balance of payments difficulties following the war. Now it’s true, Second Circuit Judge Griesa recently claimed even more extensive authority that the government of Argentina would have had under White’s proposals, seizing the US assets of third parties who’d received payments from the Argentine government. But that was strictly to make payments to creditors. No such access to foreign assets is generally available.
This situation can arise even if governments themselves don’t even have to borrow abroad. As we recently saw in the case of Ireland, a government can strictly limit its debt and still find itself with unmanageable foreign liabilities. If private institutions — especially banks, but potentially nonfinancial corporations as well — borrow abroad, government that wishes to keep them operational in a crisis may have to assume their liabilities. Or at least, they will be strongly urged to do so by all the guardians of orthodoxy. What, are you going to just let the banks fail? Meanwhile, any foreign claims generated by the activities of the banks before they failed are out of reach.
Financial commitments create obligations; when circumstances change, sometimes they can’t be met. Someone isn’t going to get what they were promised. In modern economies, the state (often in the guise of the central bank) steps in to assume or redenominate claims, to impose an ex post consistency on the inconsistent contracts signed by private agents. But with foreign-currency commitments to foreigners the authorities’ usual tools aren’t available. And just as important, there are other authorities — the ECB in the case of Greece, the US federal court system in the case of Argentina — that are ready to use their privileged position in the larger payments system to enforce the claims of creditors. In effect, while domestic contracts are always subject to political renegotiation, foreign contracts are — or can be made to seem — objective fact.
What we’ve ended up with is a situation in which private parties have an absolute right to make whatever financial commitments they choose, and national governments have an absolute duty to honor the resulting balance sheet commitments. Wealth belongs to individuals, but debt belongs to the people. They are bound by past government commitments forever.
Or as Marx observed, “The only part of the so-called national wealth that actually enters into the collective possession of modern peoples is their national debt. …in England all public institutions are designated ‘royal’; as compensation for this, however, there is the ‘national’ debt. ”
[1] The Helleiner book, along with Fred Block’s Origins of International Economic Disorder, is still the best thing I know on the evolution of international monetary arrangements since World War II. Has anything better been written in the 20 years since it came out?
[2] This brings out two general points on financial regulation that I’d like to develop more. First, it is one thing to establish different rules for different kinds of activity, but the classification has to actually match up with the legal and accounting categories in which actual economic transactions are organized. The category of “banks” is a currently relevant example. This is part of the larger issue of what I call the money view, or economic nominalism — we need a perspective that regards money payments and the labels they bear as fundamental, rather than seeing them as reflections of some underlying structure. Second, and relatedly, it is hard for individual regulations to be effective in a setting in which anything that is not explicitly forbidden is permitted, since for any regulated transaction there will normally be unregulated ones that are economically equivalent.
The coup in Brazil. My friend Laura Carvalho has a piece in the Times, briefly but decisively making the case that, yes, the impeachment of Dilma Rousseff is a coup. Also worth reading on Brazil: Matias Vernengo, Marc Weisbrot and Glenn Greenwald.
The bondholder’s view of theworld. Normally we are told that when interest rates on public debt rise, that’s a sign of the awesome power of bond markets, passing judgement on governments that they find unsound. Now we learn from this Bloomberg piece that when interest rates on public debt fall, that too is a sign of the awesome power of bond markets. Sub-1 percent rates on Irish 10-year bonds are glossed as: “Bond Market to Periphery Politicians: You Don’t Matter.” The point is that even without a government, Ireland can borrow for next to nothing. Now, you might think that if the “service” bond markets offer is available basically for free, to basically anyone — the takeaway of the piece — then it’s the bond markets that don’t matter. Well then you, my friend, will never make it as a writer of think pieces in the business press.
The bondholder’s view, part two. Brian Romanchuk says what needs to be said about some surprisingly credulous comments by Olivier Blanchard on Japan’s public debt.
Anyone who thinks that hedge funds have the balance sheet capacity to “fund” a G7 nation does not understand how financial markets are organised. There has been a parade of hedge funds shorting the JGB market (directly or indirectly) for decades, and the negative yields on JGB’s tells you how well those trades worked out.
The prehistory of Trumpism. Here is a nice piece by my University of Chicago classmate Rick Perlstein on the roots of Trump’s politics in the civil-rights-backlash politics of fear and resentment of Koch-era New York. (Also.) I’ve been wishing for a while that Trump’s role in the Central Park Five case would get a more central place in discussions of his politics, so I’m glad to see Rick take that up. It’s also smart to link it to the Death Wish/Taxi Driver/Bernie Goetz white-vigilante politics of the era. (Random anecdote: I first saw Taxi Driver at the apartment of Ken Kurson, who was at the U of C around the same time as Rick and I. He now edits the Trump-in-law owned New York Observer.) On the other hand, Trump’s views on monetary policy are disturbingly sane:
“The best thing we have going for us is that interest rates are so low,” says Trump, comparing the U.S. to a homeowner refinancing their mortgage. “There are lots of good things that could be done that aren’t being done, amazingly.”
The new normal at theFed. Here’s a useful piece from Tracy Alloway criticizing the idea that central banks will or should return to the pre-2008 status quo. It’s an easy case to make but she makes it well. This is a funny moment to be teaching monetary policy. Textbooks give a mix of the way things were 40 years ago (reserve requirements, the money multiplier) and the way things were 10 years ago (open market operations, the federal funds rate). And the way things are now? Well…
Me at the Jacobin. The Jacobin put up the transcript of an interview I did with Michel Rozworski a couple months ago, around the debates over potential output and the possibilities for fiscal stimulus. It’s a good interview, I feel good about it. Now, Noah Smith (on twitter) raises the question, when you say “the people running the show”, who exactly are you referring to? It’s a fair question. But I think we can be confident there is a ruling class, and try to understand its intentions and the means through which they are carried out, even if we’re still struggling to describe the exact process through which those intentions are formed.
Me on Bloomberg TV. Joe Weisenthal invited me to come on “What’d You Miss” last week, to talk about that BIS paper on bank capital and shareholder payouts. Here’s a helpful post by Matthew Klein on the same topic. And here is the Fed paper I mention in the interview, on the high levels of bank payouts to shareholders during 2007-2009, when banks faced large and hard to predict losses from the crisis and, in many cases, were simultaneously being supported in various ways by the Fed and the Treasury.
Maybe I should aspire to do a links post like this once a week. Today is Tuesday; is Tuesday a good day? Or would it be better to break a post like this into half a dozen short ones, and put them up one at a time?
Anyway, some links and thoughts:
Public debt in the 21st century. Here is a very nice piece by DeLong, arguing that over the next 50 years, rich countries should see a higher level of public expenditure, and a higher level of public debt, and that even much higher debt ratios don’t have any important economic costs. There’s no shortage of people making this general case, but this is one of the better versions I’ve seen.
The point that the “sustainability” of a given deficit depends on the relation between interest rates and growth rates has of course been made plenty of times, by people like Jamie Galbraith and Scott Fullwiler. But there’s another important point in the DeLong piece, which is that technological developments — the prevalence of increasing returns, the importance of information and other non-rival goods, and in general the development of what Marx called the “cooperative form of the labour process” — makes the commodity form less and less suitable for organizing productive activity. DeLong sees this as an argument for a secular shift toward government as opposed to markets as our central “societal coordinating mechanism” (and he says “Smithian market” rather than commodity form). But fundamentally this is the same argument that Marx makes for the ultimate supercession of capitalism in the penultimate chapter of Capital.
Short-termism at the BIS. Via Enno Schroeder, here’s a speech by Hyun Song Shin of the BIS, on the importance of bank capital. The most interesting thing for my purposes is how he describes the short-termism problem for banks:
Let me now come back to the question as to why banks have been so reluctant to plough back their profits into their own funds. … we may ask whether there are possible tensions between the private interests of some bank stakeholders versus the wider public interest of maintaining a soundly functioning banking system… shareholders may feel they can unlock some value from their shareholding by paying themselves a cash dividend, even at the expense of eroding the bank’s lending base.
As many of the shareholders are asset managers who place great weight on short-term relative performance in competition against their peers, the temptation to raid the bank’s seed corn may become too strong to resist. … These private motives are reasonable and readily understandable, but if the outcome is to erode capital that serves as the bank’s foundation for lending for the real economy, then a gap may open up between the private interests of some bank stakeholders and the broader public interest.
Obviously, this is very similar to the argument I’ve been making for the corporate sector in general. I especially like the focus on asset managers — this is an aspect of the short-termism story that hasn’t gotten enough attention so far. People talk about principal-agent problems here in terms of management as agents and shareholders as principals; but only a trivial fraction of shares are directly controlled by the ultimate owners, so there are plenty of principal-agent problems in the financial sector itself. When asset managers’ performance is evaluated every year or two — not to mention the performance of the individual employees — the effective investment horizon is going to be short, and the discount rate correspondingly high, regardless of the preferences of the ultimate owners.
I also like his diplomatic rejection of a loanable-funds framework as a useful way of thinking about bank lending, and his suggestion that the monetary-policy and supervisory functions of a central bank are not really distinct in practice. (I touched on this idea here.) The obligatory editorializing against negative rates not so much, but I guess it comes with the territory.
Market failure and government failure in the euro crisis. This piece by Peter Bofinger gets at some of the contradictions in mainstream debates around the euro crisis, and in particular in the idea that financial markets can or should “discipline” national governments. My favorite bit is this quote from the German Council of Economic Experts:
Since flows of capital as well as goods and services are market outcomes, we would not implicate the ‘intra-Eurozone capital flows that emerged in the decade before the crisis’ as the ‘real culprits’ …Hence, it is the government failures and the failures in regulation … that should take centre-stage in the Crisis narrative.
Well ok then!
Visualizing the yield curve. This is a very nice visualization of the yield curve for Treasury bonds since 1999. Two key Keynesian points come through clearly: First, that the short-term rate set by policy has quite limited purchase on the longer term market rates. This is especially striking in the 2000s as the 20- and 30-year rates barely budget from 5% even as the short end swings wildly. But second, that if policy rates are held low enough long enough, they can eventually pull down market rates. The key Keynes texts are here and here; I have some thoughts here, developed further here.
Trade myths. Jim Tankersley has a useful rundown in the Washington Post on myths about trade and tariffs. I’m basically on board with it: You don’t have to buy into the idolatry of “free trade” to think that the economic benefits of tariffs for the US today would be minimal, especially compared with the costs they would impose elsewhere. But I wish he had not bought into another myth, that China is “manipulating” its exchange rate. Pegged exchange rates are in general accepted by orthodoxy; for much of modern history they were the norm. And even where exchange rates are not officially pegged or targeted, they are still influenced by all kinds of macroeconomic policy choices. It’s not controversial, for instance, to say that low interest rates in the US tend to reduce the value of the dollar, and thereby boost US net exports. Why isn’t that a form of currency manipulation? (To be fair, people occasionally suggest that it is.) I heard Joe Stiglitz put it well, at an event a year or two ago: There is no such thing as a free-market exchange rate, it’s just a question of whether our central bank sets it, or theirs does. And in any case, the Bank of China’s purchase of dollars has to be considered alongside China’s capital controls, which — given the demand of wealthy Chinese for dollar assets — tend to raise the value of the renminbi. On net, the effect of Chinese government interventions has probably been to keep the renminbi “artificially” high, not low. (As I’ve been saying for years.)
The politics of the minimum wage. Here is a nice piece by Stephanie Luce on the significance of New York’s decision to raise the minimum wage to $15. Also in Jacobin, here’s Ted Fertik on why our horrible governor signed onto this and the arguably even more radical paid family leave bill.
It would be a great project for some journalist — I don’t think it’s been done — to explore how, concretely, this was won — the way the target was decided, what the strategy was, who was mobilized, and how. In mainstream press accounts these kinds of reforms seem to spring fully formed from the desks of executives and legislators, midwifed by some suitably credentialed experts. But when you dig beneath the surface there’s almost always been years of grassroots organizing before something like this bears fruit. The groups that do that work tend to avoid the press, I think for good reasons; but at some point it’s important to share with a wider public how the sausage got made. My impression in this case is that the key organizing work was done by Make the Road, but I’d love to see the story told properly. I haven’t yet read my friend Mark Engler’s new book, This Is an Uprising, but I think it has some good analysis of other similar campaigns.
Hillary’s getting a huge free ride on her purported mastery of the mechanics of policy, in contrast to Bernie. I decided to look into just one of her campaign initiatives. She likes to throw around the phrase “universal child care” or “universal pre-K.” But she isn’t proposing universal either. She’s proposing new money for pre-K, which is fine, but a) false advertising, and b) it’s not clear how it would “work.”
Google “Hillary universal child care.” The first thing you get is one of her web pages. On it we are told “Her proposal would work to ensure that every 4-year old in America has access to high-quality preschool in the next 10 years. It would do so by providing new federal funding for states that expand access to quality preschool for all four-year olds.” There’s nothing else from the campaign as far as I looked — 4 or 5 pages of google results.
“Would work to” means “won’t” in this context.
Most of the page is about how great preschool will be, for those who get it, and I’d be the first to agree that it would be. Think Progress informs us, again under that “universal” headline, that HRC also favors a “middle class tax cut” to help parents pay for childcare. To be clear, both of these initiatives deserve praise and point in the right directions.
The rub is that they are no more specific or rigorously motivated than the Sanders proposals that people have been blathering about.
On the strength of rousing approval by a compliant Congress unavailable to Bernie, HRC would supposedly provide a grant to those same evil state governments who couldn’t be trusted to implement single-payer, under a defunct Sanders proposal. Who could say whether the results would be “universal”? Is the money adequate, assuming full participation by the states? Is there anything that would prevent them substituting the money for their own limited programs? These are the usual questions applying to grants-in-aid. There are no wonky answers on her web site.
A published journalist of my acquaintance thinks the page is a real policy proposal, rather than an advertisement. She couldn’t tell the difference. She thought I was talking about a ‘brief summary’ of the proposal and gave me a link to what I was going on, which actually IS a brief summary.
Note that bumping up Head Start does not get you to universal either. It’s fine, but Head Start is a tiny program, relative to the relevant population.
How to “pay for it”? Forget it. They don’t say, not that I care. All the critics of “unpaid-for” single-payer BernieCare evidently don’t care either. Criticisms of Sanders’ vagueness on policy can be applied to HRC as well, if one delves just a little bit.
I look forward to all the deep-dive analyses of HRC’s projected path to universal health care coverage. Are there any? Why not? Because Hillary advocates are too busy blathering about Bernie. Those with policy expertise don’t apply it to Hillary’s treacle.
Last week, the Washington Post ran an article by Jim Tankersley on what would happen if Trump got his way and the US imposed steep tariffs on goods from Mexico and China. I ended up as the objectively pro-Trump voice in the piece. The core of it was an estimates from Mark Zandi at Moody’s that a 45% tariff on goods from China and a 35% tariff on goods from Mexico (I don’t know where these exact numbers came from) would have an effect on the US comparable to the Great Recession, with output and employment both falling by about 5 percent relative to the baseline. About half this 5 percent fall in GDP would be due to retaliatory tariffs from China and Mexcio, and about half would come from the US tariffs themselves. As I told the Post, I think this is nuts.
Let me explain why I think that, and what a more realistic estimate would look like. But first, I should say that Tankersley did exactly what one ought to do with this story — asked the right question and went to a respected expert to help him answer it. The problem is with what that expert said, not the reporting. I should also say that my criticisms were presented clearly and accurately in the piece. But of course, there’s only so much you can say in even a generous quote in a newspaper article. Hence this post.
I haven’t seen the Moody’s analysis (it’s proprietary). All I know is what’s in the article, and the general explanation that Tankersley gave me in the interview. But from what I can tell, Zandi and his team want to tell a story like this. When the US imposes a tariff, it boosts the price of imported goods but leads to no substitution away from them. Instead, higher import prices just mean lower real incomes in the US. Then, when China and Mexico retaliate, that does lead to substitution away from US goods, and the lost exports reduce US real incomes further. But only under the most extreme assumptions can you get Zandi’s numbers out of this story.
While this kind of forecasting might seem mysterious, it mostly comes down to picking values for a few parameters — that is, making numerical guesses about relationships between the variables of interest. In this case, we have to answer three questions. The first question is, how much of the tariff is paid by the purchasers of imported goods, as opposed to the producers? The second question is, how do purchasers respond to higher prices — by substituting to domestic goods, by substituting to imports from other countries, or by simply paying the higher prices? Substitution to domestic goods is expansionary (boosts demand here), substitution to imports from elsewhere is neutral, and paying the higher prices is contractionary, since it reduces the income available for domestic spending. And the third question is, how much does a given shift in demand ultimately move GDP? The answer to the first question gives us the passthrough parameter. The answer to the second question gives us two price elasticities — a bilateral elasticity for imports from that one country, and an overall elasticity for total imports. The answer to the third question gives us the multiplier. Combine these and you have the change in GDP resulting from the tariff. Of course if you think the initial tariffs will provoke retaliatory tariffs from the other countries, you have to do the same exercise for those, with perhaps different parameters.
Let’s walk through this. Suppose the US — or any country — increases taxes on imports: What can happen? The first question is, how is the price of the imported good set — by costs in the producing country, or by market conditions in the destination? If conditions in the destination country affect price — if the producer is unable or unwilling to raise prices by the full amount of the tariff — then they will have to accept lower revenue per unit sold. This is referred to as pricing to market or incomplete passthrough, and empirical studies suggest it is quite important in import prices, especially in the US. Incomplete passthrough may result in changing profit margins for producers, or they may be able to adjust their own costs — wages especially — in turn. Where trade is a large fraction of GDP, some of the tax may eventually be translated into a lower price level in the exporting country.
Under floating exchange rates, the tariff may also lead a depreciation of the exporting country currency relative to the currency of the country imposing the tariff. This is especially likely where trade between the two countries is a large share of total trade for one or both of them. In this case, a tariff is more likely to cause a depreciation of the Mexican peso than of the Chinese renminbi, since the US accounts for a higher fraction of Mexico’s exports than of China’s, and the renminbi is actively managed by China’s central bank.
Taking all these effects together, passthrough for US imports is probably less than 0.5. In other words, the majority of a tariff’s impact will probably be on dollar revenue for producers, rather than dollar costs for consumers. So a 10 percent tariff increases costs of imported goods by something less than 5 percent and reduces the revenue per unit of producers by something more than 5 percent.
The fraction of the tax that is not absorbed by lower exporter profit margins, lower wages in the export industry or a lower price level in the exporting country, or by exchange rate changes, will be reflected in higher prices in the importing country. The majority of trade goods for the US (as for most countries) are intermediate and capital goods, and even imported consumption goods are almost never purchased directly by the final consumer. So on the importing side, too, there will be firms making a choice between accepting lower profit margins, reducing wages and other domestic costs, or raising prices. Depending on exactly where we are measuring import prices, this might further reduce passthrough.
Let’s ignore this last complication and assume that a tax that is not absorbed on the exporting-country side is fully passed on to final price of imported goods. Purchasers of imported goods now respond to the higher price either by substituting to domestic goods, or substituting to imported goods from some third country not subject to the tax, or continuing to purchase the imports at the higher price. To the extent they substitute to domestic goods, that will boost demand here; to the extent they substitute to third-country goods, the tax will have no effect here.
These rates of substitution are described by the price elasticity of imports, computed as the ratio of the percentage change in the price, to the resulting percentage change in the quantity imported. So for instance if we thought that a 1 percent increase in the price of imported goods leads to a 2 percent fall in the quantity purchased, we would say the price elasticity is 2. There are two elasticities we have to think about — the bilateral elasticity and the overall elasticity. For example, we might think that the bilateral elasticity for US imports from China was 3 while the overall price elasticity for was 1. In that case, a 1 percent increase in the price of Chinese imports would lead to a 3 percent fall in US imports from China but only one-third of that would be through lower total US imports; the rest would be through higher imports from third countries.
To the extent the higher priced imported goods are purchased, this may result in a higher price of domestic goods for which the imports are an input or a substitute; to the extent this happens, the tax will raise domestic inflation but leave real income unchanged. For the US, import prices have a relatively small effect on overall inflation, so we’ll ignore this effect here. If we included it, we would end up with a smaller effect.
To the extent that the increase in import prices neither leads to any substitution away from the imported goods, nor to any price increase in domestic goods, it will reduce real incomes in the importing country, and leave incomes in the exporting country unchanged. Conversely, to the extent that the tariff is absorbed by lower wages or profit margins in the exporting country, or leads to substitution away from that country’s goods, it reduces incomes in the exporting country, but not in the importing country. And of course, to the extent that there is no substitution away from the taxed goods, government revenue will increase. Zandi does not appear to have explicitly modeled this last effect, but it is important in thinking about the results — a point I’ll return to.
Whether the increase in import prices increases domestic incomes (by leading to substitution to domestic goods) or reduces them, the initial effect will be compounded as the change in income leads to changes in other spending flows. If, let’s say, an increase in the price of Chinese consumer goods forces Americans to cut back purchases of American-made goods, then the workers and business owners in the affected industries will find themselves with less income, which will cause them to reduce their spending in turn. This is the familiar multiplier. The direct effect may be compounded or mitigated by financial effects — the multiplier will be larger if you think (as Zandi apparently does) that a fall in income will be accompanied by a fall in asset prices with a further negative effect on credit and consumption, and smaller if you think that a trade-induced change in income will be offset by a change in monetary (or fiscal) policy. In the case where central bank’s interest rate policy is always able to hold output at potential, the multiplier will be zero — shocks to demand will have no effect on output. This extreme case looked more reasonable a decade ago than it does today. In conditions where the Fed can’t or won’t offset demand impacts, estimates of the US multiplier range as high as 2.5; a respectable middle-of-the-road estimate would be 1.5.
Let’s try this with actual numbers.
Start with passthrough. The overwhelming consensus in the empirical literature is that less than half of even persistent changes in exchange rates are passed through to US import prices. This recent survey from the New York Fed, for instance, reports a passthrough of about 0.3:
following a 10 percent depreciation of the dollar, U.S. import prices increase about 1 percentage point in the contemporaneous quarter and an additional 2 percentage points over the next year, with little if any subsequent increases.
The factors that lead to incomplete passthrough of exchange rate movements — such as the size of the US market, and the importance exporters of maintaining market share — generally apply to a tariff as well, so it’s reasonable to think passthrough would be similar. So a 45% tariff on Chinese goods would probably raise prices to American purchasers by only about 15%, with the remainder absorbed by profits and/or wages at Chinese exporters.
Next we need to ask about the effect of that price on American purchases. There is a large literature estimating trade price elasticities; a sample is shown in the table below. As you can see, almost all the import price elasticities are between 0.2 and 1.0. (Price elasticities seem to be greater for US exports than for imports; they also seem to be higher for most other countries than for the US.) The median estimates is around 0.5 for overall US imports. Country-specific estimates are harder to find but I’ve seen values around 1.0 for US imports from both China and Mexico. Using those estimates, we would expect a 15% increase in the price of Chinese imports to lead to a 15% fall in imports from China, with about half of the substitution going to US goods and half going to imports from other countries. Similarly, a 10% increase in the price of goods from Mexico (a 35% tariff times passthrough of 0.3) would lead to a 10% fall in imports from Mexico, with half of that being a switch to US goods and half to imports from elsewhere.
Selected trade elasticity estimates for the US. The last column indicates if “price” was measured with an import price index (P), the exchange rate (E), or competitiveness, i.e. relative wages (C). The “P” estimates are most relevant for a tariff.
Finally, we ask how the combination of substitution away from imports from Mexico and China, and the rise in price of the remaining imports, would affect US output. US imports from China are about 2.7 percent of US GDP, and imports from Mexico are about 1.7 percent of GDP. So with the parameters above, substitution to US goods raises GDP by 7.5% x 2.7% (China) plus 5% x 1.7% (Mexico), or 0.29% of GDP. Meanwhile the higher prices of the remaining imports from China and Mexico reduce US incomes by 0.22 percent, for a net impact of a trivial one twentieth of one percent of GDP. Apply a standard multiplier of 1.5, and the tariffs boost GDP by 0.08 percent.
You could certainly get a larger number than this, for instance if you thought that passthrough of a tariff would be substantially greater than passthrough of exchange rate changes. And making US import demand just a bit less price-elastic is enough to turn the small positive impact into a small negative one. But it would be very hard to get an impact of even one percent of GDP in either direction. And it would be almost impossible to get a negative impact of the kind that Zandi describes. If you assume both that the tariffs are fully passed through to final purchasers, and that US import demand is completely insensitive to price then with a multiplier of 1.5, you get a 2.7 percent reduction in US GDP. Since this is close to Zandi’s number, this may be what he did. But again, these are extreme assumptions, with no basis in the empirical literature. That doesn’t mean you can’t use them, but you need to justify them; just saying the magic word “proprietary” is not enough. (Imagine all the trouble Jerry Friedman could have saved himself with that trick!)
And the very low price elasticity you need for this result has some funny implications. For instance, it implies that when China intervenes to weaken their currency, they are just impoverishing themselves, since — if demand is really price-inelastic — they are now sending us the same amount of goods and getting fewer dollars for each one. I doubt Zandi would endorse this view, but it’s a logical corollary of the ultra-low elasticity he needs to get a big cost to the US from the initial tariff. Note also that the low-elasticity assumption means that the tariff creates no costs for China or Mexico: their exporters pass the increased tariff on completely to US consumers, and lose no sales as a result. It’s not clear why they would “retaliate” for this.
Let’s assume, though, that China and Mexico do impose tariffs on US goods. US exports to China and Mexico equal 0.7 and 1.3 percent of US GDP respectively. Passthrough is probably higher for US exports — let’s say 0.6 rather than 0.3. Price elasticity is also probably higher — we’ll say 1.5 for both bilateral elasticities and for overall export elasticity. (In the absence of exchange-rate changes, there’s no reason to think that a fall in exports to China and Mexico will lead to a rise in exports to third countries.) And again, we’ll use a multiplier of 1.5. This yields a fall in US GDP from the countertariffs of just a hair under 1 percent. Combine that with the small demand boost from the tariff, and we get an overall impact of -0.9 percent of GDP.
I admit, this is a somewhat larger hit than I expected before I worked through this exercise. But it’s still much smaller than Zandi’s number.
My preferred back-of-the-envelope for the combined impact of the tariffs and countertariffs would be a reduction in US GDP of 0.9 percent, but I’m not wedded to this exact number. I think reasonable parameters could get you an impact on US GDP anywhere from positive 1 percent to, at the worst, negative 2 percent or so. But it’s very hard to get Zandi’s negative 5 percent. You need an extremely high passthrough for both import and export prices, plus extremely price-inelastic US import demand and extremely price-elastic demand for US exports — all three parameters well outside the range in the empirical literature. At one point a few years ago, I collected about 20 empirical estimates of US trade elasticities, and none of them had a price elasticity for US exports greater than 1.5. But even with 100% passthrough, and a generous multiplier of 2.0, you need an export price elasticity of 4 or so to get US GDP to fall by 5 points.
Still, while Zandi’s 5 percent hit to GDP seems beyond the realm of the plausible, one could perhaps defend a still-substantial 2 percent. Let’s think for a moment, though, about what this would mean.
First of all, it’s worth noting — as I didn’t, unfortunately, to the Post reporter — that tariff increases are, after all, tax increases. Whatever its effect on trade flows, a big increase in taxes will be contractionary. This is Keynes 101. Pick any activity accounting for 5 percent of GDP and slap a 40 percent tax on it, and it’s a safe bet that aggregate income will be lower as a result. The logic of the exercise would have been clearer if the tariff revenue were offset by a cut in some other tax, or increase in government spending. (Maybe this is what Trump means when he says Mexico will pay for the wall?) Then it would be clearer how much of the predicted impact comes from the tariff specifically, as opposed to the shift toward austerity that any such a big tax increase implies. The point is, even if you decide that a 2 percent fall in US GDP is the best estimate of the tariff’s impact, it wouldn’t follow that tariffs as such are a bad idea. It could be that a big tax increase is.
Second, let’s step back for a moment. While Mexico and China are two of our largest trade partners, they still account for less than a quarter of total US trade. Given passthrough of 0.3, the 45/35 percent tariff on Chinese/Mexican goods would raise overall US import prices by about 3 percent. Even with 100 percent passthrough, the tariffs would raise overall import prices by just 10 percent. The retaliatory tariffs would raise US export prices by about half this — 5 percent with full passthrough. (The difference is because these two countries account for a smaller share of US exports than of US imports). Now, let’s look at the movements of the dollar in recent years.
Since 2014, the dollar has risen 15 percent. That’s a 15 percent increase in the price of US goods in all our export markets — three times the impact of the hypothetical Mexican and Chinese tariffs. But before that, from 2002 to 2008, the dollar fell by over 20 percent. That raised the price of US imports by twice as much as the hypothetical Trump tariff. And so on on back to the 1970s. If you believe Zandi’s numbers, then the rise in the dollar over the past two years should already have triggered a severe recession. Of course it has not. It would be foolish to deny that movements of the dollar have had some effect on US output and employment. But no one, I think, would claim impacts on anything like this scale. Still, one thing is for sure: If you believe anything like Zandi’s numbers on the macro impacts of trade price changes, then it’s insane to allow exchange rates to be set by private speculators.
So if Zandi is wrong about the macro impact of tariffs, does that mean Trump is right? No. First of all, while I don’t think there’s any way to defend Zandi’s claim of a very large negative impact on GDP of a tariff (or of a more respectable, but economically equivalent, depreciation of the dollar), it’s almost as hard to defend a large positive impact. Despite all the shouting, the relative price of Chinese goods is just not a very big factor for aggregate demand in the US. If the goal is stronger demand and higher wages here, there are various things we can do. A more favorable trade balance with China (or Mexico, or anywhere else) is nowhere near the top of that list. Second, the costs of the tariff would be substantial for the rest of the world. It’s important not to lose sight of the fact that China, over the past generation, has seen perhaps the largest rise in living standards in human history. We can debate how critical exports to the US were in this process, but certainly the benefits to China of exports to the US were vastly greater than whatever costs they created here.
But the fact that an idea is wrong, doesn’t mean that we can ignore evidence and logic in refuting it. Trumpism is bad enough on the merits. There’s no need to exaggerate its costs.
UPDATE: My spreadsheet is here, if you want to play with alternative parameter values.
