Would A Floating Yuan Necessarily Appreciate In Value?

Terence Corcoran has an interesting article about the controversy over the Chinese currency peg that I recommend you to read whose contents I mostly (but not entirely) agree with.

As the article points out, the most desirable Chinese currency reform would be to create Chinese currency convertibility, not necessarily to create a floating exchange rate. The semi-independent territory of Hong Kong have currency convertibility, but not a floating exchange rate, and that has worked quite well for Hong Kong.

Corcoran also interviews Steve Hanke who points out:

"Mr. Hanke said yesterday in an interview that if China were to follow the West’s advice on currency flexibility and also allow convertibility, the result would not make protectionists happy. “If they floated with full convertibility, I think there’s a pretty good chance the yuan would get weaker because there would be a helluva big outflow of funds.” Chinese companies, citizens and investors — sitting on a bottled up currency — would have a strong desire to diversify their portfolios outside China."

That is an important point. As I have pointed out before, the fact that the Chinese are increasing their foreign exchange reserves is not by itself proof that the yuan would have a higher value under a pure float scheme, as the reserve build up is largely made to counter foreign capital inflow betting on yuan appreciation. If there is a yuan float, then these inflows will likely disappear and maybe even be reversed, perhaps causing the yuan to depreciate in value even if the Chinese central bank ceases its foreign exchange reserve build up.

Paul Krugman's view that even the floating exchange rate of the euro versus the U.S. dollar might justify trade sanctions because it floats in a different direction than he had hoped for (despite the fact that he had earlier argued that floating exchange rates represents the ideal state of affairs) indicates that Krugman and other China bashers would likely not be content with the outcome of a complete abandonment of the Chinese peg, especially since the yuan might in fact depreciate in value then.

Obama's Hooverite Policies

I have frequently discussed (for example here) the discrepancy between the popular myth of Herbert Hoover as some kind of laissez faire oriented deficit hawk, and the historical reality of Hoover as an intervetionist deficit spender.

Interestingly, now some prominent publications like Investor's Business Daily also tell the truth on the subject.

How To Become More Popular In Germany

Be denounced by Paul Krugman.

The Anti-Bastiat Taiwanese Opposition

China and Taiwan recently struck a free trade deal which will reduce and eventually eliminate tariffs on 539 Taiwanese products exported to China and 267 Chinese products exported to Taiwan, as well as liberalizing a lot of other cross border transactions.

A really good deal for both countries, but especially for Taiwan. Yet the Taiwanese opposition is strongly opposed to the deal, arguing it sets the stage for a Chinese political take over of Taiwan, and would turn Taiwan into a new Hong Kong.

But even setting aside the fact that Hong Kong's situation is hardly miserable (having one of the highest per capita income levels in the world, the highest level of economic freedom in the world and having a lot more political freedom than in the mainland), it overlooks that as long as a majority of Taiwanese opposes political unificatiobn, the only way that China could take over Taiwan would be through a military invasion. And as Bastiat long ago pointed out the more extensive trade is the higher will the price of war be, and the higher the price of war is, the less likely will it be. Thus, if anything, this will reduce the probability of Taiwan becoming like Hong Kong.

The Bastiat principle of "When goods don't cross borders, soldiers will" doesn't hold true in all situations if hatred is strong enough. The best example of this is the Israeli-Palestinian conflict where complete free trade (causing a dramatic boom in the Palestinian economy, with West Bank & Gaza GNP growing 7% per year between the Israeli takeover in 1967 and and the start of the first intifada in 1987) before the Intifadas between Israel and the West Bank and Gaza didn't stop the Palestinians from launching their Intifadas, as most Palestinians valued (and still values) hating and killing Jews higher than having a high material standard of living. But under normal circumstances (which is arguably the case for China), where people value having a good life higher than hating their neighbors, free trade will create peace.

Markets Vs. Sport Championships

Another point that could be made regarding the World Cup in football is how it, and other sport championships, differ from market processes.

Markets are positive sum games. Transactions are made because both the buyer and the seller expect to benefit from them. Sometimes these expectations are mistaken, but usually they aren't, and as the significant economic growth of the last few centuries illustrate, markets have produced large gains for just about everyone in the advanced economies (at least compared to how people lived a few centuries ago). The economic growth resulting from these market activities means that people can gain without inflicting losses on other people.

By contrast, sport championships are zero sum games. In any match, one team can only win if another team loses. When for example England plays against Germany tomorrow, England can only win if Germany loses and Germany can only win if England loses. English supporters can only be happy if German supporters become disappointed, and German supporters can only be happy if English supporters become disappointed. And the same goes for all other matches, except that the identity of the teams and the supporters are different.

Because people may enjoy the game in itself and not just the win of their favorite team (or individual player in sports like tennis), it could be argued that sport championships in one sense are positive sum games. But in the sense of the win or loss of certain teams, it is a zero sum game, unlike market outcomes where the successful performance of transactions and the tasks associated with them usually results in overall gains. There is no necessity in other people losing whenever some people gain, unlike in sport championships.

Soccer Again Explained

I have posted this clip before, but since some of you may have missed it and since there is a lot of attention surrounding soccer/football given the current World Cup, I will again post Marina Orlova's (AKA "hotforwords") explanation of why football is called "soccer" in America, whereas the word "football" there is reserved for the rugby-like sport known as "American football" or "gridiron" outside America.

BTW, if Marina was upset over Russia's semi final loss in the 2008 European cup, then she is probably not happy about the current World Cup where Russia didn't even qualify (Just like Sweden didn't).

Guide To Swedish Election

Tino Sanandaji has an interesting English language description of the 8 main parties in Sweden, in the wake of the upcoming Swedish election. I basically agree with the description, except for a few minor details.

It long looked as though the ruling centre-right coalition would be successful in terms of reducing taxes and welfare spending and (not coincidentally) managing the economy and boosting employment, but would still lose in the election. But more recent polls suggest that it now has greater support than the left-wing opposition.

The likely entry of the nationalist anti-immigration Sweden Democrats into the parliament would however complicate the picture, especially since both the centre-right and left-wing parties have ruled out any cooperation with them.

3 Myths About Oil

In the wake of the BP oil spill, oil is again under attack as an energy source, with for example Obama using it as an argument for more government subsidies for "renewable" sources of energy and his cap and tax scheme.

Alex Epstein has a good article at Forbes where he briefly but persuasively defends oil against 3 common arguments against it-that it will run out, that it funds [Islamic]terrorism and that it produces "catastrophic climate change" (he doesn't address the oil spill argument, but while oil spills are no doubt bad, they are fortunately rare and the damage those rare spills create are very small compared to the benefits of oil).

See also his blog post about the wide benefits of oil.

Mixed British Budget

The new budget by the new British government is focused on austerity measures, which is good since the British deficit is far too large. However, the emphasis seems to be too much on tax increases, rather than spending cuts, most notably an increase in the VAT and an increase in capital gains taxation.

By weakening incentives this will reduce structural growth in Britain, something which in turn will make it harder to reduce the deficit. Unless further cuts are implemented, the structural deficit will not be eliminated by these measures.

A Chinese Currency Adjustment

Yes, I'm back now. Not much seems to have happened while I was gone, except for an adjustment of the official Chinese currency policy.

It looks like it is essentially a re-run of the 2005 "de-pegging", which means a very slow and gradual appreciation, or in other words a Singapore-style managed float system with a controlled and slow appreciation.

This will not really change much economically, at least not if the adjustment was as slow as during the first two years of the 2005-08 adjustment. Hopefully it will however be enough to stave off a U.S.-Chinese trade war.

The China Bashers Will Never Be Content

Stephen Roach points out:

"In real terms, the trade-weighted renminbi [yuan] is up 7.5% over the past six months and fully 20% over the past five years."

And as Scott Sumner pointed to before, the yen have increased fourfold in value relative to the U.S. dollar since the 1970s (in nominal terms, less in real terms due to lower Japanese inflation, but even in real terms it's exchange rate has risen dramatically), yet Japan still has a sizeable current account surplus. It thus seems unlikely that further yuan appreciation will really eliminate the Chinese surplus, much less the American deficit.

And as the Japanese example shows, China will continue to be a scapegoat for the likes of Paul Krugman and Charles Schumer (the Senator most active to initiate a trade war) regardless of what it does since the underlying causes of America's problems aren't addressed, at least until the hypothetical appearance of a new even more suitable scapegoat (The rise of China is why Japan has now finally lost the scapegoat role it had in the 1980s, 1990s and to a lesser extent in the early 2000s).

Two Can Play That Game

Paul Krugman criticizes the case made by Raghu Rajan for Fed interest rate hikes. Krugman falsely asserts that Rajan's case only rests on two arguments (as you can see if you read Rajan's article it contains more arguments) and that these arguments are self-contradictory:

"Rajan’s argument boils down to two assertions:

1. Raising rates a bit wouldn’t significantly deter investment.

2. “Unnaturally low” interest rates are distorting asset prices.

The first thing to say about these two assertions is that they are essentially contradictory. If the difference between current rates and the rates Rajan wants is trivial — just a wafer thin mint — how can that same difference be leading to a major distortion in financial markets? Are we to believe that an interest rate change that matters not at all to firms making real investments somehow has huge effects on speculators? And actually, don’t asset prices themselves matter for real investment?"

But first of all, it is not necessarily the case that "real" investment movements mirror asset price movements exactly. Obviously the former is influenced by the latter, but because of various considerations including the volatility of asset price movements relative to the partly irreversible nature of many "real investments", the correlation of the magnitude of these two phenonemoms are unlikely to be perfect.

Because of their higher volatility and more easily reversible nature, asset prices are likely to fluctuate more than "real" investments.

And secondly, if we for the sake of the argument assume that the correlation is perfect, then this destroys Krugman's argument that monetary policy can be used to stabilize the "real economy" without creating asset bubbles, an argument he has frequently made when defending the low interest rate policy of the Fed in 2001-05.

Krugman Refusal To Accept The Consequences Of Deficits

The debt panic in Southern Europe has prompted not only countries like Spain, Portugal and Greece to undertake fiscal austerity measures, but also countries with falling borrowing costs like Germany, Holland and France to reduce government spending and raise taxes.

The crisis has brought attention to the potential perils of deficit spending even to governments that can now borrow cheaper than ever.

A predictable result of this will be a strengthening of the aggregate current account balance of the euro area, with the current small deficit being turned into a surplus. Germany's surplus could rise even as the deficits of Spain, Portugal and Greece will likely fall.

This angers Paul Krugman who after repeating his earlier call for a trade war between the U.S. and China (failing to note that the weak euro means that his earlier case for Chinese revaluation has collapsed (not that it was ever valid)) goes on to hint that America should start a trade war with Germany too to punish them for trying to pursue sound fiscal policies:

"Meanwhile, Europe is going wild for fiscal austerity. Angela Merkel says that budget cuts will make Germany more competitive — but competitive against whom, exactly?

You know the answer, don’t you? Yep: everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi. Oh, and while they rely on US demand to make up for their own contractionary policies, they’ll lecture us on how irresponsible we’re being, running those budget and current account deficits.

This is not going to work — and the United States has to take steps to protect itself.....

....And it’s also important to send a message to the Germans: we are not going to let them export the consequences of their obsession with austerity.

Nicely, nicely isn’t working. Time to get tough."

Krugman refuses to accept the undeniable fact that if the government dissaves, then this will lead to a bigger trade deficit. The only way to prevent this from happening is really to pursue a North Korea-style autarky with no trade with the outside world (it is true that if there is perfect Richardian equivalence then the trade deficit won't increase, but that is unrealistic and would at any rate defeat the purpose of deficit spending). But that would create a far deeper economic crisis than what we've seen so far.

Krugman doesn't go that far (yet), but his trade war proposals would still create deep problems and would fail to prevent the fact that a higher budget deficit would ceteris paribus increase the trade deficit.

Putting Swiss Things Into Perspective

Marc Chandler tells of the large foreign exchange reserve increases of the Swiss National Bank:

"In terms of the euro, the SNB appears to have purchased around 55 bln euros in the month of May. This is simply an incredible amount. Assuming that the SNB is QE is still operative and it is selling Swiss franc and buying foreign–primarily European bonds, consider that the ECB bought around 40.5 bln euros worth of European sovereign bonds in the secondary market. The time frames do not match up perfectly, but it would appear that the SNB bought more European bonds than the ECB itself."


It is not clear what bonds were bought, whereas the ECB purchases were known to be targeted, but assuming the numbers are correct the comparison is still interesting. Another interesting perspective is that that, again assuming the numbers are correct, this is nearly twice as high as the value of Swiss GDP during that month (Swiss GDP is roughly €30 billion per month). This is the equivalent of the Chinese central bank buying $750 billion each month, or the Fed buying $2.3 trillion each month.

German Economic Upswing Continues

Manufacturing orders rose an additional 2.8% in April, after rising a slightly upwardly revised 5.1% in March.

It is highly unlikely that this pace of increase will continue, and since this is a particularly cyclical sector, the general upswing will be a lot lower, but clearly the German recovery has been stronger than generally thought, something which bodes well for the rest of Europe as well.

Hungary proves hazard of monetary union

The great stock market sell-off yesterday was in part the result of a negative interpretation of yesterday's U.S. job numbers, but also because of news that Hungary faces a deepening crisis.

Hungary has had deep problems for several years now, and unlike most other Eastern European countries it never had a boom worth mentioning even before the global financial crisis started.

This again illustrates the hazards of having the euro as currency. If only Hungary had retained its forint then there wouldn't be any problems, that's clearly what Paul Krugman would argue, and we all know Paul Krugman is never wrong. But wait a minute, Hungary has retained the forint as its currency and yet they face deep problems. Hmmm....

U.S. Employment Surveys Diverge

Some people think that employment statistics reflects direct government knowledge of all labor related transactions, and of the absence of labor related transactions, in a similar way that the government directly know how much revenue and expenditure it has had. But at least not yet, "Big Brother" isn't that big.

So, employment statistics is instead based on surveys (polls). In the case of employment statistics this means in most countries surveys based on household respondents.

Unlike in most other countries, the United States government tries to compile two different employment surveys. One is based on the standard international method of household surveys, and the other is based on a survey of employers (the payroll survey).

Usually the message from the household survey is pretty much the same, though the exact details almost always differ somewhat. The latest employment report however had two different messages. The household survey indicated a very weak economy, as despite massive Census-related hirings, total employment actually fell.

By contrast, the payroll survey had a bullish undertone. While private (non-Census) payrolls increased only marginally, total payrolls increased significantly and both the average work week and average hourly earnings increased, suggesting a relatively solid recovery.

Since the survey results differ, and since there is only one reality, it follows that at least (maybe both) one of them is wrong. I don't know which one of them is more accurate, but based on other reports it seems likely that the truth lies somewhere in between, which would imply a continuing U.S. recovery, but only at a moderate pace.

Mining Tax Reduces Mining Activity-What A Shock

Xstra, a mining company is announcing that in the wake of the "windfall profit" tax on miners in Australia planned by Kevin Rudd's Labor government, they will cancel their investments, something which will mean the loss of more than 3,000 jobs.

Kevin Rudd is predictably in denial about this connection, but it is obvious for anyone who lacks a stake in the planned tax that if you reduce potential profits, then a lot fewer investments will be worth making, leading to fewer investments and fewer jobs-and relatively high paying jobs at that.

Assuming the Chinese boom continues, Australia's economy will also continue to boom,even if Kevin Rudd continues his destructive reign. But it won't boom as much as it would if Australian voters are wise enough to remove Rudd's Labor government from office in the next election.

U.S. Federal Debt Exceeds $13 Trillion

U.S. Federal debt exceeded 13 trillion dollars for the first time ever on June 1. More specifically, it was $13,051 billion, an increase with $543 billion compared to 3 months earlier and with $1,671 billion compared to 12 months earlier.

Al Gore Increases His "Carbon Footprint" Further

Al Gore divorces from his wife Tipper. This is awful, just think of the extra "carbon footprint" this will create!

Did Aussie Economic Growth Really Slow?

"Australia's economic growth slows", the media headline says. But that isn't really true. While the official volume growth number did slow, the more meaningful terms of trade adjusted number showed higher growth, increasing from 1.5% (6.1% at an annualized rate) to 1.8% (7.3% at an annualized rate) as terms of trade for Australia improved dramatically.

Beavis & Butthead Follow-Up

Two days ago, I discussed a "Beavis and Butthead"-clip which has now been removed from Youtube. To those of you who didn't see it, the relevant part of the story was that they had been assigned by their school to sell candy bars. They didn't have much luck though, and they only sold two (and that's after offering to sell them at half price, so it was really just one).

But then Butthead wanted to eat one of the candy bars and bought one from Beavis. And then Beavis also wanted to eat one, so he bought one from Butthead using the same money he got selling to Butthead. And then Butthead bought another one from Beavis using that same cash, after which Beavis bought another one from Beavis using that same cash and so on, until all the candy bars had been eaten, leaving them with only two dollars, something which caused some problems.

The questions I asked was first of all, what was the catch? Why did things end up bad even though they were careful to always demand payment for each candy bar? And secondly, what connection does this have to Keynesian economics.'

The answer to the first question is that the catch was that Beavis and Butthead didn't own the cash they used to purchase candy bars from each other. They illicitly "borrowed" (or in other words stole) it from the school which owned the money. When they ate those candy bars they thus in effect stole them, as the cash they exchanged in each transaction was stolen.

The answer to the second question is that they in effect acted as Keynesians by not letting the fact that they hadn't produced anything to give in return to the producers of these candy bars stop them from demanding them. When Keynesians argue that the government should borrow and print money to enable non-producers to demand various goods, they are in fact advocating the behavior that Beavis and Butthead displayed in this clip.