IPE at Middlebury College with James Morrison
Feb 9th, 2009 by James Morrison
This page will allow for a free-form discussion. Students should feel free to post whatever they like here: questions, comments, musings, &c.
A big decision this week by Obama on trade policy that I thought was relevant to the Smith reading.
I thought it was interesting that this complaint and most opposition in general today towards free trade comes from unions, while in Smith’s time it came from the manufacturers (the tire industry didn’t join the trade complaint).
This is the video that I brought up in the second discussion when we were talking about the spread of information. So, in case you’re interested, here it is.
“Ordering Pizza in the Future”:
A call to “the Invisible College” B. Cohen
I’m choosing to respond to Cohen simply because I did not only enjoy his work on the “intellectual history of IPE” but I was also moved by his sense of humor. It’s a very beautifully written piece—sound and honest. He made me appreciate the fact that I’m studying IPE at this defining moment in history; a time when economics and politics are so intertwined (like a spider web) that one can never escape their impacts or implications…well, except, maybe when one is dead. If you think that you are not affected by “the nexus of politics and economics” then you must be living on another planet. As Aristotle once put it, “man is by nature a political animal.” In a nutshell, as long as you MAKE DECISION (about the acquisition, application and/or distribution of power and material well being &c) then I’m afraid you are a political-economist animal, and that means you are in for the ride…
Cohen meticulously starts by distinguishing IPE from ipe. The former (which is “the connections between economics and politics beyond the confines of a single state”) is what we are concerned with. He provides very solid points as to why we should care about the intellectual history of IPE, and they are (in his words):
1. Diversity ( “IPE is hardly a monolith–it’s bridges are many and varied”)
2. Intellectual entrepreneurs ( that include “historians, political scientists and economists”)
3. Agency and contingency (“indispensable role of individual action” and “the unavoidable influence of chance”)
These points above are also practically important because they involve (in his words):
a. Inherent allure of ideas (since ideas and events are forever interacting and evolving)
b. Human quality (real people in real time)
Not much time to elaborate on all these profound points but they definitely do constitute an intellectual discipline…
Hmm, I wonder what other intellectual field of study is as brand new and relevant. I think this “Godfather of the monetary mafia” deserves another title. Don’t you think so? 🙂
Finally, Cohen states that “the intended audience for (his) book is first and foremost the invisible college”…So IPE majors out there, I guess that’s your call! isn’t it? 🙂
I found the analyses of the repeal of the Corn Laws in Great Britain particularly relevant to the ongoing debate regarding Health Care Reform in the US. The three I’s mode of analysis used to assess the political and economic results of England in 1846 similarly offers an alternative way to methodically evaluate what seems to be an issue dominated by partisan warfare in Congress. Vested interest groups (read: the Health Insurance Industry) have devoted considerable amounts of capital to lobby Congress and appeal to the general public (constituency groups to which Congressmen and women are beholden). This move makes logical sense from their standpoint of economic entities motivated by the bottom line, and is not entirely different from the efforts of the landed aristocracy (or even the Anti-Corn Law League, for that matter) in nineteenth century England. Ideology certainly plays a strong role in the debate, as some people promote Universal Health Care as the morally right policy, while others debate the merits and fallacies of capitalism vs. socialism economic models. Our own institutions (specifically Congress, though Obama’s decision to route reform through the legislative branch should also be noted as significant) have had a considerable impact on the present debate beyond partisan bickering, as the two Houses have each attempted to produce different versions of a reform bill with varying degrees of consensus among the myriad committees of which each House is composed. Political fault lines in Congress and in the national media are irrefutably important, though far from the only or even primary factor in the debate, impacted by interests, ideas, and the nature of our governing institutions.
Some ideas I’m working out about balance of payments and exchange rates. Not sure how accurate they are.
1) A country usually doesn’t know what its balance of payments exactly is. In a country with free floating exchange rates, they can use the behavior of ER and the relative appreciation or depreciation of their currency to estimate how much “goods and services” they owe abroad, how much of its currency is out there. This currency abroad exerts pressure on exchange rate movements. To appreciate how this is not a sure guide, imagine a rich grandmother who buys 10 billion USD and keeps it under her mattress. ERs will not be affected by that supply until she remembers it. While improbable, different countries and entities keep USD for different reasons. Day to day movements may not reflect these supplies.
2) The government can also use its present BOP to capture the gap between inflow and outflow of currency. This is pretty complicated to me because in a free floating system, the values of exports, imports, transfers, etc, are constantly changing. It doesn’t seem that governments make a note of the amount needed to balance the account and then make up the difference. Rather, governments, usually by paying attention to the ER, can sell foreign reserves for USD to prop up the value of their currency, or expand the money supply in the country (thereby increasing supply of USD). It seems that governments can directly sell USD for foreign exchange as well. And there seems to be mechanisms whereby governments can increase the supply of USD but constrain inflation within the country, influencing only foreign exchange markets – not very clear about what these are or how they operate.
This is an e-mail that I sent to Prof. Morrison and figured I’d share with the rest of you in case you had any thoughts:
If you add time and expectations into the mix about opening markets and relative power then:
Would it follow that a declining hegemony (who is apparently growing less rapidly than the other countries, hence its decline) should actively CLOSE markets, in effect causing a standstill in the world economy, stopping relative gains from trade to other countries (which is loses on), in attempt to freeze the world with it (the hegemon) at the top?
I realize that had a lot of modifiers, but the central thought being a declining hegemon closes the world economy to prevent other countries to rise to its level of power.
I’m not saying that that occurs empirically, but would that fit into hegemonic theory?
Removing the agreements reflects an acknowledgment that from the hegemon that it will no longer continue in that role, but is a better option than falsely believing it is still in power when it’s actually losing group.
I am (if anything academic) an economist, so I’m thinking in terms of marginal benefit and cost. Ideally, the hegemon would open up economies up to the point where the agreements were no longer in its benefit. Eventually (in time), however, the tables turn (all good things come to an end), and the hegemon should end all the agreements that no longer benefit it. It should still have the power to do so. This action will stall the growth of its competitors. Although that may not prevent the hegemon’s expected demise, it will at least stall the gains the other country would make. And that is why declining hegemony is supposed to coincide with market closure.
Said another way, while the hegemon is in power, it should do everything it can to prevent others from rising to its level. At first this meant subjecting other countries to trade policies that helped the hegemon, but eventually, if/when the trade policies have the reverse effect, it closes trade to make it impossible for the other countries to gain from.
Of course, if the hegemon waits too long to start closure (or if there are “regional hegemons”/close seconds), the world economy will be able to function without its leadership, and closing the economy will just result in hurting itself by excluding itself from an otherwise thriving economy. I guess that would be where the US is. Even though we may be on the decline, it’s too late to try to reverse the opening of markets (the EU and China would just go around us).
Reading about the G20 Summit and the United States attempting to close some markets (like tires for example) may give some possible credibility to this. Although there are other factors (given the widespread belief in free trade it is hard to contradict it without losing face), it seems that this might be what the US should want, even if we can’t say we do.
Let me know what you think.
I think Jason has a point with his post. But I think the bit about ‘time’ is always hard to gauge – are hegemons effective in gauging when to say ‘when’? Or will they continue to trade their relative hegemony for increased absolute gains, until perhaps it is too late?
My own comment also relates to current readings int he news on the G20, and Cohen’s “The Triad and the Unholy Trinity.”
In this article, Chen points to the “Ebb and Flow” in the collective commitment of nations as that which has diminished the credibility and effectiveness of international monetary co-operation. “Episodic” patterns are predictable and unavoidable as sovereign states relate in an anarchic system. In short, for optimum benefits to e achieved (monetary or otherwise) it is necessary for all involved parties to work in concert.
Cohen hinges his piece on the incompatibility of exchange-rate stability, capital mobility and monetary policy autonomy (the “Unholy Trinity”), and concludes that in practice, there is a “direct off between exchange-rate stability and policy autonomy.”
I found such a conclusion directly reinforced in the supplementary readings, as the Financial Times reports that “Berlin has Berlin has consistently rejected any agreement that would constrain its margin of manoeuvre in economic policy and said it would only agree on a non-binding monitoring mechanism for G20 members to assess the impact of its policies.” Cohen cites several examples in international history to highlight such “Ebbs and Flows” in commitment to policy, and it may be a while before our reality closer approximates the theory.
I wanted to respond to Jason’s post about hegemons. He said that a declining hegemon would theoretically want to “end all agreements that no longer benefit it” but even if other countries are gaining relatively more from trade agreements, the declining hegemon still benefits. It makes sense that a declining hegemon needs to close markets to keep its position, but it seems like no country should want to do that because while it would remain the hegemon, it would be leader of a world system in which all countries (including itself) are worse off. Unless being at the top is literally all you care about, you would be unlikely to take this kind of action.
On the other hand, this is without taking into account the idea of relative power discussed in Grieco and Ikenberry Ch 4. In the chapter, they talk about a recent study of American attitudes toward Japan: “a majority of the Americans polled in a survey responded that they would rather gain less overall if they could nonetheless gain more than the Japanese” (104). This idea seems self-destructive, especially for a declining hegemon like the US that needs to worry less about its security and more about its economic health. However, it seems to be the dominant philosophy. So according to this, a declining hegemon should close markets to preserve its position.
With the current economic situation it will be interesting to see which of the opposing policies will win out – closing markets to help the US domestically or opening them to help the international economy.
I think the most interesting part of the course so far has been to be able to see how economic variables are responsible for political outcomes. Specially to see how international regimes are created with the idea of establishing liberal trade policies around the globe. To ease economic relations and reduce transaction costs among sovereign states in the world market, but also to ensure the compliance of other states with the hegemon’s most beneficial economic strategy vis-à-vis other states in the international arena.
I guess one of my problems with institutions like the IMF or the World Bank is that they are responsible for the spread of false assumptions about the best way to bring growth and development to the Third World. I understand how those institutions are necessary among developed nations to foster trade relations and promote healthy commercial ties; however, their role in regions like Latin America has been slightly counterproductive. For years these regimes promoted liberal trade policies in the region as a necessary condition to achieve growth and development, when in fact those countries that integrated to the world economy most rapidly were not necessarily those with the most pro trade policies i.e. like Taiwan, Vietnam, South Korea.
These regimes’ economic rhetoric in the region has had a very negative effect on some of the members of our political elite, because repeated assertions about the benefits o global trade do not carry direct implications about how trade policy should be conducted in developing countries. Our leaders belief now that the market is the solution to everything, even now, when in the US and Europe it is clear that you need an effective and strong state for the market to operate efficiently.
Although the benefits of global trade are uncontested, I also believe that it is necessary to give the international regimes that embrace those ideals the necessary legitimacy to promote them. I think these international regimes are important in reminding nations about the importance of free trade, but they should also be more transparent about the advantages and disadvantages of these trade schemes. Otherwise free trade could be harmful for the long-term industrial development and political stability of land and labor abundant economies.
I don’t have time to address all of the important points in your post, but it got me thinking. Keep in mind that this is all just my speculation on one of the points you brought up; I really can’t substantiate anything I’ve written here.
As you said yourself, closing off markets to maintain hegemony only works when the hegemon still has a big enough “lead” over other countries that the international economy can’t function without it. Essentially, it only works when other countries are completely dependent on the hegemon. Any country in this position would need to be looking VERY far down the line to see this and close the markets in time, and, as Krasner points out in his article, there tends to be a lag between the point when states begin to lose their relative power and the point when they realize it. I don’t know that any country could time the market closure correctly. Even if it did, it couldn’t hold on to power forever. Eventually other states will establish their own markets elsewhere, and sooner or later, the declining hegemon, most likely isolated by the countries that it closed off, will suffer because of it. It might be an effective short-run approach if the timing is perfect, but in the long run, I think that the ill will it would engender among other countries makes this a poor strategy.
Of course, this is assuming that the hegemon will go to all lengths to screw its competitors and hold onto its power. This is unlikely to be the case in the real world, nor will this question be as black and white as it is in theory; the real world might yield quite different results.
Here’s a slightly old article on the current China US tire trade dispute that I found interesting.
Not only does the article raise the issue of the importance of domestic interests in foreign economic policy, but it also raises questions about the continuing openness of the international economy and that relationship with international regimes.
This could turn out to be the first sign of the eventual closing of the international economy after hegemony. China and the US could be headed towards a trade war over tires and chicken, and that could expand to other commodities if it is not settled. Indeed, it would appear as if international regimes accounted for the “stickiness” or lag time between the US’s demise as the hegemon and the closing of the international economy. And while the WTO could conceivably work this dispute out, it’s failure to do so would indicate the power of the 2008 economic crisis as a catalyst for the closing of the international economy. Just some thoughts. I hope that made sense.
Also, here is that video i mentioned two weeks ago about social networking
oh wow, did not see those other posts….sorry for completely changing the subject! I hope that was ok…?
So, Tyler’s post interested me a great deal, and I found a more current article published today by the Financial Times which can be found here:
Tyler, you mentioned in your post that you think this bilateral trade dispute could be a harbinger of an increasingly protectionist global economy as relative American economic power declines. I think this trade tension between China and the US is indicative of something else. Keohane argues in his book that even in the absence of a hegemon, the global economy can flourish through international regimes. I think what we’re seeing is just that. This article demonstrates that both sides are operating through the international institutions set up during the post-WWII US hegemonic era to maximize their interests rather than abandoning the international regimes in favor of unilateral moves that could have lasting consequences.
I think that the American response to the current economic downturn can be explained in part by the hegemonic theory and in part by fear of trade retaliation from other countries. The latter is probably not a theory but a reason that would hold the US back from closing too many markets.
As Jason already mentioned, the hegemonic theory can be used to explain why the US would want to close certain markets, like the tyre market, given that they are no longer profitable to be kept open. However, in response to Logan’s question of whether closing markets to help the US domestically or opening them to help the international economy would be the right strategy for the US, I doubt that the US would close some markets because of a greater fear of trade retaliation from other countries.
I am inclined to believe that a fear of trade retaliation might cause the US to decide to keep some markets open even if hegemonic theory predicts that the US would be better off closing them.
What do you all think?
I first found out about the US and China’s latest spat in depth from last week’s Economist, whose cover story was devoted to the developing trade dispute, and contained several other articles on the subject, including one alleging “creeping protectionism,” since President Obama’s decision in favour of the United Steelworkers sets a dangerous precedent for other groups harmed by cheap Chinese imports. At the same time, the President had rather little choice at the time, and most likely felt his hands tied politically in the matter. The President indeed delayed his decision on the Chinese tyre complaint until the eleventh hour. Having received the complaint in April, the law gave him until 17 September to reach a decision. Opinion about the actual effect of this new duties is also mixed, ranging from slight (the Economist) to severe (The Wall Street Journal). Given the range of motives and impacts ascribed to this situation, it is difficult at best to determine the possible impact on the international trade regime of this decision. While the US was within its rights under the terms of China’s accession to the WTO, the geopolitical ramifications of any sign of protectionism are usually severe. With comparisons to the Smoot-Hawley Tariff being bandied about, the US’s role in any application of hegemonic stability theory to our current times. This outbreak of protectionist sentiment is fiercely denied a such within the administration, but the closure of markets is a sign, along with the other protectionist measures (especially against China) seen in recent years of a hegemon in its twilight. And speaking of closing markets, the headline of tomorrow’s Wall Street Journal Europe is highly relevant: U.K. Reviews Foreign Ownership of Firms. In light of the dispute over the acquisition of Cadbury by Kraft, the world may be entering a new era of protectionism. Too little data to say much either way in the current moment.
In regards to our ongoing conversations regarding the influence of economics on politics and vice versa, I think this debate begins as early as our discussions of Locke and Smith. Smith believed any type of government intervention into a market economy preserved and influenced inequality; therefore the role of government should be limited to preservation of equality of opportunity. This means governments should set their focus on the creation of infrastructure and protection of the lands in which they govern. Locke however takes the stance that governments should be there to prevent market failures (something Smith would never endorse). Politics and economics are so closely intertwined, that it’s hard to see what came first (chicken or the egg) and what is most important when it comes to policy. The Corn Law readings demonstrated the ways that each institution keeps the other in check. I think economics by itself is relatively cut-throat and “Smithian” in theory, while politics can be (sometimes and slightly) more egalitarian. I liked Schonhardt-Bailey’s description of the supply side and the demand side to political economy. I think this picture provided a sense of the give and take that occurs daily regarding policy decisions. Locke and Smith debated whether one could exist without the other, and truthfully I don’t think they could, especially not for long.
yea..i just wrote “in regards to our conversation regarding”…sorry lol.
I’d also like to throw my two cents into the declining hegemon debate. And although I think the argument is interesting, and I value the attempt to do what Krasner did not, I ultimately disagree with the assumption that declining hegemons would attempt to close world markets.
Krasner points out a few reasons why hegemons look to open markets (and we can only presume that the reversal of these trends makes hegemons want to close markets). The first argument is that hegemons increase their aggregate national income. In a world where the state is still the great power, even if it faces relative decline, I have no reason to believe this wouldn’t hold true. Second, hegemons get political advantages over smaller states. But the political advantages still exist in a world where a hegemon is declining, because although with the decline the political sway decreases in effectiveness, the advantage overall still exists so long as a state maintains its power.
Finally, Krasner’s makes the argument that the rate of growth increases during a hegemons rise to power. Now, this is probably the closest argument we have that could be construed as a reason why a declining hegemon would want to close markets. But I’m unconvinced for a three reasons.
First, the rate of growth relative to other countries is still positive for a declining hegemon, it’s just not increasing at an increasing rate (it helps to think of a state’s hegemony like a bell curve…) I think this also helps explain the lag the Krasner uses to prove his model. So while from 1945-1960 the US was increasing its relative power at an increasing rate, from 1960-1990 (2000? 1980? I dunno) it was still increasing its relative power overall, but at a decreasing rate. And then now we’re trying to restrict trade with China because free trade is actually decreasing our relative power.
Second, even at the point where our relative power is decreasing because of the open economy, we don’t necessarily want to close the economy to all states, just states that are rivaling us. My reason for this is that while small states might gain a relative advantage, we can use the absolute gains to keep pace with rival states. So while open trade with costa rica, canada, etc is still valuable, we’re trying to specifically limit trade with china.
Third, even if a declining hegemony wanted to close the economy, how does a state go about that? While a hegemon can become protectionist, it is still in the interest of smaller states to maintain free trade with other small once they’ve paid the transition costs.
Part of my paper is going to be on this topic, so any objections, responses, etc would be appreciated. email me at email@example.com
Continuing Shenique’s discussion on the relations between politics and economics, I would like to summarize my own stance on the causal relationship between the two subjects.
In the first week, we started off with readings on “what is IPE? which one precedes the other? ” At first I was strongly convinced by institutionalism that emphasized on the role of politics to organize and shape markets. However, a sharp turn came around last week when we studied exchange rate market. The theory of balance of payments clearly demonstrated the “real-world” constraints that economics poses on politics, at least in the arena of foreign economic policy. I was taken by surprise to rediscover that economics actually possess such influential actor that shapes policy making. At the same time, Rogowski’s piece further helped to conceptualize the feedback loop between economics and politics.The trade policy creates winners and losers on the market, whose interests feed back to the system to create political cleavages. A domestic-politics/interest-group explanation would only be helpful to prove the latter half, but it is clear that we cannot neglect the actual economic benefit and cost involved in the first half. As a student of IPE, I am reminded again that we can no longer look at the world solely from a political scientist’s or economist’s point of view.
For example, take the discussion on hegemony and its potential policy on free trade (debated by Jason and others above). As many of my classmates have already pointed out, the hegemon can choose to behave as if maintaining its top political power is the sole purpose of existence; consequently closing the world economy. However, if we take a look at the economic cost also incurred on the domestic market of the hegemon, we begin to understand the plausibility of this argument.
Jason, I appreciate your explication of the incentives facing a waning hegemon in terms of closing markets and the accompanying policy difficulties. A few other posts have added to the theory as well. It appears to me, however, that we’re creating a theory in which we have a set of assumptions for what a waning hegemon should do (close markets) and a number of caveats for why we observe something else (continued opening of markets). The resurgence of protectionism brought on by the financial crisis seems to have renewed interest in systemic theories dealing with waning hegemons, but in sum protectionism is not what we have observed since US relative power began to decline, which makes me question our continued interest in the theory.
Even when hegemonic stability theory seems to hold true, it may be that we have one thing operating under the guise of another or at least in concert with it. Schonhardt-Bailey suggests that this is possible, with Peelites pushed by the changing interests of their constituents to support repeal of the Corn Laws but enable to support it until they developed the ideas (preserving the territorial constitution) to cover for it. Peelites were unwilling to abandon their Burkian model of a Member of Parliament as trustee rather than delegate despite their desire to support their constituents. Ideas mattered, but as a cover for interests. One studying ideas only would not understand the cause behind the idea of repeal to defend the territorial constitution.
The current round of protectionism seems fuelled mostly by domestic pressure to fight recession with support of domestic production. Obama talks about green energy and infrastructure jobs that can’t be outsourced, not because people are losing jobs to China, which has arguably been happening in some sectors for a long time, but because people are losing jobs, period, and this is a way of showing that the money spent will directly benefit them. Policy makers are spending heavily to get those jobs back and are concerned that the money will be directed to the right places (consider the backlash against A.I.G. bonuses), ideally to their constituents.
In systemic theory, international regimes are proposed as a substitute for hegemony, but they seem to function to make things “stickier” or enhance the lag already posited. Regimes are a placeholder. Keohane’s book is After Hegemony, not before or instead. With the G-20 summit, however, we see a waning hegemon actively promoting an institution, spearheading a new commitment to economic cooperation and permanently expanding the G-7 to 20 for further negotiations (see http://dealbook.blogs.nytimes.com/2009/09/25/group-of-20-agrees-on-far-tighter-financial-rules/). This last point is interesting because the US seems willing to limit its power in an international institution by including more voices, with disparate interests. Is the US motivated by maintaining relative power as a waning hegemon or is it interested in maintaining its leadership role in a changing world, despite its waning power? In all, it seems that less systemic theories are needed to explain the complicated world we observe. Ideas and interests, often conflated as Keynes argues, play too large a role to ignore.
A further consideration, it may be that the active participation of a hegemon is important for the functioning of international regimes. China, predicted at some point this century to surpass the size of the US economy, presents an alternative development model for the world. As China becomes more powerful, it is unclear whether it will seek an expanded role in current international institutions such as the G-20 and IMF or establish a unique ideological and geographical sphere of influence. If China, or any other rising state, does not wish to assume leadership in these regimes, they will be weakened. Multipolarity may lesson the importance of institutions, destroying the notion of an “international community.” This is a key prediction of the National Intelligence Council (Global Trends 2025), suggesting that hegemony plays an underlying role in international cooperation.
I have to disagree with the statements of Jason, Will and Chalene, that HST tells us the U.S. should close certain or all markets because they are no longer profitable or to maintain its hegemonic status. HST predicts that a hegemon will have a reduced interest in openness not because of a declining or negative economic benefit, but because of a declining political benefit. A hegemon has an interest in openness because it gives it political power over smaller states. As the U.S. loses its hegemonic status, openness has at least as great an economic benefit to the U.S. as it did before, but the political benefits of openness are less. On the whole however, the U.S. should still want free trade as there are modest economic benefits (as always) and the threat of closure is not so great (the U.S. is a large state with a large domestic market). Openness is not a political threat to the U.S. (and probably still enhances our political power in our negotiations with small-medium size states) and it is always at least modestly economically advantageous.
Closing markets while you are still the hegemon might maintain your hegemonic status, but you would have a great loss of economic benefits and of political power. You might hurt other’s economies more than your own, but you would become dramatically poorer in absolute terms completely ruining your own economy. Having already exercised your threat of closure, you no longer have an economic threat to use as leverage over smaller states. HST just says that as you lose your hegemonic status, you have a reduced political benefit of openness, although modest economic benefits remain.
The real threat of closure as the hegemon (the U.S) declines is from states which had previously submitted to the political authority of the U.S. in exchange for the economic benefits of free trade may no longer be willing to do so. We may also decide the political costs of openness are too high. But the economic benefit of free trade is no less than it was in 1950 for the U.S. The economic benefit of free trade is GREATER than ever before, as trade is a larger share of GDP than ever before. This is the standard of economic benefit Krasner uses.
I have been doing some (moderately) fruitful thinking on the relationship between currency reserves, trans-national markets, and ER. The case of Mexico is particularly illustrative. In the early 1990s, liberalization of trade and capital flows opened the country to the outside world; the potential for foreign investment was now huge, increasing something like 400%. American investors found they could borrow money in the US for around 4% and turn it around in Mexico for a rates of return running between 8 and 20%. This boom has all the ingredients for the logical bust. There were two precipitating factors: firstly, the social unrest caused by the rapid liberalization policies fomented rebellion in Chiapas, scaring off investors, and secondly interest rates increased in the US. Herd mentality breaks out and it becomes a race to the exit. As Mexicans and Americans alike sold off their pesos, the Mexican government had two options: allow the value of the peso to drop or buy up the excess pesos with dollar reserves. When reserves went dry, they were forced to abandon the ER peg and the economy crashed.
What makes this story particularly interesting, however, is the fact of lessons not learned. American citizens had a huge vested interest in their Mexican investments, and in order to not lose all their holdings, President Clinton committed some $20 billion as part of a larger $52 billion aid package. While it had the intended recitative effect, it dulled investors to an important fact: capital investment is a dangerous game and there will not always be some benevolent force to bail you out. A precedent for moral hazard is set and the game is played again only three years later, this time for much higher stakes, with the 1997 economic crash.
A second important point which i will briefly make is the relationship between trade liberalization and social stability. There were many factors leading to the uprisings in Chiapas, with trade liberalization being central. In the simplest of models, here is an example of trade liberalization undermining the benefits of capital flow liberalization.
I found an interesting and timely article in the New York Times today that I thought tied in nicely to our discussion of America’s waning economic power:
For better or worse, I’ve decided to wade into the melee regarding the economic implications of waning American hegemony; to me this is not only the most interesting topic of discussion, but it allows us to tie in several relevant readings from the course.
To begin with, there is little doubt that in recent years we have witnessed what Fareed Zakaria has called “the rise of the rest”, wherein the economic ascendancy of China, India, and Brazil, among others, have borne a considerable impact upon power distribution in our world. In short, Jason is correct to point out that the world appears to be undertaking a transition from unipolarity to multipolarity in the realm of economic leverage.
However, I have to disagree with the notion that American hegemony might be ‘frozen’ in place through the active closure of markets. Hegemony exists within a context of interstate competition; the situation of complete ‘lockdown’ described by Jason isolates America from global interaction, utterly obliterating the very economic channels through which it was previously able to exercise its ‘hegemonic’ leverage. American policymakers cannot simply wish away the changing global context; they are well aware that American hegemony thrived in accordance with a particular systemic arrangement, one that was founded upon openness and economic interdependence.
Rather than simply abandoning the global stage, American policymakers will have to adapt to a world of economic multipolarity; this may result in the closure of SOME markets in favor of protectionism, but hardly ALL. It can be taken as a general rule of thumb that “states want it both ways: they want to benefit from open markets, and indeed to participate in helping to create them, but they also want to avoid the losses” (Greico and Ikenberry, 95). With this in mind, it can be argued that as our world swings towards economic multipolarity, we can anticipate (and are perhaps already witnessing) an increase in the volume of protectionist measures. After all, as observed by Krasner, “let us consider a system composed of a few very large, but unequally developed states. Such a distribution of potential economic power is likely to lead to a closed structure” (Krasner, 22).
That being said, scholars like Joseph Nye have reminded us that power and hegemony are concepts riddled with nuance. Although America’s economic hegemony may be decreasing, it remains an undisputed military hegemon, and American soft power is also unrivalled. While this may change with time, it also may not – it is unclear what hegemon will emerge in America’s stead. In other words, the world may be drifting towards economic multipolarity, but if America can retain its power in other important spheres, while mitigating its economic decline, it is likely to remain the global leader in the near future.
Moreover, it is worth noting that although American economic hegemony may be on the wane – the game is not up: “by maintaining its technological lead and continually developing new industries… a very large state [can] escape the consequences of an entirely open economic system” (Krasner, 22). The American capacity for innovation and rebirth is well known. However, a hegemon must divert a significant portion of its resources towards sustaining its global influence. For this reason, as stated by Kindleberger, “the leading state must be able to resist domestic pressures to look out for its citizens’ own interests” (Greico and Ikenberry, 112). It remains a question as to whether or not the American government will be able to avoid falling into the trap of domestic over-expenditure on welfare programs, particularly with the possibility of universal healthcare on the horizon. In the same breath, the recent public backlash against the ‘greed’ of Wall St must be channeled towards productive ends, rather than permitting misdirected regulation to stifle innovation (ie. Tobin taxes).
Nick, that was much more eloquently put and well supported than in my post 21. I think your quotes of G&I 95 and Krasner 22 (multiple large states leads to closed system) are extremely important to this discussion. It is important to remember that the U.S. still benefits economically from free trade and it is a political advantage in our negotiations with other countries as well (although this political advantage has declined slightly).
In addition I would point out G&I 113: “British power peaked in the 1870s, and in the decades that followed European countries and the United States moved away from free trade. The correlation was not tight or absolute: there was some revival of trade in the decades before WWI and the UK itself remained committed to open trade, …. But its capacities to manage the system and ensure openness had diminished by the turn of the century and the system ultimately reflected this shift.”
The UK still had an interest in free trade economically and politically after the 1870s.. but free trade declined because the U.S. and Europe were less willing to subordinate themselves in dependent relationships with the UK. Likewise, the U.S. still benefits from free trade agreements economically (GROWTH) and politically (making other countries dependent on us) but our ability to convince other countries into these relationships may decline. As I said in my post, at least according to Krasner and HST, the threat to free trade comes from states which may not be willing to submit to our politics anymore. Thus far openness has not declined, and if the institutional effects discussed by Keohane are correct, then hopefully it never will.
While I agree with nearly everything you’ve said, I’m not sure I agree with tying the possibility of healthcare legislation to the issue of free trade. Or did you mean universal healthcare will limit American growth and hegemony and therefore affect the trade regime? If that’s the case.. that is a whole other can of worms, and I’m not sure I agree with you. I know for a fact many here will take issue, and so I don’t think you can just state it as a fact without delving into the reasons and derailing the discussion 🙂
There was some discussion in the 12:30 section as to the effect of free trade and the industrialization of Europe on the terms of trade for the poor periphery. I also found it remarkable that despite the deindustrializing and volatility caused by free trade, Williamson thought it was good for the poor-periphery. I found another article by Williamson, though I don’t think it’s the one he just sent in for publication, on the subject of terms of trade and the poor periphery.
The paper says free trade and the industrialization of Europe caused improving terms of trade for the poor periphery. If I understand it, the following is why. First of all, the terms of trade always fall between the opportunity costs of the two countries for producing particular goods. Market forces determine where in the range it falls at any time. Terms of trade change when the price of a given quantity of exports changes relative to a given quantity of imports relative to the base period. A shift within the previously defined range would cause the TOT to change, but the opportunity costs of goods may change over time causing the whole range to shift and this is the key variable over long time periods in determining TOT. The rapid productivity growth of Europe in manufacturing led to a decline in the price of their products on the international market (supply and demand). Meanwhile, it created per capita GDP growth which drove demand for imports of luxury goods like coffee, tea, sugar from the periphery driving up the prices of those goods (supply and demand again). So free trade and the industrialization of Europe caused an improvement in the terms of trade for the poor periphery by giving access to markets with an increasing demand for periphery exports, and by causing the price of manufactured goods to fall.
This is why Williamson said in his lecture something along the lines of: “While the rapid industrialization of the core may have caused some deindustrialization in the periphery they were forced to SHARE their productivity gains in the form of falling terms of trade for the core, and rising terms of trade for the periphery.”
Industrialization caused the opportunity costs of primary products in the core to rise. This caused the range of acceptable terms of trade for the core to expand towards terms they previously would not have accepted. Rising opportunity cost of primary products for core nations + increased wealth –> demand for luxury imports + falling transportation costs (improves TOT for all) = dramatically improved TOT for the periphery.
Williamson, as he did in his lecture, then uses the terms of trade boom as a predictive measure of deindustrialization and finds that improved TOT correlates with deindustrialization. There is also the deleterious effect of volatile TOT on growth.
I found it remarkable after all this that Williamson still thought free trade was good for the poor periphery. When I spoke to him about it after the lecture he said the real income gains and improved TOT outweighed the cost of deindustrialization. He suggested that the real income gains be put towards education and infrastructure. I certainly can believe this in the case of a small-medium size country which could not possibly efficiently produce a wide range of products. This would include all African nations, Latin America, the ME, and SE Asia. For those countries the real income gains caused by free trade and specialization are going to far outweigh anything else. But I wonder if the U.S., China, and India might be possible exceptions considering their large domestic markets.
There’s also the possibility of large regional trading blocs by countries with similar levels of industrialization so as to prevent deindustrialization. This would allow for some specialization based on comparative advantage and resulting real income growth, but it also wouldn’t cause total deindustrialization. But given the dependency of most of these small nations on primary product exports to core nations it might be too late anyways. Thoughts?
FYI anyone who missed the Williamson lecture and is interested, I think the above article makes most of the major points he made in the lecture
An interesting article that is relevant to our ongoing discussion on debtor and creditor countries; it focuses particularly on the American negotiating position vis-à-vis China:
I actually wanted to discuss the relationship between the US and China as well; I don’t see any new posts so I’m not sure what topic we’re on but this is an article from about a week ago about the weakening American dollar:
In discussion we’ve talked several times about the difficult position of the United States, with our huge debt to China and the possibility of the dollar losing its status as reserve currency. We talked about what would happen if China suddenly decided to sell all of the bonds it’s holding in USD. However, i think it’s also important to note the implausibility of this ever happening. If China were to do that, the value of the dollar would fall dramatically and China would lose its biggest market. Also, the article talks about the Fed policy of quantitive easing, which is when interest rates are so low that they can’t lower them anymore and instead they try to stimulate the economy by printing more money. It makes lending/borrowing more attractive and both the US and UK are using this policy right now. I’m not sure about this, but it seems like if China were to sell bonds now it would just emphasize the monetary policy that the Fed is already using by putting more USD into circulation. So what threat does the US face from its debt to China? This is a really pertinent topic for what we’re discussing in class and it’s in the news a lot so i would be interested to hear what you guys think.
Not surprisingly, as we turn to the contemporary international political economy, China is at the forefront. If Keynes’ chief concern for the postwar system was to rectify currency imbalances, then he would certainly would be disappointed in where we find ourselves today.
So where are we headed? The BusinessWeek article by LeVine offers one possible result; to me, however, he is misstating the issue somewhat. The Yuan is not, nor could it be, the next reserve currency. Short of some unforeseen cataclysm, no country will ever reach the relative power of America following WWII, nor will its currency reach the universality of the USD. I do not think China wants to be a global hegemon following in the footsteps of the US. Rather, to quote a professor of mine in India, China wants to be the powerhouse of a unipolar Asia in a multipolar world. It seems to want to balance against US/Western power (politically, militarily, and most importantly economically), yet it still appears to want to work within the international system, according to international norms. As LeVine reports, the Chinese central bank chief Zhou Xiaochuan as wanting to replace the dollar as the international reserve currency with a basket of currencies supervised by the IMF.
What could this mean? Firstly, this hypothesized reference basket would in some ways be a more liberal system than the one we currently have (that is, decentralized)–ironic, coming from one of the world’s most authoritarian regimes. Secondly, it is not necessarily a bad thing for the US. Eichengreen shows that the transition, which he demonstrates is already underway as of July 2005, must be gradual. The Yuan must be made convertible, the ER must float, capital controls must be liberalized, all slow processes. China will not suddenly choose to dump its US debt; we do, in a matter of speaking, own the bank. Yet, if there is an inevitable transition away from the USD as the single reserve currency, America will be forced to pursue a much higher degree of fiscal responsibility.
Lastly, not to belabor the point, this transition means an evolution in the shape of the international political economy. Global governance has, and will continue to change; so must the global trade and monetary system. It will mean a decline in the relative power of the US but if approached correctly, this relative decline does not have to be an absolute fall.
One is just a quick question or clarification about the price-specie-flow model. This mechanism assumes that governments can ensure full convertibility and have sufficient reserves for doing so. Citizens in a country who want to buy exports buy gold with their domestic currency (contracting money supply) and exchange it for foreign currency for foreign goods. People abroad exchange their currency with their central banks for gold, and bring the gold to this country’s central bank, and exchange it for domestic currency. If the government has sufficiently deep reserves to satisfy all demand, eventually a strongly positive trade balance would have much of the domestic currency changed to gold, shipped abroad, which will lower prices and cause exports to increase, etc. etc. So, the price-specie flow depends upon governments have reserves of gold that are sufficiently large so that they can hold out until change in global price levels cause the trade balance to equilibrate and their gold reserves to fill out again. Is this correct?
The other is partly a reply to Logan that throws up a few confusing but interesting questions. The notion of “value” is very interesting in that it depends on which frame of reference we are using and differs accordingly. For example, we talked today about the ideal intnl monetary system that Keynes wanted that would have a powerful IMF strong-arming creditor nations with huge reserves to lending to debtor nations. In this way, nations can have autonomy to affect price levels, exchange rate instability would be minimized, and free trade would prevail, while capital controls would be in place to help control those discrepancies in reserves. The question of what rates the IMF would compel the nations to lend at, however, seems to be highly contentious, even if it was close to market rates, since depending on circumstances a supply of necessary funds can have very different valuations, as seen by the current crisis. The problem is that all carriers of value, like goods, services, assets, money, gold, have no clear objective value; the point of the free market is to assign values to all these carriers through the interaction of market forces. In any situation where no clear market exists, or the rules, context and conditions of the market situation are politically, or arbitrarily defined, or basically decided by a non-market based approach (i.e. no market exists for deciding how markets are structured, and so on and so forth – market in a more abstract sense of the term), then it is difficult to say what certain “carriers” are worth or even to decide obligations, strategies or issues of fairness, or even to get a right sense of scale or possible risks. So, with regards to the huge reserves China has from the US, the odd question is how the Chinese are keeping up the value of their holdings precisely by maintaining their demand and managing expectations.
It is perhaps dubious to use the market price, which occurs at the margins over transactions between some buyers and sellers, to value goods, though we lack any other measure. I.e., it doesn’t quite make sense to value all the rice in your mill by multiplying current market price by the units you possess, especially if you have 30% of total stock, and have other considerations to selling your stock including global stability and also the falling price you would certainly get if you were to release too much stock at once. As it were, prices are determined by a present market frame, but true “value” seems to come from a consideration of possible actions, their probabilities, their interactions, and the different frames that would therefore come about. This gets complicated because it comes down to more complex interactions between the decisions of different entities and could have drastically different values depending on how things turn. Any policy might be much more “value-enhancing” than felt by current conditions, only by considering the much worse frame it might have helped avoid, which it is difficult to ascertain considering that the event didn’t happen.
A good example of this is how we look at the lack of an upper limit for countries to accumulate reserves. If there is excess demand for a country’s goods, the country, rather than let prices rise, can increase money supply or increase domestic currency available to exchange for foreign currency, and thus increase foreign reserves. It seems to me that if we simplify our analysis and see countries not investing those reserves, then all the states really are doing is storing up “inflation” or “excess demand” (which also seems to have redistributional effects because the government accumulates vs. the people) or “purchasing power”, and the value of those reserves, in turn, depend on factors like how necessary they are in crisis situations, to maintain political stability, prices in the future, future ERs, etc, etc, in contrast to its current “visible” value by taking into account current ERs and price levels.
A bit long, got carried away.
Yes, I think you have price-specie-flow right in broad terms. When Hume developed the theory of PSF in the 1750s, the bulk of currency in Britain still took the form of specie. So, then it was generally just a matter of either melting the coins for export. Thus, as a practical matter, states wouldn’t need reserves in such conditions since the currency itself was composed of the material needed for export. With specie, one can avoid the domestic monetary authority entirely.
The increasing use of tokens and notes changed things. To get gold or silver at the official rate (rather than the market rate), currency had to be taken into the central bank and exchanged. There currency which was “convertible” would then be exchanged for whatever was backing it (gold, silver, foreign currency, &c.). In that case, the monetary authority would then need reserves to maintain convertibility.
Does that answer your question?
Here is a very fundamental and simple theory of International Macroeconomics that I just re-discovered.
Why does a high inflation rate lead to a real exchange rate appreciation? How does it lead to a sharp depreciation in domestic currency?
Let me try to explain this. When prices increase in a domestic economy, two things would happen: people would start importing more because the imports would be relatively cheaper, and exports would decrease.
When the domestic price level falls, the real exchange rate will increase. This means that the domestic currency has experienced a depreciation. (With the original sum of money, you can buy less with it.)
From the screening of Niall Ferguson’s “The Ascent of Money” on Tuesday night, it got me thinking about some things.
This Chimerica (China & America) dynamic was perceived as a win-win situation for both parties. China could ride on its fabulous export-led growth sustained largely by America’s spending while American firms like Walmart could profit from low Chinese labor costs. This set into motion another reinforcing wave- China was determined to keep its export-led growth so it was willing to lend money to the US by continuing to buy her bonds. Thus the US Treasury was kept happy as her large lender- China, allowed her to keep interest rates low. As a result of this China-American interaction, there was an onset of new bank loans, derivatives and other financial assets which swept the world after 2000.
This gave the US added confidence to encourage more sub-prime loans. Thus I found it interesting that Sino-US trade in goods, services and financial assets played a role in contributing to the 2008 global recession which saw the collapse of Lehman Brothers, Bear Steins and Merril Lynch.
It made me realize that it is still better to pursue a cautionary or conservative approach towards balance of payments because tilting too much in one direction will have drastic ramifications in the long term, if not now.
In response to Logan’s question about the risk that the US faces if China were to start selling treasury bonds, the biggest risk is inflation getting out of control. To print money as an economic stimulus is to walk a very fine line. While the United States obviously wouldn’t be printing money on the same scale as Germany following WWI, printing any amount of money will devalue all of the currency in circulation. I would assume that the Fed has this under control, and the amount that they’re printing probably isn’t enough to cause a serious jump in the inflation rate. But add sales of Treasury bonds by China, and suddenly there are many more USD in circulation than the Fed is comfortable with, and inflation rates could easily jump much higher. Furthermore, I believe that if China were even to stop buying Treasury bonds, let alone selling them, it would cause severe inflation. I think that one of the reasons that printing money is a viable option right now is because the US still has creditors lined up and willing to buy our debt. Were this not the case, we would never be able to implement the economic stimulus plan that is currently in place without facing massive inflation. Simply put, if China were to start selling more Treasury bonds than it is buying, our economy could quickly crumble due to severe inflation.
Off topic, but I’m curious about the explanation of the abandonment of the “New Gold Standard.” We’re offered four explanations of why countries abandoned gold (no leadership, collapse international norms, democracy, and bad luck), and eventually told that they can all be combined for form one rich explanation. While perhaps this is true, it leaves me feeling a little dissatisfied because although it certainly explains why states abandoned gold, it is only because we’ve thrown every possible theory at it.
But I think you can make a pretty good case for a lack of US leadership being the main cause of the failure of the New Gold Standard. First, the “empowered populace” seems pretty unpersuasive. Sure democracy is great, but how much does the populace understand that it’s the fault of the gold standard? And even if the poor are upset, won’t politicians still cater to the capitalists that are contributing to their campaigns? Second, it seems like a stabilizing US could alleviated the problems of cooperation and that stability would have made it less likely that markets would bet against banks. Finally, although bad luck might have exposed the problems of the New Gold Standard in the future, it still seems like US leadership could have kept the NGS around for longer than it actually did. If the US took leadership and provided the needed liquidity, it solves Keynes’ bad luck problem of… a lack of liquidity. And I’d imagine that there was still enough gold around to keep the supply expanding for quite some time. In the words of Will Higgins, “Thoughts?”
We’ve said this before, but the severe depreciation of the dollar if China were to unload its reserves and Treasury bonds would damage not only the US economy but the Chinese economy, which is dependent on the United States’ appetite for its exports. China benefits by devaluing its own currency, not the dollar. This suggests that China is unlikely to make drastic moves to unload its dollars. Drastic moves are not in China’s interest, but it is difficult to imagine how China could sell any of its dollars, even a relatively small portion, without causing inflation and thus decreasing the value of its assets.
Loans make printing money and government spending possible because the US does not need to print extra money out of the air but simply return money, previously in Chinese reserves, to domestic circulation. Right?
Clearly it’s not this simple and risk free. The issue of fighting the financial crisis and inflation is taken up by Paul Krugman in his article on gold standard mentalities (see IPE homepage). He argues for prioritizing the need to maintain liquidity and access to credit above fighting inflation, arguing that government should be doing more not less to fight the recession. He illustrates this point by showing how raising interest rates in the Great Depression in an attempt to prevent price increases was disastrous and misguided. His argument is well taken, but the relationship of access to credit (maintained by low interest rates) and the current crisis is not fully explored. Although most recently the problem was a credit crunch, with banks requiring huge bailouts, this was precipitated by a crisis of easy credit – the lending of mortgages to individuals who could not repay them. Going forward, is the policy needed to end the recession the same as should be implemented in the long run? Or by continuing to maintain lines of easy credit do we risk a future crisis?
Wow, I realize the strong interest on, as Chalene put it, “Chimerica”–China Vs U.S. I agree that this is significant…but one aspect that I think is absent so far on the discussion is the importance of China’s growing hegemonic influence in Africa (a continent with vast untapped natural resources) and the implication for both countries.
The BusinessWeek article we read this week on “China’s Yuan: The Next Reserve Currency?” is insightful and timely. So is the answer to this question affirmative? Well, I don’t know. But here are things to get us thinking:
Trade between China and Africa has quadrupled and the former is stepping up its export (mainly textiles) into the continent. Increasing Chinese investment in energy, infrastructure etc. is felt across the continent from the shores of West Africa to the horn of Africa. Such partnership between Africa and China might be meaningful and less suspicious because there is no experience of colonization between the two…
Given these trends, it is theoretically possible for Africa to replace the U.S. as China’s largest importer, and eventually the continent may adopt the yuan as its reserve currency. Depending on the relative size of the entire economy of Africa (which I don’t know) to that of the U.S., the latter will no longer be able to share the “same bed” with China (refer to the article on “China & America, The Odd Couple” posted by Nick). Instead, China will get married to Africa and obtain a new bed to share with the continent. This is simply because China’s economy will be less dependent on the U.S…(ceteris paribus). And U.S. policies will then have little impact on the chinese economy
So James, don’t you think your statement “The Yuan is not, nor could it be, the next reserve currency.” is a very strong one? I think that’s an oversimplification… Yes, you are right to say that China might not be interested in becoming the “global hegemon following in the footsteps of the US”. And you are equally right (by citing Levine) about the possibility of using a basket of currencies supervised by the IMF…voila! talking about IMF rings the bell of politics. As we’ve been studying for the last couple of weeks it would be naïve to ignore the effects of politics on economic outcomes…
So how about china en politics?
As far as I know, China neither seeks to export its political ideology nor meddle with the internal politics of African states and others, yet it is seeking political influence in the international arena. One proof: Taiwan is only recognized by 5 out of over 50 nations in Africa source: http://www.heritage.org/research/africa/HL1006.CFM. Bear in mind that Africa forms about 1/4th of the U.N. General assembly…think about that for a moment. What if China manages to secure all or most of the African votes (+some of Latin America) in policy making at the U.N.? then China will be the bread winner of the system, influencing policies in IMF, WHO etc. on its favor. So James, that sounds to me like a viable approach to becoming “the power house” of a “multi-polar” world while maintaining the reserve currency….
Having said that, China’s position towards Africa is not as black and white as one may think…There are many criticisms mounted against china’s approach. Some believe it’s a new wave of neo-colonialism propping up corrupt regimes etc. Moreover, china’s cheap export (mainly textiles) to the continent undermines the competitiveness of local industries etc…oh, plus its outward growth orientation (and many other caveats) might prove disastrous, just as we learned about the experience of GREAT Britain…
ok summary: China is making huge economic progress and gaining political influence in the international system. That is good. But everything is not as rosy as we might think…
In my humble opinion, I think China is ahead of the race.
The Chimerican beast needs to be tamed.
I feel like China buying American debt and America spending kind of uncontrollably (given our NEGATIVE savings last year), is like a huge elephant in a small room…and of course, no one is saying anything. Thankfully, the Stiglitz article gave a brief and notable mention to the IMF for all of their soft power initiatives against the US and China who are clearly on the verge of sending the rest of the world into economic chaos (again).
I also think it is worth discussing what might happen if this viscous cycle is allowed to continue. Without having any economic background, it is near unfathomable to think of the US dollar, in this day and age, as a secondary trading currency. Yet, after reading those articles it really only seems like a matter of time. It worries me to think of the implications of the Yuan (or some combination of currencies) becoming the reserve currenc[ies] of choice, not just in terms of the future of the American economy, but in terms what that would say about American hegemony—pretty scary in my opinion. I think that while we should not expect to see total abandonment of US dollars anytime soon, we should expect for China to begin lowering their reserves (which they have already begun doing apparently), but for security reasons as well as economic reasons. Maybe it is my American naivete that is saying, “that’s not going to happen,”…but we are such an integral part of the world economy that if we were no longer a big player, that would have repercussions not isolated solely to economics, and I really do not see the benefit in that for anyone in the world.
So I’ve been very interested in what the future of the international monetary system is going to look like. We’ve talked quite a bit in class “Chimerica,” but my interest lies more along the lines of how real the decline of the dollar is as the world’s reserve currency and what, if anything, could or should replace it. I found an article on the IMF’s website written this September by, of all people, Jerry Cohen:
His contention, which I find very compelling, is that serving as the world’s Nth currency is not only a question of economic capacity, but also takes into consideration some serious political issues such as “the quality of governance in a currency’s home economy and the nature of relationships between states. Is the issuer of a currency capable of ensuring political stability at home? Can it project power abroad? Does it enjoy strong intergovernmental ties—perhaps a traditional patron-client linkage or a formal military alliance?”
In this light, it would seem that the Yuan is not a ready adversary to the dollar. China’s political situation at home is often less than stable, despite the image of unity and homogeneity projected by Beijing. Not to mention the huge array of capital controls we have discussed in class that already exist in China and the the fact that China’s financial system is “underdeveloped” according to Cohen. As many of the readings we’ve discussed mention, China does indeed have the capacity, but its policy and governance structure is not set up to serve as the world’s Nth currency. Over time of course, policies can change and governance institutions can be re-designed.
The Euro, also, doesn’t seem to have the ability to challenge the dollar because it exists purely as an artificial construct and is only as strong as the individual countries that comprise it allow it be. Not to mention that Europe doesn’t have the political power to match the United States.
Cohen concludes this article with something very interesting–he talks about a more fragmented global monetary system. We’ve seen this paralleled in trade with the rise of regional trading blocs such as the EU and NAFTA, and indeed, it appears that money might follow suit as a recognition of those trading preferences.
I thought it would be interesting to talk about Obama’s recovery plan and its effects on the currency market, especially because it shows how domestic conditions in the U.S. might have international repercussions.
The massive government spending that is being channeled to spur economic growth in the U.S. seems to be exposing the entire world to variations in the currency market that might have a negative collateral effect on the economic policies of other states. http://www.lemonde.fr/cgi-bin/ACHATS/acheter.cgi?offre=ARCHIVES&type_item=ART_ARCH_30J&objet_id=1101933. The devaluation of the dollar has been drastic. Since March 2009, the dollar has lost 15% of exchange rate value, even if the Fed and the Treasury have been reassuring the public about the need for a strong dollar.
If the dollar were not the main kind of commercial exchange currency and the main kind of reserve currency, Obama’s recovery plan and its concomitant massive government spending would not elicit anybody’s attention. However, that is not the case, and every country in the world depends on this currency. Therefore, as the value of the dollar decreases, people will want to sell their dollars and invest in a more lucrative currency. This cycle of capital flows is what seems to be reinforcing the depreciation of the dollar.
As a depreciated dollar implies more exports, but less imports from outside the U.S, other countries or regions (i.e. Lain America) who depend on the U.S. market for their export-competing industries, the fall of the dollar might have a problematic effect on their growth, as demand for imported goods will gradually decline if this trend persists.
Ok I just wanted to hammer out some of the details of this discussion on the imbalances between China and America and make sure we’re all getting the details right. I want to go through point by point to make sure we’re getting the mechanisms right.
Logan starts it off by arguing we shouldn’t fear a run on the dollar because China would never try to sell its bonds (of which it has over 1T). I agree with this argument, but I disagree with the argument that “China selling its bonds would help the Fed’s process of QE.” If china sells its treasury holdings, then it has to find a buyer of these USD assets. Thus there is no net change in the amount of USD in circulation. Although, it would cause devaluation of the USD leading to inflation eventually, if China sells its USD holdings to another country, or even to domestic investors, this doesn’t increase the amount of money circulating in the domestic market. It just raises interest rates and causes a devaluation of the USD. China selling its assets would work against the Fed’s QE by lowering the demand for treasury bonds. The point of QE isn’t devaluation of the currency, it’s to get lending going by increasing bank reserves. The Fed would have to step in and buy even more. It would pose an especially interesting problem because almost all of the Fed’s balance sheet is in short term bonds. Only 300 billion of the Fed’s 2T+ balance sheet is in long term T notes. Meanwhile almost all of (until recently 100%) of China’s assets are in long term treasury bonds. So while the Fed usually buys short-term, China would be selling long-term, and the Fed would probably have to take the extraordinary step of buying even more than the original 300B of long-term notes. The Fed finished up buying the 300B of long-term bonds (which they announced the middle of March) during the auction of 7-yr notes just the other day, and I don’t think they intend to buy any more long term bonds.
So short story: China selling its bonds would work against the Fed’s QE. And I agree given the tight control they maintain over investment, they’re not going to allow a panic on the USD by selling their assets.
Chalene brings up the theory from the Ascent of Money that Chinese buying of US treasuries kept interest rates low –> bank lending confidence –> sub-prime crisis. I’m curious about this. Even if low interest rates caused the crisis, wouldn’t the Fed have just used market operations to keep the target interest rate low? If that’s the case (is it?) then the problem was simply too low of a target interest rate which is Greenspan’s fault. However, I’m not convinced of this either. Yes low interest rates lead to more lending. But even if there were high interest rates, banks could still lend billions to people/groups that couldn’t pay it back. So I think it has more to do with the type of lending that was taking place, and the fact that firms had over-leveraged which magnified the fall when sub-prime burst. Low interest rates don’t necessarily lead to either with the right restrictions in place. Here are a few problems I would suggest instead of low interest rates:
1. Bundling of assets. Mortgages were bundled and then sold repeatedly between institutions and investors until what the bundle actually contained and an assessment of the risks was no longer possible.
2. Credit Default Swaps. Allowed banks to realize overnight returns on risky assets but do not account for systemic risk. AIG fails, they can’t fulfill their CDS obligations.
3. Overleveraging. I think we read a piece or two on this earlier in the semester. We had a particularly heightened business cycle where people did not make accurate risk assessments because everything seemed to just keep going up and up and up. If the Fed counted assets (think exploding home prices) in their calculation of inflation they would have seen much higher inflation rates and realized the business cycle was exploding. The IMF has recommended (ignored) asset prices (particularly homes) be factored into inflation equations.
Perhaps raising interest rates in 2005 or so would have helped cut short the business cycle and prevented overleveraging making the downfall easier. However, that doesn’t solve 1&2 and we haven’t done the necessary steps to solve them yet either. But I’m not sure why if 1&2 are solved low interest rates would be much of a problem. Thoughts?
Will suggests that China selling its assets would lead to inflation because it would put more USD in circulation. I agree it would lead to inflation but is this the right mechanism? I have been trying to figure this one out and I can’t figure it out but this is what I’ve come up with: If China sells its USD assets they have to find a buyer. So someone else takes the asset. There’s still the same amount of USD in circulation. There is less demand for dollars now yes. This causes a devaluation of the dollar. But there’s no more USD in circulation in the U.S. economy. China just sold its asset to someone else (at a loss presumably because they had to sell it cheap to get a buyer, raising the yield on the bond). So it just causes a devaluation of the dollar and high interest rates. It becomes harder for the U.S. to finance its debt, so it has to intentionally print money to make debt payment easier and cause inflation.
So the mechanism isn’t China sells assets —> more USD in circulation —> inflation. It’s China sells assets —> U.S. can’t finance debt —> Fed prints money —> inflation. Correct?
Also, I don’t think we can take for granted that the Fed has made sure not to print so much money that there will be inflation. (“I would assume that the Fed has this under control, and the amount that they’re printing probably isn’t enough to cause a serious jump in the inflation rate.”)
IMO The Fed faced an unprecedented disaster and took unprecedented steps the consequences of which are not known. They printed an unthinkable amount of money. They more than doubled the monetary base (M0) from less than 1T to over 2T in less than a year. It took the entire course of the Fed’s history to reach 1T on the balance sheet, now we just jumped to 2T. Personally, I don’t think this is destined to cause inflation but others disagree (note the tripling in gold prices the last year) and I don’t think it’s a safe assumption that the Fed has this under control.
Also Alhaji was speculating African GDP might be enough to become China’s second largest trading partner. I couldn’t find numbers for Chinese imports/exports from Africa as a whole but I did find Africa’s total GDP to be 2.5 T, which even if they maintained very close trade relations with China, I don’t think would be enough to approach the U.S. with GDP at nearly 14T.
Ok. I’m jumping into a very long and mixed debate, so I apologize if what I have to said has already been stated. You guys all have very interesting thoughts, but it’s a lot of material to sort through.
Alhaji, I think that you were right to explore the possibility of China’s currency becoming a reserve for foreign countries and I appreciate your focus on Africa. I think that previously (for example, in the somewhat dated articles we read for class) the ability of the yuan to become a reserve currency was prohibited by capital controls. The lack of yuan-dominated bonds and the difficulty in holding yuan abroad made it impossible. But now that’s starting to change:
This article, however, serves to reinforce the idea circulated in this discussion that the Chinese seek to achieve regional hegemony and do not have any aspirations (yet) of world domination. I feel like all of this is getting increasingly like 1984 with gigantic world blocs.
Recently I’ve been thinking about what the downside of China’s position is. For me, it seems too good to be true: they are amassing huge reserves while stimulating their economy. I can criticize the lack of domestic demand developed, but since the Chinese are excellent savers, a crash in domestic prices might induce a lot of money into the market. If the US stopped cold turkey buying Chinese goods, the result would be catastrophic, but domestic savings might be able to save them (whereas from our side, the lack of Chinese goods would only hike up prices for us… and we already don’t have enough money to buy what we do). The problem is (and I would love feedback on this) is that I think the Chinese are running themselves into a hole. They have so many reserves that I don’t think that they will ever be able to feasibly do anything with them. If in desperation they wanted to cash their US dollars in, they would destroy the value of the dollar and, in doing so, the value of their reserves. And I don’t see them being able to see the reserves off slowly either, seeing as changing the system would destroy their export-market. They could create a ton of trouble for the United States and destroy its currency, but eventually we would recover, and they would have lost the one threat they had. It’s a one-time game and once they do it, it’s over. They’ll be left with nothing.
I suppose our main worry would be that the Chinese would stop needing us before we stop needing them. If they “get in bed” with Africa as Alhaji suggests as a possibility or turn to Asia primarily, we’re out of luck. No longer will we be able to fund our debt and we will finally have to find solvency. Having the dollar as the nth currency has allowed our domestic government to do whatever they want (most countries don’t have the freedom we do to run budget deficits) and I think that American life would drastically change–but then again I think it needs to. I am not a proponent of eternal debt accumulation, so maybe the Chinese moving on would bring on tough, but necessary change.
I often wonder at that question Jason, what’s the point of having all those reserves if you can’t ever do anything with them. This is the answer I’ve come up with, tell me what you think. They don’t need to ever do anything with them, they’ve already done what they wanted with them: grow their economy massively by making their exports cheap via devaluation of their currency.
It’s a long-term strategy. In the short term, you lose out on standard of living gains. But if your export sector and entire economy keeps on growing 10% a year it doesn’t matter. Plus it gives added stability for you. You can change exchange rates and domestic prices however you want, reducing risk in the market, which is good for growth.
If China’s reserves suddenly dissapeared, would we say their economic policy the past 20 years has been a failure? No they grew rapidly by fueling world consumption of their goods. It isn’t actually having the reserves that is good, it’s the process of acquiring them that has been good. Plus actually having the reserves has some benefits too even if you never “cash in.” You may get some leverage over the nation’s whose currency you hold. Especially if your economy eventually becomes larger. And you get to use them to maintain market stability.
What do you think? Am I missing something? One thing that doesn’t fit with this is China’s complaints about USD devaluation. What do they care? They already accomplished what they wanted: massive export led growth. But perhaps they want to appreciate their currency on their terms, not the U.S.’s and maybe they’re not quite ready for that.
The Economist articles provided by Nick were an excellent supplement to our recent conversation regarding the rising power of the yuan and its chances of overtaking the USD as the international reserve currency. That journal is clearly of the opinion that the current status of the dollar is secure for the time being and that unwarranted US fears of Chinese economic muscle-flexing may result in overly harsh, deleterious protectionism while simultaneously detracting attention from important political and human rights issues. While the article addresses a number of factors limiting China’s economic preponderance in the near future, (social and political unrest at home, flagging technological innovation, and the shrinking – albeit slowly? – trade imbalance, to name a few) its primary argument (the one advocated by many in the class as well) seems to rely on the belief that releasing USD into the international economy would be a catastrophic and mutually destructive economic policy. Jesse comments on this, noting that the consequent decrease in US consumption would certainly damage Chinese export-driven economy. As well, since China holds $800 b of American debt (the Business Week article asserts that “Beijing holds $2 trillion in dollar assets), is it not also the case that if the USD collapses (via dollar dumping or speculation of dollar dumping), then China will lose out on close to $800 billion?
Though these arguments strongly support the notion that the USD will tentatively remain dominant as the Nth currency, it seems to me important to acknowledge the unenviable position in which the debt-ridden US finds itself. As Alhaji claims, citing increased Chinese trade with African Nations, it is possible that the current US role as the principle importer of Chinese goods and services may not remain unchallenged. His argument is bolstered by LeVine note of the bilateral arrangements between China and several other countries in April that bypassed the dollar as an intermediary currency. As the yuan seeps into foreign markets and economic deals, the need for the USD as a global medium of exchange will be inevitably diminished and its significance to Chinese trade and financial reserves will decline. Irrefutably, the dollar is buoyed by its free convertibility and the strong market for USD-bonds, two difficult, but necessary currency features that China would have to adopt in order to actually promote the yuan as the international Nth currency. LeVine summarizes the sentiments of skeptics: “The dollar is too entrenched as the international currency of choice,” the US is “by far the world’s largest economy,” and “the Chinese act so deliberately… they wouldn’t [elevate the yuan] in the short or immediate term.” That said, with such considerable debt in the hands of so powerful an economic rival, it seems foolhardy and presumptuous to neglect the real possibility that the dollar may not long remain the international reserve currency.
I mean think of it this way, the Chinese hold 1T+ in USD, but they hold a whole lot more than that in their own currency. If the USD devalues vs the Yuan, they lose out on their 1T assets in USD. But the real value of their tens of Trillions in Yuan increases. So at some point when they decide to stop using an export led growth strategy, they are going to want their currency to appreciate and they’re not going to care if that means their 1T in USD devalues dramatically because they hold many more Yuan than USD. So I’m guessing they’re just not ready to do that?
I think what’s really missing from this debate is the political aspect of China’s rise to power. Time and time again we have seen that China does not necessarily do what’s best economically because they are driven by an overpowering strong political ideology. Although the human rights situation in China has greatly improved, the authoritarian government today holds and tortures several thousand political prisoners from Tibet and violates human rights law. China has always been an aggressive and oppressive nation. Ever since China’s army opened fire on peaceful, pro-democratic protesters in Tiananmen Square, the Communist Party has had an unspoken pact with the Chinese people – they are allowed to have economic freedom as long as they give up their political freedom. Can a state be considered a potentially powerful economic power when their government holds political power through fear and threats? No, because stability on both ends needs to be achieved.
There is so much talk about China growing economically that we forget China is a very poor nation. There are regions in China where people live off of less than $3 a day, the cost of a smoothie at the grille. I remember reading something along the lines of “we should be careful because in the future we might need China more then they will need us and then we’ll be screwed”. I think this does not capture the picture accurately because China’s economy is so dependant on us that hurting us will only hurt them. China has yet again another unspoken pact, this time with the U.S. – we’ll purchase U.S. treasury bonds with the money we receive from exports in order to keep the dollar strong. Our economies are so intertwined that we will always need each other. However, according to the article, China cannot do anything about the global imbalances their relationship creates and the responsibility lies with the U.S. Each nation will continue to do what works for them until they not only feel the pressures from the outside but actually feel the economic strain within.
The Economist article I posted earlier only scratches at the surface of the China v. America or Yuan v. Dollar debate. For those who are interested, it is worth mentioning that this week’s Economist delves into much more detail regarding the ‘Chimerica’ relationship in a 14-page special report on the subject: http://www.economist.com/specialreports/displaystory.cfm?story_id=14678579.
There is little doubt that China is flexing its economic muscles; “in September it bought $50 billion in IMF bonds to boost its influence in the institution and strengthen the role of non-dollar currencies” (5, Economist). In the same breath, Alhaji is correct to point to the fact that China is expanding its global economic importance as a trading partner in the African continent, among others – a fact that is hardly insignificant. That being said, however, China and the Yuan have a long way to go. Notably, China’s GDP in 2008 was $4.4 trillion, smaller than Japan’s, and less than a third of America’s. Not only would the collapse of the dollar deal a severe blow to China, which holds over $800 billion in US treasuries, but it is not clear that China seeks to make its currency convertible in the near future – a pre-requisite that must be implemented for the Yuan to become a global reserve currency.
On top of this, China’s recent economic successes have glossed over a maelstrom of social tensions that are simply waiting to erupt, as a rising power it remains conspicuously deficient of soft power, and its authoritarian government does not inspire fiscal confidence. However, there are real reasons for concern: China is actively expanding its hard/military power beyond necessary levels, and it is seeking to put a man on the moon – many have begun to wonder if an Asian Cold War is on the horizon. If indeed this is the case, however, we can rest easy – for the moment at least, America has the upper-hand.
I found the article you mentioned interesting, but I thought it made some pretty drastic possible predictions.
I think it’s interesting how this article looks to so many parallels between our situation with China and the Cold War with Russia. While historical analogies can be useful, they can also be dangerous. I think looking for comparisons between the two situations isn’t the most applicable now because of how different they are. Despite China’s growing military, I don’t think the military force side of the Cold War is likely to be reflected, and I just cannot imagine our economies cutting ties.
Some of the key elements of the Cold War are missing in today’s relationship with China. While the Chinese government is fairly mysterious to us, there is significantly more openness than there was with the USSR. China is basically “capitalism with American characteristics,” while the USSR feared and hated capitalism. On the American side of things, we don’t have the same ideological fear of communism, nor do we have the same fear of the Chinese taking over to the extent we feared the Soviets. Furthermore, we are so interdependent and locked into China with trade, as “global economic integration has made China ‘more willing than before to accept America’s dominance.’”
I found the last paragraph of the article most interesting. “China, far more than an economically challenged America, is roiled by social tensions. Protests are on the rise, corruption is rampant, crime is surging. The leadership is fearful of its own citizens. … Its frailties—social, political and economic—could eventually imperil both its own stability and its dealings with the outside world.” I think this internal turmoil in China is something we should worry about as a base to China’s relationship to the US. I don’t see the present China causing any major problems for us, but it is a very unstable country and maybe all of our worries will be rational with an internal change of stability?
One thing I think we should take not of in relation to our global political and economic systems is the bipolarity developing between China and the US. Questions of a G2 seem significant, and while there are debates on the stability of bipolarity, I wonder what having these two large powers could mean.
So we all agree that the Chimerica ‘deal’ is out of control. It’s the major problem that nobody seems to want to (help to) solve. Scapegoating only wastes time as we dance around destruction.
Despite the burgeoning strength of the Chinese economy, Stiglitz rules-out action on the part of China to be effective. He argues that Yuan appreciation would slow China’s growth, and hence global economic growth – he has a point, but I think that’s taking it a bit too far. The resolution of the Chimerica problem is going to no doubt hurt everybody somehow – it’s that big. Of course China should do it’s part. But Stiglitz lays the major responsibility on the United States – the solution, he says, lies in a combination of U.S expenditure cuts and a progressive income tax (tax-cuts for low income Americans, and increased tax-cuts for wealthier Americans). But of course a progressive tax will almost certainly never pass in the United States, because the wealthy have earned their wealth and damn all those who would have it taken away from them, even if it is for a national objective.
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