Hillary Pilloried on Trade

The editorial pages of both the Financial Times and the Washington Post went after Hillary Clinton for her views on trade yesterday, but several economists have made counter-arguments.

In an interview with the FT, she said:

Well what I have called for is a time-out which is really a review of existing trade agreements and where they are benefiting our workers and our economy and where the provision should be strengthened to benefit the rising standards of living across the world and I also want to have a more comprehensive and thoughtful trade policy for the 21st century. There is nothing protectionist about this. It is a responsible course. The alternative is simply to pick up where President Bush left off and that’s not an option...

...So it’s not that we’re starting on some totally different approach to trade it’s that we have to take stock of where we are today. And specifically with Doha and with these large global agreements, again we have to see what works and what doesn’t work. We have benefited through most of the 20th century from trade. It has helped to raise American standards of living, it has helped to create jobs. And I agree with Paul Samuelson, the very famous economist, who has recently spoken and written about how comparative advantage as it is classically understood may not be descriptive of the 21st century economy in which we find ourselves.

We know for sure that every other country wants access to our markets, because we have high levels of consumer spending since we don’t save anything in America and we have a very vigorous competitive market that is a real prize. On the other hand I want to see living standards improve around the world. I want to see environmental standards improve. And I am concerned by some of the provisions that would prevent countries from for example enforcing stronger environmental and worker safety rules under the WTO. I think we have to take a hard look at this and do it in the right way and that is what I am proposing to do.

On its editorial page, the FT says "Hillary Clinton is Wrong on Trade," FT columnist Clive Crook is critical, and FT blogger Willem Buiter says her invocation of Paul Samuelson* is "complete codswollop." I'm not fluent in British, but I think that's pretty bad. Perhaps she'll think twice next time the FT calls asking for an interview... However, Dani Rodrik finds her views "generally sensible."

Meanwhile, in Washington... a Post editorial slams Clinton (and Edwards and Obama) for criticizing NAFTA on the stump:

Polls show that many Democratic voters are nervous about the potential impact of globalization on their job security. So some Democratic candidates are competing to validate every trade-related anxiety and grievance, no matter how far-fetched. The campaign is turning into a contest to see who can make the most extreme denunciation of the nearly 14-year-old North American Free Trade Agreement.

The editorial is headlined "Trade Distortions," but Dean Baker points out (and Krugman agrees) the biggest distortion may be the Post's use of nominal, rather than real, GDP figures to give readers an inflated picture of Mexico's GDP growth since NAFTA went into effect. That's either intellectually dishonest or economically illiterate.

*Samuelson is one of the founding fathers of neoclassical trade theory. He published a controversial paper in the Journal of Economic Perspectives in 2004 which raised questions about free trade dogma, though not quite in the way Clinton suggests (probably she's too busy campaigning to study for the Econ 441 exam).

Update (12/4): Mankiw on Samuelson's paper.

Update 2 (12/6): Dani Rodrik is critical of Clinton's critics:

Here is what I do not understand. Why is it that anyone who says that the gains from the next trade agreement are not huge, that there are real social and distributional issues we need to confront before we strike the next trade deal, and that perhaps we need to rethink the basis of the multilateral trade regime in light of the severe legitimacy problems which it has run into--all true propositions--is immediately branded as a protectionist who wants to set the clock back?

Update 3 (12/7): Clive Crook replies to Rodrik's response:

Acknowledge and respond to legitimate doubts about the virtues of liberal trade. But where the fears are exaggerated or wrong, our political leaders should say so. Unlike Dani, I think it is very dangerous to concede this intellectual ground. Once the US decides that liberal trade does not serve its collective interest--and Hillary, in effect, is proposing a time-out to think about this--the openness we have is indeed at risk.

Recession Watch: Buiter vs. Summers

Lawrence Summers is worried - like totally having a cow, as we used to say - about the subprime mortgage crisis and attendant credit crunch. In the a column for the Financial Times, he wrote:

Even if necessary changes in policy are implemented, the odds now favour a US recession that slows growth significantly on a global basis. Without stronger policy responses than have been observed to date, moreover, there is the risk that the adverse impacts will be felt for the rest of this decade and beyond.

Summers calls for monetary and fiscal policy need to stimulate aggregate demand:

Maintaining demand must be the over-arching macro-economic priority. That means the Fed has to get ahead of the curve and recognise – as the market already has – that levels of the Fed Funds rate that were neutral when the financial system was working normally are quite contractionary today. As important as long-run deficit reduction is, fiscal policy needs to be on stand-by to provide immediate temporary stimulus through spending or tax benefits for low- and middle-income families if the situation worsens.

The Fed may be seeing things the same way - markets responded positively to a hint that the fed may lower the federal funds rate at its Dec. 11 meeting. The Times reported:

Speaking one day after another top Fed official signaled that policy makers might have to reduce interest rates to head off trouble, Mr. Bernanke pledged that the Fed would remain “exceptionally alert and flexible” in setting policy.

Maybe they're just stretching, and drinking more coffee? Amidst all this freaking out, the BEA reports that the US economy grew at an annual rate of 4.9% in the third quarter (revised upward from the preliminary estimate of 3.9%, Ecconbrowser breaks down the numbers). A growth rate like that is normally cause for concern that the economy is "overheating," to which the Fed would respond by raising rates. Willem Buiter offers an incisive, contrarian assessment of the US economic situation under the headline "Should the Fed raise interest rates?":

Judging from the noise, moans and calls for policy relief coming from the financial sector, one could be forgiven for believing that the end of the world is neigh. It's not...

The good news in all this is that much of the financial sector has become quite detached from the real economy. The implosion of much of this formerly privately profitable but never socially productive financial intermediation will have little if any adverse macroeconomic effect. Many, perhaps most, financial institutions today are engaged in a gigantic, worldwide game of musical chairs in which vast fortunes are won and lost every day, but nothing of macroeconomic significance happens...

All the Sturm und Drang in the financial sector today only matters from a macroeconomic perspective, if it has a material effect on household consumption and on household and corporate investment. In my view, rather little of it does.

He goes on to argue directly against Summers, making a case that fiscal and monetary policy should not be used stimulate consumption now because a shift away from consumption into saving is exactly what's needed to correct the current account deficit:

There can be no doubt that private consumption expenditure (about 70% of US GDP and also by far the most stable component of GDP) is going to weaken significantly. And so it should. The long-overdue and necessary increase in the US private saving rate is a necessary domestic counterpart to the long-overdue and necessary reduction in the US external trade deficit, which is the contribution of the US (necessary and long overdue) to global rebalancing....

Surely the time for a consumption slump in the US is now, when the weakness of the US dollar and the strength of global demand will mitigate the impact on aggregate demand and employment? If not now, then when or under what circumstances?

And he also has harsh words for the Fed:

Throughout the crisis, the Fed's communication policy with the markets has been atrocious. My fear is that this communication policy mess reflects a deeper confusion/disagreement in the Fed about how to respond to the crisis, and about both the ultimate and the proximate objectives of monetary policy.

In addition to communicating poorly, Buiter believes the Fed is too responsive to financial markets:

They fear a large fall in the stock market; they fear financial market turmoil; and they can be moved to cut rates if there is a sufficient crescendo of anguished voices from the financial markets and money centre banks. We all know that the Great Depression of the 1930s started with a stock market collapse and was aggravated by bank runs and a misguided monetary policy. The collapse of the multilateral trading system was the final nail in the coffin. Perhaps our central bankers have studied the 1930s too much.

Ouch. That's a swipe at Bernanke, who was a noted academic expert on the depression before becoming Fed chair.

On a related note, Economists' View has a useful summary of a recent speech by St. Louis Fed President William Poole, defending the Fed against the accusation that it is too concerned with bailing out financial markets.

SWF, enjoys investing, pina coladas

One consequence of the US current account deficit is increased foreign ownership of American assets - essentially, our trading partners are getting stocks and bonds in exchange for all the goods they're sending us.

Because of central bank intervention in foreign exchange markets and since we buy much of our oil from state-owned firms, much of these assets are in the hands of foreign governments. Traditionally, much of this wealth has been invested in US Treasury bonds, but increasingly foreign governments are forming "Sovereign Wealth Funds" (SWFs) with more diversified portfolios, including, in some cases, purchases of whole companies. The New Yorker's James Surowiecki writes about the concern this is generating:

What are people so anxious about? The first concern is obvious: no one wants foreign states, especially those which might be anti-Western, acquiring Western companies that have anything to do with national security or advanced technology. But policymakers also believe that having governments play an active role in the stock market and in the global economy might make the whole system less efficient and productive, since government-run companies would likely think about things other than the bottom line, including protecting the interests of their home country. This situation has put free-marketeers in a peculiar quandary. They usually favor the free flow of capital in the world’s markets, but, in this case, supporting the free flow of capital would mean letting governments run American companies, which no free-market economist thinks is a good idea.

The New York Times ran an article on the spending spree of oil producing countries under the headline "Oil Producers See the World and Buy it Up." One notable deal was Abu Dhabi's $7.5 billion investment in Citigroup yesterday. The Times reported:

A falling dollar, a growing pile of oil revenue and an interest in not being overshadowed by neighboring Dubai’s increasingly high profile spurred Abu Dhabi to break with its low-key investing tradition to purchase a big $7.5 billion stake in Citigroup.

That is the view of analysts, economists and deal makers who keep an eye on the secretive Abu Dhabi Investment Authority, the largest sovereign wealth fund in the world, with assets estimated at $650 billion. Despite its size, Abu Dhabi’s royal family has been largely content to pour money into low-return, low-profile investments — until now.

But Abu Dhabi, the largest oil producer of the seven city-states that compose the United Arab Emirates, is worried enough about the eroding value of its pile of petrodollars that it appears ready to pursue more big-ticket deals.

The article has a nice sidebar listing some other notable SWF purchases.

Should we be concerned? Surowiecki suggests that if we really don't like foreign governments buying our companies, we might want to change our own behavior:

The prospect of American companies being sold to foreign states is, to be sure, disconcerting. But it’s a problem of our own making. The reason that sovereign wealth funds are so flush with cash is all the dollars we spend on oil and Asian consumer goods. If we want to consume far beyond our means, then, one way or another we’re going to end up selling off assets to pay for it. Passing laws barring foreign states from acquiring American companies may help treat the symptom. But it’s not going to do much to cure the disease.

Krugman's Calculation of Credit Crunchiness

In addition to affecting consumer spending, the problems in the housing sector may be contributing to a credit crunch (see earlier post). In a column titled "Banks Gone Wild," Paul Krugman writes:

But bad housing investments are crippling financial institutions that play a crucial role in providing credit, by wiping out much of their capital. In a recent report, Goldman Sachs suggested that housing-related losses could force banks and other players to cut lending by as much as $2 trillion — enough to trigger a nasty recession, if it happens quickly.

Beyond that, there’s a pervasive loss of trust, which is like sand thrown in the gears of the financial system. The crisis of confidence is plainly visible in the market data: there’s an almost unprecedented spread between the very low interest rates investors are willing to accept on U.S. government debt — which is still considered safe — and the much higher interest rates at which banks are willing to lend to each other.

He explained further on his blog:

Anyway, what I’m talking about is the spread between Libor — the London Interbank Offer Rate, which is the rate at which banks lend to each other — and the yields on Treasuries of the same maturity.

Normally, there’s just a small difference. For example, in February 3-month Treasuries yielded 5.03%, while 3-month Libor was 5.36%.

Right now, however, 3-month Treasuries are yielding only 3.18%, while 3-month Libor is 5.02%. That’s a big spread, suggesting that investors are very nervous about banks’ finances.

That nervousness is, in part, because it is hard to tell how much trouble the banks are in. One expert put it this way:

I fancy that the great New York (banking) institutions have more skeletons in their cupboards than anyone yet knows about for certain, and that their concealed anxieties cramp their action more than is admitted.

That's John Maynard Keynes, in 1930 (via EconoSpeak).

One reason Libor matters is that most corporate bank loans are priced at a spread over Libor - that is, the interest rate is "floating" and rises and falls with Libor; so this is directly affecting the cost of credit to corporations.

Some of our trading partners see the financial turmoil as a buying opportunity - Abu Dhabi is buying a $7.5 billion stake in Citigroup.

At Vox, Columbia's Charles Calomiris offers a more optimistic view of the situation.

Update (11/28): The NY Times reports "Lenders' Belt-Tightening Stifles Growth in the Economy."

The Quantity Theory and the Constitution

Money is probably the second-most divisive issue in American history. A useful tool for interpreting some of the historical battles over it is the quantity theory of money. The main implication of the theory is that more rapid growth of the money supply leads to higher inflation. Inflation (particularly if unanticipated) tends to benefit borrowers by reducing the real value of debts, while hurting creditors. This can explain, for example, why the populists of the late 19th century represented the interests of indebted farmers by campaigning for adding silver (in addition to gold) to the money supply.

It may also help understand the motives behind the Constitution itself. From the Washington Post's review of "Unruly Americans and the Origins of the Constitution" by Woody Holton:

He contends that the Founders were primarily concerned with the very democratic, revolutionary state legislatures' "excessive indulgence to debtors and taxpayers," above all by printing paper money, which made the United States an investor's nightmare. Well-heeled "Federalists" -- which included most of the Founders -- dismissed paper money as a way to allow lazy, luxury-loving people with the 18th-century equivalent of serious credit card debt to cheat their creditors...

After 1783, Holton explains, the states faced colossal war debts on which the interest alone required more revenue than the colonies collected before independence. Most states resorted to regressive "direct taxes" on real estate and polls (only adult men). The main beneficiaries were speculators who had purchased government-issued IOUs from soldiers and war suppliers for a fraction of their official worth, then collected 6 percent interest on the full face value, yielding as much as a 30 percent annual return...

To add to the problem, a severe trade deficit in the mid-1780s drained the country's gold and silver. The resulting deflation made it harder to pay private debts, which became, in real terms, larger than the original loans. Delinquents could see their farms auctioned off, then spend time in debtors' prison. The rural population did not submit quietly. Throughout the country, farmers resisted tax collectors, forced courts to close (or burned them down) to prevent foreclosures and demanded paper money and tax relief.

Circumstances called for (in modern terms) a loosening of the money supply, and Holton argues that paper money was a reasonable response. Seven states printed currency (though only three made it legal tender for all debts), and every state provided some tax or debtor relief. The goal was to let people pay their taxes and encourage economic development, but the paper currency lost value in a few states, particularly Rhode Island, which tried to force creditors to accept it. To defenders of fiscal responsibility, Rhode Island showed what too much democracy produced: a situation in which only a fool would lend money to anyone.

Article I, section 8 of the Constitution gives to Congress the power to coin money, and section 10 specifically forbids States from doing so.

Sounds like an interesting book to read over break...

Remittances

The NY Times has a fascinating feature on Western Union, the former telegram company that has become the giant of the money transfer business. Much of that business is in "remittances" - money sent by migrants back to their home countries:

With five times as many locations worldwide as McDonald’s, Starbucks, Burger King and Wal-Mart combined, Western Union is the lone behemoth among hundreds of money transfer companies. Little noticed by the public and seldom studied by scholars, these businesses form the infrastructure of global migration, a force remaking economics, politics and cultures across the world.

Last year migrants from poor countries sent home $300 billion, nearly three times the world’s foreign aid budgets combined.

As the graphic accompanying the article illustrates, remittances play a significant role in the economies of some low-income countries. As we argue over immigration in the United States, it is a useful reminder that our immigration policy is also development policy (an argument made by Economist Lant Pritchett).

Is Bernanke's Glasnost Really Perestroika?

Although Bernanke was careful to say otherwise (see earlier post), Willem Buiter believes the Fed's new communication strategy of releasing more extensive forecasts more often is tantamount to inflation targeting. On his Maverecon blog, Buiter writes:

It has taken a while, just under two years since Ben Bernanke took over from Alan Greenspan as Chairman of the Fed, but the deed now is done: the Fed has moved to de-facto inflation targeting. It will continue to be an inflation targeting that dare not speak its name. The Fed has introduced inflation targeting inside the twin Trojan horses of improved communications and greater transparency. An indeed, these proposals are likely to improve the clarity of the Fed’s communications to the market and the public at large and to enhance its transparency. But there is more that that involved. I discern a movement away from the Fed’s symmetric dual mandate to a greater emphasis on price stability as the primary objective of monetary policy. This reform will not take the Fed the whole way towards the lexicographic or hierarchical inflation targeting of the ECB and the Bank of England, whose primary objectives are price stability and without prejudice to, or subject to, the price stability target being met, output, employment and all things bright and beautiful. It does, however, represent a significant step in that direction.

The Fed will now provide projections for inflation for three years (actually a range of the forecasts of the individual board members and reserve bank members). Herein lies the target, according to Buiter:

The longer horizon matters, because, even allowing for long, variable and uncertain lags in the effects of monetary policy, over a three year horizon a monetary authority like the Fed should expect to hit its inflation target, if it has one. Second, the Fed forecasts are made on the assumption of ‘appropriate monetary policy’, that is, not on the basis of a constant Federal Funds target rate or on the assumption that the future path of the Federal Funds target rate is that implied by the market yield curve. This reinforces the presumption that at a three year horizon, if not earlier, the forecast for inflation should equal the inflation target.

The first fruits of the new transparency accompanied the minutes of the October FOMC meeting, which were released yesterday. Inflation projections for 2010 - the implicit inflation target in Buiter's reasoning - ranged from 1.5% - 2% (the projections were for "PCE Inflation" - the price deflator for personal consumption expenditures, which tends to be a smidge lower than the Consumer Price Index).

At Econbrowser, James Hamilton assessed the projections. He was surprised by the low growth projections:

I was particularly struck by the 3-year projections. GDP growth is a time series with relatively rapid mean reversion, so that one would need a lot of evidence (or courage) before offering a 3-year-ahead forecast that is anything other than the historical average. That historical average is 3.3% if you go all the way back to 1948. Yet even the most optimistic FOMC participant was expecting no more than 2.7% real GDP growth for 2010.

The inflation projections were also on the low side:

The Fed's 3-year-ahead inflation forecast also surprises me a little, in that the highest inflation rate that any member anticipates for 2010 is only 2.0%. Inflation is a time series with far less mean reversion than GDP growth, so it's probably unreasonable to use the long-run historical average inflation rate (3.3%) as your forecast for 2010. But for the FOMC participants unanimously to expect the inflation rate in 2010 to be below its average value of the last five years, and for that matter likely below even its value for 2006, should raise an eyebrow.

For more, here's the NY Times story.

Ok, I'm dating myself with the joke in the title. For those unfamiliar with the 1980's: Mikhail Gorbachev tried to reform the Soviet Union with more openness ("glasnost") and restructuring ("perestroika").

Social Security, Political Insecurity

Towards the end of last week's Democratic presidential debate, Barack Obama and Hillary Clinton had this exchange (which I've edited a bit):

SEN. OBAMA: ...I've been very specific about saying that we should not privatize; we should protect benefits. I don't think the best way to approach this is to raise the retirement age. But what we can do is adjust the cap on the payroll tax. Right now anybody who's making $97,000 or less, you pay payroll tax on 100 percent of your income. Warren Buffet, who made $46 million last year, pays on a fraction of 1 percent of his income. And if we make that small adjustment, we can potentially close that gap and we can make sure Social Security is there....

SEN. CLINTON: ....I think we have to have a bipartisan commission. I do not want to fix the problems of Social Security on the backs of middle class families and seniors. (Applause.) If you lift the cap completely, that is a $1 trillion tax increase. I don't think we need to do that...

MR. BLITZER: All right. So Senator -- so you're not ready to accept that raising of the cap on that, but I know that Senator Obama wants to respond to you.

SEN. OBAMA: I will be very brief on this because, Hillary, I've heard you say this is a trillion dollar tax cut on the middle class by adjusting the cap. Understand that only 6 percent of Americans make more than $97,000 -- (cheers, applause) -- so 6 percent is not the middle class -- it's the upper class.

As Senator Clinton pointed out, of course, he meant to say "increase." Paul Krugman, among others, has been very critical of Obama's willingness to raise the cap on income subject to social security contributions. Krugman's argument is that the idea of "crisis" in social security is greatly exaggerated, and the incorrect, but widespread, perception that social security is in financial danger has been politically exploited by those who want to replace the system with private accounts.

This chart from the report of the social security and medicare trustees shows the projected costs for social security (blue line) and medicare (red line) as a share of GDP.

The social security trust fund, which holds government bonds (i.e. the government is borrowing money from social security), is not projected to run out of money until 2041. Contrary to popular belief, social security is in pretty good financial shape. The real "entitlement problem" is with medicare, and this is driven by projected increases in the cost of health care. Therefore, the much more more urgent policy challenge is to find ways to reduce the growth in health care costs.

Although the shortfall in social security is modest, getting more money in the trust fund now would ease the future problems. Since the cap for social security taxes is a regressive feature, raising it would have the effect of making the tax code more progressive. Moreover, Obama's tax increase (and that is, indeed, what it is) would increase net national savings (private savings less the amount borrowed by the government). Currently, this is far too low to finance domestic investment, which means that we have to borrow from abroad, hence the large current account deficit. So, while Krugman's absolutely right that there is no social security crisis, Obama's idea has some economic policy merit. I have no idea whether Krugman's correct about the politics, though I suspect the failure of the Bush administration's push for private accounts, combined with disillusionment with the stock market, has shut the door on privatization for the near future, so he may be fighting the last war.

For more, check out this analysis by Times columnist Tom Redburn. Also, Financial Times columnist Clive Crook makes an interesting argument that the Democrats should embrace more radical social security reform.

China Trade

For a long time, China's trade surplus with the United States was largely offset by a trade deficit with much of the rest of the world, leading to a roughly balanced trade position overall. This fact could be pointed to by those who wished to defend China against accusations of "unfair" trade practices. Not any more.... This week's "Off The Charts" feature in the NY Times has the (official) numbers, which show that China's trade surplus began to balloon in late 2004. Floyd Norris writes:

This week, China reported that its trade surplus for October came to a record $27 billion, a figure that is larger than its surplus for the entire year of 2003.

But even as it was posting a record surplus, China was reporting that its imports were at the lowest level in several months, and were particularly weak from Europe.

Over the last three months, China imported an average of $9.7 billion a month from Europe, a figure that was almost 5 percent lower than imports in the same three months of 2006. It was China’s biggest year-over-year decline in imports from Europe since 1998, when China was only a marginal presence in world trade, rather than the dominant force it has become.

Because China intervenes heavily in foreign exchange markets to limit the appreciation of the Yuan versus the Dollar (i.e. they are keeping the value of their currency artificially low), it has inherited some of the depreciation of the Dollar versus the Euro (i.e. European goods have become more expensive to China and Chinese goods cheaper to Europeans).

US exporters may be reaping the benefit as their European competitors get priced out of the market - according to the Census Bureau's Foreign Trade Statistics, the US exported $5.6 billion worth of goods to China in September, up 21% from a year ago (US imports from China were $29.4 billion, so the deficit is still huge, but shrinking).

In addition to its currency market intervention, China appears to be doing other things to promote a trade surplus. The NY Times reported on Friday:

Few American industries have had more success in selling goods to China than makers of medical devices like X-rays, pacemakers and patient monitors. Which is why a recent Chinese decree was so troubling.

The directive, issued in June, called for burdensome new safety inspections for foreign-made medical devices — but not for those made in China. The Bush administration is crying foul.

Even more worrisome to the administration is that the directive seems part of a recent pattern in which Chinese officials issue new regulations aimed at favoring Chinese industries over foreign competitors...

This is a good example of how regulations can be used to create "non-tariff barriers" to imports, which is why World Trade Organization rules require "national treatment" (i.e. apply regulations in the same way to imports as domestically-produced goods). This would appear to be clear grounds for a case at the WTO. It will be interesting to see if the Bush administration will take them on... Or maybe we should let the Europeans do it.

CARMA chameleon

Dani Rodrik's Blog brings to my attention a new website called CARMA (CARbon Monitoring for Action) with data on the carbon emissions of over 50,000 powerplants worldwide. The site has nifty color-coded maps (like my dream, red, gold and green).

Our friendly neighborhood power plant, Duke Energy's plant in North Bend (the one you drive by on the way to the Cincinnati Airport via I-275) emits 7.5 million tons of carbon dioxide per year, 2123 pounds per megawatt hour, earning a red dot.