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Why Elizabeth Warren is right about currency values?

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  • Why Elizabeth Warren is right about currency values?

    Elizabeth Warren's proposal to increase the value of the Chinese yuan and other currencies against the dollar did not get good reviews in the media from economists. As can be expected, some arguments are quite strange.

    As clever Noah Smith said in his Bloomberg work, the problem with trade deficits is:

    "WE. Consumers consistently live beyond their capabilities, which seems unsustainable."

    The implication is that if the trade deficit is lower than we would be forced to reduce consumption. But the main problem facing the United States over the past decade, according to many economists, is "secular stagnation," which is an unclear way of saying, insufficient demand.

    Contrary to what Smith said to us, U.S. consumers do not live beyond their means, but we actually need them to spend more money to bring the economy to full employment. To be more precise, we need them to spend more in the domestic economy, to increase demand here compared to our trading partners. (We can also bring the economy to full employment by asking the government to spend more money on things like health care or new, environmentally friendly agreements.)

    Smith also disagrees with Warren's mechanism for lowering the dollar, which involves a mixture of negotiations and threats of retaliation. The idea is that the biggest actor is China, who for some reason is assumed to never agree to increase the value of his currency. CNN raises similar concerns. This view seems very off the mark.

    First, it is assumed in two parts that China no longer acts to deliberately reduce the value of the yuan against the dollar, although most economists now recognize that it deliberately suppressed the value of its currency to maintain a large trade surplus in the past. decade. (They did not recognize the management of the Chinese currency at the time.)

    It is wrong to claim that China is now not acting to suppress the value of the yuan. Even though it no longer buys large sums of dollars and other currencies, it has reserves of more than $ 3 trillion in reserves, which are far more than $ 4 trillion if we increase state wealth funds.

    The large stock of foreign assets has the effect of suppressing the yuan's value against the dollar in the same way that the Fed's ownership of more than $ 3 trillion is an asset helping to reduce interest rates. While some economists question that asset ownership by the Fed leads to lower long-term levels than it should have, they seem to deny that large shareholdings of foreign assets by China have the same effect on the currency market.

    For those who like their economy consistently, this does not make sense. If China has more normal reserves for the economy of its size (eg $ 1 trillion), the yuan will be much higher against the dollar, which will reduce its trade surplus and possibly make the country deficit.

    Again, for consistent economic fans, we should really expect a fast-growing country like China to experience a trade deficit. That is what economists usually teach - capital flows from slow-growing countries to fast-growing countries, which means the country is experiencing a trade deficit.

    As far as China can negotiate, given that Trump wants them to really change the way they run their economy, a demand that they increase the value of their currency from time to time does not seem to be beyond reason. Of course, the Chinese economy can adjust to an appreciation of 20-30 percent of its currency for two to three years.

    Actually, there is a very good precedent for this. In the 1985 Plaza Accord, Ronald Reagan Finance Minister James Baker negotiated a gradual decline in the value of the dollar against the currencies of the main trading partners at that time. This works almost exactly as planned. The dollar experienced an orderly decline of close to 30 percent between 1985 and 1989. The trade deficit, which had 3.0 percent and increased, fell to around 1.0 percent of GDP in 1990, even before the start of the recession.

    There is no doubt that there will be difficult bargaining with China and other trading partners to get a similar agreement today. We also have to make concessions, like maybe telling China that we don't really care whether they need technology transfer from Boeing and other countries that outsource production there.

    We must recognize first and foremost that trade policy is not a simple story from one country to another, it is about which interests in each country are preferred. Policies designed to reduce the trade deficit by reducing the value of the dollar, as proposed by Elizabeth Warren, are policies that are likely to help US workers by increasing total employment and the number of well-paid manufacturing jobs.

    The trade policy pursued by Trump and his predecessors is about redistributing more income. In that case, it was very successful.


    I must also mention the concerns raised in this section about the dollar losing its status as the world's reserve currency. This concern is completely misplaced. The dollar is not a reserve currency, it is a reserve currency among many. This is, of course, the dominant reserve currency, accounting for more than 60 percent of central bank reserves, but the euro, yen, British pound, and even the Swiss franc are also held as reserve currencies.

    This could be the case that central banks can move from the dollar so that they are responsible for a smaller share of reserve ownership, but it is difficult to see the big consequences of this result. As long as the United States has a strong economy, with inflation under control, foreigners will be happy to accept and hold dollars. Whether it accounts for 60 percent or 30 percent of world reserve ownership does not change this picture.

    Second addendum

    Noah Smith said that I had misinterpreted his work and that he really thought that the second type of Plaza Accord agreement was a way to go.
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