Monday, April 25, 2011

Joseph Gagnon and Gary Hufbauer On China Policy

Joseph Gagnon and Gary Hufbauer explain in CFR's Foreign Affairs, Taxing China's Assets: How To Increase U. S. Employment Without Launching A Trade War, how the US can tax China's holdings of US Treasuries to discourage China's currency manipulation that is undervaluing the RMB against the USD.

According to MMT, the interest paid on Treasuries is operationally unnecessary, since the US does not need to finance itself. Foreign holdings of Treasuries are the capital account offset of the current account deficit resulting from net imports, which constitute demand leakage and effectively export jobs. By paying interest on foreign holding of Treasuries by net exporters, the US is subsidizing export of US jobs.

Gagnon and Hufbauer explain how the US can counter this by using taxation as a disincentive to save in dollars, instead of resorting to tariffs. As net exporters lose their dollar subsidy, they will be less willing to save in dollars. This will reduce the capital account that must offset the current account. Therefore, to continue exporting to the US at the same rate, net exporting countries would have to balance their trade with the US by purchasing US goods in exchange instead of saving US dollars, or decrease the volume of exports to the US.


Matt Franko said...

The authors state: "In order to undervalue the renminbi against the dollar, China drives the dollar's value up by buying dollar-denominated financial assets, principally U.S. Treasury bills and bonds."

But where do they first get the dollars to do this? The trade deficit. So it looks like they may have it backwards. first comes the trade deficit and then comes the purchase of Treasuries.

Then, they recommend that by putting a withholding tax on the Chinese owned US Treasuries: " In the meantime, the U.S. government would enjoy a few billion dollars per year of extra revenue to reduce its budget deficit (Ed: You can tell they work for Peterson Fdn.!), and these revenues would grow to tens of billions per year as interest rates return to more normal levels over time, especially if Washington raised the withholding tax rate."

So as Tom has pointed out, the interest on the US Treasuries is not even necessary in the first place but these two see putting a withholding tax on an unnecessary coupon as revenue enhancement and a fiscal deficit reducer... this should ensure the Peterson people renew their grants!

"An important benefit of this approach is that it would explode the myth, commonly held in China, that the United States wants or needs China to buy U.S. Treasury bonds"

Ok sounds good!

" In order to buy U.S. bonds, the Chinese government has to borrow money in China."

Who lends them the so-called "money" in China? It would seem it would have to be USD to buy US Treasuries. Does the Fed have a branch there that we dont know about?

" Many middle-class Chinese are unhappy that their government is subsidizing loans to the United States when there are many willing borrowers in China"

Crowding out? Why do the Chinese citizens want to borrow US dollars?

It looks like these 2 authors have some causation backwards.... To me it's like the Chinese maintain a peg by changing out Chinese exporters USD balances for new Yuan balances at the pegged exchange rate (liability side), then the Chinese CB buys USTs with the USD balances (asset side).

To get them to stop this they have to get the Chinese to stop exporting goods for USDs.

Tom Hickey said...

Matt, the Chinese government (PBoC) borrows the dollars from the exporters' banks and invests them into Treasuries instead of allowing the exporters to convert their dollar proceeds into RMB and spend them. If the exporters converted the $s to RMB, then it would drive up the value of the RMB relative to the $ and it would also dump a lot of RMB into the Chinese economy at the same time. The Chinese purchase of US tsys sterilizes those funds, allowing the PBoC to maintain the peg and control inflation.

See Michael Pettis, What the PBoC cannot do with its reserves.

googleheim said...

Hi Tom and Matt :

In two short posts, you both nail the mechanism by which China took our shirts.

1. They exported and earned USD.
2. They saved the earnings in treasuries.
3. They prevented the earnings to come home to keep their unfair valued RMB low which keeps their slaves inside their country.
4. Savings glut destroys US mfg along with tax free China located zones for US mfg to move into in China.


all have dollar savings.

Why does Norway have a similarly undervalued Kroner ? They can do this without slaving their people since the population is way lower like 1/200th.

Musgrave said...

Here’s a better solution. Buy back US debt with printed dollars, then there’s no debt for China to buy. To the extent that that is inflationary, mix the above inflationary debt reduction method with a deflationary one: raise taxes and/or cut public spending in the US and use the money raised to buy back the debt. Get the “mix” right, and you have a buy back system that is neither deflationary nor inflationary.

Calgacus said...

Googleheim, China can only "take our shirts" by using the second-stupidest economic policy (mercantilist saving of a foreign fiat currency) if we follow the stupidest policy: Refusing to deficit-spend enough dollars into existence to offset the dollars China saves, not using functional finance. Abba Lerner called such exporting policies a "hostile gift", but the real damage can only be done if we do it to ourself. Quiz: Guess which country he used as the example.) :)

The sensible thing is to look at who in the USA is really hurt by Chinese dollar saving, and give them some $, spend the rest of the replacement dollars wherever, of course while having a full employment Job Guarantee policy as the ultimate stabilizer.

Norway is doing things similar to China, with less reason. Arno Mong Daastoel of the Gang of 8 has written a bit on this.

Anonymous said...

Receiving goods for dollars is a net benefit for importing countries, according to Warren. Are a few extra minimum wage manufacturing jobs worth reducing a trade deficit?

Some of the 'American' goods that would be sold in China would not be made in America anyway.

This tax scheme would prompt China to hold more of their USDs as cash. If they feel the need to peg their currency they have the reserves to do it, thanks to Wallmart et al.

Matt Franko said...

I think I got my understanding from Pettis via one of your links.

Pettis says: "It is the automatic consequence of China’s currency regime, in which it pegs the RMB to a foreign currency, in this case the dollar. Why? Because when the PBoC decides on the level of the RMB against the dollar, it does not do so by passing a law and making it a capital crime for anyone to trade at a different price. What it does is far simpler. It offers to buy or sell unlimited amounts of RMB against the dollar at the desired price." >>>

So when the Peterson people at the CFR say: "Without massive Chinese purchases of U.S. Treasury bonds and the resulting undervaluation of the renminbi,"

This seems to conflict with Pettis' view from on the ground over there. The Peterson people think the mechanism is via UST purchases or something (hey guys it is not a floating rate regime!), this is ex post, the deal is already done at the 'People's Exchange Rate' by the PBoC. Pettis shows how it is simple price setting by the monopolist PBoC via it's willingness to create new RMB reserves in "The People's Banking System" to exchange for USD balances from any Chinese entity at the Chinese dictated exchange rate.

What it looks like the Chinese do is establish liabilities at their PBoC, when they create the new RMB reserve balances to exchange for the USD balances that are accumulated by the Chinese exporters, not "borrowing".

Sounds to me like these Peterson people should go take one of Pettis' classes over there.... as is typical of anything Peterson, they have a deficit reduction fetish.... all roads lead to the misconception that govts "borrow" and the smaller the US fiscal deficit the better.... they are all morons.

The Peterson people are making it sound more complicated than it is probably to snow job some moron govt policymakers for another year...

Tom Hickey said...

"eceiving goods for dollars is a net benefit for importing countries, according to Warren. Are a few extra minimum wage manufacturing jobs worth reducing a trade deficit?"

Marshall argues, in contrast, that this is only true at full employment. Otherwise, the trade deficit translates to exporting jobs. OK, they are low quality jobs, but they are jobs that are not being replaced. The answer is to plug demand leakage with offsetting deficits to get to full employment. As long as the economy is at full employment a trade deficit is a benefit.

There are three problems, the biggest is that full employment is not a priority of US politicians. Secondly, China's peg is unbalancing global trade. Thirdly, China's import restrictions are preventing US exports, and China's violation of intellectual property rights is also skewing the trade balance.

Tom Hickey said...

Matt, as I understand it, China prevents its exporters from holding dollars abroad or converting them to RMB in order to control inflation. The PBoC soaks up the dollars and places them in tsys and borrows from the exporters to prevent them from spending in excess. China is a very managed economy, but it has not been able to prevent inflation due to the peg and malinvestment due to corruption.

Matt Franko said...

Wouldnt they have to trade the exporters their USDs for I guess not actual RMB (paper notes) but at least RMB denominated Reserve Balances in the China banking system? This may result in excess China RBs but I guess they may pay a support rate for Monetary Policy?

This post I did at here at Mike's


seems to suggest that eventually the entire trade surpluses of foreigners ends up in Treasury Securities... it takes a few months to settle out it looks like but eventually it ends up in Treasuries... unless it is coincidental, but that seems highly unlikely to me intuitively.

I'm suspect of anything coming out of the Peterson people...


Tom Hickey said...

Mike the trade balance ends up in tsys because it must go to buying goods, assets or savings. A trade deficit means it did not go to goods, and what is not invested in asset acquisition is saved. The way foreign government save USD is in tsys for the most part.

When Chinese companies sell to the US, they receive USD. They are not allowed to bank the USD in US banks and so these dollars go to the PBoC. The PBoC only permits the companies to draw a certain amount of RMB in order to control the money supply to control inflation. The rest is saved in the companies' accounts at the PBoC. That is the way I understand it.

Anonymous said...

If China cannot contain inflation, how long can they continue with pegging their currency?
If they ease import restrictions, would there be too many job losses to be socially acceptable?

selise said...

is there any reason to suspect brad setser's old analysis (just the data, not the interpretation which is out of paradigm)?

if not, might want to take a look at this:…/

looks like before sept 2008 china's dollar holdings in agencies and treasuries were similar. since then (at least as far as brad's data goes it was all treasuries (risk aversion?).

but brad's historical data shows that the dollar holdings need not be in treasuries... so, i'm not sure what taxing treasuries alone would accomplish other than to encourage holdings other dollar denominated paper (or purchase of commodities or usa businesses operating in china, etc) ... and would that, if correct, really be a good thing for us (i don't think so)?

or maybe i have it all wrong...

Tom Hickey said...

Tsys are a default risk free parking place that is subsidized by the US. Bad enough to subsidize anyone, but subsidizing foreign governments when the US is bleeding investment capital and employment? The funds that go to interest payments add to the deficit and increase NFA, but payments to foreign governments do nothing to contribute to spending in the US, which would relieve demand leakage.

So a tax on tsys would act as a tariff to recoup the interest on the tsys by reducing the incentive to hold USD instead of buying US goods, investing in US assets, or lending to US business.

The general idea is to create a financial incentive for China to balance its trade with the US instead of net exporting and saving dollars, but doing so without tariffs.

Of course, from the MMT vantage the better way to go is to increase the fiscal deficit in order to fill the demand leakage that is adversely affecting employment in the US.

But failing that, since this political climate rules it out, getting China to balance its trade would also reduce the demand leakage to US net imports.

selise said...

but if the PRIMARY economic motivation for chinese to hold dollar based financial assest is NOT as a risk free investment, i don't see why a tax on treasury holdings would encourage balancing trade instead of the many other alternatives.


politically, my objects are even larger:

1. i don't see how we (non plutocratic class americans) have more influence over china's gov policy than we do our own.

2. our political problems as well as our solutions are here at home, and i object to the scapegoating that is the natural outcome of blaming chinese govt. policy for our problems (stealing jobs, etc). not something i think we, the american public, need to be encouraged in doing.

3. what are the reasons for the chinese govt decision to hold so such large reserve (esp dollar based)? is it needed for the country's development? the world doesn't have such great models of economic growth (pulling people out of grinding poverty etc.) and rapid industrialization. what would be the likely outcomes for ordinary chinese if we pursued and were successful with such a policy? what impact would that have on the country's development?

4. would the world be better off if we fight china for low wage jobs instead of focusing what little energies we have on addressing our own political problems wrt to employment, institutional infrastructure and r&d?


Tom Hickey said...

selise, in my understanding foreign government do hold tsys instead of reserves at their Fed account precisely because they are default risk free and pay more interest than reserves. That is to say, they want to save dollars at interest in a way that protects them. They are not indifferent to buying goods or investing in the importer's businesses, or holding private debt. They prefer holding tsys because of the perceived advantages. If that option were not available or were more costly, they would either have to hold reserves, which is inefficient, or make other plans.

What does this matter in this case to the US and Chinese people? It is a bad deal for both of them. The US gets demand leakage which affects employment unless the US government offsets the leakage with a corresponding deficit, which it is opposed to doing. Some would say that doing increasing the deficit to accommodate demand leakage from net imports just encourages bad behavior on the part of the Chinese government anyway. Where does it end? USDs are claims on real US assets, after all.

What is happening in China is that the government is running a net export model that involves keeping Chinese wages low and domestic demand down. Chinese workers are working for foreigners instead of the themselves. Domestic consumption in China is about half of what it is in the US.

I question Warren's "imports are a benefit" assertion, because it does not benefit either US workers, who are under wage pressure due to labor arbitrage, or Chinese workers, who get exploited with low wages and fewer goods. Sure, the US consumer gets cheaper trinkets and lower inflation, and the Chinese exporters are building the Chinese GDP into the world second largest, soon to be the world's largest (projected 2016). But the US importing deflation and China inflation.

IN my view, the optimal solution is to promote balanced trade that increases incomes, demand and consumption in the trading partners, instead of favoring the exporting companies in China and employers in the US by keeping US wages depressed.

I got the idea of reducing or ending the tsy subsidy for foreign savers to discourage net importers from beowulf, and I think its an idea worth considering. It could be a useful tool in dealing with the adjustments necessary as we develop a global economy, so far on the backs of workers everywhere due to labor arbitrage reducing worker bargaining power.

Matt Franko said...

Selise & Tom,

Perhaps to Selise's point, I've always felt there is an "irrationality" or some sort of abnormal zealousness to how foreign entities approach their acquisition of US Dollars.

For instance I've travelled to Asia a few times and cab drivers would sometimes take any USD instead of the fare in local currency. I remember I had $2.00 left in my wallet and the cabbie saw it and pointed to it, but the cab ride was like $15.00 in local currency but he just took the $2.00 anyway even after I tried to point out the disparity....

I believe that even at higher levels of foreign governments and policymaking this type of behavior can be taking place...


Calgacus said...

Ralph, that solution would not work. First, as long as we don't do something crazy with the extra wealth that Chinese dollar savings provides us with, our debt to China is not a real problem in the first place. And it is a debt to them whether they hold it in currency or in bonds. To the extent they keep holding it, replacing their bonds with dollars, lowering interest rates, will be deflationary rather than inflationary.


1)One can make a good argument that the PRC government represents its people better, more democratically, than the US plutocracy does.

2)Agreed. Chinese dollar savings does deflate the US economy and reduce employment. But it is the easiest thing to counter this. Mainstream economists have worked hard for 40 years concocting pseudoscience to convince people it is hard.

3)A large reason was the late 90s Asian financial crisis. The US and its puppet, the IMF, and US companies were very happy to have a nice IMF crisis they could use to grab from and damage high-flying Asian economies that were foolishly short dollars. These governments now know just how much mercy one can expect and are never going to let that happen again.

4)Of course we should not fight China for low wage jobs. (The manufacturing export jobs lost to China are not necessarily low wage though.)

There really isn't any other solution than using functional finance to offset trade deficits. IMHO part of continued US pre-eminence came from its greater use of FF & deficit spending compared to Europe, no matter what mainstream quackonomists advised. Sure balanced trade would be better for everyone, but calling China's actions "bad behavior" is inappropriate - it hurts them more than us if we react sensibly.

Anonymous said...

Silly idea, not least of which, there's not much chance of getting inside China's OODA loop when they'll have 6 month notice that we're terminating our bilateral tax treaty.

I don't think Nixon's closing of the gold standard would have worked out so well if he had given De Gaulle 180 days lead time to adjust.

selise said...

tom, but if the PRIMARY reason for holding dollar financial assets is to control inflation, i fail to see how taxing treasuries yields will make a significant change in the desire to save dollar financial assets because inflation will still need to be controlled (i think it's about more than inflation, but i'll use it for a stand in for all the DOMESTIC reasons for their policy of accumulating dollar based assets.

making treasuries less attractive doesn't change that. it might create a change in portfolio preference of dollar based financial assets, but how would that significantly affect trade balances? i'd really love to have that mechanism spelled out so even i can understand each step.

more importantly though, the data i posted above from brad, if correct, shows that the portfolio preference of dollar based financial assets HAS undergone major shifts in the recent past (this decade). i don't think we know for sure what the data is. i'd love to see a good analysis and will look around to see what alternatives i can find.

if you were talking about germany, i wouldn't take the issue so seriously. but china is still a very poor country attempting to undergo an accelerated industrial development program and there are lots of reasons that access to usa markets is a necessary requirement for that industrialization program to succeed (i think controlling inflation is only a part of the story).

if the trade policies you want to change are required for china's development program i don't think any interest rate tax is going to make them decide to change their trade policy. it strikes me as both unnecessarily provocative and unrealistic.

but i don't really know what the data is, what the motivations are, etc. imo, these are things that need better understood first....

finally, i stand by my earlier statement that our political problems are ours to solve. i see no reason to think that we have more influence on china's policies than we do our own.

and it may be that the current arrangements, if only we could take advantage of them, would be at least for some time of great advantage to the people of both countries.


i think i'm just going to have to disagree with you on this one. but i will look for some data and leave a link (or links) here if i turn anything up of interest.

and likewise if you have any data (trade, dollar based assets, etc), please leave a link.

selise said...

Matt Franko,

maybe official exchange rates don't reflect reality within china?


3. i've read that also, primarily from stiglitz. dollar reserves are protection from the imf.

4. good point. i concede they are not all low paying jobs. however, is there any reason we could not have been replacing them with better paying ones (i mean in some wishful fantasy where our gov was representing our interests).


my thanks to all and especially to tom for introducing the topic for discussion. very interesting thread.

selise said...

here are two working papers of potential interest:

The Beijing Bubble: Inequality, Trade and Captial Inflow into China

Is China Really Running a Trade Surplus?

Tom Hickey said...

I really do not trust any of the figures coming out of China. This is a command system masquerading as a market-based one. Even the currency is controlled. Treating economic data coming from China on the level of economic date from the US, Europe, UK, etc. is just silly, IMHO.

selise said...

"I really do not trust any of the figures coming out of China..."

yes. i'm skeptical of any data i can't reproduce, especially when those producing the data have conflicts of interest. so i don't completely trust usa, uk, etc data either... but china seems much worse as i don't even have any personal observations to use as a reality check.

but i do wish for an update of galbraith et al.'s 2008 paper. perhaps they authors might have some insight into the data warren has recently posted on.