Neil Wilson — A Tale of Two Nations

A parable about trade.

Modern Money Matters
A Tale of Two Nations
Neil Wilson

Dirk Ehnts — The euro zone’s most urgent economic problem: stagnating investment

If we wish the euro zone to have less unemployment, there most be more goods produced. Goods are only produced if people demand them, so the question comes down to who is going to finance the purchase of additional goods. There are three potential sources: the private sector can spend more than it earns by running up debt. It does this by borrowing from banks. However, in most of the euro zone private sector firms and households are not in the mood to move into debt further. The second possibility to increase growth is for the public sector to spend more than it earns (taxes). This seems like a possible way to go, since the German “black zero” is not strictly necessary. Last but not least the rest of the world can buy more of the euro zone’s goods. For this a depreciation of the currency would be helpful, and the ECB has just engineered this by quantitative easing, which means an increase in central bank money held by banks. However, if pushing the exchange rate down leads to more exports for Europe (and that is a big if), then at some point Europe will grow stronger and investors will come back to invest. This would drive the euro up again, which would lead to weakness of demand once again.... 

Well, the euro’s exchange rate is not fixed, and other countries will retaliate against “gains in competitiveness” that come via depreciation of the euro by depreciating their own currencies. Hence the solution to Europe’s economic woes – low investment – cannot lie with the rest of the world. It must lie in Europe.

econoblog 101
The euro zone’s most urgent economic problem: stagnating investment
Dirk Ehnts | Berlin School for Economics and Law

Reuters — China's FX reserves may stoke inflation, a 'big burden': premier

"Frankly speaking, foreign exchange reserves have become a big burden for us, because such reserves translate into the base money, which could affect inflation," Phoenix New Media Ltd quoted Li as saying during a visit to Kenya. 

"From China's perspective, macroeconomic controls could face tremendous pressures if the overall trade is imbalanced."

China will take steps to reduce its trade surpluses with the rest of the world, including Kenya, Li was quoted as saying.

Translation: China's mercantilist trade policy is creating distortions in the domestic economy, as well as affecting the value of the RMB  in the currency market that the peg is not completely offsetting as China increases the float.

How it is it that foreign reserves have become a burden since they translate into base money? Chinese companies exports goods to the US, UK and EZ and get paid in USD, GBP, and EUR. Chinese companies are not allowed to convert the proceeds from sales into RMB in the currency market, since that would undermine the peg.

So the People's Bank of China borrows the proceeds from the exporters, puts the foreign currencies into bonds of the respective countries, and only allows Chinese companies to draw on a limited amount of RMB, mostly to pay bills and for investment. The problem with "inflation" comes importing, especially energy, in an undervalued currency and from a run up in investment that leads to asset inflation and from there to price and wage inflation. China has been dealing with this through financial repression — keeping interest rates low to encourage investment and reduce interest payments that could increase domestic demand that would fuel price inflation, hence rising wage demands.

Reuters (May 11, 2014)
China's FX reserves may stoke inflation, a 'big burden': premier
Reporting by Kevin Yao; Editing by Clarence Fernandez

Ha-Joon Chang — Britain: a nation in decay [or the race to the bottom]

Ha-Joon Chang nails it. The UK problem is Thatcherism aka Neoliberalism, in which the goal is to run permanent trade surpluses by running financial repression domestically, i.e., suppressing worker compensation and benefits by eliminating the welfare state, in order to become more competitive in the global economy. Just like Germany is doing.

In reality, though, the coalition government isn't as stupid or stubborn as it appears. It is sticking to its plan A because spending cuts are not about deficits but about rolling back the welfare state. So no amount of evidence is going to change its position on cuts.
Lost in this cross-wired debate is the issue of the long-term future of the economy. Britain has been finding it difficult to recover from the financial crisis not just because of its austerity policy but also because of its eroding ability to engage in high-productivity activities. This problem is most tellingly manifested in the country's inability to generate a trade surplus despite the huge devaluation of sterling since 2008.

The Guardian
Britain: a nation in decay
Ha-Joon Chang | Professor Economics, Cambridge University
(h/t Kevin Fathi via email)

Unfortunately, Prof. Chang perpetuates the myth about Keynes and the long term when he writes,

John Maynard Keynes once famously said that in the long run we are all dead. But a lot of us have to live for a while yet. A series of short-run policies, whether based on the coalition policy of spending cuts and loose monetary policy or on the opposition policy of increased government spending, isn't going to address the challenges facing the British economy. It is time to think for the long term.

Keynes was actually criticizing the assumption of economic equilibrium being automatically achieved in neoclassical mechanics by the working of the invisible hand absent interventions. Keynes knew, of course, that the neoclassical model is time-independent, and the adjustment could come quickly — or not. Even presuming the correctness of the model, why wait when policy tools are readily available to bring about a return to full employment and optimize output by acting now.