Explaining Dodd-Frank

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Nine years ago this month, the US sub-prime mortgage crisis morphed into a severe global financial crisis.  Many Americans across the political spectrum angrily demanded financial reform, by which they meant a tightening of financial regulation.  Indeed, important reforms were subsequently enacted, in particular the 2010 Dodd-Frank bill.

Today, those reforms are increasingly under assault.  Most recently, the Trump Administration is proposing a roll-back of regulation of banks as well as of other financial institutions.  The recent decisions of Fed Governors Stan Fischer and Dan Tarullo to retire are also worrisome signs.

Part of the problem is that few voices are heard in support of shoring up Dodd-Frank.  Have those who wanted more financial regulation in 2010 changed their minds, and decided that banks deserve to “get the government off their backs”?  Or do they not understand how much Dodd-Frank accomplished?  I think it may be the latter.

I have just written a short explanation of the Dodd–Frank Wall Street Reform and Consumer Protection Act.  I tried to make it accessible to a general readership.

It is my first contribution to EconoFact, which is a non-partisan publication designed to bring key facts and incisive analysis to the national debate on economic and social policies. The brain-child of Professor Michael Klein, EconoFact is written by a network of leading economists from across the country and published by the Edward R. Murrow Center for a Digital World at The Fletcher School at Tufts University.

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The Signal/Noise Ratio in US North Korea Policy

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Americans have under-estimated the nuclear threat from North Korea and misunderstood what policies would reduce it.  At the same time they have over-estimated the importance of bilateral trade deficits with China and misunderstood what policies would reduce them.  Now these two different issues intersect.

My preceding post discussed the Chinese trade aspect of the problem.  Here I review the geo-politics and history of the North Korea nuclear problem.

US policy has been to demand that Pyongyang dismantle its nuclear weapons program as a precondition for talks.  This is no longer realistic, given the advanced state of the nuclear program and the North Koreans’ conviction that it is the guarantor of their security.   American politicians can proclaim all they want that a nuclear North Korea is “unacceptable.”   A freeze in the nuclear weapons program is the most that we could hope for in the medium run, and achieving even that will not be easy.  There are not many good options.

Some will say that a freeze is not a sufficiently ambitious goal, even in the short run.  But the time is past when an enforceable agreement to stop short of nuclear capability is a possibility, as it might have been in 2000 and 2001.  The lessons of that period have been widely misunderstood.  The Agreed Framework of 1994 had been an important achievement: a solution to the crisis created when North Korea departed from the Nuclear Proliferation Treaty in 1993.  The Framework avoided a war that came closer than most people were aware.  As a result of the Agreed Framework, the North Koreans slowed their nuclear program to a crawl. They froze plutonium production in the Yongbyon complex for eight years (1994-2002), as they had explicitly promised to do in the most important part of the deal.

It is true that they failed to live up to some other important aspects of the agreement, as so often in the past. But the US did not live up to its side of the agreement either.  The important point is that the Framework was better than the alternative. When George W. Bush took office in 2001, discontinued negotiations, and ripped it up in 2002, the North Koreans immediately responded in the way that they had said they would: they restarted their frozen plutonium facilities and within four years were able to test their first nuclear bomb.  A nuclear North Korea has been a fact of life since that time.

Incidentally, the episode illustrates why we should stick with the Iran nuclear agreement, considering the alternative.  This is the opposite of the lesson that many have drawn from the Korean precedent.

So what is to be done about North Korea now?  My preceding post acknowledged that it is probably true that heightened economic sanctions by China on its troublesome ally, such as a cut-off of oil supplies which could cripple the North Korean economy, would be the best hope of getting Kim Jung-un to agree to suspend his nuclear program in return for certain security assurances from the US.   The question then is: how can the US persuade China to take stronger steps?

Start by considering the problem from China’s viewpoint, as any deal-maker should do.  It doesn’t want North Korea to have nuclear weapons.  But it fears even more the prospect of a breakdown of order in its next-door neighbor, with volatile consequences, including both the possibilities of waves of refugees and intervention by US troops.  The US and Korean governments should be prepared to promise that if China applies strong enough economic sanctions to bring the North to its knees, the ultimate outcome will be neither US troops north of the 38th parallel nor a unified Korea with nuclear weapons.  The US and South Korea should also be prepared to pause the deployment of THAAD (the Terminal High Altitude Area Defense system) as a short-term gesture in return for China enacting and enforcing full sanctions.

It would take credibility on the part of the US president to make this strategy work — or to make any strategy work.  Unfortunately credibility is something of which President Trump has very little.   His signals are mostly noise.

To be fair, his predecessors also exhibited a disturbingly low correlation between verbal warnings to foreign adversaries and willingness to take action.  So often in the post-war period, American presidents have made threats that they weren’t prepared to carry out and − equally − have carried out interventions that they had neglected to signal in advance.  A classic example of the latter mistake was the 1950 speech by Secretary of State Dean Acheson defining an American “defensive perimeter” in the Pacific that excluded Korea, which is said to have encouraged the North to invade the South soon thereafter.

Among many examples of the former mistake — talking loudly and carrying a small stick — is Ronald Reagan’s decision to maintain a Marine force in Lebanon, even after the rationale for their presence had vanished.  A suicide bombing in 1983 killed 241. The President said that if the United States were to withdraw, “we’ll be sending one signal to terrorists everywhere: They can gain by waging war against innocent people….”  Three days later he withdrew.  Terrorists indeed saw the signal.  The point isn’t that he shouldn’t have withdrawn.  The point is that those leaders who proclaim a military commitment under a rationale of maintaining US credibility often fail to take into account how much greater will be the loss of credibility if they are forced to back down later.  Vietnam is of course the biggest example of this lesson.

But the noise/signal ratio is extraordinarily high now.  Foreign leaders, like most American citizens, have come to realize that Trump’s statements — whether about the past, present or future — are all but uncorrelated with reality.  Consider just two examples from the Korean nuclear issue.  In January he tweeted, “It won’t happen!” in reference to North Korean aims to develop a nuclear weapon capable of reaching parts of the US.  On August 11 he said that if Kim Jong-un “utters one threat in a form of an overt threat — which, by the way, he has been uttering for years, and his family has been uttering for years — … he will truly regret it. And he will regret it fast.”  One need not wait to find out: It is already clear that these two statements were not credible or accurate.  For good measure, he then threatened military action against Venezuela.

It would not be surprising if China’s leaders have concluded that in the US President they have finally encountered a leader whose words are even less credible than those of Kim Jong-un.

[This post continues a first installment.  An earlier version combining the two appeared at Project Syndicate.  Comments can be posted there or at Econbrowser.]

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Deal-maker Trump Can’t Deal

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(August 27, 2017) — Donald Trump has threatened new trade barriers against China while simultaneously depending on Beijing’s help to rein in North Korea’s alarming nuclear weapons program.   These two aspects of US policy toward China are at odds.

It feels inappropriate to write a column that treats the two issues on a par.  To state the obvious, the stakes are vastly higher in a potential US-North Korean military conflict, especially when it comes to the real danger that nuclear weapons will be used, but even if they are not.  But we need to consider the Chinese trade issues together with the Korean nuclear issues because the Trump White House does.  (Chief strategist Steve Bannon, for example, had the priorities reversed.  Just before he was fired he said that the Korea issue was a “side show” compared with the all-important “economic war with China.”)

It is hard to know if Trump sees the two issues as related.   Quite likely he imagines that he can use trade threats against China as “bargaining chips” to secure its help in dealing with its troublesome ally.  Regardless, he is on the wrong track.  The consequences of this mistake could be disastrous.

The usual defense of Trump’s unprecedented approach to governing is that he is “transactional,” a deal-maker who presumably has bargaining skills because he was a businessman.  Many speak of this transactional approach as if it is a relevant alternative to the traditional assumption that a president should have some regard for rules and principles, and some respect for international alliances and institutions that are favorable to the long-run interest of the US.   They speak of it as a matter of short-term tactics versus long-term strategy.   But there is a serious question whether Trump can pull off even short-term tactical successes.

Despite his career in the private sector, the President acts as if he were unfamiliar with some of the most elementary requirements for successful negotiation.  One principle of bargaining is to consider the game also from the other player’s viewpoint and to think of outcomes that both sides will have reason to view as favorable compared to the relevant alternatives.  Another principle is to build credibility with respect to threats and rewards, so that the other player will perceive a genuine choice of outcomes.

It is probably true that heightened Chinese pressure on Pyongyang up to and including a cut-off of oil supplies, would be the best hope of getting Kim Jung-un to agree to suspend his nuclear program in return for certain security assurances from the US.  But how can the US persuade China to take stronger steps?

Despite Trump’s hope that he can use trade with China as a “bargaining chip” to secure its help, erratic threats from the White House are not the way.  Chinese leaders in China have already learned that they need not take Trump threats seriously. In December, before taking office, Trump challenged the One China policy.  He evidently did not think ahead or take into account that China is more willing to go to war over Taiwan than is the US.  On February 9 he had to reverse himself.  He got nothing for his “bargaining chip” other than loss of face and a bad precedent for future threats.

Another example of a threat that Trump backed down on was his oft-repeated campaign promise that he would name China a currency-manipulator as soon as he took office.  This policy was foolish all along.  If Chinese authorities had agreed to US politicians’ demands that they stop intervening in the foreign exchange market during the period 2015-16, the result would have been a more competitive yuan, not a stronger one.   But regardless of whether there was any merit to the original charge, which Trump repeated as recently as April 2, 2017, he again lost face with the Chinese by suddenly reversing himself a week later.  By now Chinese President Xi Jinping, like most observers, has learned to discount warnings from Trump because they bear such a very low correlation with reality.

The White House is still pursuing aggressive trade policy actions against China.  The measures cover a range with respect to their merits.  An attempt to block steel imports by means of a national security exemption is farcical — flimsy on legal grounds and bad policy on economic grounds: excluding steel imports, if successful, would raise costs for the rest of US manufacturing.  Some other measures have more merit, such as attempts to enforce intellectual property rights.  (On August 18, the White House launched a formal inquiry into whether China is stealing intellectual property.)

But none of these trade initiatives would have much of a positive effect, if any, on the US trade balance, on US real income or employment. And, regardless of the merits, the penny-ante games they are playing on trade policy will not work in favor of enlisting Chinese help in dealing with their neighbor, but more likely will work against it.

In a follow-up column I will address the right way to deal with the North Korea problem.

[An earlier version of this column appeared at Project Syndicate: “Can Trump Deal with North Korea and China?” Comments can be posted there or at Econbrowser.]

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