Category Archives: Asia

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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Demonetization on Five Continents

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Several countries are undergoing “demonetization” or currency reforms in which the government recalls bills of particular denomination that are circulation and replaces them with new notes. Some of these initiatives are going better than others.

India is still reeling from the consequences of Prime Minister Modi’s announcement on November 8 that 500- and 1000-rupee denomination bills, which constitute 86 % of the cash in circulation, could no longer be used and that residents have until the end of December to turn them in. They have been waiting in long lines, only to find in many cases that the banks have not received enough of the new currency to make the exchange. Some businesses are unable to operate. India’s experiment is unique in that it combines mostly benign motives – a crackdown on illegal activities – with an abrupt implementation that has inflicted unnecessarily high costs on the economy.

Demonetizations fall into several widely different categories. The most dramatic and disruptive episodes are usually signposts on the highway to hyperinflation. Venezuela’s President Maduro on December 11 announced a recall of the 100-bolivar note, creating chaos by giving residents only 10 days to make the exchange into new higher-denomination-notes (500-bolivar notes and higher, up to 20,000 bolivars).

Venezuela will almost certainly be in hyperinflation in 2017. Economists generally define hyperinflation as a pattern of price rises that exceed 50% per month. The inflation rate may cross over the line into technical hyperinflation within the next few months. Hyperinflation had become much rarer in the 21st century, compared to the 20th century. Venezuela’s would be the first since Zimbabwe’s hyperinflation in 2008-09 — which exceeded 79,600,000,000 % per month, rendering the Zim dollar worthless long before it was officially demonetized.

The current Venezuelan episode continues in a long tradition of gross mismanagement of their currencies by some governments, especially in Latin America and the former Soviet bloc. They have demonetized as a means of confiscating wealth from the public, in effect, and transferring it to themselves. The fundamental problem is that the government spends way beyond its means, unable to finance the spending by taxation or borrowing, and so relies on debasing the currency. The “currency reform” may be announced in the name of a program to end high inflation. But true macroeconomic reform requires fundamental measures to end the excessive printing of money and its origin in excessive primary budget deficits. Without such a true reform, the exchange of new bills for old is just one more symptom of mismanagement (along with price controls and the rationing of goods).

A very different category of demonetization entails the orderly decommissioning and replacement of bills for technical reasons. The technical reasons can range from the lack of popularity of a particular note, to the desire to honor a national hero, to a re-design of features to block counterfeiting, to more consequential – but still orderly – reforms such as a European country’s switch-over to the euro as the national currency. An example was the announcement in April by US Treasury Secretary Jack Lew that the $5, $10 and $20 bills are to be replaced with new designs that include women and civil rights leaders.

What differentiates this second category is that citizens are given enough time to trade in their old currency for the new unit. The monetary authorities plan ahead, so that they have plenty of new bills available. Nobody needs to lose out or even to wait in long lines at the bank. Lithuania is the most recent country to have joined the euro, having given up their lita in 2015. The currency transition went smoothly, as it had when the Germans traded in their marks for euros in 2002, the French their francs, and so on with the rest of the 19 countries that have joined the eurozone.

The main motive for India‘s demonetization apparently puts it into a third category, which includes what the US did in 1969, when it announced the phasing out of $500 bills and higher denominations, and what the European Central Bank commendably decided to do in May of this year with its decision to phase out the 500-euro note. In each of these cases, most of the high-denomination notes are used in illegal activities, ranging from tax evasion to corruption to drug trafficking and even terrorism. So the government stops issuing the big bills to avoid facilitating these illegal activities. Such prominent observers as Ken Rogoff, Larry Summers and Peter Sands think the US should do the same with its $100 bill.

In these cases, the phase-out period is typically long — in some cases indefinitely long, until all the existing paper notes wear out on their own. If the leaders are brave, they could set a relatively short time period, of less than a year, after which the note in question is no longer valid, and could ask tough questions of anyone trying to cash in a large quantity of the high-denomination notes. The goal would be to go beyond merely phasing out the facilitation of illegal activities in the future and to strike a strong blow against those who acquired stockpiles by engaging in such activities in the past. The need for bravery arises because some citizens would object strongly, probably ranging from survivalists to grandparents who want to give a crisp new $100 bill to a grandchild for a special occasion.

Although the discouragement of illegal activities is a motive to be applauded, the implementation in the case of India has obviously fallen short. The reform did not need be so very sudden and so very secret. Especially because the notes were relatively small (worth approximately $7 and $15, respectively) and widely used by all Indians, not just in illegal activities, the authorities should have allowed enough time to print plenty of the new notes and even to allow businesses to accomplish some of the desired switch-over to non-cash means of payment (checking accounts and electronic funds transfer).

Even with the advance warning time, those who had accumulated large wealth stashes in the form of the bills would still have lost some value – in effect a tax – if they had been unable to demonstrate to a bank that they had valid reasons for having the bills. Yes, they would still have been able to take recourse to an unofficial market in the phased-out bills, but they would have had to sell the bills at a discount. Most importantly, allowing more time would have avoided the serious inconveniencing of ordinary people and disruption to the economy that India has experienced since November.

Given the problems that it has created for ordinary Indians, why did the Modi government feel the need to launch the reform so suddenly, without time to print enough new notes? One theory is that a goal was to disrupt rival parties that use cash heavily in their campaigns, ahead of important elections in early 2017 (in the state of Uttar Pradesh). If the theory is valid, it is hardly an uplifting justification for what is supposed to be a good-government reform.

Western leaders probably do not act with sufficient boldness and bravery when they choose to phase out big bills as gradually as they do. But Prime Minister Modi acted too boldly in ending the use of medium-sized bills so abruptly.

[A shorter version of this column appeared at Project Syndicate. Comments can be posted there or at the Econbrowser site.]

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