Category Archives: China

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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Mnuchin and Manipulation of Money

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US Treasury Secretary Steven Mnuchin already finds himself hemmed in on all sides.

Domestic constraints come from the promises that he and President Trump have made and the laws of arithmetic.    How, for example, is he ever going to be able to reconcile the specific tax proposals that candidate Trump campaigned on with the promise of the “Mnuchin rule” that taxes won’t be cut for the rich?  That is even harder than the traditional conundrum that faces Republican Treasury Secretaries: having to explain how massive tax cuts (to which they are truly committed) can be reconciled with a reduction in the budget deficit (to which they claim to be committed).

Many of his predecessors found that they had more latitude in the international part of their job than the domestic part.  Their voice would often receive more respectful hearings from their foreign counterparts on the international stage, at multilateral meetings like the recent G-20 gathering in Baden-Baden, than from domestic political players in Washington.

But Mnuchin will have a harder time in the international context.  To begin with, the current Administration has indicated in many ways that it no longer wants the job of leader of the global system.  The leader is the one who persuades other countries that certain agreed-upon rules, such as an open trading system, are in everybody’s interest.  The Trump administration has no interest in playing that role.  Its view is that the appropriate thing to do in international negotiations is to make unilateral demands.

It is fortunate that Mnuchin realized that the scheduled opportunity to name China a currency manipulator comes in April, when the biannual Treasury report to Congress is due, rather than, the day that Trump assumed the presidency as promised.  But he should pass on the opportunity.  He needs to explain to his boss that China is no longer manipulating its currency, preferably in time for Trump’s meeting with Chinese President Xi Jin Ping, scheduled for April 6-7, at Mar-a-Lago.   President Trump has explicitly re-asserted his earlier campaign allegations of manipulation by the Chinese.

“Deal-makers” don’t do well with ill-informed bluster that they are subsequently forced to back down on.  This principle was illustrated when Trump challenged the “One-China” policy in December but was then unsurprisingly forced to reverse himself, in a February 9 phone call with President Xi.  Unpredictability is not always an advantage, as he seems to think.  Chinese know the difference between a bargaining chip and loss of face.  Trump is now that much weaker in dealing with China.  A leader who has a very good brain should learn the lesson.

Is China manipulating its currency?  The language regarding “manipulating exchange rates” originated in a 1977 decision by IMF members. Of the various criteria to determine whether a country is guilty of intentional manipulation to gain competitive advantage and frustrate balance of payments, the sine qua non is the systematic purchase of foreign exchange reserves to push down the value of the national currency (“protracted large-scale intervention in one direction in the exchange market”).  The other two criteria are the partner’s current account balance and the value of its currency (e.g., judged by international price competitiveness relative to an appropriate benchmark).

Those are the three criteria in international law.   The US Treasury’s biannual reports to Congress on foreign exchange policies of major trading partners were originally mandated in a 1988 law, later “intensified” in a 2015 law.  The Treasury is directed to include the country’s bilateral trade balance vis-a-vis the US as one of the three criteria, even though bilateral balances per se play no role in either the IMF rules or economic logic.  (That the US runs bilateral trade deficits with many countries has far more to do with factors other than their currency policies.  For one thing, the US runs a trade deficit overall because it has a low rate national saving.  This is bound to worsen under Trump fiscal policies.)  A statistical analysis of Treasury decisions regarding whether to name countries as possible manipulators in particular reports shows a significant role for the US unemployment rate in election years, along with the bilateral balances.

It is true that the RMB was undervalued in 2004 (by roughly an estimated 30%), according to a wide variety of criteria.  But as of today China no longer qualifies as a currency manipulator under any of the three internationally accepted criteria:  exchange rate level, trade balance, and use of foreign exchange reserves.  The RMB appreciated 37% between 2004 and 2014 (on a real broad trade-weighted basis).  Its trade surplus, after peaking at 9% of GDP in 2007, then adjusted to the receding price competitiveness: the surplus has been less than half that level each year since 2010.

Furthermore in 2014 – as the Chinese economy slowed relative to the US economy — China’s capital inflows turned to capital outflow.  As a result the overall balance of payments went into deficit.  Foreign exchange reserves peaked in July of that year and have been falling since then.  The People’s Bank of China, far from pushing the renminbi down, has spent a trillion dollars of reserves over the last three years trying to support the currency in the foreign exchange market, by far the largest such intervention in history.  The authorities have also tightened controls on capital outflows, again with the objective of resisting depreciation. They have succeeded, in the sense that despite some adverse fundamentals the RMB has continued to be one of the world’s more appreciated currencies, second only to the dollar and a few others that are even stronger.

These points are not new.  True, it took a while for most American commentators to notice the sea change in China’s foreign exchange market.  By now it has been three years and most observers have figured it out.  But not the US president.

Some other Asian countries meet one or the other of the manipulation criteria.   Korea’s trade surplus has been running at around 7% of GDP and its current account even higher; but it is not piling up foreign exchange reserves the way it was several years ago.  Similarly with Thailand.  It is not clear if there is an Asian country that meets all the criteria.

Peter Navarro, director of Trump’s new National Trade Council points the finger at Germany, saying it “continues to exploit other countries in the EU as well as the U.S. with an ‘implicit Deutsche Mark’ that is grossly undervalued”.   It is true that Germany’s trade surplus is a big 8% of GDP and the current account surplus close to 9%, which is indeed excessive.   But Germany has not had its own currency since the mark gave way to the euro in 1999. The European Central Bank has not operated in the foreign exchange market in many years; and when it did, the intervention was to support the euro, not push it down.

Given the absence of direct foreign exchange intervention among G-7 countries, those who allege currency manipulation suggest that some governments are doing other things to keep their currencies undervalued, particularly expanding the money supply.  Of course central banks do engage in monetary stimulus knowing full well that one effect is likely to be a depreciation of its currency and a stimulus to its exports.  But one has to keep pointing out that:

  • Countries have the right to use monetary policy to respond to domestic economic conditions.
  • In normal cases, it would require a mind-reader to know whether currency depreciation was a major motivation for the action,
  • A successful monetary stimulus will also raise income through domestic channels and thereby raise imports, so that the net effect on the trade balance could go either way, and
  • If other countries don’t like the exchange rate and trade balance results, they are free to undertake monetary expansion of their own.

In 2010-11, these were the arguments that were given (correctly) in defense of the Fed’s quantitative easing and the dollar’s depreciation, when Brazilian leaders accused the US of waging “currency wars.”  They are just as valid when other countries are the ones needing monetary stimulus.

The Trump administration’s accusation against Germany is a uniquely foolish instance of manipulation allegations.  It is true that the European Central Bank responded to the 2008-09 global recession (belatedly) by lowering interest rates and undertaking quantitative easing, and that this contributed to a depreciation of the euro.  But it has been plain for all to see that Germany has consistently opposed the ECB’s monetary stimulus.  One does not have to read the minds of the German officials to see that a charge of manipulation would be nonsense.

Other forces have been working to weaken foreign currencies against the dollar.  Perhaps the biggest in the last five months has been Donald Trump  himself.  His talk of raising tariffs against Mexico, China, and other trading partners has worked to depreciate those currencies against the dollar.  The proposal for a Border Adjustment Tax has the same effect.  Finally, Trump has promised big tax cuts and they are likely to pass Congress — though he unintentionally delayed his tax plans substantially, by putting Obamacare repeal first.   The result (not promised) will be a rapid acceleration in the national debt, which will probably force up interest rates, the dollar, and the trade deficit.

The multilateral calendar includes a G-7 leaders meeting in Sicily in May and a G-20 summit in Hamburg in July.  Mnuchin’s unenviable task is to acquaint Trump with reality by then.

[A shorter version appeared at Project Syndicate, March 22, 2017.  Comments can be posted there.]

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