Category Archives: International Monetary Fund

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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Fiscal Education for the G-7

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As the G-7 Leaders gather in Ise-Shima, Japan, on May 26-27, the still fragile global economy is on their minds.  They would like a road map to address stagnant growth. Their approach should be to talk less about currency wars and more about fiscal policy.

Fiscal policy vs. monetary policy

Under the conditions that have prevailed in most major countries over the last ten years, we have reason to think that fiscal policy is a more powerful tool for affecting the level of economic activity, as compared to monetary policy.  The explanation can be found in elementary macroeconomics textbooks and has been confirmed in recent empirical research:  the effects of fiscal stimulus are not likely to be limited, as in more normal times, by driving up interest rates, crowding out private demand, running into capacity constraints, provoking excessive inflation, or overheating in other ways.  Despite the power of fiscal policy under recent conditions, economists continue to lavish more attention on monetary policy.  Why?

Sometimes I think the honest reason we economics professors are attracted to monetary policy is that central bankers tend to be like us, with PhDs, and to hold nice conferences.

The reason that one usually hears, however, is that fiscal policy is “politically constrained.”   This is an accurate statement, but not a good reason for us to give up on it.  Indeed, if the political process gets fiscal policy wrong, which it does, that is all the more reason for economists to offer their contributions.

Of course if one is a central banker, or is advising a central banker, then one must concentrate on the job at hand, which is monetary policy.  But precisely because there is a limit to what central bankers can say about fiscal policy, there is more need for the rest of us to do it.

The heyday of activist fiscal policy was 50 years ago. The position “we are all Keynesians now” was attributed to Milton Friedman in 1965 and to Richard Nixon in 1971.  In the late 20th century, most advanced countries managed to pursue countercyclical fiscal policy on average: generally reining in spending or raising taxes during periods of economic expansion and enacting fiscal stimulus during recessions. The result on average was to smooth out the business cycle (as Keynes had intended).  It was the developing countries that tended to follow procyclical or destabilizing policies.

Leaders forget how to do counter-cyclical fiscal policy in the US, Europe and Japan

After 2000, however, some countries broke out of their familiar patterns. Too many political leaders in advanced countries pursued procyclical budgetary policies: they sought fiscal stimulus at times when the economy was already booming, thereby exaggerating the upswing, followed by fiscal austerity when the economy turns down, thereby exacerbating the recession.

Consider mistakes in fiscal policy made by leaders in three parts of the world — the US, Europe, and Japan.

US President George W. Bush began the century by throwing away the large fiscal surpluses that he had inherited from Bill Clinton, and then continued with big tax cuts and rapid spending increases even during 2003-07, as the economy reached its peak.  It was during this period that Vice President Cheney reportedly said “Reagan proved that deficits don’t matter.”

Predictably, the rising debt left the government feeling less able to enact fiscal stimulus when it was really needed, after the Great Recession hit in December 2007.  At precisely the wrong time, Republicans “got religion” deciding that deficits were bad after all.  Thus when President  Barack Obama took office in January 2009, with the economy in freefall, the opposition party voted against his fiscal stimulus.  Fortunately they failed then, and the stimulus was able to make a big contribution to reversing the freefall in the economy in 2009.  But having regained the Congress in 2011, they did succeed in blocking Obama’s further attempts to stimulate the still-weak economy for three years. The Republicans appear to be consistently procyclical.

Greece is the “poster boy” of an advanced country that unhappily switched to a systematically procyclical fiscal policy after the turn of the current century.  Its first mistake was to run excessive budget deficits during the expansionary period 2003-08 (like the Bush Administration).  Then, as if operating under the theory that “two wrongs make a right,” Greece was induced after its crisis hit to adopt tight austerity in 2010, which greatly worsened the fall in GDP. The goal was to restore its debt/GDP ratio to a sustainable path; but instead the ratio rose at a sharply accelerated rate, because of the fall in GDP.

Europeans suffer even more than other countries from basing their budget plans on official forecasts that are unnecessarily biased, which can lead to procyclical fiscal policy.   Before 2008, not just Greece, but all euro members were overly optimistic in their forecast and so at times “unexpectedly” exceeded the 3% ceilings on their budget deficits.  After 2008, qualitatively similar stories of procyclical fiscal contraction, leading to falling income and accelerating debt/GDP, also held in Ireland, Portugal, Spain and Italy.

The native land of austerity philosophy is, of course, Germany.  The Germans had (reluctantly) gone along with an agreement at the London G-20 Leaders Summit of April 2009 that the US, China, and other major countries would expand demand in order to address the Great Recession.  But when the Greek crisis hit at the end of that year, the Germans reverted to their deeply held beliefs in fiscal rectitude.

At first the IMF went along with the other members of the troika in believing — or at least pretending to believe — that fiscal discipline in the European periphery countries would not greatly damage their GDPs and thus could restore their debt/GDP ratios to sustainable paths.  But in January 2013, Fund Chief Economist Olivier Blanchard released a paper that was widely interpreted as a mea culpa.  It concluded that fiscal multipliers were much higher than the IMF (among other forecasters) had thought, suggesting that the austerity programs might have been excessive.  This conclusion was based on a statistical finding that the countries which had attempted the biggest fiscal retrenchment in response to the crisis turned out to experience the most damage to GDP relative to what the IMF forecasters had expected. Today, IMF Managing Director Christine Lagarde explains to the Germans that Greece cannot achieve the elusive path of a sustainable debt/GDP ratio if it is not given further debt relief and is instead told to run primary budget surpluses of 3 ½ percent of GDP.

Now to Japan, host of this week’s G-7 meeting.  In April 2014, even though the economy had been so weak that the Bank of Japan had been pursuing aggressive quantitative easing, Prime Minister Abe went ahead with a planned increase in the consumption tax (from 5% to 8%).  As many had predicted, Japan immediately went back into recession.  Even though the first arrow of Abenomics, the monetary stimulus, had been fired appropriately, it was evidently less powerful than the second arrow, fiscal policy, which unfortunately had been fired in the wrong direction.

Prime Minister Abe has indicated that he is sticking with his plan to go ahead with a further rise in the consumption tax (to 10%), scheduled for April 2017.  It is easy to see why Japanese officials worry about the country’s huge national debt.  But, as near-zero interest rates signal, creditworthiness is not the current problem; weakness in the economy is.  A more effective way of addressing the long-run sustainability of the debt is to announce a 20-year path of very small annual increases in the consumption tax, calculated so as to demonstrate to investors that the ratio of debt to GDP will come down in the long term.

Developing countries

Not all is bleak on the country scoreboard of cyclicality.  Some developing countries did achieve countercyclicalfiscal policy after 2000.  They took advantage of the boom years to run budget surpluses, pay down debt and build up reserves, which allowed them the fiscal space to ease up when the 2008-09 crisis hit.  Chile is the poster boy of those who “graduated” from procyclicality. Others include Botswana, Malaysia, Indonesia, and Korea.  China’s 2009 stimulus was very countercyclical.

Unfortunately some, like Thailand, who achieved countercyclicality in the last decade, have suffered backsliding since then.  Brazil, for example, failed to take advantage of the renewed commodity boom of 2010-11 to eliminate its budget deficit, which explains much of the mess it is in today now that commodity prices have fallen.

Politicians everywhere might improve their game if they re-read their introductory macroeconomics textbooks.

[This is an extended version of a column appearing at Project Syndicate.  Comments can be posted there or at Econbrowser.]

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The Threat to US Global Leadership

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President Barack Obama has had a remarkable series of foreign policy triumphs over the last 12 months.  One of the lesser-known was the passage of legislation for reform of the IMF on December 18, 2015, after five years of obstruction by the US Congress.   As the IMF convenes in Washington DC for its annual spring meetings April 15-17, we should pause to savor the importance of this achievement.  One could almost say that if Americans had let yet another year go by without ratifying the IMF quota reform, they might as well have handed over the keys of global economic leadership to someone else.  That would be China.

The IMF reform was an important step in updating the allocations of quotas among member countries. (Quota allocations in the IMF determine both monetary contributions of the member states and their voting power.  They are supposed to be determined by economic weight.)   The agreement among the IMF members was to allocate greater shares to China, India, Brazil and other emerging market countries, coming primarily at the expense of European and Persian Gulf countries.  The change in IMF quotas is a partial and overdue adjustment in response to the rise of the newcomers.  President Obama managed to get the leaders of the other G20 countries to agree to this reform at a 2010 summit in Seoul.

Approving the agreement should have been a “no-brainer” from the viewpoint of the United States:   it was neither to pay a higher budget share nor to lose the voting weight that has always given it a unique veto power in the institution.  The reform was an opportunity to exercise US global leadership.  But one might have thought it was a threat to US leadership if one judged from congressional opponents who blocked passage of the legislation until last December.

If the game is a competition between China and the US for international power and influence, then some damage has already been done.  China feels that its economic success merits a greater role on the world stage.  If the status quo powers “move the goal posts” by denying China the place at the table of global governance that it has earned, it will look to establish its own institutions.   Meanwhile, Asia has been wondering if the US is committed to the region (as its “pivot” claimed).  Indeed, the rest of the world has often in recent years wondered if internal politics prevents the US from functioning at all.  Asians tend to prefer to have the US engaged. China’s territorial assertions in the South China Sea confirm its neighbors worst fears. But they will look elsewhere if need be.

Thus Asian countries (and others) were happy to join a new China-led institution, the Asian Infrastructure Investment Bank. The AIIB, widely viewed as a serious diplomatic setback for the US, went into operation December 25.

The good news is that the AIIB is off to a good start, with no sign so far of the feared lowering of standards relative to other multilateral development banks (such as the World Bank).  But it is even better news that the US can now get back into the game, after a string of international successes.

It has been a busy 12 months for President Obama in the international arena.   Consider  global achievements in four areas (in addition to the IMF reform):

  • On April 2, 2015, the United States (and five other major powers) reached a long-shot breakthrough with Iran over its nuclear program, which was then consummated in a July 14 agreement diverting Tehran from what had seemed an inexorable march to nuclear weapons.   On January 16, 2016, the International Atomic Energy Agency verified that Iran had in fact completed the necessary steps under the agreement to ensure that its program remains exclusively peaceful.
  • On June 24, 2015, Congress was persuaded to give the White House Trade Promotion Authority.  It allowed the administration to complete the Trans-Pacific Partnership (TPP) in October.
  • On July 20, 2015, the US and Cuba re-opened embassies in each other’s countries.  Last month, on March 20, Obama because the first president to visit Cuba in 90 years. The historic event marked the end of 55 years of an attempted isolation policy that had only succeeded in giving the Castro brothers an excuse for economic failure and in handicapping American relations throughout Latin America.
  • On December 12, against all expectations, representatives of 195 parties to the UN Framework Convention on Climate Change successfully reached an agreement on global action in Paris, spurred in no small part by an earlier breakthrough between President Obama and Chinese President Xi Jin Ping.  This month, on April 22, the two leaders are scheduled to sign the Paris Agreement on behalf of their respective countries, the world’s two largest emitters of greenhouse gases.  The signing will encourage others to ratify.

These accomplishments are not the kind that come automatically with possession of the Oval Office.  A year ago, not one of them was expected.  Not only did the international political obstacles appear nearly insurmountable; the domestic obstacles looked even worse.  The overwhelming conventional wisdom was that Obama would not be able to accomplish much in his remaining time in office.  After all, the Republicans had succeeded in blocking almost all Obama’s proposals since they took the House of Representatives in November 2010.  Why should he have any better luck after they took the Senate (in November 2014) and especially now that he was a “lame duck” as well?

The Trade Promotion Authority legislation was declared virtually dead last May.  The IMF quota reform legislation was considered so moribund, the press did even consider it worth reporting on.

A lot of the opposition came from Republicans who from the start have been eager to line up on the opposite side of whatever position President Obama takes.   But opposition to such internationalism comes from the far left of the political spectrum as well as the far right, and not just in the area of trade.  To take the salient example of Bernie Sanders, historically he has joined with congressional Republicans in trying to block efforts to rescue emerging market countries in Latin America and Asia at times of financial crisis.  (These rescues are invariably called “bailouts,” even while they cost the US nothing – the Treasury made a profit on the 1995 loan to Mexico that Sanders fought – and even while they sustain economic growth.)  To take another example, New York Senator Chuck Schumer joined the Republicans in trying to block the Iran nuclear agreement, an effort that failed on September 8.

The IMF deal is done.  Managing Director Christine Lagarde is doing a good job (especially compared to her three predecessors, none of whom was even able to serve out his term).   She is right, for example, to tell the Germans that a solution to the Greek problem requires further debt-reduction as one of its components.

But each of the other four initiatives could still be de-railed by US politics, especially if the far left and the far right join together.  Congress has yet to repeal the Cuba embargo.   It could reject the TPP, in effect telling Asia it is on its own.  On June 2, a federal Appeals Court will hear a challenge to the Clean Power Plan whereby the Obama Administration hopes to begin implementing its commitment under the Paris Agreement.  Donald Trump and Ted Cruz both say that if elected president they would tear up the Iran nuclear deal.   (What would happen then?  Probably the same thing that happened when George W. Bush took office in 2001 and tore up Bill Clinton’s “framework agreement” with the North Koreans:  they predictably and promptly got a bomb.)

The struggle over whether the US will lead the world continues.  It is not a struggle between the US and rivals, but a struggle within American politics.


[This is an extended version of a column that appeared at Project Syndicate.  Comments can be posted there or at Econbrowser.]

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