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Only Tsipras Can “Go to China”

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Alexis Tsipras, the Greek prime minister, has the chance to play a role for his country analogous to the roles played by Korean President Kim Dae Jung in 1997 and Brazilian President Luiz Inácio Lula da Silva in 2002.  Both of those presidential candidates had been long-time men of the left, with strong ties to labor, and were believed to place little priority on fiscal responsibility or free markets.  Both were elected at a time of economic crisis in their respective countries. Both confronted financial and international constraints in office that had not been especially salient in their minds when they were opposition politicians.  Both were able soon to make the mental and political adjustment to the realities faced by debtor economies.  This flexibility helped both to lead their countries more effectively.

The two new presidents launched needed reforms.  Some of these were “conservative” reforms (or “neo-liberal”) that might not have been possible under more mainstream or conservative politicians.

But Kim and Lula were also able to implement other reforms consistent with their lifetime commitment to reducing income inequality.  South Korea under Kim began to rein in the chaebols, the country’s huge family-owned conglomerates. Brazil under Lula expanded Bolsa Familia, a system of direct cash payments to households that is credited with lifting millions out of poverty.

Mr. Tsipras and his Syriza party, by contrast, spent their first six months in office still mentally blinkered against financial and international realities.  A career as a political party apparatchik is probably not the best training for being able to see things from the perspective of other points on the political spectrum, other segments of the economy, or other countries.  This is true of a career in any political party in any country but especially one on the far left or far right.

The Greek Prime Minister seemed to think that calling the July 5 referendum on whether to accept terms that had been demanded previously by Germany and the other creditor countries would strengthen his bargaining position.  If he were reading from a normal script, he would logically have been asking the Greek people to vote “yes” on the referendum.   But he was asking them to vote “no”, of course, which they did in surprisingly large numbers.   As a result – and contrary to his apparent expectations — the only people’s whose bargaining position was strengthened by this referendum were those Germans who felt the time had come to let Greece drop out of the euro.

The Greek leadership discovered that its euro partners, predictably, are not prepared to offer easier terms than they had been in June, and in fact are asking for more extensive concessions as the price of a third bailout.  Only then, a week after the referendum, did Mr. Tsipras finally begin to face up to reality.

The only possible silver lining to this sorry history is that some of his supporters at home may – paradoxically – now be willing to swallow the bitter medicine that they had opposed in the referendum.  One should not underestimate the opposition that reforms will continue to face among Greeks, in light of the economic hardship already suffered.  But like Kim dae Jung and Lula, he may be able to bring political support of some on the left who figure, “If my leader now says these unpalatable measures are necessary, then it must be true”.  As they say, Only Nixon can go to China.

None of this is to say that the financial and international realities are necessarily always reasonable.  Sometimes global financial markets indulge in unreasonable booms in their eagerness to lend, followed by abrupt reversals.  That describes the large capital inflows into Greece and other European periphery countries in the first ten years after the euro’s 1999 birth.  It also describes the sudden stop in lending to Korea and other emerging market countries in the late 1990s.

Foreign creditor governments can be unreasonable as well.   The misperceptions and errors on the part of leaders in Germany and other creditor countries have been as bad as the misperceptions and errors on the part of the less-experienced Greek leaders.   For example the belief that fiscal austerity raises income rather than lowering it, even in the short run, was a mistaken perception.  The refusal to write down the debt especially in 2010, when most of it was still in the hands of private creditors, was a mistaken policy.  These mistakes explain why the Greek debt/GDP ratio is so much higher today than in 2010 — much higher than was forecast.

A stubborn clinging to wrong propositions on each side has reinforced the stubbornness on the other side.  The Germans would have done better to understand and admit explicitly that fiscal austerity is contractionary in the short run.  The Greeks would have done better to understand and admit explicitly that the preeminence of democracy does not mean that one country’s people can democratically vote for other countries to give them money.

In terms of game theory, the fact that the Greeks and Germans have different economic interests is not enough to explain the very poor outcome of negotiations to date.  The difference in perceptions has been central.  “Getting to yes” in a bargaining situation requires not just that the negotiators have a clear idea of their own top priorities, but also a good idea of what is the top priority of the other side.   We may now be facing a “bad bargain” in which each side is called upon to give up its top priorities.  On one side, Greece shouldn’t expect the ECB and the IMF to be willing explicitly to write down the debt they hold.  On the other side, the creditors shouldn’t expect Greece to run a substantial primary budget surplus.  A “good bargain” would have the creditors stretch out lending terms even further so that Greece doesn’t have to pay over the next few  years and would have the Greeks committing to structural reforms that would raise growth.

One hopes that the awful experience of the recent past has led both sides to clearer perceptions of economic realities and of  top priorities.   Such evolution is necessary if the two sides are to arrive at a good bargain rather than either a bad bargain or a failure of cooperation altogether. The non-cooperative equilibrium is that Greek banks fail and Greece effectively drops out of the euro. This may be even worse than a bad bargain, although I am not sure.

Admittedly, both Kim and Lula had their flaws.  Moreover, Korea and Brazil had some advantages that Greece lacks, beyond Syriza’s delay in adapting to realities.  They had their own currencies. They were able to boost exports in the years following their currency crises.

But a recurrent theme of the Greek crisis ever since it erupted in late 2009 is that both the Greeks and the Euro creditor countries have been reluctant to realize that lessons from previous emerging market crises might apply to their situation.  After all, they said, Greece was not a developing country but rather a member of the euro.   (This is the reason, for example, why Frankfurt and Brussels at first did not want Greece to go to the IMF and did not want to write down the Greek debt.)  But the emerging market crises do have useful lessons for Europe.  If Tsipras were able to shift gears in the way that Kim dae Jung did in Korea and Lula did in Brazil, he would better serve his country.

[An earlier version appeared in Project Syndicatecomments are welcome there.]



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Does the Dollar Need Another Plaza?

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We are at the 30th anniversary of the 1985 Plaza Accord.  It was the most dramatic intervention in the foreign exchange market since Nixon originally floated the US currency.   At the end of February 1985 the dollar reached dizzying heights, which remain a record to this day.  Then it began a long depreciation, encouraged by a shift in policy under the new Treasury Secretary, James Baker, and pushed down by G-5 foreign exchange intervention.  People remember only the September 1985 meeting at the Plaza Hotel in New York City that ratified the policy shift; so celebrations of the 30th anniversary will wait until this coming fall.

The dollar has appreciated sharply over the last year, surpassing its ten-year high.   Some are suggesting it may be time for a new Plaza, to bring the dollar down.   In its on-line “Room for Debate,” the New York Times asked, Will a strong dollar hurt the economy and should the Fed take action?”   Here is my response:

Any movement in the exchange rate has pros and cons.  When the dollar appreciates as much as it has over the last year, the obvious disadvantage is that the loss in competitiveness by US producers hits exports and the trade balance.   But if the dollar had fallen by a similar amount, there would be lamentations over the debasing of the currency!

Overall, the strong dollar is good news.  This is because of the macroeconomic fundamentals behind it.  Indeed textbook theories explain this episode unusually well.  The US economy has performed relatively strongly over the last year — compared to preceding history and to other countries).  This is why the Fed is getting ready to raise interest rates — again, in contrast to the preceding six-year period of monetary easing and also compared to other countries.  (“Divergence.”)   American economic performance and the change in monetary policy are both excellent reasons for the strong dollar.   These developments should be welcomed, taken as a whole, notwithstanding the effect on exports.

Nevertheless, the soaring dollar – especially if it goes much higher – would be a reason for the Fed to hold off past June on its long-anticipated decision to raise short-term interest rates, so as to avoid a growth slowdown or even a descent into deflation.  I believe the Fed would indeed respond in that appropriate way.   In that sense, although the dollar strength is bad for exporters, it will not be bad for output and employment in the economy as a while.

Might a more aggressive intervention to bring down the dollar be justified, in which central banks would get together to sell dollars in exchange for euros and yen?   The last major effort of that sort was the Plaza 30 years ago.  (They also did it in a more minor way, to help the undervalued euro, in 2000.)

But 2015 is not 1985.   Neither the US authorities nor those in other G-7 countries will intervene in the foreign exchange market.  (They agreed not to, two years ago.)  Nor should they, in the current context.   In the first place, the appreciation is not yet anywhere near as big as it was 30 years ago (or even 15 years ago).  In the second place, today’s dollar appreciation is fully justified by economic fundamentals, unlike in 1985.

[The response to the NYT’s question from me and the others can be viewed at Room for Debate: “The Fed and the Dollar.”]

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If China Stops Manipulating, Its Currency Will Depreciate

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A rare issue on which the two parties in the US Congress agree is the problem of “currency manipulation,” especially on the part of China.   Perhaps spurred by the 2014 appreciation of the dollar and the first signs of a resulting loss of American net exports, Congress is once again considering legislation to attack currencies that are seen as unfairly undervalued.  The proposed measures include the threat of countervailing duties against imports from offending countries, although that would be inconsistent with international trading rules.

Even if one accepts the possibility of identifying a currency that is manipulated, however, China no longer qualifies.  Under recent conditions, if China allowed its currency to float freely, without intervention, the renminbi would more likely depreciate against the dollar than appreciate.  US producers would then find it harder to compete on international markets, not easier.

The concepts of manipulation or unfair undervaluation are exceedingly hard to pin down from an economic viewpoint.   That China’s renminbi depreciated slightly against the dollar in 2014 [2%] is not evidence:   Many other currencies, most notably the yen and euro, depreciated by far more last year.  As a result the overall value of the renminbi was actually up slightly on an average basis during 2014 [3%], reaching an all-time high.

The sine qua non of manipulation criteria is intervention in the foreign exchange market: selling the domestic currency, in this case, the renminbi, and buying foreign currencies, the dollar, so as keep the foreign exchange value of the domestic currency lower than it would otherwise be.   To be sure, the People’s Bank of China did a lot of this over the preceding ten years.   Capital inflows on top of trade surpluses contributed to a huge balance of payments surplus.  The authorities bought the dollars needed to make up the difference, the excess supply of dollars.  The result was an all-time record level of foreign exchange reserves, reaching $3.99 trillion by July 2014.

The situation has recently changed, however.  In 2014, net capital inflows into China reversed and turned to substantial net capital outflows.  As a result, the overall balance of payments turned negative in the second half of the year, which constitutes an excess demand for dollars or excess supply of renminbi.  The People’s Bank of China actually intervened to dampen the depreciation of its currency against the dollar, the opposite of its actions over the preceding decade.  As a result, foreign exchange reserves fell to $3.84 trillion by January 2015.

There is no reason to think that this recent trend will necessarily reverse in the near future.  The downward market pressure on the renminbi relative to the dollar is easily explained by the current pattern of a relatively strong economic recovery in the US, prompting the end of a period of American monetary easing, together with a weakening of economic growth in China, prompting the start of a new period of monetary stimulus there.

Similar economic fundamentals are now at work in other countries, particularly Japan and euroland.    When the American congressmen propose to insert currency provisions into the Trans-Pacific Partnership, even though it is currently in its final stages of negotiations, they are presumably targeting Japan.  (China is not included in this trade agreement.)   They may also want to target the Eurozone in coming negotiations for the Transatlantic Trade and Investment Partnership.   Both the yen and euro have depreciated sharply against the dollar over the last year.

But, unlike China, it has been years since the Bank of Japan and the European Central Bank intervened in the foreign exchange market.   They accepted a proposal by the US Treasury to refrain from unilateral foreign exchange intervention, in an unheralded G7 ministers’ agreement two years ago.

Then what do those who charge Japan or the Eurozone with pursuing currency wars by pushing down the values of their currencies have in mind?   They have in mind the renewed monetary stimulus of recent quantitative easing programs by those central banks.   But, as the US government knows well, countries with a deficiency of demand can’t be asked to refrain from increasing the money supply or decreasing interest rates just because the likely effects include a depreciation of the currency.   One cannot even say that the likely effects include a “beggar-thy-neighbor” rise in the trade balance, because the exchange rate effect is counteracted by an income effect that boosts imports.

Indeed in 2010 it was the US that had to explain to the world that money creation is not currency manipulation.  At the time, it was the country undertaking quantitative easing and was accused by Guido Mantega, the Brazilian Finance Minister who coined the “currency wars” phrase, of being the prime aggressor.   The US hasn’t intervened in the foreign exchange market to sell dollars in a major way since the 1985 coordinated interventions associated with the Plaza Accord, which began precisely 30 years ago this month.  (There was also a smaller intervention to sell dollars in 2000, to help the euro.)

There are other criteria besides foreign exchange intervention that are used to ascertain whether a currency is undervalued or even  “manipulated” for “unfair competitive advantage,” language that is in the IMF Articles of Agreement.  One criterion is an inappropriately large surplus in its trade balance or current account balance, relative to GDP.   Another is an inappropriately low foreign exchange value for the currency, in real terms.   Many countries have large trade surpluses or low currencies.  Sometimes they are appropriate, sometimes not.  Usually it is difficult to say for sure.

China’s currency 10 years ago was unusual in that it did seem to meet all the criteria for undervaluation.  The real value of the renminbi was estimated to be about 30% below equilibrium in 2005.  The Chinese trade surplus reached 7% of GDP in 2007 and the current account surplus reached 10%.  But things have changed.   The currency appreciated about 30% in real terms between 2006 and 2013, enough that the most recent purchasing power statistics (for 2011), show it in an area that is normal for a country with real income per capita around $10,000.  The surpluses as a share of GDP came down too.  (The trade surplus is back up again over the last six months due to a fall in China’s import spending, particularly in the energy import bill.)

The criteria that US congressmen focus on is one that has no relevance for economists or for the IMF rules:  the bilateral trade balance between China and the US.   It is true that China runs a bilateral surplus with the US that is as big as ever.  At the same time, however, it runs bilateral deficits with Saudi Arabia, Australia and other exporters of oil and minerals.  And with South Korea, from whom it imports components that go into its manufactured exports.  Roughly 95% of the value of a “Chinese” smart phone exported to the US is represented by imported inputs; only 5% is Chinese value added.   The point isn’t that the trade statistics need to be corrected.  The point is, rather, that bilateral trade balances have little meaning.

If I insisted that in return for a haircut my barber must listen to me give an economics lecture, he or she would be unlikely to consider that acceptable payment.  I pay my barber in cash, and am in turn paid by Harvard University for my economics lecture.  My bilateral balances are not of concern.

Congress requires by law that the US Treasury report to it twice a year whether countries are guilty of manipulation, with the bilateral balance specified as one of the criteria.  It would be ironic if China agreed to US demands to allow the exchange rate to be determined freely in the market place and the result were a depreciation of its currency and a gain in the international competitiveness of its exporters.

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

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