John Cochrane on currency manipulation in Germany and Italy
Several people directed me to a John Cochrane post that has an amusing critique of the US government’s recent attempt to label Germany and Italy as “currency manipulators”. The most obvious objection raised by Cochrane is that neither Germany nor Italy has a national currency to manipulate—both use the euro.
I will end up showing that this US government initiative is every bit as absurd as John claims, but I will first try to explain the logic of the currency manipulation argument, before criticizing it on other grounds.
When I began investigating the issue of currency manipulation, I discovered that the concern isn’t actually about currencies at all. Rather what people object to is better described as saving manipulation. Policies that boost the current account by increasing domestic saving.
A recent book by Fred Bergsten and Joe Gagnon provides the best explanation of why some people worry about “currency manipulation”. Indeed it’s the only plausible interpretation that I’ve run across. In their explanation, it’s obvious that the actual concern is governmental attempts to artificially boost the current account surplus, almost always via policies that boost the national saving rate.
Actual currency manipulation, say by a new populist government in Latin America that devalues its currency, is not a source of concern. Because simple currency devaluation does not boost domestic saving, it does increase the current account. Instead, the gains from devaluation are offset by higher inflation, as predicted by Purchasing Power Parity.
The sort of currency manipulation that worries Bergsten and Gagnon is when countries artificially depreciate their real exchange rate by purchasing lots of foreign assets, or via fiscal austerity. Even countries such as Germany and Italy can do this sort of manipulation without impacting the nominal exchange rate at all. For instance, a Eurozone country can run a tight fiscal policy (currently more true in Germany than Italy.) Fiscal austerity can then depreciate a Eurozone country’s real exchange rate by reducing the domestic price level.
Despite the preceding, I end up in the same place as Cochrane. Let’s start with the question of why the government doesn’t honestly tell us exactly what it is objecting to. Why not label Germany and Italy “saving manipulators”, if that is what we actually object to?
I suspect the reason is political. If our government says, “those devious Germans are manipulating their currencies”, then it sounds bad to most Americans. If we say, “those devious Germans are running balanced budgets”, it doesn’t sound bad at all. Most Americans already believe that Germans are sensible people, and if we tell them that Germany balances their budget then Americans will look even more enviously on the highly disciplined German economic system.
It’s true that academic economists now tend to worry about the “paradox of thrift”, and the associated idea that more saving will depress aggregate demand. But most people still believe that balanced budgets are prudent. While I usually agree with the professors over the man on the street on macro issues, fiscal policy is one area where I go with popular prejudice. I don’t believe that we are hurt by German saving, as any negative effects on aggregate demand are offset by US monetary stimulus. Indeed more saving is often good, as it boosts investment without reducing aggregate demand.
Here’s my general rule of international relations. If you have a quirky theory that most people do not accept, you are free to implement that theory in your own country. But you are not free to force the entire world to adhere to your quirky theory. Thus America should be free to tear up our nuclear agreement with Iran, but it is not free to force all other countries to follow our lead in a policy rejected by most experts in America and in our allies. Similarly, the US government is free to run trillion dollar deficits if it believes that the theories of John Maynard Keynes are applicable to an economy where the Fed targets inflation at 2% (they aren’t), but it’s not free to force other countries to adhere to Keynesian theory. I think most Americans understand this, which is why the Treasury hides a policy directed at saving manipulation under the extremely misleading label of “currency manipulation.”
In fact, the US government policy is far worse than what one might infer from the previous discussion. The Treasury Department’s accusations of currency manipulation are based in part on the level of bilateral trade deficits, a concept almost universally regarded by economists (including Bergsten and Gagnon) as being utterly meaningless. It’s hard to overstate the craziness of implementing US policy that is aimed at harming other countries and that is based on the economic equivalent of astrology. Here’s Cochrane:
I called this post “institutionalized nonsense.” Yes, every president brings to his (or, someday, her) Administration some nutty ideas, some campaign rhetoric that does not correspond to cause-and-effect reality. Sensible cabinet secretaries and career staff must indulge the rhetoric.
But by this document the Treasury is institutionalizing nuttiness — setting up rules and procedures that monitor bilateral goods “deflcits,” and waste our Nation’s vanishing prestige haranguing countries about their “macroeconomic policies” that produce such undefined and ill-measured ephemera. Why listen to us on, say Iran sanctions or Tiananmen square if we are going to indulge in this sort of nuttiness?
Meanwhile, the administration continues to badger the Fed to lower interest rates in order to… well, to manipulate our currency!
PS. I’ll present my paper on saving manipulation at the upcoming WEA meeting in San Francisco.