Sunday, April 5, 2009

Comments on some articles

I have been quite lazy just posting pictures and not writing, so this morning I thought I'd link to some news-related articles that I've read lately that are thought provoking.

Tom Friedman's "The Price is Not Right" in the April 1 New York Times argues that our climate and financial problems stem from mispricing risk. In econ-babble, this means we are not internalizing the externalities on the climate side, and properly evaluating uncertainty and risk on the financial side. I think this is correct (and obvious), but the problem comes from the ability of folks active in these sector to transfer the costs (and responsibility) to others, a fundamentally political problem.

Davesh Kapur and Arvind Subramanian "The G-20 and IMF Reform" in The Business Standard addresses the mismatch between economic power today and the voting structure at the IMF. They begin, "The current Euro-Atlantic Monetary Fund must become an International Monetary Fund," and go on to say that probably the only thing that would force the Europeans to accept the necessary changes would be for the non-Europeans to "vote with their feet" and threaten to establish an Asian Monetary Fund (that I will label the AMF for short). I feel very old, as I have seen two rounds of discussion on such an AMF -- first after the 1982 debt crisis when the Japanese led the way, and now again. The self-insurance schemes the Asian countries have established themselves by building up reserves via sustained current account surpluses are of course part of the problem, as their fixed exchange rates and mania for these surpluses are the necessary flip side of the tremendous deficits in the US. I can already see some of my readers' eyes glazing over, but yes, this will be an economics lesson here.

Economists often debate about what drives what -- so, does my current account deficit drive your deficit or vice versa, or do other things drive the external sector (mismatches between savings, investment, and consumption)?; do capital flows drive the consumption/investment side or vice versa? We can talk about relationships between the variables, but we can't really see what determines what, can we? We can talk about a mathematical relationship, that after the fact capital account plus current account plus change in reserves must be equal to zero, and that the difference in the capital account and current account leads to reserves increasing or decreasing. On a personal level, the availability of credit allows one to consume more than the available cash, yet sometimes one looks for credit to finance a large purchase. So it is very hard to say what drives what. However, we certainly can say that the East Asian trade-driven growth based on undervalued exchange rates led to huge trade surpluses for them, and "enabled" the overconsumption credit binge in the US (I don't know enough about the European situation here to say anything intelligent about it in this case). A floating exchange rate would have allowed, no, required some of the adjustment that is happening violently now to happen gradually, and in a more orderly way by making these Asian exports more expensive, making US products more competitive there, and prevented some of these huge imbalances.

Okay, bear with me, just a little more economics here. Now, part of the problem with the IMF historically (there are many problems, but I'll just focus on one here, and one that traditionally isn't discussed much) is that while it has power over countries with deficits (as they desperately need to finance them), they have no such power over countries with big surpluses, who can continue to run them and build up reserves if they decide they want to (I won't bore you with the costs of that right now).

So .... I agree that the voting shares need to be dramatically shifted. But we also need to think about what the IMF does, the kinds of policies it implements, and many other things about it.

Paul Krugman's "China's Dollar Trap" talks about the problems the Chinese have because of their huge reserve holdings of US dollars and dollar-denominated securities. As he notes, this causes a problem for them as much as for us (and the world) because they stand to lose a lot of value if the dollar were to depreciate substantially. He says that the Chinese call for increased use of SDRs is a sign of weakness. I agree with his statement:
"The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us." The domestic implications of these international changes are going to be dramatic, and perhaps the biggest unknown of all with the largest implications for the future of the world economy is how the Chinese government, and then its economy and people, adapt. Again, I think this is fairly obvious, but when I read articles in the press around the world it seems like many are ignoring this.

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