Worth Reading #2: Paul Krugman: Capital Export, Elasticity Pessimism, and the Renminbi (March 20, 2010)
Capital Export, Elasticity Pessimism, and the Renminbi: I think it would be useful for me to explain how I think about the current China syndrome, and why I believe that most of the responses I hear are missing the point. In what follows, I’ll focus on three questions: the macroeconomics of Chinese currency intervention, the fallacies of elasticity pessimism (which I’ll explain when I get there), and the political economy issue of how to deal with Chinese intransigence.
I. Macroeconomics of intervention: Let me start with a proposition: the right way to think about China’s exchange rate is, initially, not to think about the exchange rate. Instead, you should focus on China’s currency intervention, in which the government buys foreign assets and sells domestic assets, on a massive scale.... [W]hat the Chinese government is doing here is engaging in massive capital export – artificially creating a huge deficit in China’s capital account. It’s able to do this in part because capital controls inhibit offsetting private capital inflows; but the key point is that China has a de facto policy of forcing capital flows out of the country... exporting savings to the rest of the world. In normal times, you could argue that this policy provides benefits to the rest of the world, by reducing borrowing costs (although given what we did with those capital inflows, maybe not). But these aren’t normal times. We’re currently living in a world in which both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment; so it’s a paradox of thrift world, in which anyone who tries to save more reduces demand, reduces employment, and – because investment responds to excess capacity – ends up actually reducing investment. By exporting savings to the rest of the world, via an artificial current account surplus, China is making all of us poorer. Notice that I didn’t mention the value of the renminbi at all in this account. It’s there implicitly: a weak renminbi is the mechanism through which China’s capital-export policy gets translated into physical exports of goods. But you want to keep your eye on the ball: it’s the artificial capital exports that are the driving force here. What this means, in particular, is that you can disregard people who offer calculations suggesting that by some criterion – say, Balassa-Samuelson adjusted purchasing power parity – the renminbi isn’t undervalued...