Monday, May 31, 2010

The negatives of a stronger Chinese currency—higher prices and lower exports for the U.S.—offset the positives.

The Yin and Yang of Yuan Appreciation. By RAY C. FAIR
The negatives of a stronger Chinese currency—higher prices and lower exports for the U.S.—offset the positives.WSJ, Jun 01, 2010

China is under increasing U.S. pressure to allow its currency to appreciate. Many argue that a yuan appreciation would result in more American jobs. Late last year New York Times columnist Paul Krugman said his "back-of-the-envelope" calculation suggested that if there is no appreciation, then over the next several years what he calls "Chinese mercantilism" "may end up reducing U.S. employment by around 1.4 million jobs."

But that's by no means a foregone conclusion. The question of what a Chinese appreciation of the yuan would do to the world economy is complicated. There are many economic links among countries, and they need to be accounted for in analyzing the effects of exchange-rate changes. The standard link that has been stressed in the media is that if the yuan appreciates, Chinese export prices rise in dollars and the U.S. substitutes away from now more expensive Chinese exports to now relatively cheaper American-produced goods. This is good for U.S. output and employment—U.S. jobs are created.

A second link is that China may buy more U.S.-produced goods because they are now cheaper relative to Chinese-produced goods. (The yuan price of U.S. produced goods is lower because a given number of yuan buys more dollars than before.) This is also good for U.S. output and employment.

A third link is that China's output is lower because it is exporting less. With a less robust economy, China imports less, some of which are imports from America. So from this link U.S. exports are lower, which is bad for U.S. output and employment. The second link is a relative price link—China substitutes towards U.S.-produced goods. The third link is an income link—China contracts and buys fewer imports. Which link is larger is an empirical question.

A fourth link is what I will call a U.S. price link. Import prices on Chinese goods are higher. When shoppers go to Wal-Mart they will find higher prices on Chinese-produced goods. This may lead some U.S. firms to raise their own prices since Chinese price competition is now less. So prices in the U.S. will rise. An increase in U.S. prices leads to a fall in real wealth and usually a fall in real wages, since nominal wages usually adjust slowly to increasing prices. This is bad for U.S. consumption demand and thus for U.S. output and employment. In addition, the Federal Reserve may raise interest rates in response to the increase in prices (although probably not much in the present climate), which decreases consumption and investment demand.

Other issues that matter when analyzing the effects of a yuan appreciation against the dollar are what the euro, pound and yen do relative to the dollar, what the monetary authorities in other countries do, and how closely tied countries are to each other regarding trade. One needs a multi-country model to take into account all these effects. I have such a model and have used it to analyze the effects on the world economy of a Chinese yuan appreciation against the dollar. It turns out that the two positive links mentioned above are roughly offset by the two negative links—the net effect on U.S. output and employment is small. The net effect is in fact slightly negative, but given the margin of uncertainty the bottom line is roughly no net effect at all.

It thus seems to be the case, at least from the properties of my model, that the two negative links mentioned above are larger than many people realize. Chinese output is down enough to have a nontrivial effect on Chinese imports. In addition, the negative effects from the increase in U.S. prices are nontrivial. It seems unlikely that there will be a large increase in U.S. jobs if the yuan does in fact appreciate, contrary to what many think.

Mr. Fair is a professor of economics at Yale University.

Press Briefing

Jun 01, 2010

Madeleine Albright on the future of NATO

Europe's GDP Envy - The effort to hide its poor economic performance with a new metric won't fool anyone

The Ongoing Administration-Wide Response to the Deepwater BP Oil Spill: May 30 and May 31, 2010

WaPo Editorial: The flotilla fiasco

The West's Wrong Turn on Natural Resources - If democracies don't extract oil, dictatorships will

It's time to end secret holds on Senate legislation

The New Cannery Row - Congress wants $18 million to offset the jobs it destroyed in Samoa

Statement of the Press Secretary on the President's Briefing Call with National Incident Commander Admiral Thad Allen and

Assistant to the President for Energy and Climate Change Policy Carol Browner

Peter Wehner on Federal President's thin skin

Peter Wehner writing last week at

Obama is among the most thin-skinned presidents we have had, and we see evidence of it in every possible venue imaginable, from one-on-one interviews to press conferences, from extemporaneous remarks to set speeches.

The president is constantly complaining about what others are saying about him. He is upset at Fox News, and conservative talk radio, and Republicans, and people carrying unflattering posters of him. He gets upset when his avalanche of faulty facts are challenged, like on health care. He gets upset when he is called on his hypocrisy, on everything from breaking his promise not to hire lobbyists in the White House to broadcasting health care meetings on C-SPAN to not curtailing earmarks to failing in his promises of transparency and bipartisanship.

In Obama's eyes, he is always the aggrieved, always the violated, always the victim of some injustice. He is America's virtuous and valorous hero, a man of unusually pure motives and uncommon wisdom, under assault by the forces of darkness.

It is all so darn unfair.

Not surprisingly, Obama's thin skin leads to self pity. As Daniel Halper of The Weekly Standard pointed out, in a fundraising event for Sen. Barbara Boxer, Obama said,

"Let's face it: this has been the toughest year and a half since any year and a half since the 1930s."

Really, now? Worse than the period surrounding December 7, 1941 and September 11, 2001? Worse than what Gerald Ford faced after the resignation of Richard Nixon and Watergate, which constituted the wors[t] constitutional scandal in our history and tore the country apart? Worse than what Ronald Reagan faced after Jimmy Carter (when interest rates were 22 percent, inflation was more than 13 percent, and Reagan faced something entirely new under the sun, "stagflation")? Worse than 1968, when Bobby Kennedy and Martin Luther King, Jr. were assassinated and there was rioting in our streets? Worse than what LBJ faced during Vietnam—a war which eventually claimed more than 58,000 lives? Worse than what John Kennedy faced in the Bay of Pigs and in the Cuban Missile Crisis, when we and the Soviet Union edged up to the brink of nuclear war? Worse than what Franklin Roosevelt faced on the eve of the Normandy invasion? Worse than what Bush faced in Iraq in 2006, when that nation was on the edge of civil war, or when the financial system collapsed in the last months of his presidency? Worse than what Truman faced in defeating imperial Japan, in reconstructing post-war Europe, and in responding to North Korea's invasion of South Korea?

Nuclear Non-Proliferation Treaty Review Conference Final Document

The Yin and Yang of Yuan Appreciation - The negatives of a stronger Chinese currency—higher prices and lower exports for

the U.S.—offset the positives.

Background Briefing on Nuclear Nonproliferation Efforts with Regard to Iran and the Brazil/Turkey Agreement

Israel's Gaza Flotilla Fiasco - Israel had no obligation to allow the ships to reach Gaza, but surely there was a smarter way to stop them.

Israel's Gaza Choices - How is the Jewish state supposed to stop Hamas from re-arming?

United States Closing Statement at the 2010 NPT Review Conference

The Union Pension Bailout - A scheme for taxpayers to cover mismanaged multi-employer plans

The Lessons of the GM Bankruptcy - Everybody knew it was ridiculous and unsustainable to pay UAW workers not to work.

Seoul Reviews U.S. Military Ties

Seoul Reviews U.S. Military Ties. By JAY SOLOMON
WSJ, May 31, 2010

In the wake of North Korea's alleged sinking of a South Korean naval vessel, South Korean President Lee Myung-bak's government is reviewing its long-term defense policy in ways that could significantly impact the Washington-Seoul military alliance, according to officials engaged in the reform process here and in the U.S.

Over the past week, U.S. and South Korean leaders have outlined plans to conduct new war games and strategy sessions to better equip the South for combating the type of submarine attack Pyongyang is accused by international investigators to have staged this March, killing 46 South Korean sailors.

But longer-term, Mr. Lee's conservative government also could seek to alter the alliance's command structure and Seoul's weapons arsenal in ways that would challenge the Pentagon's current strategic planning for Northeast Asia, according to these officials.

South Korean defense strategists already are publicly pressing Mr. Lee to delay the planned 2012 transfer of operational control of the combined U.S.-South Korean fighting force to Seoul from Washington, arguing South Korea isn't prepared yet to oversee American forces. The agreement between Washington and Seoul has a clause that allows South Korea's president to formally request a suspension of the transfer. The U.S. currently deploys 29,000 troops in South Korea, and the South Korean military deploys 600,000.

Some South Korean officials involved in the president's military-reform drive also are calling for Seoul to develop more offensive strategic weapons as a means to deter the nuclear-armed North from future aggression. Currently, South Korea isn't allowed by its defense agreement with the U.S. to deploy precision-guided missiles with a range of more than 300 kilometers.

"We need to have our own ways to threaten North Korea," said Kim Tae-woo, a South Korean defense expert who sits on one of two committees President Lee has established to assess Seoul's military preparedness. "We need to have this dialogue with our allies."

Mr. Lee took office in 2008 calling for an overhaul of South Korea's military apparatus, which his party had charged was weakened during 10 years of liberal rule in Seoul. But South Korea's new government initially agreed with its predecessor's plans to shrink the size of Seoul's military ranks while reining in defense spending.

Many in South Korea have viewed North Korea's million-man military as largely targeted at the U.S. South Korea's late President Roh Moo-hyun successfully pushed for the U.S. to lower it military profile in his country and to transfer control of the joint-military command to South Korea's defense department.

The North's alleged attack March 26 on the South Korean naval vessel, the Cheonan, however, has shaken up Seoul's strategic thinking, according to South Korean and U.S. officials. A major concern here now is that Pyongyang's development of nuclear technologies has provided leader Kim Jong Il with a deterrent against the more-advanced militaries of the U.S. and South Korea. This, in turn, could allow Pyongyang to stage more-aggressive conventional attacks on the South, with the belief that Seoul won't retaliate for fear of an escalation.

This fear seems to have been borne out in recent days as Mr. Lee's government has shown a reluctance to take some new steps to challenge Pyongyang over the Cheonan incident. Seoul, for example, stepped back from an initial pledge to use loudspeakers to blast pro-South Korean propaganda across the Demilitarized Zone between the two Koreas after the North threatened to attack the broadcasting infrastructure.

South Korea's leaders also have publicly sought to play down the idea that the North's two recent nuclear tests have given it a military advantage or that it has succeeded in developing atomic weapons. "Regarding North Korea's nuclear capabilities, we have not been able to verify those capabilities," South Korean Foreign Minister Yu Myung-hwan said last week at a joint-news conference with U.S. Secretary of State Hillary Clinton.

Still, many leading defense thinkers in Seoul said Pyongyang's growing nuclear technologies are "game changers" that now require South Korea to significantly upgrade its own capabilities. In addition to developing longer-range missiles, many are calling for the purchases of advanced new strike-fighters and antiballistic-missile batteries. They also are calling for the Pentagon to remain in charge of the joint-military command in South Korea beyond 2012, given the lethal effectiveness displayed by North Korea's mini-submarine fleet during the Choenan attack.

"There has been an asymmetrical shift that has weakened our deterrence structure," said Kim Byungki of Seoul's Korea University. "We are supposed to have air, ground and sea dominance."

South Korea's effort to renegotiate in the coming months its decades-old nuclear-cooperation agreement with the U.S. could now prove particularly tricky, according to current and former U.S. officials.

South Korea, under the 1974 pact, faces strict guidelines on its ability to store and reprocess the spent nuclear fuel produced by the country's 20 power reactors, because of fears it could be diverted for military purposes. The U.S. is seeking to limit any major alterations in the treaty, which expires in 2014, so as not to undermine Washington's efforts to contain the nuclear advances of countries like North Korea and Iran.

South Korean officials have said they are seeking to amend the agreement to in a bid to allow Seoul to better manage the storage of its nuclear waster. They are specifically citing South Korea's need to reprocess the spent fuel into a form that can be more easily disposed. But some analysts said Mr. Lee's government also could resist the constrictive terms being sought by the U.S. by citing the North's flouting of a 1992 agreement calling for the removal of all atomic weapons on the Korean Peninsula.

"This incident with the Cheonan could be the spark for turning around a number of things" between the U.S. and South Korea, said Victor Cha, who served as a senior White House official working on Asia during President George W. Bush's second term.