Exporting Gold Bugs to China
While it has been a while, let me start by thanking Kash for his post on the CNOOC bid to buy Unocal as well as his various posts that discuss the benefits of free trade. The NRO has even featured very good defenses of free trade from William Buckley and Bruce Bartlett. I was hoping to say the same thing about the latest from Lawrence Kudlow with his colorful title “The Insanity of Smoot Schumer and Hawley Graham”. Alas, Kudlow spent more time of this theme:
This rhetorical question was asked by economist Arthur Laffer last week in connection to an unprecedented attack on China trade by numerous U.S. senators. In response to the China bashing, the stock market plunged … Art Laffer argues that a stable yuan linked to the dollar has promoted strong economic growth at low inflation for the U.S., China, and the rest of the world … Think of the dollar-link as China’s gold standard … Ironically, since the dollar has been floating freely, the dollar-linked yuan has also floated compared to a market basket of currencies. Between 1995 and 2001 the yuan-dollar appreciated by nearly 50 percent and in recent years has fallen by about 30 percent. Both the U.S. and China adjusted internally to deflation and inflation. But the common link between the two has given the yuan global financial confidence while at the same time giving the U.S. enormous leverage over the Chinese economy. What’s wrong with that? We buy their goods and they invest in our country through the purchase of Treasury bonds and more recently through direct investment in large U.S-based corporations (like Maytag and Unocal).
First of all – for all the NRO’s devotion to every word written by Art Laffer, why can’t they identify what Laffer paper they refer to? Secondly, U.S. monetary policy is neither tied to the price of gold nor should it be. Perhaps, Kudlow should review these words from John Tamny:
given the rise in the price of gold from $255 in 2001 to roughly $435 today … from 1996 until 2001 – a time in which the price of gold plummeted from roughly $385 to $255.
If one looks at the bottom right of this webpage, one can plot gold prices and see Tamny at least got the data right. Even though gold prices fell during the late 1990’s, I would not argue that monetary policy should have been more expansionary. And even though Mark Thoma seems to be more comfortable with recent FED tightening than I am, he is not saying the FED should try to reverse the recent rise in gold prices.
Kudlow argues that Chinese inflation roughly tracks U.S. inflation. Reported inflation in China has been less than reported inflation in the U.S. over the past several years per this IMF report, but one could argue that the official statistics understate Chinese inflation. The IMF data also shows that China’s monetary growth rates have been double-digit since 1997, which is what one would expect under a fixed exchange rate regime where China has consistently run current account surpluses, while the U.S. has consistently run current account deficits.
And yet Kudlow’s whole argument seems to be that we should retain the current exchange rate peg. His claim seems to be that Chinese real GDP growth, which has been in excess of 8% per year since 1997, is due to its pegged exchange rate. Yet, the IMF also reports that real GDP growth in China averaged 10% per year from 1987 to 1996. The current exchange rate peg has not been in place for this entire period. Additionally, fixed exchange rates are neither a necessary nor a sufficient condition for macroeconomic stability. While a yuan revaluation might be in order to reduce China’s current account surplus, the impact on U.S. net exports is likely to be quote modest.