Exchange Rates and the Savings Rate: Reverse Causation

Steve Kyle is off to a superb start as an Angrybear:

My rationale was that if the US continues to spend more than it produces then the Current Account will remain in deficit and while an increase in the value of the yuan could help (by reducing our real income and/or by shifting demand to other goods, some of which are domestic and some from other countries) it can’t be expected to correct the huge underlying imbalances in income vs. spending that drive our deficits.

As AB readers likely know, I’ve touted the Mundellian argument that fiscal restraint could lead to an exactly offsetting increase in net exports if we let the dollar devalue. Steve’s post has attracted the attention of Dean Baker in part because he linked to this discussion. Dean reminds me that we might be under a Bretton Woods II regime whereas my Mundellian logic relies on floating rates. But it was this line from Dean that got me thinking – which variable (national savings rate v. exchange rate) is the cause and which is the effect:

It’s also worth notiing that China’s currency policy has been one of the main factors lowering the U.S. savings rate. China’s central bank has bought hundreds of billions of dollars of U.S. treasury bonds. This has kept long-term interest rates extraordinarily low, which in turn has fueled the housing bubble. The unprecedented run-up in housing prices has allowed people to borrow against their homes at an incredible pace, giving us the first negative savings rate since the depression. While the Fed deserves blame for not trying to counteract this effect and acting to burst the bubble, China’s policies are a major factor behind the record low U.S. savings rate.

Touche! Greg Mankiw points us to a related discussion from Ben Bernanke where Chairman Ben wants the Chinese to save less. Mark Thoma picks up on where Chairman Ben suggested an overvalued yuan is effectively an export subsidy.

And while we are on the topic, Kash announces that he will be discussing exchange rates with Menzie Chinn.

Update: Kash extends the discussion in a very enlightening post.

Update II: Menzie Chinn joins the discussion. Menzie and Kash should have much more on Monday!