24 Apr 2013

Stockman Bask

Economics 34 Comments

I am reviewing David Stockman’s book, The Great Deformation, for Barron’s. I want to run two things by you folks that gave me pause. These probably won’t make it into the review, but I’m nonetheless curious:

==> On page 61 he writes:

This arrangement [of Asian countries keeping their currencies artificially low vis-a-vis the dollar in order to boost exports to US] defied every tradition of sound international finance…During the nine years after 1991, the US trade accounts literally collapsed, with imports growing at 11 percent annually…The trade deficit thus surged from $66bn in 1991 to $450bn by the year 2000…It was an unfathomable figure by the canons of classic finance because it was literally upside down. The reserve currency country was supposed to run a trade surplus and export capital to less developed trading partners, not incur massive deficits and drain capital from them. [Bold added.]

It’s the part I put in bold that intrigues me. First, is that right? Has anyone else heard of such a relationship?

Next, how does this work under a commodity standard? Let’s say the whole world uses gold, and I mean literally they use gold as the money, not sovereign currencies that are redeemable in gold. Suppose one country just so happens to have the only gold mines left. How would that show up in the trade statistics? Depending on the accounting, you would arguably see that country run a perpetual trade deficit with the rest of the world, as it shipped out money every year, in exchange for net imports of goods.

==> On page 63 Stockman writes that Professor Taylor “had seen fit to name the rule in his own honor.” Is that right? The “Taylor Rule” got its name from Taylor himself, in narcissistic fashion?

34 Responses to “Stockman Bask”

  1. David R. Henderson says:

    I’m virtually positive that John Taylor didn’t name the Taylor rule after himself.

  2. Jonathan Finegold says:

    Yea, I understand it the other way around: Triffin dilemma. Their buying our dollars with real goods (unless we hold a comparable amount of their assets).

  3. Neal Provost says:

    Could this “rule” have come from the situation after World War II? At that point, the U.S. was basically the only industrialized country left standing. This helped set up the dollar as the world reserve currency at the same time as every other country in the world wanted to buy stuff from the U.S. which led to trade surpluses. In classical empirical fashion, this correlation became a cause-and-effect relationship. Of course, I’m totally making this up, but I could see most economists falling for it. It seems clear to me that having world reserve currency status sets up an irresistible moral hazard resulting in chronic trade deficits.

    • Neal Provost says:

      In the previous post, the “rule” I was referring to was not the Taylor Rule, but the reserve currency/trade surplus relationship mentioned by Mr. Stockman.

    • Jorge Borlandelli says:

      Neal your are right,
      The US gave a lot of loans to European governments (capital account deficit) and they purchased US goods (current account surplus). However, the overall balance of payment was probably negative due to the dollar being bought by other central banks as reserves.

  4. Brent says:

    I think it is a question of how one becomes the international reserve currency in a world of fiat money. I think, in order to become that designation in the first place, you must be the exporter of real goods and services. However, once your country has become the source of the world’s chosen reserve currency, then it is the opposite of what Stockman claims.

  5. konst says:

    I think he means something having to do with Bretton Woods. I read something somewhere about it. Supposedly there was some sort arrangement where in return for the US dollar being chosen as the reserve currency, that the US would send foreign aid to third world countries or something like that. Sorry I couldn’t be more vague.

  6. Daniel Kuehn says:

    Ya he phrases it kind of awkwardly because he combines the trade surplus issue with the reserve currency issue. I think there are at least three conflicting “standard economics” forces (Jonathan alludes to them above with the Triffin dilemma):

    1. The reserve currency nation needs to run deficits (not surpluses) to provide liquidity globally
    2. The reserve currency nation needs to run surpluses to maintain the value of the reserve currency, and
    3. We expect the marginal product of capital to be higher in less developed countries so we expect capital to move from here to there

    Since 1971, nobody cares about #2 (at least not as much as they did before), so the conflict he is alluding to is really between #1 and #3.

    I do hear #3 mentioned a lot in the language that he uses (“capital should be moving to Asia, not vice versa”), but on its own it has little to do with reserve currency status. Usually the explanation doesn’t have to do with reserve currency status either – the explanation is that Asia has underdeveloped financial markets relative to the U.S., so even though marginal product of capital is higher there people send their money here.

    • Brent says:

      People care about #3 in the first place, though. The US dollar would have never become the reserve currency (Bretton Woods to present) if the US hadn’t been the strongest large economy in the world. That is, the US was producing things, exporting them to countries in Europe that needed them post-War(s) and so the demand for dollars became very strong… leading to countries wanting to hold dollars and, hence, dollars flowing out of the US on net.

    • Bob Murphy says:

      Yeah this is what I was thinking Daniel. I’ve heard stuff in terms of rich/poor nations but not reserve currency / non nations. Obviously you’d expect the reserve currency nation to be very developed.

      • guest says:

        It’s the part I put in bold that intrigues me. First, is that right? Has anyone else heard of such a relationship?

        I noticed that the below article had some language that was similar. Maybe it will help:

        Hazlitt’s Battle With Bretton Woods
        http://speaklibertynow.com/2013/03/19/hazlitts-battle-bretton-woods/

        The Bretton Woods system established a gold dollar that was fixed at $35 per ounce. But it was the only currency so fixed. Every other currency could be a fiat currency based on the dollar. What this obligated the U.S. to do, as the main creditor nation to the world, was ship out dollars to the world while somehow maintaining the dollar’s connection to gold.

    • Adrian Gabriel says:

      “Usually the explanation doesn’t have to do with reserve currency status either – the explanation is that Asia has underdeveloped financial markets relative to the U.S., so even though marginal product of capital is higher there people send their money here.”

      Yeah good point Daniel, like the Fed selling bonds with false yields. Why not send your money to the US when the Fed will buy that money right back from you? Seems like we need to read more Rothbard and less Mankiw is what Stockman needs to do.

      • Adrian Gabriel says:

        **correction, the Fed gives it right back to them. The key is that the market should return it to them, not give it right back.

  7. Smiling Dave says:

    “It was an unfathomable figure by the canons of classic finance because it was literally upside down. The reserve currency country was supposed to run a trade surplus and export capital to less developed trading partners, not incur massive deficits and drain capital from them.”

    What he is saying is pretty simple, if you reason from first principles.

    Let’s look at a world where there is no reserve currency, just every nation for itself, issuing its own fiat currency.

    A fiat currency is desirable because of what it can buy, and it can only buy stuff made in the issuing country. That’s why you don’t see people falling all over themselves to get North Korean money, because you can’t buy anything with it, because North Korea doesn’t make anything.

    When a country makes so much great stuff at a great price, everybody wants to buy from that country, meaning everybody will want their currency. This demand for a particular currency [let's say it's the US Dollar, just to be specific] may be so great that countries, say England and France, may buy and sell to each other and accept dollars as payment, because they so love dollars, because the USA has so much you can buy with dollars. In fact, the dollar may become so coveted that countries will start making big stashes of it, to make sure they have plenty in reserve should some great bargain present itself, since after all, the USA makes so many cool things so cheaply.

    So the very fact that dollars are chosen by all as a reserve currency means they will all be buying tons and tons of USA goodies, meaning one would expect the USA to be a net exporter, or at least roughly balanced between exports and imports [since the whole point of exporting is to import].

    But look at the situation now, says Stockman. The USA isn’t exporting anything [meaning much less than they import]. Nobody is buying things made in the USA, so there is no reason for anyone to want huge piles of dollars. We no longer make what people want, so our money has turned into North Korean money. Why should anyone want it, why should anyone stockpile big piles of it, why should anyone accept it as payment from France, say, instead of asking for Chinese or German or other net exporting countries [net exporter = symptom of country making coveted stuff]? Why, in short, should it any longer be the reserve currency?

    That’s the point Stockman is making.

  8. Lord Keynes says:

    “The USA isn’t exporting anything [meaning much less than they import]. Nobody is buying things made in the USA, so there is no reason for anyone to want huge piles of dollars. “

    Having a trade deficit does not necessarily mean that a nation makes nothing.

    If fact, the US makes and exports a vast amount of goods. That is perfectly consistent with having a trade deficit.

    Also, investors all over the world demand US real and financial assets. These are a major source of demand for US dollars.

    • Anonymous says:

      Of course, everything is wonderful, LK.

    • Smiling Dave says:

      LK, horse has been led to water.

      • Adrian Gabriel says:

        Of course here LK seems to miss the pertinent fact of the central bank and fractional reserve banking leading entrepreneurs to illusory profits and thus the boom-bust cycle. Perhaps he doesn’t see Stockman’s attempt at delineating the problem here (considering the fact that he probably doesn’t understand the failure of economic socialist calculation and thus, much like Taylor and Friedman, advocated a silly fiat paper scheme as is presently in place). Stockman believes in the silly economic models of your mundane mainstream economics class. They make talking heads like Stockman seem like intelligent people who can advocate a government controlled system to their liking. Stockman no doubt preferred Friedman’s statism.

  9. Blackadder says:

    It’s almost as if Stockman doesn’t know what he’s talking about.

  10. Yancey Ward says:

    I have been trying to get my suppliers of goods and services to to take YanceyDollars in exchange, but they won’t do it because they know they can’t buy anything with them (I don’t work)- all they can do is accumulate them endlessly, building up their net worth of YanceyDollars.

    • skylien says:

      Maybe you should try convince Opec to sell oil only in YanceyDollars.

      • Yancey Ward says:

        Yeah, but then what would OPEC do with them?

        • skylien says:

          When Opec sells for YanceyDollars only, then every country who produces stuff needs oil. To get oil they need YanceyDollars. So Opec can buy stuff in those countries in exchange for YanceyDollars.

  11. Jason Quintana says:

    Robert, you have it right but I understand what he is talking about. The reserve currency status should tend toward a trade deficit (everything else being equal). The general point he has in mind though, if I’m guessing right, is probably sound. Under a gold standard even under the circumstance you describe (with the single gold mine country under a free market) we probably wouldn’t have the level of trade deficits we have today. A large exporter like China in which the central bank sucks in Dollars and Treasuries and prints Yuan to constantly debase its currency does something above and beyond what we would see in the gold mine scenario you describe. This process provides a constant high level of artificial demand for dollar denominated assets.

    The problem I believe he is describing occurs when trade surpluses are being rigged via money printing. This probably does have effect of “exporting capital” to the reserve currency country. It probably also makes it hard for comparative advantages to be fully taken advantage of. And here is what I think he has in mind. Since the Yuan (Chinese purchasing power) is depreciating vs. the Dollar (at an artificial rate beyond your gold mine scenario) Americans have to take this into consideration when investing in China. Given this, not as much capital is invested there from overseas as there would be without the debasing. The exporters in China are winning because they are long Dollars, but other parts of the economy probably aren’t as developed because less capital is invested there.

  12. Ken P says:

    Being a reserve currency requires exporting money that does not return. Exporting money or goods creates a trade surplus. Sending money overseas would also be expected to increase the value of our currency relative to the increased supply. One would expect foreign investments to look more appetizing in this scenario due to their lower exchange rate. However, a strong currency encourages lower interest rates, which results in an attraction of external investment dollars and increased appetite for deficits. As a result, we have a scenario where countries like China use taxes from their poor citizenry to send money to the United States to purchase bonds.

  13. Ken P says:

    ” Depending on the accounting, you would arguably see that country run a perpetual trade deficit with the rest of the world, as it shipped out money every year, in exchange for net imports of goods.”

    I thought that exporting anything, including money adds to the surplus side of the ledger. Check out this letter by Don Boudreaux:

    http://cafehayek.com/2012/07/open-letter-to-a-politician.html

  14. Gamble says:

    Hi Bob,

    Please place this in a greater context. Who is David Stockman referring to? Is this David’s plan and desired result or was this how the Cabal wanted things to operate and result? I don’t have the book in front of me so I can’t read the surrounding pages.

    On a side note: I think it is great you would conduct such a thorough review to ferret out the few criticisms, especially regarding somebody from the same team. This is a good example of why Mises and his objective and superior thinking skills were usually correct in all matters. Simply put, we are truth seekers above all else.

    Hopefully in the future, Bob you are not above reproach. I have seen your karaoke, so obviously you have thick skin, lol…

  15. Jim Hodge says:

    I agree and would argue that Freedom is often times less than free. It hard work. Jimhodgeallied.com

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