Private sector deleveraging
A critical perspective on energy, international politics & current affairs
firstname.lastname@example.org Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.
In my darker and more cynical moments, I imagine making a campaign contribution to Chuck Schumer, the democratic senator from New York. The amount I would give him would cover the cost of an economics course in a local school because a man obsessed with legislating on economic policy should not be illiterate in economics.
My first encounter with Mr. Schumer was a few years back when he wrote an op-ed in the New York Times challenging comparative advantage (January 6, 2004). According to Mr. Schumer, the theory is outdated because David Ricardo, the theory’s exponent, had assumed factors of production to be immobile. As Mr. Schumer wrote, “Comparative advantage is undermined if the factors of production can relocate to wherever they are most productive: in today's case, to a relatively few countries with abundant cheap labor.”
Comparative advantage leaves much to be desired. It does not explain, for example, what causes countries to differ in their productivities, hence taking as a given a variable that should be explained. And developing countries often specialize in the production of primary goods, thus losing out on the dynamic gains from trade. But Ricardo’s central insight remains: a country benefits from trade even if it is less productive than its trade partners. Factor mobility does not invalidate that point. In fact, trade in goods acts similarly as trade in factors of production. And anyway, factors of production are nowhere nearly as mobile as Mr. Schumer claims.
Now Mr. Schumer is back again. For years he has been musing, along with Senator Graham, about imposing a 27.5% tariff on Chinese goods if China does not revalue its currency. This campaign has been abandoned in favor of implementing trade measures against countries that manipulate their currencies. Mr. Schumer claims the plan is not directed at China (in an article co-authored with three other senators): “our bipartisan legislation is not to punish any one country but to encourage all countries to follow international rules.” But China is the bill’s more immediate and likely target.
Mr. Schumer is an economic looney toon, not to be taken really seriously. But his legislation has drawn support from both Senators Barack Obama and Hillary Clinton, two democratic frontrunners for the presidency. And the legislation is seen as responding to growing anxiety in the United States about free trade. If nothing else, it reveals just how fragile free trade remains to politicians who are keen to exploit voter anxiety (although actual legislation, thankfully, often lags behind).
The most obvious drawback with this legislation is that determining exchange rate manipulation is extremely difficult. Anyone working with exchange rates will admit that predicting exchange rate movements is nearly impossible; economic theories are no better than guessing in being able to forecast exchange rates. Hence, judging what a “fair” value for a currency should be is nearly impossible.
It is equally unclear how much exchange rate movements affect trade flows. According to economic theory, an appreciating currency makes imports cheaper and exports more expensive. If the Chinese Yuan were to appreciate, China’s imports would increase and its exports would shrink. Reality is different, however. The obvious statistic to cite is from the Yuan itself: since allowed to “float,” it has gone from 8.28 ¥/$ to 7.59 ¥/$, but China’s trade surplus with the United States has grown from $162bn in 2004 to $233bn in 2006.
The same is true about the US trade deficit with the Euro area, where the dollar has depreciated more dramatically. After 2003, when the $/€ rate was in parity, the US bilateral trade deficit in goods went from $78bn to $93bn in 2006, despite a drop of nearly a third in $/€ rate. (The deficit stabilized somewhat in 2006). Prices respond slowly and imperfectly to exchange rate changes, making deficits less correlated with exchange rates. An appreciating Yuan, in other words, would bring uncertain changes to the US-China bilateral trade deficit. (Those interested to read more on this issue can look at the IMF’s World Economic Outlook, April 2006, p. 114-115).
Nor is China alone is to blame for the US trade deficit. In 2006, the bilateral US deficit with China was $233 billion, while the overall trade deficit was $838 billion - China accounted for just a quarter of the total. More importantly, US trade with Asia has remained constant over time, with 25% of US exports going to Asia and 36% of US imports coming from Asia in the past five years. The trade with China reflects a shift in production processes – trade that used to be with other Asian countries is now channeled through China.
The truth is that America’s trade deficit reflects underlying economic realities, especially low savings and high spending in the United States, and high savings and low spending in China. The flow of money from China to the United States would be expected to persist as long as these economic fundamentals remained.
The question is whether legislation is the optimum way to address these imbalances. (A more fundamental question is whether imbalances need to be addressed in the first place, but I will stay away from that question for now.) The senators note that, “A little pressure can go a long way to encouraging the right policies.” This is surely naïve: legislation is much more likely to encourage either reciprocal retaliation or, at the very least, a stubborn Chinese reaction.
It is really discouraging to see how much economic debates are detached from economic reality, though this is to be expected, more so in an election period. Trade raises important policy questions, but dealing with them is made no easier by politicians who ignore basic tenets of economic theory and fact. These misconceptions are numerous and above I have just touched on a few. More to come in later posts.
For a few months, I will be writing for my school’s blog http://blogs.sais-jhu.edu/saisgeist/
You have to sympathize with Neelie Kroes, the European Commissioner on competition. For years now she has been screaming loudly that the internal market on gas and electricity, supposedly liberalized and supposedly competitive, is dysfunctional, and that this is no small part because big European utilities are acting anti-competitively. A week ago, her Directorate released a comprehensive inquiry into the gas and power sector in Europe.
The report is enough to make any free marketer cringe. Big companies (“incumbents” as the Commission calls them) are stifling competition. They are able to do that because they have national governments on their side. Either socialist by inclination, or socialist because energy is a “strategic” sector not to be trusted on markets, or socialist because energy insecurity warrants new powers to be granted to government, states are engaged in an alliance with businesses at the expense of the consumer, who is sold the idea, unconvincing at best and ludicrous at worst, that it is really his interests that are being defended.
To be fair, there are certain problems that are fundamentally intractable. Long-term contracts, for example, are often necessary to finance big projects like cross-border pipelines, but they erect barriers to entry and “freeze” market conditions for years as well as adding illiquidity to a market since gas committed to one place cannot flow to another. Infrastructure is supposed to operate on open-access principles (capacity allocated by bidding rather than who owns an asset), but being guaranteed access to a pipeline is often needed before a company can sign deals abroad or commit the money to build expensive projects.
There are other problems too, problems that lie at the core of “Europe.” What is the appropriate level for regulation: at the state or at the European level? How should Europe balance a general commitment to the market (which the EC is meant to defend) with a commitment to democracy (which means states ought to make their own rules)?
What Europe faces, therefore, either than powerful incumbents, is an incomplete consensus on how to deregulate energy, made harder by the fact that each European country has its own view on how to do things and is willing to defend its sovereign right to act differently. Yet it is disheartened to think how all this is playing out. If the European Commission cannot succeed in infusing competition, what are we to think of its powers as the defender of the EU’s laws, and what are we to think of its commitment to the free market?
As I think of this, I am torn between two visions of Europe: one is a persistent, and to me indefensible, tendency to glorify cooperation and uniformity; the other is a Europe that helps member states do the things they are supposed to do by making the politics a bit easier. I have always liked Europe for the latter and criticized it for the former. What the European Commission is doing today on energy I approve and believe in; but it is not succeeding yet, and that makes me sad, both for what this means today and what it spells for the future.
I thought it best to avoid both of these arguments and just append the relevant graph from the Quarterly Review of the Bank for International Settlements (look at the graph in the far right). The point that should stick out is that while the dollar holdings of oil producers have come down, they have done so from very high levels, and the dollar remains, by far, the most sought after currency for oil producers. While this does not negate the obvious implications for the dollar (which will fall as relative demand for it declines), it should put the discussion in context before jumping onto any grand geopolitical conclusions.
From Al-Jazeera.Net: “Beijing families were first restricted to one child, and now the Chinese authorities have set the limit on pets too with its one dog policy. China's capital will institute a "one dog" policy for each household in nine areas, the official Xinhua News Agency reported on Wednesday." (link)
The latest news suggests that OPEC has agreed to cut its quota by 1 mbd, bringing its target output down from 28 mbd to 27 mbd (in August, OPEC produced 30.04 mbd, which included 2 mbd from Iraq, which is excluded from quotas). But reaching consensus was not easy: first came production cuts from Nigeria and Venezuela totaling about 200 kbd. Saudi Arabia protested the move to voluntary cuts, though its own production was coming down too. It took a while before others agreed to reduce quotas as well.
From this picture emerge two interesting points. The first is about OPEC’s cohesion, which fluctuates wildly, though the organization usually comes together more easily when tasked to defend rapidly falling prices (rather than, say, cut production to hike prices). This should serve as a reminder to those who have hasten to notice an “axis of oil” emerging to threaten Western interests. Even OPEC, the most concrete manifestation of the axis, finds it hard reach consensus on oil production. It is hard to see how so varied a group can hold together any other meaningful political alliance for a considerable period of time.
The second point is about asymmetrical power. The common assumption these days is that oil producers have all the power. But the drop in oil prices has seriously jeopardized their fiscal plans. Granted, they have too much money in the bank for anyone to claim that these regimes are in trouble—a $60/bbl world is still great for them. But given how resilient economies have proven to high oil prices, it is not unreasonable to state the oil exporting countries have more to lose from low oil prices than importing countries from high ones.
These are important lesson amidst our energy hysteria.