Senate passes bill to raise tariffs on China

Senate passes bill to sanction China over currency

First off, while this bill passed the Senate -- and probably would pass the House -- it most likely won't become law for two reasons.  The House GOP leadership will most likely not bring it for a vote, and if it did pass, it is pretty likely Obama would veto it.

The bill basically makes it easier to massively increase tariffs on imported goods from countries with major currency misalignment.  The bottom line is if this passes, tariffs would be raised from roughly 2% to 20% on a wide variety of Chinese products and services.

I am against this bill (and thus in agreement with Obama's, the GOP House leadership's position, and most economists) for several reasons.

The first reason is it risks a trade war with China.  If China retaliates with higher barriers to trade, as is very possible, we could be looking at an event that triggers a Depression.  Much like in the Great Depression, the first few years, while a very sharp Recession, wasn't actually a Depression until the government started a trade war.  There were many other government and Reserve Bank policies that contributed to causing that recession to turn into the Great Depression, but most economists believe the trade war was one the most significant.  We could be repeating that mistake, and the US exposure to international trade is much larger than it was in the 1930s, so while we wouldn't be in a trade war wtih Europe, Mexico etc, the impact would probably be similar with massive increases in unemployment.

Second, even if China "gives in", this isn't necessarily going to help and actually would probably make things worse for unemployment in the short run.  The mechanism China uses to reduce the value of its currency is to purchase huge amounts of US Treasury bonds, and US mortgage debt to a lessor degree.  If China allows the yuan to rise, this goes hand in hand with reducing their purchases of Treasury bonds and investing more in China instead of the US.  What that does is reduce the supply of financing to the US, increasing interest rates.  That in turn means mortgages would be more expensive, businesses would have less access to capital, etc.   The US Federal Reserve can somewhat counter this by printing money to buy US bonds to replace China as the largest purchaser, but unlike real investment, this has major risks such as inflation.

If China "gives in" thus devaluing the US Dollar, prices for most foreign imported goods would increase, and unless nominal wages rise, that means US workers would see a net real (inflation-adjusted) wage cut.   That isn't a terrible thing right now since one of the reasons unemployment is so high has to do with so called sticky wages which basically means wages are higher than they should be (workers for cultural reasons fight hard against wage cuts, and that in turn actually increases unemployment to some degree).   But overall, this real wage cut to US workers should be taken into account as what it means is even with somewhat lower unemployment (from this aspect), standard of living might be lower.

The politicians love to talk about the US exporters who would be helped by a US Dollar devaluation, and it is true, that would help many exporters.  However, they don't talk about the exporters who get hurt by the currency change; namely those where input costs are more dependent on foreign inputs than exports.  For example, take a steel rod manufacturer; it may have to lay off works if the price of imported steel increases faster than its sales price of finished steel goods it is selling.

Third, a large amount of US imports from China comes from US multinational companies.  By reducing their sales volume, that hurts the global profitability of these major US-based corporations.    Less profit means lower shares prices, and in some cases less US hiring as they have less overall resources available to expand.

Fourth, even if China gives in, this may not help the US trade deficit and could even make it worse.  We went through this whole thing with Japan a few decades ago.  Japan agreed to appreciate versus the dollar, and over the next few years the US trade deficit both overall and with Japan increased significantly!   Trade deficits, while influenced by currency rates, are much more determined by relative savings rate differences and economic growth patterns.

Firth, the real exchange rate gap with China has already been improving towards balance.  While the actual yuan-dollar rate has improved slowly, once you factor in inflation running at around 3% faster in China than the US, that means the real exchange rate has already being moving towards parity at a decent clip.  If that moves too much faster, it could risk increasing unemployment in both China and the US as the trade patterns (which industries have advantages) shifts too fast, causing short term unemployment as the size of business creation and destruction increases.  It's like being on a canoe and shuffling position to optimize roles; if you do it slowly it is fine and you'll eventually fix it, but if half the people try to change places at once someone will fall off.

Sixth, some people think this will hurt China, and they like this because of the projections that currently China's economy will overtake the US's sometime in the next 10 years (next 5 years by purchasing-power parity calculations, next 10 years by exchange rate calculations).  Beyond the fact that weakens trading/investment partners hurts us, not helps us, even if China were to appreciate their currency faster it would hurt them less than it hurts us (or help them more than it helps us).  You would be taking $100 - $300 Billion per year and investing that in China, not the US.  That would imo increase China's growth even faster than it already is, not slow it down.  Right now they make capital gains and dividends on their investment in US treasuries etc but local investment would probably lead to more balanced growth for China.  Their exporters would be somewhat hurt (possibly) but many of their domestic productive capacity would hugely benefit with that $100 - $300 Billion in extra investment.

So overall, I do want to see their currency's under-valuation come to parity, but this should happen gradually, say over 5-12 years not 1-2 years.  That shifts too fast and it just means more unemployment for both countries as entire industries are created and destroyed faster than the rate of absorbing new workers.  But even worse is the Trade War scenario which puts us at very high risk of the Great Depression II.

Indiana's voucher program

Indiana is currently putting into place the most significant State-wide voucher program in the US.  If this goes through, (courts are currently challenging it, but I think prospects are pretty good), then over the next 5 years we're going to see some pretty dramatic changes to educational delivery in Indiana.

Of all countries, Sweden has the most comprehensive voucher program.  Vouchers are available to parents of every child, in the amount of 100% of the average public school per child cost.    They have a highly rated school system with very high parental satisfaction.  School choice is seen as a right.  One interesting thing is even after almost 20 years, only 10% of  students are in private school, less than I would expect.  Some of that is due to the public schools being in better shape relatively than US public schools when the voucher programs started, and competition with the voucher schools has also helped the public school remain competitive.

In Indiana's situation, I believe if the program isn't held up by courts or reversed by the public in 5 years, it could be hugely beneficial and become a tipping point in educational reform.  I believe ultimately, unlike Sweden, you will see a huge rate of private school enrollment, probably over 50% within 20 years.  Unlike Sweden, parents are far less satisfied with the current state of public education.  Unlike Sweden, demand for private religious schools is much higher.  Unlike Sweden, politically there are significant numbers of people ideologically interested in backing a solution other than public (socialized) education.  When you add these three factors together, it could lead to a situation where the private school sector overtakes the public school sector, and parental satisfaction skyrockets.

What Went Wrong in Ireland?

What Went Wrong in Ireland?

This is a pretty good summary of not only the property market bust, but also both major phases of the historic boom conditions in Ireland for two decades before that.

Herman Cain's 999 Plan

GOP Presidential Candidate Herman Cain has proposed a 999 plan.  It consists of throwing out the current federal tax system and replacing it with 3 sources:
  - 9% national sales tax
  - 9% flat personal income tax (gross income minus charitable deductions)
  - 9% flat corporate income tax (gross income minus all investments, all purchases from other business and all dividends paid)

I like his plan enormously.  While it does introduce an entirely new major federal tax (sales tax), it does overall greatly simplify the federal tax system.   I am not certain that it is revenue neutral though, and in any case would like to see our current federal taxes raised around 3% GDP in the short term to help address the deficit.  So that might be something more like an 11-11-11 plan.   Also, in terms of avoiding income tax fraud, I would hope he would implement it by allowing charitable deductions only to verifiable charities which report (perhaps the largest 100 or so, or at least require a brick and mortar presence like a church).

Still, this has many benefits.  First, it would overall be an enormous simplification.  That should free up a lot of dead weight in the economy to focus on more productive uses of time.  

Second, just on the corporate tax side, it would put the US at one of the lowest corporate taxes in the world (lower than even Ireland's rate), with simplicity to boot.

Third, it would create substantial incentives for saving and investing by taxing only consumption.  This is critical to getting the US long term in better private fiscal shape.

Finally, I think these taxes would be enormously popular with many people, not just the middle class, but in particular entrepreneurs and investors.  Any change can be unsettling in the short term, but hopefully the "short term" would last no more than half a year after implementation and then this would give a tremendous boost to consumer and business confidence after that.

Obama picks Alan Krueger; minimum wage job losses to continue

Labor economist picked as next top White House econ adviser

This is exactly the wrong decision to make.  Some of Krueger's most well known work relates to the minimum wage and unemployment.  

Greg Mankiw's response I fully agree with:

Sperling on the Minimum Wage

I would go so far as to say I would recommend the exact opposite of Krueger; specifically it would help the economy (including low-wage workers) to immediately end the minimum wage entirely.  This would provide an immediate, substantial boost to employment.  

Dealing with national debt - Lessons from Canada and Sweden

Dealing with national debt - Lessons from Canada and Sweden

The above short but excellent piece illustrates some of my preferred responses to the fiscal crisis.  A credible plan to balance the budget in a few years, mostly through spending cuts but with some tax increases, has been successful.

Canada did it with more substantial cuts to government spending as a % / GDP, and with deeper cuts to a more limited number of programs and few tax increases.

Sweden did it with spending cuts that weren't nearly as deep as to some Canadian agencies, but were across the board and coupled it with higher taxes.

Both approaches are recent (in economist terms) successful examples of effective strategies that turned around countries facing recessions primarily related to lack of confidence over too high deficits and debt levels.

Contrast these responses, with Japan's dismal nearly 20-year failure to get its economy back on track.  In Japan's case, the response rather than cutting government spending was to increase it significantly, especially are large infrastructure projects.  While this boosted government job creation, it decimated the private sector competitiveness and the economy to this day has not recovered.

Euro bonds

Fresh Plan for Euro Crisis

The big news isn't what was agreed, but what wasn't.  Specifically, many people believe a great way out of the European mess is for any EMU members to agree that collectively, they all guarantee each other's sovereign debt.  What that means in essence, is strong players right now like Germany's full faith and credit are on the hook for the indebted country's sovereign debt.

There are pluses and minuses.  On the plus side, it would certainly bring down the interest rates substantially for the PIIGS.  This would make it much easier for them to, if politically able, bring their deficits closer to balance which would be a huge economic win.  

However, I'm personally against the idea as it now stands, and agree with Germany's position.  The big minus, is Germany and other countries are on the hook and would have their taxpayers (and/or the ECB indirectly) be required to bailout any countries who come close to defaulting.  In the short term, I have no doubt it would be a huge help overall.  And for the debt heavy, low growth countries in the EMU, it would be a great deal.  But, the cost to Germany and the rest of the low debt, better managed EMU countries is great.  Their interest rates would rise somewhat, as they are carrying the weight of the cost to insure the debt of the PIIGS's loans.  Also, it encourages moral risk, which in this case is to say it would be all to easy to use the lower interest rates to put off enough deficit tightening.  Then, down the road you have a much bigger problem in that Germany and the rest of the EMU countries' feet would be even more tied to the anchor of any fiscally irresponsible countries.  In other words, most of the EMU countries would win today's battle, but lose tomorrow's war so to speak.

Germany's position is that if the EMU has an enforceable, balanced budget mechanism in place (or possibly at least strongly in the works), then and only then would it agree to insuring other EMU countries' sovereign debt.  In other words, its message to the others is make the tough budget cuts and austerity programs now, prove you are getting the situation under control, and then we'll at that point be able to further help.

Of course, Germany is already on the hook indirectly by virtue of the intervention of the ECB.  The banks purchases of Italian and Spanish debt increase the risk to the other EMU countries.  The ECB's actions are inflationary (in a negative sense) to Germany; eg German workers will see their prices rise more rapidly (or fall more slowly) given a particular nominal income/wage level than if the bank did not intervene.