China and the U.S. Depression--Posner

I agree with Becker that China is not responsible for our current depression. It is true that China's trade imbalance with the United States--it exports much more to us than we to them, and so has built up huge dollar balances that it has invested in the United States, mainly as Becker points out in the form of purchasing federal government bonds--was a factor in keeping interest rates low in the 2000-2005 period. And it is true that those low interest rates are a major culprit in the housing bubble and the ensuing financial collapse. The usual effect of an increase in the supply of money is to lower interest rates, because interest is the price of money. But low interest rates were a policy of our Federal Reserve under the chairmanship of Alan Greenspan, who remained chairman until the end of the 2000-2005 period; the Federal Reserve can create all the money it wants; and so even if there had been no Chinese investment in the United States, interest rates would probably have remained low. I say "probably" rather than "certainly" because the cheap Chinese exports to the United States were one of the factors that enabled the Federal Reserve's policy of low interest rates to avoid creating serious inflation. Had there been inflation, the Fed would have raised interest rates, killing the housing bubble before it became serious. Because houses are bought mainly with debt, cheap credit encourages home buying; and since the stock of housing expands only slowly, an increase in the demand for homes can and did result in a steep increase in home prices, which turned into a speculative bubble. Furthermore, China is of course not the only country with a positive trade balance with the United States. I do think that China's trade policy was bad for the United States. I do not think that it is healthy for the United States to run huge budget deficits, whether they are financed by China or by anyone else. One reason that we are in a depression and not merely the "severe recession" that is the preferred euphemism is that, because of those deficits, we cannot spend our way out of the depression without increasing the national debt to a point at which either horrendous inflation or huge tax increases will be required to pay it down. But I would not "blame" China for giving us what we very much wanted, which was cheap goods and the financing of our debt. Nor do I think that China's trade policy is foolish from China's standpoint. In a fascinating chapter of The General Theory of Employment, Interest and Money, Keynes offered the following qualified defense of mercantilism (the policy of accumulating foreign exchange by running a persistent export surplus). Suppose a country has weak domestic demand for goods and services, perhaps because its people are poor or they lack confidence in their economic prospects and therefore hoard money rather than spending it. Because of this weak demand, labor and other productive resources will tend to be underemployed--unless producers have foreign markets. By stimulating exports, the nation can increase the utilization of its productive resources, which by reducing unemployment can increase consumer confidence and thus increase spending and in turn investment. Average incomes in China are very low, domestic demand therefore weak relative to potential output, and so it may make sense for China to encourage production for export, especially if it has a comparative advantage in producing goods that foreign countries such as the United States demand. Moreover, because average incomes in China are so low, there may not be much demand for the types of product that the United States produces, and this would be an independent reason for our trade imbalance with China. But it would not explain China's large dollar balances, unless no other country produces the types of product that Chinese consumers could afford to buy.

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