Naked Economics: Undressing the Dismal Science pdfdrive com

partner instead. We’re buying cars now by giving up future income.
That’s not our only choice. We can buy our merchandise on credit. We can
ask some willing party in the global financial community to loan us $50 million.

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ask some willing party in the global financial community to loan us $50 million.
In that case, we “pay for” our $100 million in Japanese cars with $50 million in
planes and $50 million in borrowed capital. That, too, has obvious future costs.
We have to pay back the loans, with interest. Again, we are paying for current
consumption by borrowing against the future—literally in this case.
Why is the United States running chronic current account deficits? It has
virtually nothing to do with the quality of our goods and services or the
competitiveness of our labor force, as conventional wisdom would have it. (To
my earlier point, do you think Azerbaijan and Botswana are running current
account surpluses because they are producing better stuff with more productive
workers?) The United States is running chronic current account deficits because
year after year we are consuming more than we produce. In other words, we are
doing the opposite of saving (in which you produce more than you consume and
set the extra aside). As a nation, we are literally doing what economists call
“dissaving.”
The connection between the current account balance and a nation’s savings
rate is crucial. Any country that is consuming more than it produces must by
definition be running a current account deficit because (1) the stuff you are
consuming beyond what you produce must come from somewhere else in the
world; and (2) you can’t trade goods and services for the extra stuff that you’re
getting from the rest of the world because you’ve consumed everything you
have.
As usual, a farming analogy will help. Suppose Farmer America grows corn.
He is a highly productive farmer, handsome and smart, who uses only the most
modern farming techniques. (These details are irrelevant here, just as they are
when describing whether a national economy runs a current account surplus or
deficit.) There are only four broad things that Farmer America can do with what
he grows: He can eat it (consumption); he can plant it for next year’s crop
(investment); he can send it to the government to pay for services (government
spending); or he can trade it for other stuff (exports traded for imports). That’s it.
So let’s imagine that Farmer America’s year looks like the following:
He grows 100 bushels of corn. He eats 70. He sends 30 to the government.
He needs 20 to plant next year. But if you do the math, you’ll see that Farmer
America is using 120 bushels a year but growing only 100. He must be a net
borrower of corn—20 bushels in this case. That is the equivalent of a current
account deficit, and it’s just math—if he uses more corn than he grows, the rest
has to come from somewhere else.
Farmer China works across the way. He grows only 65 bushels of corn,
because he is new to farming and uses relatively primitive methods. Farmer
China consumes 20 bushels, sends 10 to the government, and sets 15 aside to

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China consumes 20 bushels, sends 10 to the government, and sets 15 aside to
plant next year. Again, some quick math suggests that Farmer China is not using
everything he grows. He has an extra 20 bushels. As convenience would have it,
these bushels can be traded to Farmer America, who has come up short. Of
course, Farmer America doesn’t have any crops to trade, so he offers an IOU
instead. Farmer China gives Farmer America the corn (an “export”)—and loans
him the money to buy it.
Let’s jump from farm analogies to reality: So far, the United States owes
China about a trillion dollars.
Normally these kinds of global imbalances have self-correcting mechanisms.
The currency of a country with a large current account deficit will usually begin
to depreciate. Assume that New Zealand is running a current account deficit. The
rest of the world is steadily accumulating New Zealand dollars because they are
selling more goods to New Zealand than they are buying from it; foreign firms
will want to trade their accumulated New Zealand dollars for their home
currency. On the foreign exchange market, the supply of New Zealand dollars
for sale will exceed the demand for them, pushing the value of the New Zealand
dollar down relative to the currencies of its trading partners. The falling New
Zealand dollar helps to correct the trade imbalance by making New Zealand’s
exports more competitive and imports more expensive. For example, if the New
Zealand dollar depreciates relative to the yen, then Toyotas become more
expensive in New Zealand while New Zealand’s farm products (kiwis?) look
cheaper in Japan. Meanwhile, the same thing happens with other countries; New
Zealand will begin to import less and export more, narrowing the current
account deficit.
The current situation involving China and the United States is different. The
two countries are arguably locked in an unhealthy symbiotic relationship that has
the potential to come unglued at any time. China has created a very successful
development strategy built upon “export-led growth,” meaning that the bulk of
job growth and prosperity has been generated by firms making products for
export. Many of those exports come to the United States.
China’s export-oriented development strategy depends on keeping the
renminbi relatively cheap (as we saw with the Big Mac Index). To accomplish
that, the Chinese government recycles accumulated dollars primarily into U.S.
treasury bonds, which are loans to the U.S. federal government. Both parties get
what they want (or need), at least in the short run. The Chinese government has
used exports to generate jobs and growth. America has funded its dissavings
with enormous loans from China. The situation really isn’t much different than
Farmer China and Farmer America: The United States gets loans from China to

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Farmer China and Farmer America: The United States gets loans from China to
buy its exports.
In the long run, the situation poses serious risks for both parties. The United
States has become a large debtor nation. Debtors are always vulnerable to the
whims and demands of their creditors. America has a borrowing habit; China
feeds it. James Fallows has noted, “Without China’s billion dollars a day, the
United States could not keep its economy stable or spare the dollar from
collapse.”
13
Worse, China could threaten to dump its huge hoard of dollar-
denominated assets. That would be a ruinous thing to do. As Fallows points out,
“Their years of national savings are held in the same dollars that would be
ruined; in a panic, they’d get only a small share out before the value fell.” Still,
that’s an awfully powerful weapon to give a nation with which we often
disagree.
The Chinese have it worse. Suppose America’s debt burden grows beyond
what U.S. taxpayers can (or are willing) to pay back. The U.S. government could
default—simply refuse to honor its debts. That is highly unlikely, mostly
because there is another irresponsible option that is more subtle: America can
“inflate away” much of its debt to China (and other creditors) by printing money.
If we recklessly print dollars, the currency will lose value—and so will our
dollar-denominated debts. If inflation climbs to 20 percent, then the real value of
what we have to pay back will fall by 20 percent. If inflation is 50 percent, then
half of our debt to China effectively goes away. Is this a likely outcome? No.
But if someone owed me a trillion dollars and also had the authority to print
those dollars, I would spend a lot of time worrying about inflation.
This dysfunctional economic relationship will end. The crucial questions are
when, why, and how. James Fallows has summarized where we stand now: “In
effect, every person in the (rich) United States has over the past 10 years or so
borrowed about $4,000 from someone in the (poor) People’s Republic of China.
Like so many imbalances in economics, this one can’t go on indefinitely, and
therefore won’t. But the way it ends—suddenly versus gradually, for predictable
reasons versus during a panic—will make an enormous difference to the U.S.
and Chinese economies over the next few years, to say nothing of bystanders in
Europe and elsewhere.”
14
Given the stakes involved, are any adults supervising all of this? Yes, but they
are getting long in the tooth. In the waning days of World War II, representatives
of the Allied nations gathered at the Mt. Washington Hotel in Bretton Woods,

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New Hampshire. (It’s a delightful place in both summer and winter, if you are
looking for a New England getaway.) Their mission was to create a stable
financial infrastructure for the postwar world. They created two international
institutions, or “the two sisters.”
The institution at the center of the global fight against poverty is the
Washington-based World Bank. (The first $250 million loan was to France in
1947 for postwar reconstruction.) The World Bank, which is owned by its 183
member countries, raises capital from its members and by borrowing in the
capital markets. Those funds are loaned to developing nations for projects likely
to promote economic development. The World Bank is at the center of many of
the international development issues covered in
Chapter 13
.
If the World Bank is the world’s welfare agency, then its sister organization,
the International Monetary Fund (IMF), is the fire department responsible for
dousing international financial crises. Iceland called the IMF. So did Argentina,
Mexico, and all the others. The IMF was also conceived at Bretton Woods as a
cooperative global institution. Members pay funds into the IMF; in exchange
they can borrow in times of difficulty “on condition that they undertake
economic reforms to eliminate these difficulties for their own good and that of
the entire membership.” No country is ever required to accept loans or advice
from either the IMF or the World Bank. Both organizations derive power and
influence from the carrots they wield.
Few institutions have attracted as much criticism as the World Bank and the
IMF from such a broad swath of the political spectrum. The Economist once
commented, “If the developing countries had a dollar for every proposal to
change the ‘international financial architecture,’ the problem of third-world
poverty would be solved.”
15
Conservatives charge that the World Bank and the
IMF are bureaucratic organizations that squander money on projects that have
failed to lead nations out of poverty. They also argue that IMF bailouts make
financial crises more likely in the first place; investors make imprudent
international loans because they believe the IMF will come to the rescue when a
country gets into trouble. In 2000, the Republican-led Congress convened a
commission that recommended shrinking and overhauling both the World Bank
and the International Monetary Fund.
16
At the other end of the political spectrum, the antiglobalization coalition
accuses the World Bank and IMF of acting as capitalist lackeys, forcing
globalization on the developing world and leaving poor countries saddled with
large debts in the process. The organizations’ meetings have become an occasion
for violent protest. When the two institutions held their fall meeting in Prague in

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for violent protest. When the two institutions held their fall meeting in Prague in
2000, the local Kentucky Fried Chicken and Pizza Hut both ordered replacement
glass ahead of time.
As the global recession of 2007 unfolded, the United States criticized several
European nations for not doing more to stimulate their economies. The specific
criticism is debatable, but it makes a crucial point nonetheless. For the American
economy to recover, the European economies needed to recover, too. And Japan.
And China. And every other major economy. Nations are not competitors in the
traditional sense of the word. After all, the Red Sox would never complain that
the Yankees were not doing enough in the off-season to improve their team.
Baseball is a zero-sum game. Only one team can win the World Series.
International economics is the opposite. All countries can become richer over
time, even as individual firms within those countries compete for profits and
resources. Global GDP has grown steadily for centuries. We’re richer
collectively than we were in 1500. Who got poorer to make that possible? No
one. The goal of global economic policy should be to make it easier for nations
to cooperate with one another. The better we do it, the richer and more secure we
will all be.
*
Soros borrowed a huge sum in British pounds and immediately traded them for stronger currencies, such
as the German deutsche mark. When the Brits eventually dropped out of the ERM and devalued the pound,
he swapped his currency holdings back for more pounds than he had originally borrowed. He paid back his
loans and kept the difference. Numbers make this all more intuitive. Suppose Soros borrowed 10 billion
pounds and swapped them immediately for 10 billion deutsche marks. (The exchange rates and amounts are
contrived to make the numbers easier.) When the pound was devalued, its value fell by more than 10
percent, so that 10 billion deutsche marks subsequently bought 11 billion pounds. Soros swapped his 10
billion deutsche marks for 11 billion pounds. He paid back his 10-billion-pound loan and kept the tidy
balance for himself (or, more accurately, for his investment funds). Soros supplemented his currency gains
with ancillary bets related to how the devaluation would affect European stocks and bonds.
†
Economists make a distinction between the nominal exchange rate, which is the official rate at which one
currency can be exchanged for another (the numbers posted on the board at the currency exchange), and the
real exchange rate, which takes inflation into account in both countries and is therefore a better indicator of
changes in purchasing power of one currency relative to another. For example, assume that the U.S. dollar
can be exchanged at your local bank for 10 pesos. Further assume that (1) inflation is zero in the United
States and 10 percent annually in Mexico; and (2) a year later your local bank will exchange $1 for 11
pesos. In nominal terms, the U.S. dollar has appreciated 10 percent relative to the peso (each dollar buys 10
percent more pesos). But the real exchange rate hasn’t changed at all. You will get 10 percent more pesos at
the currency exchange window than you did last year, but because of inflation over the course of the year,
each peso now buys 10 percent less than it used to. As a result, the total purchasing power of the pesos that
you get from the bank teller this year for your $100 is exactly the same as the purchasing power of the

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(fewer) pesos you got for your $100 last year. Any reference to exchange rates in the balance of this chapter
refers to real exchange rates.

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CHAPTER 12
Trade and Globalization: