China should be spending like a Keynesian.

Throughout the post second world war period, America’s economy played the role of a shock absorber to the global economy by being the spender of the last resort. Now, with the government and private American in debt, it is up to the savers of foreign currency reserve to spend.  (i put China in the title because they are the largest holder of foreign reserves.) These savers has been buying huge stockpiles of American debt partly for the purpose of keeping  their currency cheap to encourage Americans to buy their export. Its time to spend what they have saved by cashing in their American debt to buy American export.

Buying American Export will kill 2 birds with one stone. Since many savers are developing countries where there are many opportunities to gain productivity (and living standard) by investing and spending. The productivity gain alone can easily pay for the initial investment, result in few or no debt in the long run. This is lest true for developed countries that are already sitting on the technological frontier, and are thus at the inefficient end of diminishing return scale.

Buying American, will mean that the American government wont have to embrace the Keynesian option of trying to raise even more debt to spend their way of a recession, again. It will selectively boost America’s most competitive industry while reducing American debt and spread confident all around.

Why is there no sign of this happening? A lot of this has to do with the other rational for the build up of foreign reserves by the savers. Namely, to accumulate enough dollar to counter any excessive devaluation of their currency. In current crisis, the savers are even less likely to spend their savings, without which the savers would be vulnerable to currency fluctuation.

End game. In order for the savers to be comfortable enough to spend their savings, two things need to happen. (1)  a coordinated spending plan with the participation of all major dollar holders and (2) a guarantee to bail out in case of excessive currency devaluation by stronger and more independent IMF would be needed.

related stuff to read.
On liquidity crunch – “Baby-Sitting the Economy.”
On “The Causes and Consequences of the Economic Collapse“

UPDATE 090403: G-20 Leaders To Give $1 Trillion To IMF, World Bank

G-20 participants announced a tripling of loans available to the International Monetary Fund, to $750 billion, a $250 billion expansion in a special IMF fund to help members\’ foreign exchange reserves, and $250 billion to the IMF to support trade. They also agreed to sell IMF-held gold to poor countries.

Thats an okey amount of money, but the point is that they prove that they are willing to use IMF and WB and they are willing to put resources into it. However whether this will be enough to get the savers to start spending will depend a lot on how exactly this money will be use, and who will have power over it. I personally knows too little about the inner working of the IMF and WB to offer any insight.

UPDATE 090405: World Wad
A world currency is another way to eliminate currency shocks, naturally. SDR, if its rely upon more, it has a change to become a predecessor to a world currency, just like ECU is to Euro Lets hope so.

The Keynesian Proposition

Over at Economist.com, they got Brad DeLong and Luigi Zingales representing Keynesianism and Neoclassical respectively over an online debate on the proposition “We are all Keynesians now.”

The proposition is awkwardly framed, i mean come’on, arguing for the proposition is like arguing that entire political and economic elites agrees over the remedy needed to recover from the current financial crisis, which is an impossible position to defend. This forced DeLong to declare defeat in the opening sentence of his opening remarks. And belatedly, moderator re-frame the debate to be “whether we—or rather, economists and policymakers—should be [Keynesian].” on the third day.

anyway, here is the problem

There are two recession dynamics at work:  (1) plummeting real estate value and consumer spending is discouraging or disabling mortgage payment, leading to piling bad debts that is spreading through the financial sector via securitization and derivatives, banks thus concentrating their capital on deleveraging and not lending to business for expansion. (2) lowering consumer spending is reacted with output contraction and increase unemployment, that further reduces spending and thus the deflationary spiral ensues.

and the Keynesian Proposition

Delong is obviously not against government intervention to get the banks to start landing again or using every possible monetary policy to stimulate the economy. What he is saying that those measures have limits. Monetary tools is already exhausted. and not without politically unacceptable amount of taxpayer’s money can government keep the banks capitalized.

Even with recapitalized banks, in the short-run, under overwhelming uncertainty and pessimism, healthy business that would have invested, will not; innovations that would been commercialize with venture capitalist’s funding, will not; employed people would have leave their job to start a new spin-off, will not. And there are no guarantee that the money from the recapitalized banks wont just be used to fill another bubble, which is precisely what happen when federal bank pump money in response to the busting of Dot-com bubble in 2000 only to walk straight into a real estate bubble. Therefore, DeLong argues that in the absent of private investment and deteriorating consumer spending , government who can borrow cheaply has to step in to invest and spend.  DeLong also believes that government investment in public goods like infrastructure, basic research, education, broadband access in rural area can create new innovation and business opportunities that fuels economic growth in the future (off setting tax increase needed to pay government debt), and fights deflation now.

the criticism

The fear of fiscal stimulus is that it is hard to execute effectively, because government (by design is slow), wont move quick enough to start projects to deal with short-term problems. By the time government is able to initiate most of its spending, some private business that are ready to invest, will be force to compete with the government for capital (goods, service and labor). Even worst, if in a state of panic, the government is legitimized to pursuit projects that does not have benefit worthy of its cost in order to keep people employed, people will be under an illusion of job security,  and not looking for new job, retrain, or staring new entrepreneurial enterprises.

The other problem of allowing government to allocate resource is that it is often inefficient and it expands politician’s power and attract lobbyist, which by the way is already happening. Obama promised greater transparency to mitigate this problem, but even some Democrat supporter are skeptical.

Furthermore unlike isolated national economic recession, this is a global recession where US government borrowing will have an adverse effect of draining the fund other economies needs for their recovery, subsequently weakens demand for US exports that is crucial for recovery. Unfortunately, global dimension of the recession is noticeably absent from the debate.

to conclude.

If the fear of massive unemployment is that it will lead to social unrest and deflationary spiral, then the government should simply increase and extent unemployment benefit. When people’s livelihood are secure and not occupied by bogus project they will have time to fund jobs, retrain or invent the next growth inducing innovation. Government spending in public goods can be very efficient considering the low cost of everything in a recession. However as Zingales points out these these projects “should be argued on their own merits, not as a stimulus.

So, am i thinking Keynesian? I am not too sure, i mean the label Keynesian is so loaded with different meaning. I am however definitely for unemployment benefit in a recession.

more on this later.