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Wednesday, April 12, 2017

Bernstein: Larry Summers, of all people, misses China’s role in “secular stagnation”

Larry Summers, of all people, misses China's role in "secular stagnation"

Jared Bernstein

April 10th, 2017 at 8:57 am

My old Obama admin econ team colleague Larry Summers gets some important aspects of the China story wrong in this oped today. Weirdly so, given his exposure as a top (and very effective) policymaker the last time the downsides of financial imbalances whacked the globe.

Larry argues, and I agree, that none of the stuff team Trump is worrying about re China's economy and international accounts makes sense. The problem, he argues, is China's grab for "soft" power, filling an international gap while making an international power-grab, as the US goes insular. That may well be true. I don't like when economists, myself included, get all policy sci on us, but it happens, and Larry may be onto something important.

He's also clearly right that China is not intervening in currency markets to depreciate their currency. The Trump team is about 20 years late on that one.

But Larry is surprisingly blasé about a China problem: excess savings (really, an East Asia problem, as Brad Setser points out). I associate this problem with Summers' own work on "secular stagnation"—persistent demand shortfalls even in recovery. Another way to view sec stag is as a function of excess savings: the globe is awash in more savings that we have good, productive uses for. That, in turn, can lead to depressed interest rates, credit bubbles, large trade surpluses in savings glut countries, which in turn force large trade deficits elsewhere, and high unemployment, depending on what offsets are in play in trade deficit countries. Larry himself has recognized this problem (as has Ben Bernanke since the mid-2000s in his seminal savings glut speech) and wisely called for public infrastructure investment to help offset it.

Our trade deficit with China is 1.6 percent of GDP; that's a significant drag on demand. In terms of offsets, the Fed is pushing in the other direction (tightening) and the fiscal authorities…um…Congress…can't find the light switch. We're of course doing better than most other advanced economies, but here we are in year eight of an expansion and (slight) output gaps still persist.

Just last week, Martin Wolf at the FT wrote about the threat China's close-to-50-percent-of-GDP savings rate poses for the rest of the world (our savings rates are typically in single digits). He worries about excessive internal investment, enforced in part by capital controls prohibiting outflows, generating an asset bubble. Or, if the controls break down, large-scale exports of their surplus savings to a world that is already demand constrained. Interestingly, a smart paper by Larry et al. provides an explicit role for such capital flows in dampening demand and making it harder for the US to hit higher growth rates ("We find capital flows transmit recessions in a world with low interest rates and that policies that trigger current account surpluses are beggar-thy-neighbor.")

If a Chinese asset bubble forms and implodes, and/or they export a lot more of their excess savings, that will slam down their currency—no matter what propping up they try to do—and our trade deficit with them will grow, perhaps sharply (Setser's worried about this too, though less so than Wolf). Unless offsets are in play, a big "if" in the Trump-Republican-Congress world, this will hurt American workers.

There's a problem in economic criticism today where people argue, essentially, if Trump does it, it's wrong. Re China, the Trumpists are shooting at the wrong target—currency vs. excess savings and capital flows. But that doesn't mean all's clear on the Asian financial front.

John Case
Harpers Ferry, WV

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