"Kee" Points with Jim Kee, Ph.D.


  • Outlook
  • And Speaking of Monetary Policy Actions


Outlook

The International Monetary Fund’s July Global Economic Outlook sees 3.2% global growth this year followed by 3.5% in 2020. This outlook is somewhat precariously (their words) based upon expected stabilization in some emerging and developing countries, and also upon continued accommodative monetary policies around the developed world. I agree with the outlook, but less because of monetary policy and more because of fiscal policies like the substantial business tax cuts and deregulation passed in the US at the end of 2017. There seems to be a widespread view that the tax cuts offer a one-time “shot in the arm,” which I think is a misperception or misunderstanding of the way tax cuts work. Right now the tax cuts seem to have impacted the US economy very little (Tax Foundation). Think about tax cuts as changing the rates of return to productive or business activities, and, over time, tax cuts encourage resources to flow into the now higher return sectors of the economy. Output expands until rates of return are competed back toward a new equilibrium at a higher rate of output. This is a multiyear process, as it takes time to update plans and for resources to get recommitted. Working against this has been the trade war. Tax cuts spur production but trade concerns thwart exchange. And wealth is created by production and exchange; it is a symbiotic relationship where both encouraging production and widening exchange or trade are required. That’s why I refer to the President’s policy agenda as being somewhat at war with itself: it encourages production, and discourages exchange. A little progress on the trade front (less uncertainty, more permanence) would go a long way towards encouraging continued US and global expansion. That to me is what we need to see, not so much monetary policy actions. Monetary policies can help facilitate production and exchange, but they are the lesser tool for encouraging economic growth. I think that’s been plain to see with all of the monetary innovations of the past 10 years and the sluggish growth that has accompanied them.


And Speaking of Monetary Policy Actions

Yesterday the Chinese allowed the yuan to depreciate against the dollar, the main currency in the basket of currencies to which the Chinese yuan is more or less pegged. That makes sense to me, although markets certainly didn’t like the tone or the timing of the move. China has pegged its currency to the US dollar since 1994. That smart act helped the Chinese gain credibility on the monetary policy front, which is necessary for countries to attract capital and grow. The peg or “reference” rate was 8.32 yuan per dollar (+2%) from 1995 mid-2005 (ten years). By that time China was growing at double digit rates. When you peg your currency to another country’s currency and you are growing dramatically, there is tremendous upward pressure on your currency, that is, pressure to appreciate. Many in the US were calling China a currency manipulator and demanding that China let its currency float, or appreciate dramatically. China’s better council at the time (e.g. Robert Mundell) cautioned against that, warning that a floating, fiat communist currency might just collapse amidst gut-wrenching capital flight. So China allowed the currency to slowly appreciate in a sequence of moves, and by 2014 it hit 6.04 yuan per dollar (so it only took 6 yuan to buy a dollar, rather than 8+). But China has experienced a pronounced slowdown since then, which has put downward pressure on the currency. The yuan has slowly ratcheted back down, trading at 6.8 yuan per dollar by the end of July (2019). The big story today is that China allowed its currency to fall further to around 7 yuan per dollar. It is still not back down to the original peg of 8.32 per dollar, but it seems to be getting there. Think of the yuan as completing a round-trip that began in the mid-2000s. So a yuan devaluation shouldn’t be a big surprise given how much China’s economy continues to slow. But yesterday’s move – occurring after the Fed cut rates and in the midst of Trump’s latest tweets with regards to China – is seen as China hitting back with belligerence of its own. That’s why markets were selling off Monday.