A Conversation with Janet Yellen

I had the opportunity to chat with San Francisco Federal Reserve Bank President, Dr. Janet Yellen after her presentation June 30 to the Commonwealth Club. In her remarks she had not mentioned exports as a stimulus for the recovery.

“Willie Sutton said he robbed banks because ‘that’s where the money is,’” I began. “Why wouldn’t you expect foreign lenders to be the source of demand to re-stimulate the U.S. economy, since they’re the ones with the money these days?” I asked.

“We’ve tried for years to get them to buy more of our goods and services,” she replied, “However, the Chinese won’t allow Chinese consumers to replace American consumers as drivers of their economy.”

“That was when the U.S. economy was strong,” I noted “Things have changed. Besides, it need not be Chinese consumers,” I continued, “It could be investment in China’s infrastructure. They have, after all, announced a domestic stimulus package in excess of $500 billion dollars. They’ll have to repatriate some of their dollars to fund it, which will drive the dollar down. That would make our exports more competitive, providing a source of demand to drive the American economy.”

“Yes, that would drive the dollar down,” she agreed, “But China will have no trouble borrowing the money.” She went on to state that she thought the Chinese would rather borrow than repatriate in order to continue undervaluing the yuan so as to sustain their export economy.

Others were lining up to speak to her, so I felt obliged to cut our conversation short, despite many unresolved related issues. So I took my leave with a parting thought: “The Machiavellian scenario,” I added “would be for China to repatriate dollars, drive the dollar down, and then buy up American corporations on the cheap with their remaining dollars.” She smiled. “I hope you will agree to receive a small white paper from me on the subject,” I concluded. “I’d be happy to,” she replied. (I'm sending her the most recent Chronicle: "The Surest Road to Recovery" available to all subscribers.)

EPILOGUE: I’m troubled by reticence among mainstream economists to visualize the reconfiguration of international trade and corresponding currency revaluations as the best solution to the present global economic and financial crisis. Three weeks ago I had the opportunity to ask Christina Romer, Chair of the President’s Council of Economic Advisers, if she saw the devaluation of the dollar and concomitant stimulus for U.S. exports and sales of U.S. assets to foreigners as a promising way out of the present downturn. While responding that exports were important, she basically ducked the question, doubtlessly to avoid tagging the Obama administration as being in favor of a weak dollar and foreign purchases of U.S. assets. I have previously written about similar blind spots exhibited in recent articles by New York Times columnists Paul Krugman and David Brooks (see below).

This reticence seems to be driven by “Demon Extrapolation” – projecting the recent past into the indefinite future – leading mainstream pundits and policymakers to fail to see the inevitable cyclical turns in the road ahead. Consequently, they remain fixed in their assumptions – e.g. Asians won’t allow their currencies to appreciate, or their economies to become domestically rather than export-driven. What is needed is a forward-looking, inverse variant of “dynamic scoring” whereby changes in the economic situation are factored into revisions of policy on both sides of the Pacific.

It should be obvious that at a time when the U.S. and Europe are in crisis because of too much debt incurred largely as a result of trade deficits with Asia and OPEC, that the way out of the morass is by reversing the dynamics of international trade. One arrives at this conclusion by process of elimination: the U.S. consumer, laden with too much debt and needing to save, will not be a source of demand growth any time soon. Any policies calculated to revive the economy by propping up credit-fueled consumer spending or investment in housing will fail, simply by compounding the core problem of too much debt. (Tax-cutting Republicans take note.) Presently, the government is attempting to fill in the demand void left by consumers. However, government can't continue doing so indefinitely by taking on ever-more debt, or it will become insolvent or, if it prints its way out of debt, will produce runaway inflation. Nowhere is there much appetite for increasing taxes. Business can't be the source of its own demand without an ultimate purchaser of its product. That would be like business pulling itself up by its bootstraps. Additions to inventory are temporary and variable, not long-term sources of demand growth. That leaves U.S. exports as the sole remaining possible source of demand to fuel a robust, sustained recovery.

Reversing the dynamics of international trade means shifting the role of “engine of world economic growth” from over-extended, demoralized and frightened U.S. and European consumers to the domestic economies of creditor nations in some combination of investment and consumption. In seeking a source of sustainable robust demand, it makes sense to “go where the money is” i.e. Asia and OPEC.

Such a shift in the net balance of international trade necessarily requires a downward revaluation of the currencies of debtor nations relative to those of creditor nations. Without it, things will remain as they are, with Asia and OPEC unsuccessfully trying to remain export-driven by flogging the moribund markets of their U.S. and European customers with artificially low-priced goods and services. World trade will eventually come to a grinding halt, and without a new, sustainable source of robust global aggregate demand, creditor nations will have no alternative but to default or resort to the printing presses to repay their international debt. Didn’t Einstein define insanity as “repeating the same behavior and expecting a different result”?

Since, as net creditors, Asia and OPEC are in the driver’s seat, I suppose these suggestions for major shifts in policy vis-à-vis capital flows, currency revaluation and trade balances should be properly addressed to them. I suspect Asian and OPEC governments are aware of the present impasse and, since it’s in their best interests to do so, will make the necessary policy adjustments once they lay the groundwork to stimulate domestic investment and consumption. At least I trust they will, or they will suffer the consequences of default by or debasement of the currencies of their debtors. All American policymakers need do is stay out of their way by not supporting jingoistic “King Dollar” policies or xenophobic policies prohibiting foreigners from acquiring U.S. assets. That may be a tall order; but then again, Mr. Obama is a tall man.