Interview with Edward Harrison, founder of Credit Writedowns
This interview was published in the October 11 edition of DNA
As a former diplomat who served the US State Department, Edward Harrison can speak six languages. But as a former strategy and finance executive with 20 years’ business experience and the founder of popular financial news website Credit Writedowns, he speaks a seventh language: the language of money. A frequent contributor to many reputed financial websites, including Roubini Global Economics, Seeking Alpha and Naked Capitalism, Harrison offers insights into the state of the financial markets. In an interview to DNA Money’s Venky Vembu, Harrison flags the risk of a currency war, but reasons that blaming China alone – as politicians and policymakers in the US have done – is wrong and risky. Excerpts:
There appears to be widespread concern about the undervaluation of the yuan. It used to be just the US; now it’s spreading wider. Is that criticism warranted or are countries ganging up on China?
I think it’s warranted; the yuan is undervalued on a purchasing power parity basis. That may have been fine before the crisis, when too it was undervalued, but now it becomes more critical for countries looking to remain competitive in an environment in which there’s slow credit growth, slow aggregate demand.
However, the Chinese say they’re looking for some sort of exchange rate stability; they could say that in good times and in bad, the yuan has stuck with the peg to the US dollar. There were times when the dollar was trading high against the euro and the pound, and there are times when it’s been low. But the yuan has been anchored to the dollar. To the degree that other countries outside the US are complaining, it goes back to the US exchange rate. Since the yuan is anchored to the dollar, if the dollar moves, it’s going to move too.
Chinese Premier Wen Jiabao has argued that a rapid appreciation of the yuan – for which China is coming under increased pressure – will trigger social unrest. Is that a credible line of defence?
It’s a credible line of argument to keep the pace from being too rapid. Obviously, you want to see them appreciate their currency, revalue on some level; the question is how rapidly can they do that without creating this social unrest that he talks about. If they were to revalue, but at the same time increase credit growth to alleviate that pressure, the problem is with all of the asset price appreciation we’ve seen till date. Is that a sustainable way to have a release valve in the event that all these jobs disappear from the export sector when they start to revalue?
The easy thing for them to do is to revalue in baby steps: something like 5-10 per cent a year. But the US is looking for 20 per cent revaluation.
All this talk of a ‘currency war’ ignores, to a large degree, basic negotiating tactics. Obviously you’ll go to war only if you think there’s nothing superior to be obtained from a negotiated agreement. Basically, Krugman and Wolf are saying: “We’ve given up on waiting for the Chinese; they’re going to go too slow; we in the US are going to get more benefit out of going to ‘war’ with them than we would if we tried to get some sort of agreement.” I think that’s the wrong interpretation to take.
What will happen if you actually have this currency war? The answer probably is: you’re going to get tit-for-tat retaliation. Every single time the US has done something with regard to tariffs (on Chinese imports), there’s been a response from China. So, you know there will be a response: the Chinese government is not going to sit by and watch the US push it around and start a currency war without retaliation.
But does China have economic leverage over the US to make retaliation count in the event of a trade war?
I don’t know if China has any leverage per se, but then I don’t know if the US too has any leverage. I wouldn’t necessarily look at it that way: I would look at it from a Game Theory perspective. If the US feels that they can’t get benefits from a negotiated agreement and decide to go to a trade war, the question, from a Game Theory perspective, is: what will be the likely response? The likely response would be some sort of retaliation in terms of currency or tariffs. Ultimately it hurts domestic consumption demand in the US because tariffs only increase prices (in the US), and retaliatory tariffs at the other end are going to reduce trade. So you’re looking at a decrease in aggregate demand, a decrease in consumption: in a world in which that’s the problem, you’re only creating more problems rather than solving anything.
The argument has been made that a tariff war with China would force multinational companies to move out of China into other low-cost production areas, and to that extent the US will be insulated from price increases. And that only China will hurt only China. Do you buy that?
I don’t buy the argument that the US would be insulated. The reason companies are in China is because it’s the lowest cost producer, even if the currency is undervalued. If you increase the tariffs on imports from China, companies could go to the next lowest cost producer. But they’re the next lowest, which means they’re higher than China. So, prices will rise in the US – and that’s a drag on the US economy.
But in a trade war, isn’t it the ‘creditor nation’ – in this case China – that’s hurt the most? And to that extent, might China calculate that it stands to lose more from a trade war?
It might, but these things have a tendency to spiral out of control. It’s beyond the control of individual decisions. The rhetoric takes on a certain momentum, it morphs in a certain way. You feel you need to take that next step – and hope it will be the last step. But there’s a response from the other side because they feel the need to take the next step….
This is what we’ve seen in terms of devaluation of currencies. You start out with the US reducing interest rates to zero per cent. Then you have Quantitative Easing. Immediately, you see the Swiss, the British, the Japanese engage in Quantitative Easing. Once the economy turned in 2009, all that went away: everything was hunky-dory to a certain degree. But then you had the Dubai and Greek crises, and everybody wanted to have a second round. Europeans were the first to go, printing money in order to buy sovereign debt of Ireland, Greece, Spain and Portugal. Now, the US is thinking of QE 2; all of the gains that the Europeans got has gone away. Meanwhile, Brazil has seen a 25 per cent appreciation in its currency versus the US dollar. All of these things go around in circles. It’s a multilateral situation, not between just China and the US. And any move that is predicated on the premise that you have more to lose than I is a mistake. It’s a slippery slope.
The US has a current account deficit with 90 countries – not just China. But isn’t it true that some of those deficits might be adjusted if China revalues its currency?
If you look Asia ex-China, the US has a large current account deficit. And with the rest of the world, the US has an even more enormous current account deficit. To the degree that you think that other Asian nations are being dragged in tow with China in order to compete, you might say: if the Chinese revalue, it would have an effect all around. But the reality is that the US has a trade deficit with the rest of the world ex-Asia that’s about $484 billion.
The problem is not China per se. The problem is that the US has a low savings rate, and a huge trade deficit. The US has to worry about its own house as well as China. To put all the blame on China is a cul de sac from a policy perspective.
Why has the debate focussed exclusively on China? Is China easy game?
Exactly. It’s hard for leaders to say: “We need to get our own house in order”, because that won’t gain them any votes. The best thing to do politically is to point a finger specifically at a target, and when it comes to trade, it’s China.
But is China blameless?
Not at all. Their currency is undervalued, you can consider that to be currency manipulation. We’re living in a world of floating rate currencies; the Japanese have had to deal with a currency appreciation of ridiculous amounts even though they have the same sort of export orientation that China does. The Chinese somehow want to live in a fixed rate world, and the reality is that even countries like Brazil, which are also nascent emerging markets, live in a floating rate world. Either they move to a floating rate world or they put their currency in a situation where it’s more in line with purchasing power parity. That’s the basic US position, and it’s legitimate.
There’s mounting frustration in the US that billions of dollars in stimulus are creating jobs – in China. What kind of a policy response is appropriate?
Martin Wolf had some good points. The negotiated agreement you’d want to make with China would concern a quicker appreciation of the yuan, and include potentially a moratorium on the amount of currency intervention they could do, or it could mean the US starts to buy Chinese assets: you could call that retaliation, but you do whatever you can. Obviously, it would be better to negotiate this rather than resort to unilateral action. But tariffs are probably one of the worse ways to go about it.
From a Game Theory perspective, again, will China see the wisdom of a negotiated settlement, or will it hold out for a maximalist position?
I think they’d see a negotiated settlement is better. Your point that exporting nations suffer more is completely valid. If you look at Germany and Japan as examples, they had a much worse decline peak-to-trough during 2008 and 2009 than the US or the UK. They were crushed by the downturn. The Chinese were too: their year-on-year reporting masked that somewhat, and they had a huge stimulus package that masked that as well. But they know point-blank that if things go pear-shaped, they’re going to be hurt much more than the US. I agree that they don’t want to go to a trade war; they will want to negotiate, which the US should understand. The tactic should be to speak softly and carry a big stick. The weapons are there, and they can point to the weapons in the negotiations: but tariffs and belligerently talking the Chinese into a corner would force the Chinese to respond.
Will another round of Quantitative Easing in the US accentuate the currency crisis?
I think QE 2 is definitely going to happen, but how much we get is the question. My baseline scenario is a double dip: I would give it a 50-60 per cent chance. But at the same time, a multi-year recovery is still a distinct possibility. In that case, as we saw in 2009, QE is not a factor. The currency war becomes less of a factor. If bank lending in the US increases, and if we start to create jobs in the US, you could see the problem at least from a US perspective disappear. I don’t think a QE is going to improve the economy in itself. Hopefully the economy is already moving in the right direction, and we can avoid having to escalate the currency debate.