19 Responses to A monetary answer to trade “imbalances”

  1. Arthur Felter says:

    “Let’s consider what happens when money leaves…” But in the case of the other two examples, money really isn’t leaving. In the case of hoarding the money, they will *eventually* spend it. In th. case of the foreign dollar-denominated markets, any profits on those markets will be in US dollars; and, likewise, they will *eventually* bring those dollars back to the US and spend them.

    (Or they’ll trade them to someone else who will be spend them)

    • PrometheeFeu says:

      Even if the money eventually comes back, more may have already left which means that the money supply would vary depending upon the speeds at which money is leaving and entering the country. (Think of it this way. Every month, you sell something to the US and get $100. 1 month later, you buy something from the US. The money supply will fall permanently by $100.) That’s what would be so nice about NGDP growth path targeting. As the money would come back, the Fed would shrink the money supply to stay on target. If more money started leaving, the Fed would expand the money supply to stay on target.

      • Arthur Felter says:

        So the money supply permanently falls even though the $100 was gone for one month?

        • PrometheeFeu says:

          On January 1st, $100 worth of goods are imported. On the 1st of Ferbruary, $100 of goods are imported and $100 are exported. So the $100 bill keeps changing, but there is always one that is outside the country.

      • Viking Vista says:

        Why do you not think that the price changes which would naturally occur with those changes in money supply would be a sufficient regulatory mechanism? Why on top of that natural market regulation do you want the central bank further manipulating supply and prices with NGDP targetting?

  2. Emericah says:

    I think it’s worth being more specific about how money can even leave. Seems to me that unless it’s taken out in cash currency, there’s no impact on the money supply. If it’s taken out any other way, the money will always remain on the books of a U.S. bank, just with changing ownership. An offshore bank with dollars can only hold dollars if it has an account, whether directly or via intermediaries, with a U.S. bank. Or where am I going wrong?

    • Viking Vista says:

      If you look up the BoP numbers, you see that whatever such leakage there is, it must be very very small.

  3. Viking Vista says:

    You assume too much in the exchange equation. First, money leaking out of a booming economy would be expected to correlate with increasing V. Second, falling M with or without falling V can occur with a huge surge in T, as long as P falls. Finally, if a company is experiencing a great economy with surging T, you can let them worry about any prior nominal contracts–it is after all a great economy.

    In other words, the exchange equation has explanatory power for any given set of assumptions, but no predictive power with so few assumptions. If you want to assume recession in your example, fine, but you can’t deduce it from the EE. Assuming either a good (increasing T) or bad (decreasing T) economy still leaves you with two full degrees of freedom, one of which, V, you typically cannot peg down directly.

    Your point might be more accessible from the extreme example of a sudden drop in M to near zero. That would mean a sudden collapse to a barter economy–a true disaster. Gradually tempering that toward a more realistic scenario would for a span mean lesser degrees of bad. But starting with a good economy and slowly dropping M doesn’t work, since even the EE allows for all manner of market adustments that accomodate even an IMPROVING economy.

    • PrometheeFeu says:

      You are right that if V adjusts to accomodate the fall in M. I’m interested as to why you would expect that to happen.

      • Viking Vista says:

        I don’t. I merely said that in a strong economy, you would expect falling M to be associated (perhaps causally) with increasing V, not fixed V, and not necessarily compensating V. My point is even bolder. I am saying that WHATEVER direction either M or V or MV change, you cannot assume recession, because these may very well be happening in a spectacularly growing economy (increasing T, falling P).

        You can introduce additional macro ideas, like sticky prices, to try to deduce recession (and I may still disagree), but the EE and nominal contracts don’t do it for you.

        • PrometheeFeu says:

          OK, I see what you’re saying. You’re right. I’m depending upon the idea that due to short-term nominal rigidities, (linked to nominal long/medium-term contracts) unexpectedly low NGDP will result in a recession.

          • Viking Vista says:

            Right. And I’m disagreeing. “Will result” is way too strong a phrase. I would argue that other factors, like the current state of the economy, are more important, perhaps dwarfing such rigidity to insignificance.

          • PrometheeFeu says:

            I agree that the phrasing was too strong. I’ve updated the post with a more measured statement on the topic.

  4. Viking Vista says:

    “Chinese exporters are sending us a clear market signal: they currently value pieces of paper with pictures of dead presidents more than widgets.”

    As with so many statements about money, this is only half the story. They are telling us that they value American gidgets and investments more than widgets, but recognize that the current best way to get them is with USD. They couldn’t care less how many USD they can get for their widgets. They care how much US *stuff* they can get for their widgets. This makes the money supply irrelevent so long as it is accessible, sufficiently divisible, and not being unexpectedly devalued while they hold it or hold contracts denominated in it.

    • Aceofwhat? says:

      So the Chinese exporters “recognize that the current best way to get them is with USD”. In other words, barring some large, unexpected event, they do indeed value dead presidents more than widgets. And as with most helpful explanations of complex transactions, the exclusion of large and unexpected events is a worthy sacrifice in the name of Simplicity. I don’t find the assumptions of an accessible, divisible and stable US money supply wild enough to warrant a “half the story” rating. It’s at least 90.23% of the story, right?

      • Viking Vista says:

        Whatever strange precision you want to give it, it misses an essential story about the value of a medium of exchange and the arbitrariness of price units. For instance, regardless of its trade value, the value of a TV is always meaningful to you. If I hand you a paper note from the Bank of Parmesia for 10,000 Parmesian Dollars, it means nothing to you until you find its trade value for, e.g., TVs.

        This is essential in thinking about money issues, because it leads to the important realization that it is the trade ratio not of money to good&services that markets target, but rather the trade ratio of goods&services to other goods&services. Transient effects excluded, this is why manipulation of currency trade ratios by a central bank result in corresponding changes in the prices of goods&services denominated in that money.

        More to the point, Chinese central bank manipulation of the quantity of the Chinese monopoly money not only affects the trade ratio of US to Chinese monies, but also an ultimately compensatory change in the trade ratio of goods&services to Chinese money. This effect is because people value money ONLY (with trivial exceptions) because of the goods&services they can trade for.

        Chinese widget makers don’t care one bit if their widgets each trade for $1 or $1 million, so long as they get at least 3 gidgets. It’s the gidgets they value, and any value they hold for dollars is 100% derived from that.

        The purpose of money is to make barter efficient. A medium of exchange is a MEDIUM of exchange. Regardless of money manipulations, one cannot correctly think about the economics of money looking at only half of the barter it replaces.

        • aceofwhat says:

          Good stuff. And think of my strange precision as a small attempt at levity to keep the discussion friendly, nothing more.

          But I think that I could obliquely say that it is also half of the story to only consider money (in today’s modern marketplace) as a medium of exchange. For example, if I purchase stock in the fictional company Parmesia Oil & Gas, I am exchanging pieces of dead president paper for pieces of PO&G paper. Let’s say I do so because I believe that I can purchase more widgets in 12 months by holding PO&G paper than if I held the medium of exchange itself for 12 months. After 12 months, I may use dollars as a medium to exchange PO&G paper for widgets, and life is good. Hopefully I have expounded on your point so far, and we are in agreement as of this sentence.

          But what if I believe that the US dollar paper is the better investment? If I’m using dollars as a medium of exchange, I will accumulate investments and widgets, using the medium to convert investments to widgets and back again. However, if I use dollars as the actual investment vehicle, I will affect US money supply because I’m hoarding and valuing money because of the goods&services that I may trade for in the future. The fact that my paper investment won’t need to be converted to a medium of exchange before I purchase future widgets doesn’t change the fact that I am treating money more like a commodity/investment than as a medium of exchange.

          Chinese are hoarding dollars. There are many reasons why one might choose to hoard a medium of exchange rather than a widget or more traditional investment, but I think it’s accurate to say that the hoarding of an item creates an effect more aptly described with the supply language used by Promethefeu in the original post. Our central bank can create more pieces of paper which, at present, seem to be valued by the Chinese for reasons beyond their facility as a medium of exchange.

          • Viking Vista says:

            Thanks for your reply.

             “seem to be valued by the Chinese for reasons beyond their facility as a medium of exchange.”

            In a barter system, almost everyone is using all kinds of intermediate goods to obtain the consumption goods they desire. It is the only way for specialization to occur. But those intermediate goods always have market value for consumption. A medium of exchange refers to a particular intermediate good used by the market at large. The classic characteristics of money tell us what such a good is likely to look like, at least early on. But common use is an essential feature for its role in obtaining widely disparate kinds of G&S, that other goods, including titles to ownership shares of a company, lack.

            Another important property is that a medium of exchange has value in itself–for its function as a MoE. People value the added efficiencies of using money over performing barter. A commodity money like gold has market value for its consumption uses in jewelry, electronics, etc. But on top of that is the additional value, and increased demand, as a MoE. A fiat money, like USD or RMB, lack that consumption value and have value SOLELY as a medium of exchange (with trivial exceptions like collectors). So USD have *no* value to the Chinese or anyone beyond their function to exchange for G&S. If the Chinese were to hoard USD, it would only be because of such exchange value, because there is no other value in it. That is to say, if dollars could not be exchanged for G&S, they never would’ve been interested in them. No other good besides a MoE has that feature. And ultimately all anyone in the market is ever interested in are G&S.

            When money is being manipulated, which is the activity of any central bank, the manipulation is therefore a way of redistributing G&S to different owners. With any use of money, the purpose is always (w/trivial exceptions) the exchange of G&S. This is not to say such manipulations aren’t incredibly important to understand in their own right, or that the use of money does not allow dramatic economic effects not possible with barter, but no correct understanding can come from incorrectly believing fiat money has any value beyond a MoE. Only a collector hoards dollars for their own sake.

            Since a barter involves the exchange of two goods A and B, considering only one of those goods in such an exchange facilitated by money, say A for M, is to only consider 1 of the 2 parts of the trade. 1 part / 2 parts = 1/2 = half. That’s why I say most discussions about money consider only “half” the issue. That fracturing of the true intentions of money users does lead to erroneous economic conclusions. One such erroneous conclusion is that there is not a compensatory price change following a money manipulation that tends toward keeping the exchange ratios of G&S the same.

  5. Joe Seydl says:

    The issue is that the U.S., as a large, developed economy, should not be running current account deficits to the developing world. Neoclassical trade theory states that rich, developed economies should be capital exporters to the developing world; because rates of return are typically higher in the developing world. When capital flows from the developing world to the developed world – which is the case today – the predictable outcome is an asset bubble in the developed world, since capital forced to seek high rates of returns in a low-return economy will ultimately make its way into risky investments. It’s no coincidence that when the current account deficit first exploded in the late-1990s, the U.S. economy morphed into a bubble-creating machine — first in tech stocks, like pets.com, then in housing. There’s no need for protectionism; we just need to let the laws of international trade work. Unfortunately, that entails geopolitical compromises with developing Asia, which no policymakers seem to want to make.

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