Supply-Side Economics Today
Big news this week that China passed Japan to stand as the world's second-largest economy. The question that naturally arises is two-fold. How did China come to grow so fast, and Japan so slowly, over the last twenty years? For their part, supply-siders have been fretting since the 1980s that Japan was prone to lose its edge.
Ask any of the supply-side soldiers from a generation ago what's the one that got away, and they'll say the same thing. The supply-siders got their tax cuts, even if the Reagan-era reductions were more enduring on the personal than the business side. And they got an approximation of money stability by means of the inflation-targeting that animated the Fed and Treasury for a while beginning in Reagan's first term. But they never got one big thing: a reform of the international monetary system.
Reading Robert Mundell's work from over the decades, you see that the man is in favor of fixed exchange rates and currency parities to gold. In other words, a redo of the monetary system that prevailed in the greatest era of world economic growth, that of the "second industrial revolution" of the decades surrounding the turn of the nineteenth century into the twentieth. This is true for supply-siders nearly across the board, even if some (such as Norman Ture) were ready to accept any plausible formal system that kept the dollar and all the other currencies regular.
In point of fact, however, nothing of the sort ever happened, even once the supply-siders gained influence in Washington. Does the following account suggest that international currency stability was ever achieved even through the era of supply-side ascendance?:
"Between 1971 and 1980 the mark doubled against the dollar, to $1 = DM1.7; between 1980 and 1985, it halved, to $1 = DM 3.4; between 1985 and the crisis of 1992, it more than doubled, to $1 = 1.39; and it has since fallen to $1 = DM 1.9. The mark-dollar rate has fluctuated up and down by more than 100 percent, a mountain of volatility that would make the ERM crisis of 1992 seem like a little hillock. Comparable movements of the dollar-euro rate would crack Euroland apart.
"Nor does looking at the yen-dollar rate give us more comfort. The dollar has gone down from 250 yen in 1985 to 79 yen in 1995, and then it went up to 148 yen in 1998 (with forecasters expecting it to hit 200!), and down to 105 yen in early 2000."
These words come from Mundell's Nobel Prize lecture of 1999. Despite the fact that in the 1980s, the three largest economies "“ the US, Japan, and Germany "“ all achieved stability with respect to consumer prices, and all were on a keel of good growth, their currencies bore no relation to one another. 100% swings based on no real differences whatsoever. Nobody took care of that.
Which brings us to the supply-side interpretation of the Japanese funk, which started on or about 1990.
Did Japan ever get hectored by the US in the 1980s. If you think the main economic policy preoccupation of the new administration in Washington in early 1981 was the tax-cut bill, guess again. The Transportation department had somehow scored a large amount of Oval Office face time just as Reagan was settling in and got the administration to impose quotas on Japanese car imports, with clear threats for more. A good part of Paul Craig Roberts's memoir of being a supply-side official in the early Reagan Revolution days is devoted to stories of Transportation Secretary Drew Lewis successfully pushing Carter-era departmental policies over all other priorities.
And yet with concurrent steps being taken to end inflation, the dollar was sure to strengthen, "worsening" the US trade balance, adding to the pressure to extend those quotas. The easy solution here was to nail down a system of fixed exchange rates such that cars made in Japan were no longer suddenly cheaper in the US because the dollar kept filliping. But instead of opting for this piece of cake "“ such as supply-siders proposed at their shadow G-7 conference in Spring 1983 "“ the quota gambit was soon supplemented by the tabling of the germ of NAFTA, along with severe talk to Japan about raising the value of its currency.
In 1985, Japan signaled it was all too willing to keep US manufacturing (and political) interests placated and would see to it that the yen would appreciate against the dollar. The idea was that Detroit might finally have a chance in the US car market if the yen went up. The problem was that in the over-strong dollar era of the past few years, the US manufacturers couldn't make profitable cars. These manufactures hence had gotten creative about cutting costs, which is to say cutting quality, and this only redounded to the growing allure of Japanese makes in the American taste, no matter the price.
Response: more fingers in the dyke. Japan even volunteered to raise its capital gains tax after the US passed the Tax Reform Act of 1986 (which took the US rate up 8 points). In the US, this tax increase was counteracted by a 22-point drop in the marginal rate of the income schedule. Still, Japan volunteered just for the increase part of the bargain, on the understanding that this move would raise the costs of investment and production in Japan and thus make it a more "equitable" trading partner with the US, still fuming as it was over its newly struck Rust Belt.
That's right: Japan appreciated its currency and raised its taxes by the end of the 1980s in order to calm down the whining big dog of the day, the United States. Japan's compensation for this turned out to be the lost decades of the 1990s and 2000s. Now China has the place in its rear-view mirror.
The whole foolish row with Japan could have been avoided by one simple thing. There could have been fixed exchange rates. Crazy, you say? Countries with similar high growth rates and similar nil inflation rates can't trade at the same par for the long haul? The burden of proof is on those who oppose this contention, especially in view of the hyperbolic growth rates that ensued all over the globe in both the second industrial revolution/gold standard heyday and the Bretton Woods period.
The following is certain. If similarly high performing countries see their exchange rates go nuts all across 100% ranges, lots of industries will find themselves burned and ask for redress. If redress is granted, a fly enters the ointment of an otherwise well-functioning economy. In Japan's case, it became enough to stall the greatest economic success story of the twentieth century.
So China's now number 2. And yet the most recent macroeconomic policy move to come from the place was to submit to American hectoring and delink the yuan from the dollar, with the yuan duly appreciating by, what, some 15%. This sounds all too familiar. The US refuses to grow up in terms of its obligations to steer the world toward a stable, convertible currency system, as its lessers only oblige its immaturity.
Econoclasts readers recall that Mundell called for a new Bretton Woods conference to be held in Shanghai, coincident with the world expo in this very year of 2010. Well, that's a dead letter. Unless China can work up the gumption "“ heck, I'd take trickery "“ to get the US on board with a fixed exchange-rate international monetary system, there's no good reason to think that China itself won't slip on the skids that complaisant Japan greased.
August 19, 2010 6:53 AM
Japan Shows China How to Stumble
Read Full Article »