Friday, July 22, 2005

Dollars and Deficits

Today's Paul Krugman column raises the question, just how many elementary errors in economics does it take to have a John Bates Clark Medal revoked?:

To keep China's currency from rising, the Chinese government has been buying up huge quantities of dollars and investing the proceeds in U.S. bonds.

Krugman doesn't seem to realize how the mechanism of buying dollars works, as we can see from:

But pressures against China's dollar purchases are building. By keeping the yuan down, China is feeding a trade surplus that is creating a growing political backlash in America and Europe. And China, which is still a poor country, is devoting a lot of resources to the accumulation of a basically useless pile of dollars instead of to higher living standards.

A 'basically useless pile of dollars'! One wonders why they bother to exchange goods for them.

The question is what happens to us if the Chinese finally decide to stop acting so strangely.
An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan.

An end to China's dollar-buying spree would be because of a sharp decline in China's selling spree to the United States of Chinese manufactured goods. Just how does China buy dollars if not with goods.

...But if the Chinese stopped buying all those U.S. bonds, interest rates would rise. This would be bad news for housing - maybe very bad news, if the interest rate rise burst the bubble.

Note we have switched to talking of buying U.S. bonds rather than dollars. But immediately go back to:

In the long run, the economic effects of an end to China's dollar buying ....

First, it's an open question what China's spending its dollars on oil, Napa Valley wine, Washington state cherries, Boeing airplanes, etc. rather than on U.S. Treasuries would have on U.S. interest rates. The people who receive the dollars from China might use them to buy Treasuries.

Second, it doesn't appear that Krugman grasps the difference between buying dollars and buying bonds. Or, if it's simply a matter of sloppy writing, that he hasn't thought through the impact increased Chinese purchases of foreign goods and services with dollars would have on the U.S. economy.

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