2011 January 19 Wednesday
Michael Mandel: Exchange Rates And Knowledge Transfer
Michael Mandel continues to flesh out his thoughts on knowledge capital flows and why Americans are feeling poorer/ Mandel sees China's exchange rate policy as a tool China uses to cause knowledge flows into China. This devalues US knowledge capital.
The short summary: The Chinese policy of buying dollars can be best understood as an indirect purchase of U.S. knowledge capital–technology and business know-how. That, in a nutshell, is why we feel poorer today. Unless the Obama Administration understands the link between the undervalued yuan and the global flows of knowledge capital, negotiations with China are doomed to fail.
He does not mention China's other tools for grabbing intellectual property. For example, it will require foreign sellers to use Chinese suppliers and it will force foreign suppliers into business partnerships with Chinese companies with IP flow into the Chinese partners. China's trying to force foreign car makers to turn over their electric car technology to Chinese companies for example.
The crux of Mandel's argument.
Consider this. When China keeps the yuan low, that’s an inducement for U.S.-based companies to set up factories and research facilities in China, both for sale in China and for imports back to the U.S. . And that, in turn, requires a transfer of technology and business know-how from the U.S. to China.
Sounds right to me. Mandel argues for a change in the dollar-yuan exchange rate in order to slow the flow of knowledge capital to China. I think we need a multi-prong strategy to slow that flow including a trade policy that opposes Chinese mercantilism. One of the factors driving manufacturing to China (and pulling a lot of engineering along with it) is the Chinese government's subsidies for key industries. Our tariffs and other trade rules should be shaped to reduce China's ability to gain so much from their mercantilism.
We also need less naive Western corporate management. But part of the problem with corporate management is their short time horizons. If you are obsessed with earnings over the next couple of years you are going to put less weight on the longer term impacts of, say, letting software developers in your China office get access to your full source code base.
Also see my previous posts Rapid Knowledge Spread Lowers Western Growth and Boeing Depleting Intellectual Capital With Suppliers?.
riight, the best solution is to go for the root causes :-). Now the deeper and the less relevant a root we can find, the less the likelihood anything will change for the better, which is why this approach is especially beloved by hope and change variety of folks (no offense meant to the author of the blog, btw). The point is, you don't respond to a spree of armed robberies by introducing "respect your neighbor" classes in kindergartens. And you don't deal with Chinese knowledge import by manipulating currencies either (although such strategy might be quite appropriate for the more specifically relevant issues).
The part about Western management has been conventional wisdom for more than a decade, but we haven't been usually getting what we need lately. Why expect any change?
China has four big state banks and can issue Yuans debt free. The U.S. by contrast issues its money with debt attached. In effect, most of the Yuans circulating are real money, not debt money as in the U.S. If each dollar has to drag around debt, that is a hidden tax. The cost of capital for housing is about 78%, and the overall cost of capital in the U.S. is about 50%. We Americans have to shoulder a large burden relative to State Banking (Chartalist) money such as that of China. China simply prints debt free yuans and trades them out for dollars that enter their economy. The difference in the money system is the key difference in the two economies. Debt/Credit money like Federal Reserve Notes are crowded out by real money. Real money exists as a medium for settling transactions. Debt Money is a promise to pay something else – like the bankers who created the debt money. The U.S. citizen is bent over trying to shoulder the burden of wealth transfer to the creators of their money. That is why financial pariah capitalism of the West is losing to state capitalism of China. Chartalist state money has an inherent advantage because it conforms to reality. Money is a fiat (Law) of the State. Our credit/debt instruments as it has become known to the West, masquerade as money. The privately controlled central bankers of the west, who issue credit money to their host governments, are up against a power they cannot handle. Reality must trump fiction, or in this case the fiction of the big lie that underlies our debt money system.
Hitler used Chartalist money, and between 1930 and 1938 took Germany from being the poorest in Europe to the richest in only 8 years. Germany prosecuted WW2 without gold based fiat (debt bearing) money. A relatively small German population held off the combined might of much of the world. Hitler used to laugh at the gold based debt money of the west. Fascist states like Nazi Germany, and now China, coupled with a superior chartalist money systems, cannot be easily defeated. They do not subject their working populations to wealth transfer usury. Therefore the costs of goods, services and transactions do not have hidden costs imbedded. There is a monetary reason why China can produce $70 bicycles and still make a profit. All the concern about knowledge transfer and other economic dislocations can be traced directly to the difference in money systems. Knowledge transfer is not monetized on accounting ledgers, but accountants do see the imbedded costs of usury. Wall Street transfers our jobs and then crows about what a good job they are doing. After all, that is what the numbers say they should do. It cost less to do it over there…for some reason.
If the West wants to survive as an economic polity then it will have to scrap its debt based money system. Unfortunately, our intellectual class is agonizingly slow to grasp economic facts. We have been duped by decades of economic thought that money must originate as debt. Ironically, chartalist money was rediscovered by our Colonial predecessors. Lincoln used chartalist greenbacks to win the Civil war. We used Continentals to win the revolutionary war. There would be no U.S. if we hadn’t used chartalist money in the past. There may not be a U.S. if we don’t convert in the near future.
The central feature of Chartalism is government deficit spending. And it has been done for many decades. There is partial Chartalism in the US, but the issue of Usury is real, and the cost of capital is the interest the lenders are charging as a tax on the manufacturers and inventors, a hidden slavery. Essentially the inventors and manufacturers need to ask for permission from the banks to set up a business. This, however, can be solved very easily: The Federal Reserve gave nearly $1 trillion in interest-free loans to financial institutions; now is the time for the Fed to do the same for the small businesses: just give the same loans to small businesses with near zero interest, and you will see that the US economy will be revived very fast, and it will be booming like before. Government deficit spending works very well ONLY when the foreign trade deficit is under control. In the absence of severe foreign trade deficit, the government deficit spending always gets recycled in terms of taxes and the system works flawlessly. The only complication is that when the government deficit spending leaks out of the US and goes abroad, then it loses traction.
Our dollar as a reserve currency means that tariffs must be low. We have to accept imports in order to export dollars. Foreigners receive dollars that they can then use to buy commodities and oil on the world market. This means that our dollar always has demand upward pressure on it, which is a disadvantage for main street manufacturing vs foreign competition. Wall Street and the banking class like dollars as reserve, because they can create money at will and it must be accepted worldwide.
Since tariffs are held low, then it is a no brainer for wall street to finance the export of whole industries. American labor is then under attack by the buried debt of our credit money system, and is also under attack by dollar as reserve. American labor has the further indignity of suffering high immigration rates of low cost low skilled labor. This is to compete with foreign concerns that are in a race to the bottom, exporting to the U.S. to acquire dollars. Foreigners also need dollars held as reserves in their banks in order to prevent Wall Street and other Financiers from doing Bear raids against their currencies.
If money is a store of value and a signaling mechanism for capitalism, then jerking around with the value of our money is like a cancer in the body. All of our systems get sick and stop working. Entrepreneurs cannot easily see holes in the market because the signaling is damaged. We send our intellectual capital to China for pennies.
The Chicago plan, and its child - the updated American monetary act, did away with fractional reserve banking. This means that private banking entities can no longer create new credit money and no longer benefit from usury transfer. Private entities tend to look out for themselves and not the welfare of the country. The plan also puts the Federal Reserve into the Treasury, so money power is “democratized” and controlled by LAW and supervised by the people. New money is issued debt free, so the people don’t have to borrow their own credit like today. Money becomes money and not credit.
In addition to the American Monetary Act www.monetary.org, we could use a bank clearing system. This prevents our money from leaving our economy, and insures that trade imbalances are settled by an automatic mechanism. This is Keynes one good idea that we could use. A bancor type clearing system insures that exports and imports balance out. We would no longer need the dollar as a reserve, and we would return real money power to the people, where it belongs.
If our money problem does not get fixed, then we do not have a bright future ahead of us. We will have continued debt loads and the transfer of real wealth from the producers to the financiers. Eventually a wealthy plutocracy will arise, and we will become debt slaves on plantations. This pattern already happened in the past, and ushered in the dark ages.
The privately controlled central bankers of the west, who issue credit money to their host governments, are up against a power they cannot handle.
Oh, I wouldn't count the central bankers of the West out just yet. Armies march at their command. They may yet enslave the Chinese as well. On the other hand there are signs that the Chinese know what they're up against, and they do have nuclear weapons, so who knows.
NotProgressive, the US is not issuing money "with debt attached" in any meaningful sense. What actually happens when people hold money, is that they're making an interest-free loan to the government. Neo-Chartalists reach the same conclusion as mainstream economists about this; they just see the issue from a slightly different perspective.
Lincoln and Hitler may have overperformed simply because they went off the gold standard at a time when it was causing far too tight money. For a similar reason, the silver standard was advocated in the 1890s--recall William Jennings Bryan's famous speech: "you shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold".
The dollar as a reserve currency is good for the US, because (again) foreigners holding dollar currency are lending to the government at zero nominal interest. It also stabilizes exchange rates and thus creates a large market centered on the US economy. However, the overall level of exchange rates is set by other factors in the long run, especially purchasing power parity.
Anon, horizontal money (money created by banks) does have debt attached. Vertical money (MMT theory) can be argued that no debt is attached in any meaningful sense. But, we still have to raise our debt limits for vertical money to come into existence. The dollar as a reserve is good for us if you think in terms of credit money. It is a zero interest loan. However the term “money” is slipping from our lexicon and economists often conflate credit/debt money and money. Real money is a promis to receive not a promis to pay in something else (like credit money). Credit/Debt money comes into existence when you hypothecate real wealth, like your house, in order to borrow the money. Real money, by contrast, has value in that its volume in circulation is held to an amount needed for the economy, which is not an exact science. A sovereign country can issue as much debt free real money as it needs to for full employment. Therefore credit money loans of zero percent mean little when thinking in terms of real money. We can simply inject enough real debt free money into the economy - greenback style, in amounts needed. We don’t need foreigners to borrow from us and hoard our dollars. Benjamin Franklin’s Pennsylvania colony had nearly full employment and very low inflation because his money was in proportion to the economic needs of the people. This is about as good as you can get, and Chartalism can match “money amount” to actual needs. Henry C.K. Liu says that when people figure out that money doesn’t have to be debt, that will be a human event akin to discovering the world is not flat.
Since our dollar as reserve forces low tariffs, then our money system makes us a net importer. There are some things to consider:
A net importer has a chronic increase in aggregate supply, which drives down prices. For the importer’s domestic industries, both price and quantity are reduced, and therefore revenue, price times quantity, is reduced. The economy then contracts. A net exporter has a chronic decrease in aggregate supply, driving up prices. For the exporter’s domestic industries, both price and quantity are increased, (quantity because of returns from exports.) So revenue, price times quantity, is increased. The exporter’s economy grows, at the expense of the importer’s economy. Does this ring any bells? China?
The ideal you can do in any economy is to be able to purchase your own output. If the market is like a store, then people are purchasing your output, and you are purchasing theirs. But ultimately, you can purchase no more than the value of your own output. Money as credit gets in the way of allowing humans to trade their output as a hidden hand siphons off our productive output via usury. If you purchase more than your output, then the store shelves are bare, and you must borrow from another economy - hence go into debt. That is why we need bancor type clearing houses to prevent exporting countries from debt enslaving importing countries.
To recap, we still need real money, not debt money. Debt money can be manipulated and has a hidden wealth transfer mechanism imbedded in it. Bank created debt money causes bubbles and depressions. Usury from debt money is a hidden tax that accrues to those who create money e.g. bankers and the rich who loan to get richer. Ultimately a plutocracy arises with a debt based money system. Credit/debt dollars used as reserve currency is unnecessary when compared to a real money system with clearing house banks (bancors). Any fair system should allow people to keep their wealth and not have it siphoned off to financial interests, or to foreign countries.
Also, all those debt based ”federal reserve dollars” floating around in the world economy puts us at huge risk. If they ever come flooding back home to their source, they will collapse our economy. As we drive down the value of our reserve dollars, those stored in overseas accounts are declining in value. This does not make foreigners happy as their wealth, stored in dollars, is being debased. They are already agitating for a new reserve currency. Virtually all of our problems start and end with our defective money system. Americans and the West have been duped with a credit/debt based money system and we are reaping its ill effects.
Even the reserve currency status would not be too bad for the American industry if the foreign trade deficit is kept reasonable as a percentage of the GDP. As you said, for many decades the US was running a trade deficit to support the reserve currency status of the dollar but the loss of American jobs was not too bad until 1990s when the foreign trade deficit really started to get out of control. Running a trade deficit for raw materials (especially oil) is one thing, and the other trade deficit that destroys local jobs is another.
Anon, horizontal money (money created by banks) does have debt attached. Vertical money (MMT theory) can be argued that no debt is attached in any meaningful sense.
Yes, I was mostly thinking about base money (e.g. currency) in my previous post, since whether fractional reserve banking "creates money" that didn't exist before is a fairly contentious issue. It looks like you're advocating full-reserve banking here, which is sort of sensible, but then decrying "usury from the rich who lend their money out" makes very little sense. With full reserve banking, banks can no longer lend money from your bank account on your behalf. So your checking account is going to cost money, pay you no interest, _and_ long-term interest rates will be that much higher, since only a few rich people and institutions will make long-term loans. Is it worth the increased financial stability? Perhaps. But there are lots of costs attached, so the jury is still out.
We just put the industrial revolution into hyper-drive with the advent of high tech manufacturing and telecommunications. We are producing goods and services at an increasing rate, yet we are going more in debt? Things, as they stand, do not pass the smell test.
With full reserve banking, banks lend out your and my savings. With full reserve, banks cannot loan out what is in our checking accounts. Private bankers would earn their money from fees, not by fractional reserve mechanisms. New money would have to enter the supply debt-free from the treasury. Our debt money burden has been calculated at around 50%; even if calculations are off slightly, the cost is still considerable. China’s money costs are lower than ours because their debt-free state banks are a big part of their money creation process.
If we got rid of our credit money system, then the savings from hidden costs can be used to strengthen our economy. As it is now, the benefits of credit money accrue to those who create the money. In a full reserve system, the benefits go to those who have “saved” their money. The benefits then shift from wall street to main street. Our rent seeking class will have a much more difficult time siphoning off wealth from the productive. China’s lower cost money helps them to keep a low peg to the dollar. China can grow its economy with low inflation, as long as their money supply increase matches economic growth. The growth can be insured for some time as their interior needs to be built out, and they have a vast labor pool to supply industry. Growth can be insured further if China sucks jobs and technology out of the U.S., that way they can become the head of industry instead of the hands. Wall street aids and abets the rise of China, because shifting jobs and technology shows up as profits to the financial class. Eventually though, it hollows out main street U.S.A. We are at the point where main-street has been hollowed out, and the banking class loans start turning into junk. After all, if your debtor cannot pay, then your loan portfolio goes bad. With the loan portfolio turning to junk, horizontal debt money creating banks slammed their loan mechanism off. The credit money supply then shrunk, and we have entered into depression type conditions. The Government has countered with vertical money deficit spending.
The American worker has to carry the burden of credit/debt money cost, and has been put at risk with dollars as reserve currency. Also, not discussed is the cost of our military which insures passage of goods, including protecting sea lanes for China. The cost of proxy wars is yet another burden for the American taxpayer.
As things stand, accountants are happy to make the calculations and they always give short shrift to intellectual property. For example, in a rush to bring up SMIC, we are teaching 45nM technology to China. The Chinese engineers are being drug into the 21 century by their short hairs, with Western engineers teaching them our trade secrets. The accountant’s ledgers say it is the right thing to do. The money system is our feedback mechanism, and the money system is rigged.