Posted by: Dirk | March 22, 2010

The Roach/Krugman debate on the yuan

FT Alphaville reports on a spat between Paul Krugman and Stephen Roach:

And because economists appear to have far too much time on their hands/just don’t know when to quit, Krugman responded in kind. To which R.A, inevitably, replied at length.

Given that in the long run none of this will matter because we will all be dead (etc), FT Alphaville does wonder why economists find these tiffs impossible to resist.

Perhaps the behavioural economists will be able to comment on the motivations of their colleagues?

I am not a behavioural economist, but let me comment on the motivations anyway. Paul Krugman is motivated by being an economist, Stephen Roach is being motivated by being the Morgan Stanley Asia Chairman. Whereas the former is thinking about how to maximize welfare in general, the latter has the responsibility of running a business in Asia. This business hugely depends on whether China keeps on exporting and hence the Chinese central bank buying dollar-denominated assets. Selling these is what Morgan Stanley does  – at least they say so on their own webpages:

Since its founding in 1935, Morgan Stanley and its people have helped redefine the meaning of financial services. The firm has continually broken new ground in advising our clients on strategic transactions, in pioneering the global expansion of finance and capital markets, and in providing new opportunities for individual and institutional investors.

So, at least from my point of view the motivations are clear. China can only buy US assets while they generate a – the larger the better – current account surplus. The way they achieve this is an undervalued exchange rate, which is defined by, well, having a sustained and sufficiently large current account surplus. The ensuing inflows of cheap money from China have been extremely beneficial for the US financial sector, while creating a bubble that has cost US taxpayers billions of dollars, created unemployment, destroyed part of the social fabric and left the US without a sustainable economic system. And we’re not even done yet.

FT Alphaville quotes Roach once more: “We’re lashing out at China rather than tending to our own business,” which is raising U.S. savings, Roach said. As every economist knows, people react to incentives. How will Americans save when interest rates are low because China is investing hundreds of billions of dollars a quarter in the US financial markets? Well, they won’t.

Don’t get my wrong here: I don’t blame Stephen Roach for his opinions. I think that business leaders react to incentives as well, and these are influenced by institutions. So he should maximize the profit of his business obeying all the rules. If the outcome however is bad, rules should be changed. Paul Krugman wants the rules changed, and he has a point. Why does the FT (Alphaville) think that Stephen Roach is the right guy to discuss a change in the rules when he obviously has a monetary interest in the outcome?

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