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Epstein: The focus on China’s monetary policy is a diversion from the real problems facing US economy

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to the real The Real News Network. I’m Paul Jay in Washington. A lot of the talk these days in New York and Washington, at least in finance and business circles, is about the possible currency wars with China. Currency wars often lead to trade wars, protectionism, and protectionism and trade wars often lead to real wars. So how serious is this? Now joining us to help us make sense of what’s going on with the Chinese-American standoff on currency is Gerry Epstein. He’s the codirector of the PERI institute in Amherst, Massachusetts, and he joins us from there. Thanks for joining us, Jerry.


JAY: So what is this really about? And how serious is it?

EPSTEIN: Well, part of it is a longstanding fight between the United States and China about trade. And for many years, members of Congress and members of the administration, when they want to bash China, try to bring up the currency issue, the fact that we’re importing so much from China, and so much of it is so cheap, goods in Wal-Mart and so forth. People cry foul. They say that the currency is undervalued and gives the Chinese an unfair advantage. So when political heat rises, it’s time for the United States to start beating on China about the currency situation. So part of this is just a long-standing political problem that’s connected to the election cycle, but part of it is also a reflection of the current situation we’re in with the global crisis. Just as in the 1930s when there was mass unemployment in many parts of the world, countries tried to gain an advantage by trying to export more. And Obama has said that one of the keys to getting out of this depression is to increase our exports by a quarter, by 25 percent. How’s he going to do that if we can’t compete with China? So part of this is a part of this whole problem that the world is facing about how do you generate employment during a depression.

JAY: Now, if I understand it correctly, the issue is the Chinese currency is linked or pegged to the US dollar, so it doesn’t really matter, to some extent, what’s really happening within the Chinese economy. If the US dollar goes down, the Chinese currency goes down in the same amount. And the American argument is that that’s not legitimate, that the Chinese economy is growing, and there should be some rise in the currency because of that. Is that not a legitimate argument on the US side?

EPSTEIN: It is a legitimate argument. And, in fact, I think it is a problem for the United States and for the global economy that China is linking its currency so closely to the dollar, though they have allowed their currency to appreciate a bit over the last year and a half or so, which does raise the cost of their exports to the United States and elsewhere. But they haven’t let their currency appreciate enough. And as a country that’s running a very large trade surplus, which is creating problems for many countries in the world, they should allow their currency to appreciate to some extent vis-à-vis the dollar and vis-à-vis other currencies. But this is not a panacea for the problems that we face, either in the bilateral relationship with China or in the global economy, which is facing this huge crisis.

JAY: Now, I mean, some of the argument that comes from countries outside the United States say, well, you want all the advantages of being the world’s reserve currency, so if you’re going to be the world’s reserve currency, you’ve got to take some of the problems that goes with that, which means a lot of people, countries may want to peg their currency to you. So what do you make of that argument? I mean, like, we’ve heard in previous interviews we’ve done that being the world’s reserve currency might be good for US banks; it’s not necessarily so good for ordinary Americans. Talk about reserve currency and what it means in terms of this whole currency fight.

EPSTEIN: Yeah. Well, I think people bringing up the reserve currency issue is very crucial here. With the United States having the reserve currency, all that means is that the dollar is widely accepted around the world. And it also means that countries like China use the dollar in their foreign exchange reserves. They use the dollar to intervene in their foreign exchange markets. And what does this do? It creates a demand for dollars, not only by China but elsewhere in the world. And what that really means is that the United States is able to borrow very cheaply and a very large amount. So the fact of the matter is the United States is running a huge budget deficit and a huge trade and current account deficit, and it’s not really a problem that much for the United States as long as we can continue to borrow cheaply from the rest of the world, including China. And that’s why the deficit hawks have it all wrong. That’s one of the reasons. There are many reasons why they [inaudible]

JAY: And borrow, first and foremost, from China.

EPSTEIN: But other countries as well, the oil-producing countries, Japan, other countries as well. So it gives us the flexibility to run large deficits. And we could run much larger ones. However, this is not an infinite—we don’t have an infinite capacity to do this. If the United States starts undermining its reserve currency status by doing things like telling all the rest of the world that they have to revalue their currencies, that they can’t peg to the dollar by running what’s perceived to be inappropriate policies, then, yes, I do think there is a danger that we will eliminate that privilege that we have.

JAY: Well, one of those policies that might cause—some people say might cause a problem is what’s being called quantitative easing. The Federal Reserve has announced that they’re going to start buying some of the assets, some of the bonds from the government, with—in other words, putting a lot more currency into the economy. And that’s something you can do when you have the world’s reserve currency, and you can then just create more of it. You have a tremendous advantage, although some of the critics here in the United States say, well, eventually that leads to either inflation or just a credibility crisis about what the US dollar’s actually worth. How does that play into this whole issue with China?

EPSTEIN: Well, I think it’s creating a lot of pressure, not just with China but with other countries. The quantitative easing that the Federal Reserve is doing is driving interest rates very low, creating a lot of credit. And instead of that credit being channeled into the United States to generate more investment and more jobs, which is what it should be doing (I can come back to that in a minute), it’s either lying idle on bank balance sheets or in corporate balance sheets or it’s flowing out to other countries, which is leading to huge capital inflows into Brazil, into South Africa, to India, elsewhere, and forcing up those countries’ currencies, which are making those countries less competitive in terms of trade and putting inflationary pressures on those countries. So, in a sense, instead of reflating our economy and generating employment in our economy, it’s creating problems for the rest of the world.

JAY: Just to be clear on what’s happening here, if I understand it correctly, the big banks are getting money from the Fed at practically zero percent interest, and then they go and they loan it to foreign governments or foreign companies at a spread of—I don’t know whether it’s two or three points, but they’re making money off essentially American taxpayer money being given to them, loaned to them, and then they go abroad instead of investing it in the United States. It’s—am I getting what’s going on here?

EPSTEIN: Yeah, that’s more or less what’s happening. More hedge funds and private equity funds are borrowing from the banks or selling bonds directly to the Treasury.

JAY: And the danger of creating asset bubbles abroad while recession carries on inside the United States.

EPSTEIN: That’s right. So the fundamental problem is that the United States has not dealt with this crisis, and this crisis is spilling over into the rest of the world. We should be putting much less stress on monetary policy, which is creating—it can only do so much and it’s creating these problems, and put more stress on public investment, on direct job creation, more money for the state so they can keep hiring people, dealing with the mortgage foreclosure prices [sic]. We’re putting all of the pressure on monetary policy to solve this problem. And traditional monetary policy or even quantitative easing can’t work, because the Federal Reserve isn’t implementing tools to make sure that this credit is going to generate jobs in the United States. So we need a more balanced fiscal policy, we need a more hands-on monetary policy to allocate this credit to generate jobs, or in the end what we’re doing is having our problems spill over to the rest of the world. And bashing China is not going to solve this problem.

JAY: So doesn’t there have to be either some kind of law that says, if you’re going to borrow money at practically zero percent interest from the Fed, you can’t use this to ship it abroad and/or—. I mean, the threat these banks have against this is that, well, if you don’t loan us all this money, there won’t be any liquidity in the US economy, ’cause you need us to lend to small business and so on, except they’re not. So if these big private banks continue either to sit on more than $1 trillion of assets that they more or less got for free from the Fed, or take it to make dough abroad, and if they don’t put it into the US economy, then what else can be done, other than have some public way of putting liquidity into the economy and stop giving banks free money?

EPSTEIN: You’ve hit on a number of different possibilities. The first was a type of capital controls. Capital controls are now gaining legitimacy all over the world. Even the head of the IMF has said capital controls should be in the toolkit. He’s referring primarily [to] developing countries, who are imposing various kinds of controls on this massive wave of, inflow of dollars into their economies. So they’re taxing it; they’re forcing the banks to hold them in extra reserves that don’t get any interest; they are preventing some of this money from going to particular kinds of areas, like real estate. So, many countries, in Brazil and in Thailand and elsewhere, are putting on capital controls on inflows. What you suggested is that we have some kind of capital control on outflows of this money from the United States. This is something that not many people are talking about, but it would be a very good idea to tax these outflows so that they are more likely to stay in the United States. So that’s one thing that I think we should do. A second thing is—and my colleague Bob Pollin has put together a whole program that’s been published in The Nation and elsewhere of taxing the excess balance that banks hold on their balance sheets so they have a big incentive to lend them. And number three, to have loan guarantees and other kinds of credit allocation mechanisms so that that money gets invested in the United States to generate jobs. So capital controls or taxes on outflows, tax the banks who hold these excess reserves, and mechanisms to channel that credit to generate jobs here at home.

JAY: Now, one of the arguments you hear from the sort of libertarian economists is that interest rates are simply artificially low. That’s part of the cause of the problem, that the Fed’s, you know, loaning money to banks practically at zero interest. But if there was a more market-established interest rate, banks wouldn’t be getting this free money. What do you make of that?

EPSTEIN: Well, once again, the libertarians are implicitly assuming that the market economy would work just fine by itself. The fact of the matter, and Keynes showed this and Hyman Minsky and many others, in a depression, as we’re almost in at the moment, the equilibrium interest rate (if you say by “equilibrium” the one that would generate full employment) is actually negative, zero is too high: we should actually have a negative interest rate. And in fact, economists at one of the Federal Reserve banks, I think Federal Reserve Bank of San Francisco, did a study showing that the equilibrium interest rate in that sense is -7 percent. So the problem isn’t that we should just let the market establish the interest rate; the problem is that when you have a massive unemployment situation where the basic mechanisms of the economy are no longer working, you have to have much more directed investment.

JAY: The problem now is you’ve got one half of the equation’s kind of in place, which is the practically free money for the banks to act as a kind of stimulus, but you don’t have the other half, any kind of public interest mandate or regulations on the banks. So it doesn’t work if that’s all you do.

EPSTEIN: That’s right. So you need to tax the banks and you need to have more regulation of the banks to incentivize and to push them to lend the money for real investment. But also, getting back to China, China, which is now running this huge surplus, which is this emerging leader of the global economy, they do have to take on more responsibility. And at the G-20 meeting I hope that China would be willing to say, yes, we’re going to increase our domestic demand, or we’re not going to keep trying to export our problems to the rest of the world. And I think this is an important shift that has to be taken globally as well.

JAY: Thanks very much for joining us, Gerry.

EPSTEIN: Thank you.

JAY: Thank you for joining us on The Real News Network.

End of Transcript

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Gerald Epstein is co-director of the Political Economy Research Institute and Professor of Economics at UMass Amherst.