Roach v Krugman: They're Both Right

There seems to be a bit of a debate going on between economists Stephen Roach, from Morgan Stanley, and Nobel Laureate Paul Krugman. It started with Krugman criticizing China's manipulation of its yuan's value. Then it extended into U.S. savings. I think there are kernels of truth in what each argue.

Bloomberg documents the debate in an article this morning. It all started with Krugman asserting that China shouldn't depress the value of the yuan because it's bad for global demand. The argument goes: if other nations could better compete with China's relative prices, then they would have more jobs, and consequently, more demand for goods. That's true.

Roach counters that China's consumers will experience increased demand through its currency's low value, and that's good for the global economy. He thinks that's a better way to reduce trading imbalances. He then says that the U.S. should tend to its own business, which should be encouraging savings.

Krugman counters saying his analysis would better reduce trade imbalances and adding that he wonders where global demand would come from if the U.S. spends less and saves more. He thinks that savings is a good idea in the long run, but not now.

That's the abridged version, anyway. There's a lot of economic analysis in-between that I'm glossing over. I'll just consider their theoretical arguments in broad strokes. So who's right? Both of them, at times.

I would give the global demand point to Krugman. All trading nations would be better off with floating exchange rates. That would best reduce trade imbalances, and global demand, on a whole, should benefit. China's population may, indeed, experience more demand through higher employment in its nation, but with a devalued currency, it would be harder to afford imports. Besides, part of the reason for the yuan's low value is that Chinese consumers save so much instead of spending. So trade imbalances would worsen here, as Krugman says.

Yet, Roach is probably right that the U.S. shouldn't care very much. We aren't the ones who would benefit much if China let its currency value float. The nations this would help are those that could compete with its manufacturing prowess. The U.S. is not one of those countries. Our wages would never come down to a level close to China's, even if the yuan had a fairer value. As a result, our consumers would benefit far more through cheaper Chinese products. The idea that, suddenly, something like textile manufacturing will ramp up in the U.S. if China's currency isn't so undervalued is pretty ridiculous. Other developing nations, however, would certainly benefit and should be complaining.

On the U.S. savings issue, I would fall somewhere in between Krugman and Roach. Krugman is right that too much savings during an economic recovery will make it slower -- especially for the U.S. which has an economy 70% reliant on spending. With that said, however, borrowing caused the recession in the first place. Americans are credit addicts and they need to break the habit. So a gradual increase in savings would be the start of a healthy paradigm shift. U.S. consumers shouldn't get too thrifty yet, but some spending restraint would be prudent.

So ultimately, I would probably side more with Krugman, but there is some sense in what Roach says. The devaluation of the yuan is bad, but probably not as much for the U.S. as for other developing nations. Savings shouldn't ramp up too quickly, but I'd find it hard to complain if Americans started down the road to better fiscal responsibility.