Monday, October 03, 2005

Teacher Taught by Disciple
-China vs. the US on free trade


Long Yongtu, former deputy trade minister who led China into the WTO, in a May speech to the Institute for International Economics in Washington, D.C. made the following comments, "Ironically, now our teachers are getting worried because, we, the students, followed your advice so faithfully and became so successful. As the students, we believe that our teachers should not be worried about that."

In 1997, when I was still a college student, in our international trade class, one of my classmates stood up (I don't know if the students are still required to stand up today when asking questions) and asked the following question, "Why China still doesn't have anti-dumping law?" She was asking this question because we all got so frustrated by the practice of the US using anti-dumping law to protect their industries and we just wanted to use the same protectionist measure to realease our anger.

Now China made its way to the WTO and expects a more fair treatment in bilateral trade, but still the US government are using various protectionist measures. The recent textile dispute is an example.

After this, the disciple will only get smarter. Next time, when the U.S. is preaching something, such as flexible exchange rate, free flow of capital account, or even democracy that is so dear to the American people, the disciple will tell his citizens it's a lie. I wonder how the Clinton administration and its trade representative will feel about this when they promised a more democratic China to the American people.

Bet on 2005 Econ Nobel Prize


The Nobel prize in economics will come out next week. To have some fun, I am putting out $50 as the prize money for people (not only for students) who successfully bet on any of the winners of this year. If you are interested, please send your speculations to my email address at The deadline is by this Saturday (Oct. 8th). You can only have two nominees and one field. If nobody has the right names (I know it's very hard, but I have people who have got it right before), the first 2 people who bet on the right field will get $10 each. Your email to me should look like this:

name 1: first last
name 2: first last
field: game theory

If you want to know recent winners or try to find out some patterns, you can go to: .

BTW, my bet for this year's prize is, Oliver E. Williamson.

Let's have some fun.


PS: the bet is only limited to Brandeis community.
Why Chinese Stock Market Is Not Looking Good (at least in the mid-term) ?


I took this view based on the following two reasons:

First, the big chunk of share of the publicly listed companies in China is still held by the State government, not in circulation. Sooner or later, the goverment will find ways to dump most of their holdings as SOE cannot be made profitable due to its distorted incentives structure. Currently, such experiment (of privitazation) is already under way. With vast shares dumped to the market, it will create an oversupply of the stock.

Second, thanks to the requirement of WTO and the trend of a less strict capital control, domestic investors, espeically those stuck in the stock market will find more channels to divert their investment to abroad. This create a shortfall of demand of the stock.

So what is the policy implication? Gradually release the state-owned share to the stock market and do it quickly only when the state-owned share of the economy becomes more insignificant, say under 15% of the GDP. Right now, the share is roughly 1/3.

Crash or What? The Dollar and the U.S. Current Account Deficit


One of my PhD classmates asked a question after our in-class presentation of Blanchard's NBER paper (w11137) that predicted the depreciation of the dollar, in the worst scenario, could be as much as 40% from today's level. His question was, "Why the heck the dollar would depreciate, cuz the demand for the dollar is so high, in foreign investmetn and trade? Is the prediction in contrast with our basic economic theory of supply and demand?"

My impulsive response was that he must be wrong. The high demand of the US assets just means more future income paid to the foreign investors, either in the forms of interest or dividend. As for the demand for the dollar in the international trade, the dollar just serves as the transaction facilitator. The demand for that purpose is much dependent on the velocity of circulation, not much on the volume of the trade.

But I don't feel it right. I actually hold some sympathy towards such a view. The dollar is indeed strong everywhere in the world. Asian central banks hold it; Saudi oil tycoons store it. Although the exchange rate of the dollar against the euro decreased to 1.20 recently, it may just reflect the fact that the euro was undervalued when it was debued in 2000.

To tell the truth, right from the start, I am not convinced of the idea of current account rebalancing. If the dollar remains strong, the reversal may never be realised. On one hand, the current account deficit has the potential to drag down the dollar; On the other hand, the strong preference/bias toward dollar lifts the dollar from the depreciation. So, when we talk about the relationship between the current account deficit and the dollar, first we should ask, "if there will be a depreciation", and second, "when the depreciation will be realised".

For small countries, the current scale of current account deficit in the US may have already triggered a crisis. But for the US, it may not be necessarily the case. With $200 billion reconstruction bill due to hurricane Katrina, the deficit may soon reach 7% of GDP. It's historically high. But how high the investors can bear before they lose confidence to the dollar, and the US economy? Remember, for the most of the developed world, the US is still the No. 1 choice to invest. Japan is recovering, but not so quickly; Europe needs serious structural reforms, not likely to come back soon either.

So the sharp depreciation of the dollar is not inevitable. It's just one of the scary theoretical scenarios our economists love to play with. Even if it happens, it can be a smooth landing. But the possibility indeed is there if the current deficit is still growing irresponsibly. Looks like we have gone back to the psychology of investment again -When will the investors ditch the dollar?