Geo-Graphics

China has since 1994 operated some form of currency peg, harder or softer, between its yuan and the U.S. dollar. While China’s state-run Xinhua news agency has in recent years railed against U.S. management of the dollar, and has called for “a new, stable, and secured global reserve currency,” this week’s Geo-Graphic illustrates why China has little incentive to press for such a thing. During the 1956 Suez crisis the Eisenhower administration threatened to create a sterling crisis in order to force Britain out of Egypt. A collapse in sterling would have caused minimal collateral financial damage in the United States owing to trivial U.S. government holdings of British securities – amounting to just $1 per U.S. resident. In contrast, China’s holdings of U.S. securities today amount to over $1,000 per Chinese resident. Any major fall in demand for dollar-denominated assets would cause a collapse in the global purchasing power of China’s massive dollar hoard. For its part, the United States finds congenial a world in which a dollar sent to China for cheap goods comes back overnight in the form of a near-zero interest loan, which can then be recycled through the U.S. financial system to create yet more cheap credit. Neither partner in this monetary marriage is, therefore, likely to file for divorce any time soon. Steil: Red White Steil: The Battle of Bretton Woods Eichengreen: Exorbitant Privilege Treasury: Report on Foreign Portfolio Holdings of U.S. Securities Xinhua: U.S. Must Address Its Chronic Debt Problems

Big-name economists have been lining up to show their support for yet another target-based approach to monetary policy making: nominal gross domestic product level (NGDP) targeting. The basic idea is that a central bank should aim to stabilize GDP, unadjusted for inflation, at around 4.5% as a means of stabilizing aggregate demand and avoiding recessions. NGDP targeting having once been the intellectual stomping ground of economists on the right (notably Scott Sumner), its newest supporters come overwhelmingly from the left (such as Christy Romer). After the collapse of Bretton Woods in the 1970s, targeting of the money supply became the monetary Holy Grail. In the 1990s, as money supply targeting became operationally too problematic, the world shifted to the targeting of consumer price inflation. But after 2008, when July U.S. CPI hit 5.6% in the midst of a financial crisis, support for inflation targeting – which had become as close to global monetary orthodoxy as the gold standard had been in the late 19th century – melted away. Credible justification was needed for loosening policy at a time of elevated inflation. A year later, with CPI at -2.1%, such justification was no longer necessary. But those fearing a too-early tightening in policy turned to other targets. Targeting the price level, rather than price inflation, became popular, as it required the Fed to tolerate more inflation in the future to compensate for deflation and under-inflation in the past. The Fed itself has now turned to a temporary unemployment-level target. But NGDP targeting is truly the new intellectual rage. New Bank of England governor Mark Carney is the most prominent advocate in policy-making circles. We think the rage will be short-lived. The reason is that NGDP targeting’s newest supporters are bad-weather fans. That is, they like it now, when NGDP is well below its 2007 “trend” line, meaning that the policy implies extended and more aggressive monetary loosening. But what happens when NGDP goes above its target, as it eventually will? NGDP targeting then requires tightening, even if inflation is low – it may even require a deliberately deflationary policy stance. In this week’s Geo-Graphic, we identify in yellow 11 periods between 1983 and 2003 when the Fed was loosening policy but where a 4.5% NGDP target would have prescribed tightening.* This suggests strongly that NGDP targeting has no legs: when it tells the Fed to tighten, its prominent new supporters will abandon it even more quickly than they embraced it. Indeed, two noted monetary economists have even called pre-emptively for the abandonment of NGDP targeting once it’s done its job of justifying looser policy today. “Once the nominal GDP growth shortfall has been eliminated,” Michael Woodford and Frederic Mishkin wrote in the Wall Street Journal on January 6, “ it will be appropriate to again conduct policy much as was done before the crisis.” Yet since the rationale behind both inflation targeting and NGDP targeting is that they anchor public expectations for the long-term, adopting them opportunistically is a particularly bad idea. * We look at the annual rate of NGDP growth, rather than NGDP levels—using levels would suggest continuous tightening throughout the period and many more yellow bars. Sumner: The Money Illusion Romer: Dear Ben: It’s Time for Your Volcker Moment Steil: The Battle of Bretton Woods Mishkin and Woodford: In Defense of the Fed's New Interest-Rate Policy

In 2011, then Secretary of Defense Robert Gates warned that “there will be dwindling appetite and patience in the U.S. . . . to expend increasingly precious funds on behalf of nations that are apparently unwilling to devote the necessary resources to be serious and capable partners in their own defense.” France in Mali is now a case in point; the Obama administration is providing only grudging assistance to an under-resourced French intervention.  As the small upper right figure in today’s Geo-Graphic shows, France has very little of the vehicular equipment necessary to prosecute the Mali operation—less than 5% of what the U.S. has in stock. French military spending, as shown in the large left-hand figure, has since 2001 exhibited a marked constancy—one which is inconsistent with the country’s newfound passion for military engagement.  (Libya in March 2011 was another example of the French, as well as British, military biting off more than it could chew.)  It also highlights the need for the Obama administration to address Gates’s prescient concern and to develop a clearer policy foundation for America’s global military “lender of last resort” role.  At the very least, this should prod U.S. allies to match their military expenditures more closely with their ambitions, and to avoid miscalculating the level of tacit U.S. support that can be brought to bear at a moment’s notice. Chart Book: Trends in U.S. Military Spending New York Times: Blunt U.S. Warning Reveals Deep Strains in NATO IISS: The Military Balance 2012 SIPRI: Military Expenditure Database