Trading on Mars: How Global Imbalances Really Work with Michael Pettis

(upbeat music) - Welcome to Policy Punchline. Here on the show, we interview scholars, policymakers, and leaders shaping the frontier issues of our world today. I'm Maddie Feldman, co-president of Policy Punchline, and I'm joined today by Maya Chu. Our guest today is Michael Pettis, an economist and non-resident senior fellow at the Carnegie Endowment for International Peace, whose work has shaped global debates on trade debt and Chinese economic trajectory. With the career spanning, sovereign debt, restructuring on Wall Street to more than two decades teaching finance and Beijing, Professor Pettis brings a rare vantage point at the intersection of global capital markets and Chinese political economy. He is the author of several influential books, including The Great Rebalancing and Trade Wars, our class wars, though, it all starts with the volatility machine that I have right here, which argue that global trade tensions are deeply connected to domestic inequality and structural imbalances. Over the years, he has been an outspoken voice on the risks of over-investment, rising debt, and the long-term sustainability of China's growth model, interventions that have sparked both serious debate and policy reflection. Michael Pettis, we are so glad to have you on the show today. Thank you so much for joining us. Thank you very much. It's a pleasure to be here. Amazing. So first things first, super excited dive into all things US-China trade, et cetera. I do want to zoom out a little bit. We mentioned on the walk over here, you're very international upbringing, starting with Spain ending in Spain before college, but also we got Peru, Pakistan, Morocco, Haiti, et cetera. How did constantly moving shape you as a person, maybe also shape your general outlook? I know that you spent now a quarter of a century in Beijing, but did it kind of bring you this nomatically style, this interest in international affairs, et cetera? Well, you know, when you grow up under whatever conditions under which you grow, you sort of think that's the normal thing, and everything else is a little bit exotic. So we really didn't think my brothers and I really didn't think about it that much. But I think, you know, one of the things that I'm pretty certain about, and there are other people, like my best friend in New York, I actually met him in boarding school when I was 13 years old in Morocco. He had a very similar background to me. And I find that people with that kind of background, we tend to be, you know, I don't want to sound all kumbaya, but people really are quite similar. And even cultural differences are vastly overstated. Culture has much less of an impact on behavior than people think. It affects you in small ways, like in China, they use chopsticks rather than forks. But, you know, much beyond that, it tends to be that it's the same sort of things that drive people. What really matters are the institutions. And the other thing that I think makes me a little bit different from a lot of Americans is that, you know, one of my professors told me that there are basically two kinds of Americans. Americans who believe that everything good in the world is caused by America. And Americans who believe that everything bad in the world is caused by America. But there's actually a third possibility, which is a lot of things happen regardless of what Americans want or think or do. So I think we tend to overstate American agency at times. Things do happen outside for reasons that have to do with very, you know, local institutions. And then I think sometimes Americans underestimate the extent to which the rest of the world carries on without us. I'm sure that's a unique perspective to your American ties, but from a totally different vantage point, it's pretty cool. Awesome. All right, Maya. Yeah, I mean, I think we should just get right into it. So I guess trade is kind of something on everyone's mind. So I think we want to hear from you. You've argued that there are really two separate trade questions. First, how countries can gain from specialization when trade is roughly balanced. And then second, how persistent trade surpluses can arise when some countries export their domestic problems like excess savings. So in your view, the real problem today comes from the way that surplus countries like China offload the costs of their domestic distortions on two deficit countries like the United States. So could you just begin by walking us through that framework and kind of explaining why you think that most economists are missing that distinction? You know, economists use to understand this very well. I often refer to Keynes and to one of Keynes' friends in disciples, a woman by the name of John Robinson, who wrote brilliantly on trade. We used to know all of this stuff. And then I think in the 1970s, '80s, '60s, in that period, we saw a big shift in economic thinking. A lot of people call it neoliberalism. You can call whatever you like. But we started to divorce ourselves from a real understanding of trade. If you read most economists on trade, what you'll find, whether they realize it or not, is that underlying their thinking are models that implicitly assume balanced trade. So under conditions of balanced trade, you can argue that tariffs are a contractionary. And so they will argue that tariffs are, you know, the seed of Satan. In fact, tariffs are just a transfer. They're a transfer from importers to exporters under certain conditions they can be contractionary. But under other conditions they can be expansionary. They worked very well for China, for example. But I think that gets missed in a lot of the economic debate because economists have real trouble understanding how trade works when trade is deeply unbalanced. That's starting to change. You know, last year, the head of the English Central Bank acknowledged that imbalances are a real problem for the global economy. It may seem obvious to you. But for an economist to say that, it's pretty surprising. The head of the EU has recently made the same claim yesterday, the IMF report on China came out. And it acknowledged that Chinese trade imbalances are a real problem for the global economy. So we're starting to shift. And the irony is that we're moving back to a 1930s, much deeper understanding of trade and capital flows. We're moving back towards canes in his contemporaries. And I think that's really important. Yeah, definitely. And I guess from my understanding, there is sort of a difference between the balanced gains from trade and then the costs of persistent surpluses. So I'm curious, is there a point where efficiency enhancing enabling trade stops? And that becomes imbalanced German inequalities. I don't know. Could you identify any breaking point? Sure. If you and I are trading, and the reason I'm exporting to you is to pay for imports from you. And the reason you're exporting to me is the same reason to pay for imports. Then we're both maximizing demand. And by shifting production around to where you have a comparative advantage, you increase your production where you have a comparative advantage, but you reduce your production where you have a comparative disadvantage and buy from me. Under those conditions, productivity tends to grow. There are many problems with comparative advantage, including it's really basically a static assumption. It assumes that God came down, gave us all our comparative advantages, and they're never going to change, which, of course, is nonsense. But even within that framework, but the problem that we have in trade today is that that's not what we're doing. Many countries are not exporting in order to pay for imports. They're exporting in order to resolve weak domestic demand. So what they've done is they have a set of industrial policies. For example, in China, they very clearly stated that they wanted to expand their share of manufacturing. They wanted manufacturing to be a rising share of the Chinese economy. But because productivity growth and manufacturing is very rapid, manufacturing is a good thing. Again, counter to what many economists will tell you. So they expanded their manufacturing. Now, how do you expand your manufacturing? 20 years ago, China produced pretty crappy stuff. Its electric vehicles were second rate. Its drones were second rate. A lot of it was second rate. But what they did is they took a leaf from the page of a book of somebody who almost came to Princeton, Alexander Hamilton, who argued way back in 1792 that you could support certain industries until you reach the point where you become very, very competitive. And that's what the Chinese did. And as a result, their electric vehicles and their drones and lots of other things are far more competitive, far more efficient than the rest of the world. That's fine where it stands. But the thing is if you're going to subsidize certain industries, then somebody has to pay for those subsidies. And typically, what happens is that it's some other part of the producing part of the economy. So again, to go back to old American history, one of the reasons for the Civil War was because the subsidies were paid for by the agricultural sector, the subsidies to manufacture. So of course, the South hated that and the North loved it. But there is another way you can pay for those subsidies. And rather than have a different part of the producing economy, You can force the household sector to pay, right? And there are many ways you can do that. You can do it through taxes in a banking system like that of China's where almost all the lenders are households and all the borrowers are businesses. If you artificially lower interest rates, you're basically forcing households to subsidize business borrowing. You can do it by not providing a social safety net. You can do it through an undervalued currency. Lots of ways you can do it. But the result is this. You're subsidizing production. So production is growing faster than GDP. But you're doing so at the expense of households who account for most consumption. So consumption will grow slower than GDP. And as a result, unless investment goes up infinitely, you end up with a big gap. You're producing far more than you can consume domestically. So what do you do? You run a trade surplus. Is that a good thing or a bad thing? It depends. In theory, if you run a trade surplus with a developing country, because remember when you run a trade surplus, you're exporting capital. And if you export it to developing countries, they can use that to expand their investment because developing countries have high investment needs. Again, the United States is a great example. In the 19th century, we imported capital from England and the Netherlands to fund our investment needs. But what ends up happening in today's world is that nobody really wants to lend to developing countries. They're small loans to developing countries. But the vast majority of the excess savings goes to rich countries that don't need the capital. And this is what Cain's warned about. He said, "When that happens, then the expansion in your manufacturing has to be matched by a contraction in their manufacturer." And we see that all the deficit, all the advanced economies that run persistent deficits, they all have very low manufacturing shares. There's the advanced economies that run persistent surpluses have very high manufacturing shares. So in that case, what ends up happening is, John Robinson said is that your factories close down and your workers are unemployed. And for those of you who have taken economics, you'll know an unemployed worker has a negative saving rate. So as Chinese savings go up, the U.S. balanced it with a reduction in American saving caused by a rise in unemployment. Now Robinson was writing at a time of gold constraint, gold standard times. Since the breakup in 1971 of the gold constraint, there's another thing you can do. And that is, if you're a deficit country, you can allow debt to rise so that you don't have unemployment, either household debt or fiscal debt. And again, you'll know that debt is negative saving. So as Chinese saving goes up, American saving goes down because of the rise in debt to prevent a rise in unemployment. And that was basically Robinson's argument. China, or it's not just China, Japan, South Korea, Taiwan, Germany, Sweden, they're not exporting because they're very efficient. They're not running surpluses, I should say, because they're very efficient. They're running surpluses because they simply don't consume enough domestically, and they don't consume enough domestically because their workers are getting paid less relative to productivity than those of their trade partners. So total global demand contracts and only rising debt can keep it from contracting. When you talk about rebalancing toward higher household consumption in China, that sounds really straightforward in economic terms. I know that the main thesis of that first opening question was that we all are living much more similar lives. Sometimes we make it up to be that cultural difference can be blown out of proportion. But I'm curious if there is a bipolar dimension to household behavior around precautionary savings or attitude towards the state. Maybe that we're less predictable in this very kind of binary savings. Go up, down, whatever, is there an aspect to the cultural life that you've now lived for the last 25 years, 24 years, that about spending and economic behavior that maybe is harder to convince American economists exists across the Pacific? Well, I don't think there are cultural constraints. You know, when China was booming, you could come to China because the Chinese love consuming. When your future is doing well, you consume like crazy. Now consumption has gone down, but not because suddenly they've become confusion. Consumption has come down because they're very nervous about their future. They're getting fired, their wages are going down, etc. And under those conditions, anybody cuts back on consumption, doesn't matter what country you're from. In fact, the little story about Confucianism, because everybody knows as a fact that Confucian cultures are very thrifty and hardworking and tend to save a lot. The problem is that in the 1960s, when development economists were very pessimistic about East Asia. Whenever you talked about the part of the world that was going to get rich, it was always Latin America. And the part of the world that was never going to get rich was East Asia and Africa. And one of the reasons East Asia was never going to get rich is because of Confucianism. People said very clearly, Confucian philosophy is against thriftyness and against hard work. So it's strange, you know, when Asia is growing slowly, we say, "Oh, because they're Confucians." And then when they grow quickly, they say, "Oh, well, of course, they're Confucians." It becomes sort of a silly explanation for things. Do we tend to use equally silly explanations to explain Stunted Growth in Latin America? Yeah, I think so. You know, when I was in college, my family lived in Haiti for four years. I used to go there for all of my holidays. And we all know the stereotypes of Haiti. They're lazy. They don't do this. But you know, the funny thing is that Haitians, when they come to the United States, their kids are more educated than the average American, which may not be very difficult anymore. But the fact is that you just move them to a different set of institutions and then they completely change their behavior. So it's really hard to believe that that behavior is inherent. And in China, they love to consume everywhere they love to consume. I remember 20 years ago, people would have three or four watches to show how rich they were, you know. Fascinating. Yeah, I mean, you discussed how various policy decisions have suppressed consumption in China as of today. So I'm curious, if you see those trends reversing anytime soon, what can be done to bring that number up? Well, I just sent out a tweet. I'm quite active on Twitter pointing out a couple of things. Yesterday, the IMF came out with their new report on China. And finally, individuals have understood this for a while, but finally, formally, they acknowledge that China has a huge problem in balances. And they say, what China must do is raise the consumption share of GDP. Great. You know, some of us have been saying that for over a decade, when Jiao Bao, the former premier said that way back in 2007, we know China must raise the consumption share of GDP. But the next step in our understanding is why haven't they done so? They've been talking about this since 2007. Are they just too stupid to figure it out? This was a question that was asked about the Japanese, because in 1986, they said, we've desperately got to raise the consumption share of GDP. And they didn't. It was very difficult. So the important thing is, why is it so difficult? It seems like raising consumption, giving people more money. It's a no-brainer. Who's going to say no? The problem is that when you understand that low consumption is not an oversight or an accident, it's the flip side of manufacturing competitiveness. Right? So if I force households directly or indirectly to subsidize manufacturing, my manufacturing is going to be much more competitive, but my household demand is going to be very weak. So if I solve the problem of household demand, basically I'm reversing those transfers. And that means I have to give up manufacturing competitiveness. But manufacturing is such a large share of the economy that that's very risky. So the example that I use for that is Japan. Japan's a great way to think about China. In '86, the Japanese recognized they had a big consumption problem. They have to raise the consumption share of GDP. For the next five years, consumption actually declined a little bit. Very difficult to raise it. It bottomed out in 1991, and they finally raised it by roughly 10 percentage points by 2008. So it took them 17 years to raise consumption by 10 percentage points. During that time, Japanese growth was barely above half a percent GDP growth. And the manufacturing share, this is not a coincidence, the manufacturing share of the economy went from 27% of GDP to 19%. And the point that I would make there is that your manufacturing is so competitive because your demand is so weak, it's the same process. So if you want to raise demand, you've got to undermine your manufacturing competitiveness. And that's quite hard to do when manufacturing is a quarter of your economy, manufacturing in China is bigger than the property sector at its peak. So it's not that easy to do it. And one of the conditions almost certainly is that you have to tolerate much slower GDP growth. And I don't think Beijing is willing to tolerate that yet. So all this talk about raising the consumption share, it's going to go where it did in the last five years, basically nowhere, until they accept much lower GDP growth rates. It is really hard to raise the consumption share of GDP. I like that last piece of your tweet this morning to asking Beijing to reduce specific subsidies as pretty meaningless and suggest, quote, "more of lawyers approach to understanding China and the economy is different." Yeah, it's sort of what you're doing wrong is you're breaking the regulations, so stop breaking it and everything will be fixed. Right. You know, that's not how it works. We got a lot of lawyers over here. I'm sure. Well, okay. So you have those-- Well, you know, James and Greer is a lawyer. Yeah. And before him, Kathy Tai was a lawyer, so some of them really get it. Oh, with that. And from DC, if you throw a rock, you had a lawyer. I can appreciate one for sure. So you emphasize also that real distortion isn't just, okay, explicit subsidies, but transfers from Chinese households to manufacturers, through current policy, financial, oppression, labor constraints, et cetera. If that's the core mechanism, what would genuine rebalancing actually require politically inside of China? I mean, if job out, for example, has been saying this for the last two decades, and if we see a pretty strong example of what growth would entail with Japan, what would you advise? Well, let's start a little bit behind that, right? So here's just an arithmetic problem. If I want the consumption share of GDP to grow by definition, consumption must grow faster than GDP, right? Otherwise, the consumption share can't grow. So how do you get consumption to grow faster than GDP? Well, one way, I call it the American way, which is what we did in the 1930s, is you get a collapse, except that production collapses faster than consumption. So the way the US had excess savings, very high trade surplus, bad investment, all of the problems we associate with China today, the US had in the 1920s, and how did the US resolve it? It resolved it brutally, but quickly, right, with a collapse in the economy, and a collapse in consumption that was only half as bad as the collapse in the economy. And that makes sense, both production and consumption go down, but production go down much faster. That's one way you can, by definition, rebalance. The other way, or a second way, it's the only other way that we've seen historically, but it's not the only possible other way, is what I call the Japanese way. In Japan, consumption didn't drop after 1991. It dropped a little bit, but the Japanese households were growing just as quickly, almost as quickly before, after 1991, as they were before 1991. And in fact, they were doing better than European households. They were in line with American households, and the 90s was a pretty good time for the US. But what happened is GDP growth dropped basically to zero. So consumption grew at around 2%, GDP grew at around half a percent, and Japan rebalanced. Now the advantage of the Japanese rebalancing is that it's politically and socially much less disruptive. The Japanese didn't even vote out the ruling party until many years later. The disadvantage is that it's taken 30 years. And during that time, Japan went from 17% of the world. So by 2008, it was 9% and today it's about 5% or 6%. So you can argue that that's a much less disruptive adjustment, but much more painful over the long term. Those are the only two models we've seen historically. There is technically a third model, and that is what if you could get consumption to pick up pace, consumption growth? What if you get it to accelerate? And you can do the math, it's not that hard. If you can get consumption to grow at 6%, and GDP to grow at 4%, so no meaningful slowdown in GDP growth, you could raise the consumption share of GDP by 10% at points in 10 years. The question then becomes how do you get consumption to grow by 6%. When it hasn't grown at that rate for a long time, the last time it grew at that rate, GDP was growing at around 10%. There are a couple of ways you could do it. One way is the Hail Mary Pass, you can hope for a technological breakthrough that is historically massive, that causes a surge in productivity and 100% of the increase in productivity. It goes to workers in the form of wages, no profits, no taxes. Then in theory, if we had like a 1920 style in the US, we had a huge jump in productivity in the 1920s, if we had that kind of productivity jump, translated 100% into wages, then China could rebalance that 4% growth. Another way they could do it is the government in China owns a lot of assets. You could take those assets away from the government and give them to households, and as they get wealthier, they'll continue spending. The first one is, you buy a lottery ticket and you hope you win, you might, but you probably won't. The second one involves huge political transformations, and I'm not sure China is ready for that. But otherwise, just arithmetically, there's no other way to rebalance. I think that's not enough people are just doing the arithmetic. The arithmetic says either GDP growth has to slow, or you need something magic that causes at least a 2% of its points surge in consumption without a slowdown or without a speeding up of GDP growth, or you need a political transformation. Once we understand that, then I think it becomes easier to see why it's so hard to rebalance. Do there are any kernels of excitement and technological breakthrough in innovation last quarter century that you think could lead to that Hail Mary possibility? I don't think we've seen that kind of technological breakthrough in the last quarter of the century. In the 1920s, of course, we saw chemicals, aerospace, radio, automobiles. I mean, it was a real perfect storm of technological innovation in the United States. Maybe AI will give us that. Some of my friends say it will. I don't know. I'm old enough to know that we've had many technological breakthroughs that we're going to change everything, and they changed a little bit, but not enough. Maybe AI will be different, but we'll see. Yeah, we'll see. I think we've talked a lot about what China can do on their side, but I kind of want to flip the conversation to the US. There are probably a lot of structural barriers and reasons why this wouldn't be a good idea, but I kind of want you to lay it out for us. Why can't the United States just also subsidize production, maybe suppress consumption a little bit and export those problems elsewhere? Why would we ever do that? Why is that a bad idea? That's sort of what the Trump administration is trying to do. So far not very successfully, but they have some pretty smart people. I think James and Greer of Scott Vesent are really smart people, and they're going to get there eventually. I think maybe our president is a little bit random and maybe undermining the process, but eventually they'll get there. But here's the problem. So China and not just China, this is really not about China. This is about a very bad global trading system. China, South Korea, Taiwan, Germany, Japan until recently, and other countries have very weak domestic demand. They control their external accounts. If I run a surplus, one of you guys is going to have to run the deficit, right? Which one of you will run the deficit? The one of you who controls your external account, the least, right? Because then I can force my surplus onto you. Again, this is Jane, Jane, John Robinson's point. There is now going to be a competition between the two of you over who can intervene more in your external account. Because if you don't, you accept all of the imbalances, you have to accommodate my problems. And it looks like the US has been the first to decide that we're not going to accommodate these imbalances. So what the US is doing is what Keynes didn't want countries to do. It is now trying to create its own, it's not someone trying to create a domestic imbalances, trying to reverse its domestic imbalances. Which it was the big contributor of demand to the world. It wants to contribute less demand to the world. That's bad for the world. But that's especially bad for other countries that don't intervene. And when you go through all of the countries, basically it means Europe. If Europe does nothing, they will replace the US as the big accommodator of excess production. But they should intervene too. The problem is that if we're all intervening, we're all intervening in the same way. We're all trying to subsidize our exports by reducing domestic demand. And that's what you run into a version of the problem that the Polish economist Michael Koleski warned about. So Koleski argued that. in a normal market system if we're all competing, if I lower my wages, I will be more profitable than the two of you, right? But if all three of us lower our wages, our profits will go down, because it's wages that support demand. And if we lower wages, we're going to produce less stuff. And even if we're more profitable per unit, we're going to make less profit. So what you really want to do is the world in which everybody is raising wages. But we live in a world where if I raise my wages and you suppress your wages, then much of my demand, I'll pay the full cost of that increase in demand, but I'll share the benefits with you. And that's the problem that we have in our world, where you are rewarded for quote unquote cheating. So what we need is a very different system, where countries are no longer rewarded for cheating. And Keynes proposed that at Bretton Woods in 1944, a trading system where you're not allowed to run persistent trade imbalances. There are penalties for doing so. But absent that, we fall into the world. If we don't go into the world of Keynes, we go into the world of Robinson. And she said eventually, everyone's going to be putting trade restrictions on everybody else so that they don't absorb the cost of the imbalances. And that's how the good world, that's a terrible world. But if you don't play the game, you're the big loser. So you have to play that game. Yeah, I mean, you kind of hinted at Keynes's vision at Bretton Woods, this trade union. So I would love for you to go into a little bit more depth on that. So how would a balanced trade union actually enforce compliance? What exactly does that vision look like? Well, Keynes was very, very logical, right? And he said, there are a thousand ways you can cheat. And I can't catch all of them. But I can tell you that if you're cheating, I know because you're running a persistent trade surplus. So he said, let's, you know, let's just cut to the chase and make it very difficult to run persistent trade surpluses. And so what he proposed, which I don't think we can do today, Bretton Woods, remember, was at the end of the destruction of the world. So you could recreate a lot of institutions, but the idea is what's important. What he proposes that if you run a trade surplus, you have to acquire foreign assets, right? You got to get paid. Normally you export in order to import, but if you don't import, then you've got to get paid something and it's got to be a foreign asset. So he said, let's make that foreign asset something called bank or, which will be created by some central entity. And by manipulating interest on bank or we can make it less valuable or more valuable. So let's say we're in a world of, you know, back then the concern was inflation. So let's say we're in a world of 6% inflation and you run a trade surplus. Your reward is bank or and the interest rate might be zero, right? So you're losing 6% of the value of your trade surplus, if your accumulated trade surpluses every year. And the trade deficit country, which is also borrowing at zero, is being subsidized. So the surplus countries are forced to subsidize the deficits of the deficit country. So it no longer becomes a winning solution to run, you know, expand your manufacturing share by running surpluses. There is a penalty. So he said, by manipulating by that interest rate, we can bring trade balances down to zero. And notice something else that he said, because England was no long of the great power of the world. It became more respectful of power. And it said what Keynes was saying is that basically we won't tell you how to run your economy. You want to be communist, fascist, capitalist, socialist, whatever you like. You just cannot externalize the cost of your domestic policy mistakes, right? You cannot run persistent imbalances. Otherwise, it's up to you. And I think, you know, I think that's a great non-interventionist policy. You can do whatever you like, accept externalize the costs of your policy mistakes. Yeah, I mean, if you were all of a sudden, present in the United States, like what would the strategy for creating this union look like, who would be involved, who has to be involved? Do you think it's politically viable? I think right now, if the US were to create a trade agreement, nobody would join. But in principle, you don't need many countries to join. You need the United States, Canada, England, who together account for about 70% of all deficits. For good political reasons, throw in India another deficit country, Mexico, you know, one or two other deficit countries, maybe France, if they can be separated from the EU. And that's it. You've got all the deficits. And if the deficit countries say if you want to trade with us, you cannot run deficits, you cannot run surpluses, then the surplus countries have no choice, right? And unless we trade with Mars, they cannot run surpluses. So ultimately, everybody will join and will have the type of customs union, a Cain's called the currency union, but along the lines that Cain's proposed. Yeah, that makes sense. It all balances out. So if a union like this is impossible, you've argued that the US is justified in acting unilaterally. But instead of focusing on tariffs, which is obviously what we're doing now, you argue that the US should consider restricting capital inflows to absorb, or to stop absorbing excess global savings. So how would capital controls actually rebalance trade and what would the US economy look like during this sort of transformation? The important thing to remember is that a current account surplus is a capital account deficit, and a current account deficit is a capital account surplus. People say if you run a trade deficit, you must run a capital account surplus to finance it. That's not true. That's not what the identity tells us. The identity tells us if you have one, you have the other, but it could be the trade deficit that sucks in capital, or it could be capital coming into your country that forces a trade deficit. So imagine if you're a surplus country, you have to acquire foreign assets, right? Where will you acquire them? Well, you don't really want to acquire assets in developing countries, because that's very risky. You want assets in financial markets that are very deep, very flexible, in which foreigners are much better protected than they are in the rest of the world, where you can go in and out, you can buy a $10 billion on Monday and sell it on Tuesday without a big cost. And so what are those markets? Well, they're basically the so-called Anglophone markets, the United States, Canada, England, Australia until recently when the Iron ore boom pushed it into surplus. Those countries accounted for almost all of the deficits. So the question is, is there something about people who speak English that make them consuming maniacs, or is something else happening? And I would argue that what's really happening is the similarity of their financial markets. Whether you're a drug dealer or a dentist in Belgium or a central banker in Asia, when you acquire assets, the easiest safest place to acquire them is in the U.S. So foreigners are not financing the American deficit. The governor of the South Korean Central Bank doesn't wake up in the morning, pick up the newspaper, and say, "Oh dear, the Americans have reduced their savings rate. We had better help them." No, what he does is he said, "We've got a trade surplus. We don't want the currency to go up. We have to buy foreign assets. Let's buy American assets." Because it's the safest and the cleanest. But if money is coming into the U.S., the U.S. must run a deficit. And the easy way to think about it is if all these people are buying U.S. assets, they're pushing up the value of the dollar. And as the dollar goes up, that's a subsidy for importers, right? And that's a tax on exporters. Who are the net importers in any country? It's the household sector. All households are net importers except maybe subsistence farmers, which we don't have any in the U.S. Who are the net exporters? The manufacturing sector. So what they've done is by pushing up the value of the dollar, they have increased the household share of GDP and they have reduced the profitability of the manufacturing sector. And so the U.S. ends up running a deficit, not just a deficit, but a decline in its manufacturing share. So I would argue that that's the problem. You can put tariffs on imports, but wouldn't it be much more efficient to put taxes on capital imports? If you want to invest in the United States, pay a small Tobin tax, right? A Tobin tax, I think he taught here at Princeton, I'm not really sure. But a Tobin tax basically says, if you're going to make a long-term investment, if you're going to build a manufacturing, a car manufacturing plant in Tennessee, the tax will have almost no impact on your returns. If I charge you a quarter percent for a one-time investment that takes 20 years, 30 years, it's going to have no impact. But hot money inflows, it's going to have an impact. It's going to really reduce your incentives. So you'll stop bringing unnecessary money into the U.S. and the U.S. dollar will stop being permanently overvalued, which will be a big relief for American farmers, American workers, American manufacturers. Wall Street will hate it, but the rest of the U.S. will probably do well by it. So that's basically the proposal. You know, take 10 years ago this was considered so absurd that nobody would discuss it. But a lot of people are discussing it now. But where the debate is, is I think it's a good idea, but I don't think anybody else does, so it won't pass. But if enough people say that, you know, that problem resolves itself. >>Simon, majority. Maybe speaking English is just our God-given comparative advantage. >>There we go. Okay, clearly mentorship plays a big role. You're referring to the philosophies of Robinson and Keynes. I'm curious if you could sit down for a meal with the two of them. Sorry, forgive the hypothetical Keynes, John Robinson, and the late mentor of Resmeical Adler. What would be maybe your first question? >>I probably ask Adler to leave the table because he manages to piss everyone off. He's pretty erratic. I've never really thought about that. >>I know, it's a bizarre question. >>I would ask Robinson, does China today fit into her model, why or why not? And I'd be very interested to see. Because Robinson was more on the left, so that makes it more difficult to criticize the country like China. >>Cool. >>I would love to get into the dollar just a little bit more. You've argued that a weaker dollar would benefit the US for reasons you just mentioned, restoring the balance of production and consumption. Currently the dollar is down around 8% from last year due to policy uncertainty largely by the Trump administration. What are the downsides of a structurally weaker dollar? And why are you so confident that the upside outweighs? >>Well you can't really say a weaker dollar benefits the US. It benefits certain sectors and it hurts other sectors. So does Wall Street like a weaker dollar? No, they like a stronger dollar. Creditors like a stronger dollar. Barrowers prefer a weaker currency. If you're an American tourist of course a weaker dollar is terrible because now it costs a lot more to travel. If you're a foreign tourist you know, a weaker dollar is great because it's much cheaper to come to the US. If you're a manufacturer a weaker dollar makes you more competitive against foreigners. If you're a farmer a weaker dollar brings you more income for whatever it is that you produced. So there's these different sectors that benefit and lose out with a weaker dollar. So then the question really becomes a political one. Is it better? Are we better off if workers and manufacturers are doing better but Wall Street is doing worse? I think many of us would immediately say yes, screw the bankers. We have to be a little bit careful. It's a legitimate question. Are we overall better off by improving conditions for these sectors and hurting conditions for those other sectors? But how's the dollar really weakened? I don't know if I mentioned Brad sets earlier. I did to you and we were talking. He's done really good work on that topic and I think he's the best guy to read on that topic. And the point that he makes is yeah, we're a little weaker from our old time high but we're still way above any reasonable measure of the dollar. The dollar is still far too expensive. So we have a long ways to go before we start resolving the problems. Yeah, and if the dollar's dominance actually does significantly decline, what would replace it? Nothing. You know, Ray Dallio did that famous chart where he showed the dominant reserve currencies over the last 500 years. It's not true. Those weren't dominant reserve currencies. In fact, the most important currency in the world at the end of the 18th and beginning of the 19th century doesn't even show up on that chart. It's the Mexican silver dollar, right? His argument is that powerful countries have powerful currencies but Mexico is not a powerful country and it had the best currency in the world. But more importantly, the role of the dollar is totally unprecedented. Some people say, "Oh, well, Sterling was a bit like the dollar." No, it wasn't. Sterling was respected. It was credible to the extent that its link to gold was credible. But there were periods when England ran into gold problems and then Germany and France would get together and lend England gold. But until that loan happened, people would move out of Sterling and into Franks. Basically what they wanted was gold. And Sterling was the closest, the easiest thing to gold. But the US doesn't play that role. Nobody buys dollars because the US has a huge stack of gold, which it does. It's the biggest stack of gold in the world. And they buy dollars for a completely different reason. They buy dollars because it's safe, it's flexible, it's secure, foreigners are protected. And they have to buy something because they're running trades surpluses, right? And so the role of the dollar is unique in history. We've never seen a currency play this role before. And we probably shouldn't see a currency play this role. Even the dollar shouldn't be playing this role. So when the hegemony of the dollar ends whatever that means, it's not going to be replaced by the euro or replaced by the remembe. It won't be replaced. We will have a multi currency. One of the fun things to do and I recommend to anybody listening to this is to read those sort of books that came out 20 years ago, 40 years ago, 50 years ago, and see how certain we were of certain things and how we are always wrong. There is a wonderful book, I forget the name of it. It's a monetary history that came out in 1993. And he has the inevitable last chapter about the future of the currency. And he said it's very clear that in the 21st century either the dollar and the yen will be the dominant currencies or the yen will be the dominant currency. Obviously, anyone who doesn't see that as an idiot, well, it turns out that, we didn't even come close to that. We knew for a fact what was going to happen and it didn't happen. So I would say there's a lot of misunderstanding about the role of a currency. But the thing about the dollar is that it's totally unique and it's probably not a good thing, either for the US or for the world. Yeah, I mean, I guess a lot of Princeton students go into policy and mostly finance, I guess. But I'm curious if you were to recommend a Fresh Princeton grad to focus on one thing in this sphere of trade and trade deficits, what would that be? In the short term, what do you think the path forward is? Well, we're going through a change in the structure of the global economy as deep as we went through in the 1970s or in the 1930s. And one of the things we know from the history of the 1970s and 1930s is when we go through such major changes, also the way we think about economics is completely transformed. So economics after the 1970s were thought very, very differently than before the 1970s. And the same, of course, even more so in the 1930s. So I would argue that we're going through a really big transformation in our understanding of the economy. So the first thing I would say is that if you're a young Princeton grad, in a way that's a good thing. And that's what I tell my students at Peckin University. The good news is that the world is completely changing and our understanding of the world is changing. The big advantage people like me have over people like you is that we know lots of stuff than you don't. But it turns out that much of what we know becomes irrelevant, it's just not true. So immediately you're your comparative or your relative advantage improves. That's the good news. The bad news, of course, is that during a period of great change, there's a lot of uncertainty about jobs, et cetera, et cetera. It can be a lot of fun, but it can be very distressing. But we are going through that. And so I would say if you really want to understand economics, don't waste your time reading economics, textbooks, or the top economic journals, they're going to tell us what we used to think. It is much economic and financial history as you can, just overdose on the stuff. And when I say financial history, one of my favorite financial crises, well recorded financial crises, occurred in, I think it was in 33 AD in Rome. And I remember once telling a friend of mine who's actually a professor here, I said, why don't you write up the Roman crisis, but take out all the names and dates, give it to your students, and ask them to identify the crisis. And he said, I've already done that. And most of them think it's the Japanese crisis of the 1980s. And some of them think it's the American real estate crisis of the 2000s, 2008. And what that tells you is that these crises are remarkably similar. That's the same process over and over again. And so the more you read about history, you can read about, you know, Samarian history where they invented options. And you're reading the same thing in a way. And you're getting a much deeper understanding of the way the world really works. So my recommendation is just read as much economic and financial history as you can. I love hearing that as a history. major. All that I say, I don't do a lot of economic and financial history in particular, but you have such a knack, I think, for putting really complex topics and layman's terms for maybe a very humanity side history. There we go. I appreciate that. Okay, maybe just a few more questions to conclude. This one's a little, going to be also a little bit silly, but you mentioned that if this beautiful scenario of a trade union comes and then we are working with people in trade surpluses, they will have no choice but to trade with us unless they're trading with Mars, which makes me think about maybe Mars, or a music production company if I'm correct. You also say that I've heard this outage before, like door number one rising and employment, door number two rising debt and you cannot exist in the status quo. If door number one were joy side and door number two were car sick cars, what would you choose? You know, it's like you're asking your mother to choose which one of her sons is her favorite. It's a real Sophie's choice. Yeah, and it's really destructive, but fortunately neither of them will be listening to this podcast. I think John Chowong, the leader of a car sick cars, is one of the most brilliant musicians I've ever worked with. Now, bear in mind that when I was at business school, I ran a club in the East Village and Sonic Youth started their swans, composers like Elliott Sharpe, a lot of those guys. So I've been lucky. I've worked with a lot of really great musicians. I just think he's brilliant. And car sick cars is one of the things that he does. It's maybe the most influential young band. They're no longer young, but when they started in China, a lot of people said when they first heard car sick cars, a lot of Chinese kids, because at the beginning of the century, the Chinese were just starting to learn through the internet a hundred years of modern music, whether it was jazz or rock or, you know, messa and whatever. And there was the sense in China at the time that foreigners can do this, but we can't. The best that we can do is imitate the foreigners. So you had a lot of bands that were perfect copies of British or American bands. And the importance of car sick cars, sort of socially, historically, was they weren't the first band to really do great Chinese music. I would argue that PK 14 is really the grandfather of all of the good Chinese bands and Joyside. But there were the first ones to do with such gusto and such ease that we always heard kids from all over China say, we didn't think the Chinese could do this. And then we saw car sick cars and then I started my own band. And I think, you know, that's a really important influence on the development of the scene. So you got to also applaud maybe for music history if you're consuming. I spent a few discs myself, but I have to say maybe to understand and appreciate some of the number, but original influencers wielding their, but, but, but, influence, original artists wielding influence in the, what, 90s early 1000s, I feel like that'd be a pretty cool pivot for my DJ and career. Well, there you go. Yeah, you know, and what was funny is that I'm a music fanatic. And so in the early 2000s, everyone came to me and said, no, you know, tell me about Vellate Underground. Tell me about, but, you know, like 10 or 15 years ago, I just felt really incompetent because there were these kids who knew so much more about music that I did. The level of sophistication just exploded. And I think we can thank the internet because before that, the only music you really heard was whatever diplomats brought over and left and diplomats on how particularly good taste. So, you know, the internet really caused a massive change. Unfortunately, that explosion in Beijing and Chinese music sort of went on until around 2012, 2015. And since then, it's been, they've been under a lot of pressure. Things are quieter. There's no longer that sense that Beijing will be one of the great cities of the world for culture, but it'll come back. It'll come back. Is the name Maybe Mars? Does that have anything to do with that statement before that you use unless you trade with Mars? No. Jan Haiseung, who is a poet and the leader of PK-14, all of my names, I just go to Young Haiseung and say, "Come up with a good name." And he came up with Bing Ma, which is maybe Mars in Chinese. Yes. Cool. We have maybe one more question as a standard fashion on policy punchline that we have every one of our guests finished the episode with their own policy punchline. I don't mean to put you on the spot here, but I feel like you're just producing all these kinds of small bits to memorize. But do you have any final punchline that you want to leave us with? Yeah, I read a lot of history books. I wrote my guess that you would say is it's not about consuming money. It's about consuming resources. If you talk about consumption, if you talk about some big argument I have with many academic economists is that they're always concerned about how do you increase American consumption? Right? Well, fair. And so one problem with tariffs is that that reduces, that increases the price of imports and that's bad for American consumers. That's the wrong way to think about it. There's only one sustainable way to improve your standard of living, to improve your consumption, and that's to improve your production. The more goods and services that you're producing, the more you'll be able to consume. So the focus really has to be on the producing side of the equation, not the consuming side. Amazing. Well, DJs, musicians, I think we have a pianist right here. Yes, historians, economists, will read more books. Yes. Thank you so much for joining us today. Thank you. Thank you. Thanks. You've been listening to Policy Punchline, a podcast generously supported by the Julius Rubinowit Center for Public Policy and Finance at Princeton University. Policy Punchline is intended to be informational only and does not reflect nor represent the views of Princeton University or the Julius Rubinowit Center for Public Policy and Finance.