Swan Songs

---

November 17, 2010, 8:49 am

I read the news today: China is considering price controls to rein in surging inflation.

Can we talk, again, about the utter craziness of China’s currency policy?
The best way to think about this sort of thing remains the Swan diagram, a half-century-old creation of the Australian economist Trevor Swan. He pointed out that, at minimum, economic policy has two instruments and two goals: the exchange rate and measures that affect domestic demand, on one side, and a sustainable balance of payments position and full employment without inflation, on the other. He then argued that you can usefully look at the state of an economy to get some idea of which policies are out of line — but that it’s not as simple as saying that a trade deficit means you need to devalue, or unemployment means you need more demand. Instead, the “zones of economic happinessunhappiness” are delineated as shown:

And I have, as you see, written in two major economies. Clearly — clearly! — China has an undervalued currency; you can tell this not simply from the fact that it has a trade surplus, but from the fact that it’s fighting inflation. The United States, which is fighting unemployment while suffering a large trade deficit, is in exactly the opposite situation — which is why it’s ludicrous to suggest that US QE and Chinese currency manipulation are equivalent.
And now China is considering price controls to help it maintain its undervalued currency. Bizarre, and disastrous for all of us.