I hesitate to disagree with Paul Krugman about something like this, but I think today’s column on the US/China currency imbalance would benefit from adding in a distinction he doesn’t draw.
Look at Brad DeLong’s chart of how dropping the gold standard helped countries recover from the Great Depression:
By devaluing early, Japan and Britain gave themselves a competitive advantage over Germany, France, and the United States. This was a problem for Germany, France, and the United States. But there were too different ways the imbalance could have been rectified. One would have been for Germany, France, and the United States to somehow coerce Japan and Britain into raising the value of their currencies. That would have lessened the extent of the relative disadvantage. But in a larger sense pressing Japan and Britain to return to misguided deflationary policies would have just reduced overall global output and put the whole world back into the downward spiral of depression.
The other way to restore balance was for Germany, France, and the United States to follow Japan and Britain in dropping the gold standard and snapping the deflationary spiral. That’s what eventually happened and it helped lead the world out of disaster. If it had happened faster—if Germany, France, and the United States had all joined Britain in dropping the gold standard back in 1931—then it’s possible that the world could have avoided several extra years of contraction, the rise of Hitler, etc., etc., etc.
So to return to China. When it comes to getting the US and Chinese currencies in a different alignment, it seems to me that it matters whether we’re talking about doing that through more expansion in the United States, or through more tightening in China. There’s good reason to believe that policy is too tight in the United States. Unemployment is very high. Inflation is very low. The “Taylor Rule” tradition indicates that the Fed’s normal response to this level of economic activity would be to try to achieve a -5 percent interest rate. There’s not really much reason to believe that policy is too loose in China. Growth is below the recent trend. Inflation is not accelerating.