Political chaos and institutional meltdowns are all too common in Ecuador’s recent history. A cynic could even interpret yesterday’s violent police uprising that threatened the continuity of President Rafael Correa’s government as “a return to normalcy” in a nation that has had 10 presidents in the last 15 years.

Yet, despite the chaotic nature of its politics, Ecuador has enjoyed relative economic stability since it adopted the U.S. dollar as its official currency on January 9, 2000.

In a country where presidents are regularly toppled by mob protests or popular uprisings, it can be expected that the economy—and particularly the value of its currency—would go into a tailspin with every crisis. This was precisely what happened in the decade prior to 2000, when inflation averaged 37.5% per annum. However, in the 10 years since dollarization, the yearly inflation rate has averaged 6.8%. This number is itself inflated by the fact that inflation reached a peak of 91% in the first year of dollarization, and remained high the following year too. (That initial high rate is explained by the fact that, at the time of adopting the dollar, the government set a particularly high conversion rate for the sucre, Ecuador’s old currency, forcing a massive devaluation that led to high inertial inflation that year.) However, Ecuador’s inflation rate rapidly went down and has largely converged with that of the United States in recent years.

Of course, there are no silver bullets in economic development. Ecuador’s sound monetary policies have not been matched by similar coherent reforms on taxes and spending, or in the areas of trade policy, or labor and business regulations, for example. Ecuador stands in dismal 109th place (out of 141 economies) on economic liberty, according to the latest Economic Freedom of the World report. However, even as their country’s political and democratic institutions constantly fall apart, Ecuadorians can take satisfaction that the value of their currency is not under threat thanks to dollarization.

The Chinese currency issue is in full bloom this week, as the House of Representatives passed the Currency Reform for Fair Trade Act of 2010 by a vote of 348–79 on Wednesday. Though there is so much to criticize about the bill and about the layers upon layers of misinformation, myth, and subterfuge that brought us to this point, this post concerns the dubiousness of the bill’s central premise: that Yuan appreciation will significantly reduce the bilateral trade deficit.

That is the position of the Peterson Institute’s Fred Bergsten and Bill Cline.

The premise seems plausible enough. At least, the economics textbooks tell us that as a nation’s currency appreciates, its people will consume more imports and foreigners will reduce consumption of that nation’s exports. Hence, a stronger Yuan vis-à-vis the dollar would mean that the Chinese buy more from the United States and sell less to the United States, reducing the bilateral deficit.

But in March Cato published a short paper of mine titled “Appreciate This: Chinese Currency Rise Will Have a Negligible Effect on the Trade Deficit.” The central argument of that paper was that our national obsession with the value of the Chinese currency is misplaced—a red herring, in fact. I presented recent historical data showing that despite a 21 percent increase in the value of the Yuan between July 2005 and July 2008, the U.S. deficit with China increased from $202 billion to $268 billion, or by 33 percent. U.S. exports to China increased (as would be expected) by $28 billion, but U.S. imports from China increased, as well (contrary to expectations based on the old textbooks), and by $94 billion, or 38.7 percent. 

In other words, in the face of a 21 percent increase in the Yuan’s value, the U.S. bilateral trade deficit with China increased by 33 percent—a fact that raises serious questions about the integrity of the testimony, discussion, and “debate” that preceded the House vote on Wednesday. 

How can the premise that Yuan appreciation will reduce the bilateral deficit still hold? Why is so much credence given to economists with fancy models who project with certainty that an X% increase in the value of the Yuan will generate a Y% increase in economic growth, which will produce Z number of new jobs in the economy, when recent evidence plainly refutes those claims? What is the value in holding hearings when conjecture matters more than fact?

Bergsten and Cline (in testimony and podcast, respectively) dismiss the counterintuitive relationship between currency and the trade deficit during 2005–2008 by suggesting that there is a long lag period to consider—two to three years, according to Bergsten; two years, according to Cline. In other words, the impact on the trade deficit of Yuan appreciation in the period 2005–2008 would not be fully manifest until the period 2007–2010. While lags are expected (economists speak of a J‑curve effect that accounts for the process of adjustment to the new prices in both countries), a two- or three-year lag in an era of instant communications, cyberspace transactions, transnational production, and airtight supply chains is simply not credible. It took only a matter of months for the financial meltdown in 2008 to spread to the real economy, which prompted an overnight crash in international trade volumes, as production orders were terminated, shutting down operations throughout supply chains across the globe.

The two- to three-year lag theory is convenient merely because it puts in play the data for 2009, when international trade tanked worldwide, and the Chinese global trade surplus and the U.S. deficit with China were cut in half. If the two- to three-year lag theory were plausible, the U.S. trade deficit with China would be falling in 2010, not rising, as the steepest appreciation in the Yuan occurred in 2008.

There’s a more plausible theory than that.

In my paper, I went on to examine whether the increase in imports was attributable to American demand for Chinese goods being price inelastic. In other words, if the price of Chinese goods to American consumers increased by 21 percent (on average) and Americans reduced their consumption of Chinese goods by less than 21 percent, then demand would be considered inelastic, the price effect would dominate, and total import value would rise (adding to the trade deficit). There are plenty of reasons that American demand for Chinese goods is price inelastic including, most importantly, that there are limited substitutes for those goods. Much of what Americans consume from China is not made in the United States anymore. So facing limited alternatives, Americans are forced to absorb the higher prices (a fact that currency legislation supporters are undoubtedly unwilling to share with their constituents). Of course, eventually American consumers might adjust their consumption habits (which speaks to the lag factor).

But closer examination of the data revealed something else.

The fact that a 21 percent increase in the value of the Yuan was met with a 38.7 percent increase in import value means that the quantity of Chinese imports demanded increased by nearly 15 percent after the price change. Increased! Higher prices being met with greater quantity demanded would seem to defy the law of demand.

So what happened? Chinese exporters must have lowered their Yuan-denominated prices to keep their export prices steady. That would have been a completely rational response, enabled by the fact that Yuan appreciation reduces the cost of production for Chinese exporters—particularly those who rely on imported raw materials and components. According to a growing body of research, somewhere between one-third and one-half of the value of U.S. imports from China is actually Chinese value-added. The other half to two-thirds reflects costs of material, labor, and overhead from other countries. China’s value-added operations still tend to be low-value manufacturing and assembly operations, thus most of the final value of Chinese exports was first imported into China.

Yuan appreciation not only bolsters the buying power of Chinese consumers, but it makes Chinese-based producers and assemblers more competitive because the relative prices of their imported inputs fall, reducing their costs of production. That reduction in cost can be passed on to foreign consumers in the form of lower export prices, which could mitigate entirely the intended effect of the currency adjustment, which is to reduce U.S. imports from China.

That process might very well explain what happened between 2005 and 2008, and is probably a reasonable indication of what to expect going forward. Yet this elephant in the room continues to be wantonly ignored in the anlayses that push us toward provocative legislation.

It seems that the textbook discussion of currency and the trade account needs to be updated to account for the compelling facts of globalization.

That’s the title of a recent paper from the liberal Center for American Progress, which attempts to demonstrate “what reducing the federal budget deficit through large spending cuts could really look like.”

The authors, Michael Ettlinger and Michael Linden, issue a challenge that I whole-heartedly embrace:

By showing sets of specific spending cuts we hope to deepen the discussion of where deficit reduction is going to come from. The challenge we issue is this: If you think all or most of the deficit problem should be dealt with on the spending side, are you then willing to own the cuts we outline? If not, then it’s time to go public with what your cuts are, with at least the same level of precision we do—no gimmicks, “sunsets,” or other games. No infomercial claims that you’ve got a magic elixir that gets the same results for half the money.

My colleague Chris Edwards anticipated this challenge with his 2005 book Downsizing the Federal Government. The book led to the creation of Cato’s Downsizing Government website, which is going department-by-department to outline specific — and substantial — spending cut recommendations.

The CAP authors lay out specific spending cuts of $255 billion in fiscal year 2015, which is the projected figure necessary to achieve a balanced “primary budget” in that year. (The primary budget is total spending minus outlays for servicing the federal debt). The White House’s most recent projections show “primary” spending of $3.8 trillion in FY2015, so we’re talking about an overall reduction of about 7 percent.

Ettlinger and Linden acknowledge that their proposed spending cuts will invite criticism. For instance, the authors only conjure up $57 billion in spending cuts from “entitlement” programs, which are the chief drivers of our unsustainable fiscal direction. More than 40 percent of the cuts come from defense. While many conservatives will have a problem with defense cuts, it’s definitely something Cato scholars support. In fact, the proposed cuts match up well with defense cuts proposed in a new policy analysis written by my colleagues Ben Friedman and Chris Preble.

Where we part ways with the authors of the paper is the presumption that “most spending cuts are painful, and in some ways, harmful.” There are two sides to the spending coin. As the Downsizing website repeatedly demonstrates, government spending not only inflicts pain on those who are forced to pay for it, but it also has harmful effects on the economy and even those who it purportedly helps.

Ettlinger and Linden also make a claim that is both subjective and obvious: “The truth is that, contrary to popular wisdom, most federal government dollars go to good and popular things.”

Even if one accepts, for the sake of argument, that most federal spending goes to “good things,” there’s still the tiny little question of whether the government should undertake the spending. What about the possibility — we’d say reality — that there are superior private and voluntary alternatives to the federal government assuming responsibility for doing “good things”?

From a moral perspective, it’s important to remember that everything “good” the government does necessarily comes with a “bad” given that government forcibly takes from one to give to another.

The authors claim that federal dollars go to “popular things.” Of course, subsidies are always popular with the recipients. Farm subsidies are popular with farmers, weapons programs are popular with defense contractors, and subsidized student loans are popular with students. As Frederic Bastiat so succinctly put it, “The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else.”

Regardless, Ettlinger and Linden deserve credit for moving the ball in the direction of a serious debate on which government programs can be cut. As they correctly note, the position that all we need is “just a little belt-tightening and reductions in wasteful government spending” is “nonsense.”

In case you missed Daniel Hannan’s speech at the forum for his new book, The New Road to Serfdom: A Letter of Warning to Americans, you can watch his full remarks right here:

We spoke just before the forum about the book in a Cato Daily Podcast out today (iTunes/RSS):

Taxpayers Against Earmarks is a new effort to rid the federal legislative process of some of its most acute horse-trading: earmarks. Find it at the cleverly named URL, End​ingSpend​ing​.com. 

There’s little doubt that many spending earmarks are part of a subtle—or not-so-subtle—quid pro quo in which federal legislators buy votes by directing funds to favored home-state or home-district interests. Taxpayers Against Earmarks has a well-produced web site that invites people to sign up and join the anti-earmark effort.

Earmarked spending is a small part of the overall budget, of course, but earmarking is emblematic of the “favor factory” that Congress has become as the federal budget and federal power have bloated. Federal spending is appropriate in the small number of cases when it provides national public goods that benefit the country as a whole, but refurbishing local museums, funding projects at state universities, and requiring the military to buy from a particular defense contractor do not benefit the general welfare. Taxpayers Against Earmarks is working to begin the process of getting federal spending under control.

In all of Washington, is there a greater enemy of free speech than Secretary of Health and Human Services Kathleen Sebelius?

• Her department is forcing millions of Americans to finance speech that they oppose, by using taxpayer dollars to broadcast (misleading) television ads that promote ObamaCare.
• She is using the powers granted her under ObamaCare to threaten insurers with bankruptcy if they publicly disagree with her about the law’s cost.
• Now, she is decrying the growth of anonymous political speech in congressional campaigns.

Would that coerced speech, or government suppression of speech, troubled her as much as anonymous speech.

First, a dozen insurers said they would stop writing child-only health insurance policies. Now, according to the Wall Street Journal:

By forcing the exit of Principal Financial Group — which ran a profitable, $1.6 billion health insurance business — ObamaCare has now left 840,000 Americans to find another source of coverage.

According to The New York Times, other insurers may soon follow:

More insurers are likely to follow Principal’s lead, especially as they try to meet the new rules that require plans to spend at least 80 cents of every dollar they collect in premiums on the welfare of their customers…

“It’s just going to drive the little guys out,” said Robert Laszewski, a health policy consultant in Alexandria, Va. Smaller players like Principal in states like Iowa, Missouri and elsewhere will not be able to compete because they do not have the resources and economies of scale of players like UnitedHealth, which is among the nation’s largest health insurers.

Mr. Laszewski is worried that the ensuing concentration is likely to lead to higher prices because large players will no longer face the competition from the smaller plans. “It’s just the UnitedHealthcare full employment act,” he said.

Let’s remember what President Obama told a joint session of Congress just one year ago:

So let me set the record straight here. My guiding principle is, and always has been, that consumers do better when there is choice and competition. That’s how the market works… And without competition, the price of insurance goes up and quality goes down. And it makes it easier for insurance companies to treat their customers badly — by cherry-picking the healthiest individuals and trying to drop the sickest, by overcharging small businesses who have no leverage, and by jacking up rates.

Everybody got that?