Martin Baily, Senior Fellow, Brookings Institution

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MARTIN BAILY, SENIOR FELLOW, BROOKINGS INSTITUTION, TALKS ABOUT CHINA AND THE ECONOMY AT BLOOMBERG SURVEILLANCE

MARCH 21, 2011

SPEAKERS: TOM KEENE, BLOOMBERG SURVEILLANCE HOST

MARTIN BAILY, SENIOR FELLOW, BROOKINGS INSTITUTION

9:07

TOM KEENE, BLOOMBERG SURVEILLANCE HOST: Thrilled to have on Martin Baily, the former chairman of the president's Council of Economic Advisers, of course, with the Brookings Institution. Dr. Baily, good morning.

MARTIN BAILY, SENIOR FELLOW, BROOKINGS INSTITUTION: Good morning to you.

KEENE: You have a terrific, short policy brief. Folks, go to Brookings, Brief 179 from a few months ago on our relationship with China.

First off, are we solving our relationship by having a weak dollar? Are we managing ourselves to a weak dollar?

BAILY: Well, the trouble is the Chinese set their currency against the U.S. dollar, so we don't have that weaker dollar against the Chinese currency. And right now, of course, the global economy is in somewhat of a chaotic state, so there are pluses and minus to the weak dollar.

I am one of those who thinks we need a competitive dollar, which against the euro would be maybe around 1.40, against the yen would be somewhere around 90.00 perhaps. If we get way out of align with those, then that is not helping us. But generally, we need to have a dollar which U.S. manufacturing can be competitive in the world economy, and those are our principal competitors - Europe and Japan.

Now in terms of China, I think probably the bigger issue, which I raise in the piece that you mention, is China is sort of developing technology and are they going to really develop their own? Are they going to come and take some of ours? And are we going to be able to compete with them on an appropriate basis?

KEENE: Well, you have a spectacular chart. I mean I guess I knew this, but it takes Martin Baily to put it in front of my face and say, hey, you, shut up and look at this chart. It is remarkable how the differential in Chinese exports and our imports is computers and electronic products. I mean they dominate everything, don't they?

BAILY: They do, and it certainly should be a wake up call that that has traditionally been one of our strengths. It is still where we have very strong companies and a lot of innovation. But they are coming up fast on that and we need to make sure that we are developing the right technology.

Now keep in mind that a lot of what they do in that area is assembly, so we get most of the money from iPods and iPads and all of that stuff. They do the assembly of that. So their prowess as yet is still sort of developing. It's not there. But it is amazing how they have come forward on that.

KEENE: From where you and your experts at Brookings sit, if we get the value added of an iPad, and that's all fine and well, is that accounted for in the trade statics? When we quote our trade deficit, does it adjust for the reality that we get the value added?

BAILY: The trade statistics probably will not. So it does make our trade deficit look larger. We do get quite a lot of income flows, so it - I don't want to get too into the weeks here, -

KEENE: Sure.

BAILY: - but on our current accounts it would count. The only other problem though is that while the money comes to the designers and obviously the folks like the shareholders of Apple, which is appropriate enough, but it does not create a lot of manufacturing jobs here.

And that has been one of our problems. We've just seen a huge drop in the number of manufacturing jobs. And now one of our tasks is try to get some of those back. Manufacturing is not going to be the salvation of full employment, but it should going forward begin to create some more jobs and some more good jobs.

KEENE: If you're just joining us, folks, Martin Neil Baily, Brookings Institution, as we look at just a really wonderful update on China. We'll get onto some other things here in a bit.

BAILY: Thank you.

KEENE: Dr. Baily, when you look at our issues and saying technology is not the problem, do we just dollar depreciate our way out of this? Or do you see actually a new industrial policy that leads to a manufacturing renaissance?

BAILY: Well, industrial policy is kind of a dirty word or a dirty two words here, and I am not a big fan of industrial policy.

But what we can do is to make sure we have the right environment here to continue to be innovative, which we already are, and make sure that we have the right skills in the workforce, which I think at the moment we probably don't have. We just haven't done a good job of continuing to maintain a strong, educated workforce. We have good people at the very top, but the bulk of the workforce is falling behind I think the rest of the world. So that's one problem.

And then I think there is a reasonable role for government to play and which it has always played in sort of funding basic science and making sure that our universities continue to be top universities. So that is important, too.

But industrial policy, no, I don't think we want to say let's pick this industry or that industry.

KEENE: Right.

BAILY: I think we can give general support to technology. And, of course, traditionally the Defense Department, the Energy Department have been a big source of innovations, which have then gone into the rest of the economy.

KEENE: You were at the White House I believe it was '01, '02, right?

BAILY: No, I left just in the beginning of '01.

KEENE: Okay.

BAILY: I was there in '99 and 2000.

KEENE: Well, I'm looking at real trade weighted dollar and you were on the economic watch during a strong dollar policy. What exactly is a strong dollar policy?

BAILY: Well, we did have a strong dollar policy, and I always have to say that a strong dollar is in the best interests of the U.S. economy. To be honest, I -

KEENE: Did they give you a card that said that? Did you like have to - did you sit at home and like memorize it at the kitchen table?

BAILY: Pretty much. Pretty much. And one reason is you don't want your government officials talking down the dollar. I mean that is never a good idea to go out and say we want a weak dollar because we don't want a weak dollar.

What we don't want though is an overvalued dollar. And the dollar appreciated - it was pretty low in 1995. It came up and by 2002, after I had left the White House, it definitely was overvalued at that point. And our trade deficit was just getting bigger and bigger.

So that, I think, does not do us any good. Maybe it makes trips overseas cheaper, but it is really bad for our tradable good sectors, particularly manufacturing.

KEENE: Yes, I mean I'm looking here, Dr. Baily, and we're going to run here and come back, but we are now 2.8 percent below the 1995 [NADR]. I mean we went up to the Martin Baily peak, and then we came down, and we elegantly sat there at the 1995 level. The last two months have been disconcerting to say the least.

BAILY: Well, we've had this - obviously this financial crisis, which has caused the dollar to go up and down. It has remained somewhat of a safe haven during the financial crisis. So that is one of the, of course, important issues is that our dollar is not just determined by our trade position. It is determined by the capital flows that come in and out.

And so now we have to try to go forward I think, see if we can get the dollar on a sound, but reasonable footing so that everybody can compete on a level playing field.

KEENE: We're going to come back. Martin Neil Baily with us. Thrilled to have him on, from the Brookings Institution.

I want to come back and talk about one of his areas of focus, and that is our budget deficit. We have been so international recently. Baily on what he has learned at CBO.

9:14

(BREAK)

9:21

KEENE: From the Brookings Institution, Martin Baily. Martin, I'm looking at a March report from Camp Elmendorf at the CBO. And it is real simple, we go from just under the value of our economy - $10 trillion - out to a $20 trillion deficit, oh, I don't know, ten years out or so. Have we made any headway in the last 12 months in our budget analysis?

BAILY: We - this is a horrendous problem. I mean - and it is linked to the thing we were just about it because if we run these huge deficits all the time, that is one of the reasons we have this huge inflow of capital, and then we have a trade deficit that goes with it. But it's - the numbers you are citing are just horrendous. We've got to do something about it.

I think most economists and there actually are a group of former CEA chairs - Republican and Democrats - that are pushing now that Congress really should take seriously the Deficit Commission. And, you know, even if you don't think that is the perfect way to do it, there is a blueprint laid out to do something about the deficit. And we simply have to do something about that deficit going forward, otherwise it is going to overwhelm all our other economic issues.

KEENE: Out of the tragedy of Japan, I think something that has been so good, folks, thanks to Jim McCormick of Nomura for his really wonderful work today, this idea that Japan is not the gloom that we think. Yes, there is a huge public debt and there are massive problems there. But they are a saving nation. We're not. That's the key distinction, isn't it?

BAILY: Well, it is, and their debt is not owned by foreigners. A lot of our debt is owned by foreigners, so we are sort of more dependent on the global capital market than they are.

But one thing about Japan is that it is an aging nation. It is not saving as much as it used to.

KEENE: Right.

BAILY: And going forward, it may save less. So I think it has an issue around its deficit, too, especially as it has got to do a lot of rebuilding after the earthquake.

KEENE: Well, I'll give you the demographic call there. Our nominal GDP, are you focused more on our ability to grow inflation adjusted? Or is Martin Baily just looking for an animal spirit at the top line?

BAILY: Well, right now, I could just use a little animal spirits. But basically it is real GDP that we need to grow, yes.

KEENE: Let's leave it there. Martin Baily, thank you so much, with the Brookings Institution, with a terrific piece. Look for it, folks, BrookingsInstitution.com, Policy Brief 179, January of 2011. I'm going to try to put that out on Facebook today. It's just a terrific three or four page summary, some interesting dynamics there on Japan.

9:24

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