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Tuesday, September 16, 2003

Your Questions Answered

Kevin Drum now has the full transcript of the Krugman interview posted. Among the more notable extracts:

Train wreck is a way overused metaphor, but we're headed for some kind of collision, and there are three things that can happen. Just by the arithmetic, you can either have big tax increases, roll back the whole Bush program plus some; or you can sharply cut Medicare and Social Security, because that's where the money is; or the U.S. just tootles along until we actually have a financial crisis where the marginal buyer of U.S. treasury bills, which is actually the Reserve Bank of China, says, we don't trust these guys anymore — and we turn into Argentina. All three of those are clearly impossible, and yet one of them has to happen, so, your choice. Which one?

Will China keep financing that forever?

They're financing both the current account deficit, and, as it turns out, directly financing the government deficit. We were running a big current account deficit that accelerated through the late 90s, but there you could say that it was due to the strength of the U.S. economy, it was all this investment demand, technological revolution, and after all, the government was in surplus.

Now, we're back in twin deficits territory, and there are two related issues, the solvency of the federal government and the solvency of the United States per se, and both of them are now somewhat in question.

Maybe I'm a captive of my own model, but I think that what happens when the world loses faith in the U.S. as a place to invest is that the dollar plunges, but that in itself is not so bad because the lucky thing is our foreign debts are in dollars, so we don't do an Indonesia or an Argentina. But the federal government's solvency is a much more critical thing because it needs to keep on borrowing more and more just to pay its bills............

Oh, I don't think China is going to do it to pressure us. You can just barely conceive of a situation where they're mad at us because we're keeping them from invading Taiwan or something, but more likely they just start to wonder if this is really a good place to be putting their money.

So what happens is a plunge in the dollar when they decide to stop buying and start cashing in, and a spike in U.S. interest rates. But you might also get in a situation where the interest rates the government has to pay to roll over its debt become so high that you get an accelerating problem, which is what happened in Argentina. What happened was that suddenly no one would buy Argentine debt unless they paid a twenty something percent interest rate, and everybody says, but if they have to roll over their debt at a twenty percent interest rate, there's no way they can pay that back. So the whole thing grinds to a halt and the cash flow just dries up.

Yeah, just take the numbers as they now look, and that's where it heads. And you might say, OK, we can easily handle it. U.S. taxes are 26 percent of GDP in the U.S., in Canada they're 38 percent of GDP. If you raise U.S. taxes to Canadian levels there's plenty of money to cope with all of this. But politically we've got a deadlock, and it's hard to imagine that happening.

So it's a bit clearer. he isn't saying Argentina, as in Argentina, since the US has it's debts denominated in dollars. But he is saying there will be a big financial mess. He is saying the dollar is going to fall, substantially. This part is perfectly logical. I just have two problems. (Well two problems and an observation).

Firstly, we need to think through the implications of this. This substantial reduction in dollar value will imply a substantial reduction in the purchasing power of the US consumer. This will entail an internal re-adjustment in the US. This will also have political consequences. Since it is difficult to see what these might be, we are still pretty much in the dark. Brad is an optimist. He thinks the US civil society, with its strong democratic traditions will resist the pressure, and will rebound. I do not disagree. I am more with Brad than I am with Krugman here, I think sometimes the phantoms that haunt Krugman are real enough, and sometimes they are of his own creation. But we are still left with the question, what can be done? There is no easy way out. This needs following a step at a time. There are a lot of variables in play. And any future US government, whatever its political complexion, will be faced with some difficult choices. In particular the days of living on a never ending spiral of credit, the days of the US as the 'consumer of last resort' will be well and truly over. We are back with Roach's alternative growth engines.

Secondly, the end of the 'high dollar' is bound to have major repercussions for the whole global monetary system. If Krugman is right the dollar's role as the reserve currency will be in question. With the euro (for more reasons than I care to go into here) unlikely to be the ready recipient of this role we may well see the US financial mess being accompanied by a global monetary one. I hope not, but at least the possibility has to be entertained.

Now for the observation. Krugman has waxed strong on the 'baby boom' problem in the US. But what about the European one? Economics Commissioner Pedro Solbes is on record as saying that the finances of half the EU member states are unsustainable in the mid-term. This is an opinion just as important as the Krugman one, but which has received somewhat less exposure. So imagine it: Argentina style problems in the US, global monetary disorder, and default in a number of EU member states (Italy?, Spain?, Belgium?.........). Not a pretty picture, is it? Lets hope all this is up the gumtree.

In conclusion, and as a finale: Kevin wasn't the only one with questions. Here are mine and Maynard's:

First Maynard

He talks a lot about America, but not about the rest of the world. I'd like his opinion on such matters as

* We hear vast amounts of hype about China's rate of growth, while we hear about India's growth in services but not so much a massive growth in the economy. How much of this is real --- China really is getting richer much faster than India --- and how much is a product of hype and statistics that are more easily faked in China?
* Has China reached a take off point where they can grow their economy by themselves (this is a kinda fuzzy notion, but encapsulates things like technical expertise and capital equipment) without the US (US demand, US money, US-trained personel)? This is of interest because there's currently a whole lot of pissing on China by Congress going on right now, and it seems to me that the US needs China more than vice versa, but am I wrong?
* A larger question than the above is, how much does the rest of the world need the US? Let's assume that the US does continue down its present self-destructive path with everything that entails---massive debt, either heavy duty inflation or default on treasuries, a population that can no longer afford to buy from the rest of the world; does this REALLY doom everyone else as well. We hear (certainly this is _The Economist_'s second favorite theme after how great Bush is) that the US is the only engine of the world economy, blah, blah. But in a longer term scheme of things, say over 5 to 10 yrs, does the decline of the US really mean the decline of everyone else? It seems to me that countries like India and China have the potential for enormous demand for low-end goods, while places like Brazil and Thailand and Indonesia are moving more upscale in their demands. What am I missing?

Now Me:

Apart from everything in the spirit of what Maynard has just said, I would ask:

(a) The current round of GATS (services) negotiations in Cancun. Is it still so clear that globalisation will be beneficial to the US in the growing services area, given that the 'comparative advantage' of US workers may well be a lot less than their current salary differential. (This is NOT an anti-globalisation question, clearly globalisation can favour now this, now that country. It is therefore an EMPIRICAL question whether any particular counry will be a prime beneficiary at any particular moment in time. But no reasonable gambling school would let the punter who had just had the longest winning streak yet seen at the table simply walk away, sin mas).

(b) Assuming the other big problem of the moment is deflation, and (running a little 'what if' thought experiment) imagining a worst case scenario where Ben Bernanke's 'unconventional' tools don't fix the problem, what's the next move? I mean we should have a plan 'b' in reserve, shouldn't we?

(c) And if you're really stuck for questions you could try: are we running out of the fiscal policy option? We all know that conventional monetary policy has only one notch left to fall, but the World Bank Global Outlook suggested this week that, with aging populations around the OECD, and unfunded pension and health care liabilitieslooming, this round of the business cycle could be the last for the time being where we have the possibility of using fiscal stimulus in any big way (in fact France and Germany already can't, and maybe Japan shouldn't).

And in order to keep this last one from being a 'let out' question/excuse to talk one more time about the 'great GWB tax cut' I'd focus on Europe and Japan.

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