Wednesday, April 20, 2011

Some Politics of U.S. "Hooliganism"

. Wednesday, April 20, 2011

Paul Krugman sends us to Vlad "the Destroyer" Putin:

“Look at their trade balance, their debt, and budget. They turn on the printing press and flood the entire dollar zone — in other words, the whole world — with government bonds. There is no way we will act this way anytime soon. We don’t have the luxury of such hooliganism,” he said.

As Krugman notes, it takes two to tango. A big reason the U.S. has such a large trade deficit is because emerging markets have undervalued their currencies relative to the dollar*. And the big reason the U.S. has engaged in so much monetary stimulus is to boost employment, some of which would could have happened through the nominal exchange rate if so many other countries weren't actively managing their currencies. But adjustment still needs to happen, so now we're seeing pressures on the real exchange rate rather than the nominal exchange rate. In other words, inflation in emerging economies will rise until things become more into balance. And now Russia, and China, and Brazil, and others are complaining about the inflationary pressures that U.S. monetary policy is putting on their economies. But they can't have it both ways: while the U.S. economy is depressed, adjustment has to coming through the nominal exchange rate or the real exchange rate.

This isn't hooliganism. This is using monetary policy in textbook ways. As it happens, U.S. monetary policy has a great effect on external economies, which is why Putin calls the whole world the "dollar zone", but let's be clear: those countries want the U.S. to pursue less expansionary monetary policy so they can free-ride on it. It's fine for them to have that preference, and as I've argued before, I think the U.S. should allow some free-riding. But the U.S. government has citizens to satisfy as well, so those countries can't very well expect the U.S. to pursue a contractionary policies while the economy is so weak.

Krugman explains this as "capital wants to go South". I actually don't think that's right. I think capital "wants" to go North: witness the flight to safety, the historically low U.S. bond rates, the fact that the S&P downgrade warning had no effect on those rates, the rallying U.S. equity markets. Look at how developed countries increased their holdings in U.S. banks immediately following the banking crisis (clear in the animation here).

There's nothing preventing capital flight from the U.S., and yet that hasn't happened. Likely because while the U.S. has some problems, compared to many other large economies they are manageable. They aren't trying to stave off the collapse of a currency union, or a nuclear meltdown, or all the things China has to deal with. There's a high demand for safe, liquid assets, and the U.S. public and private sectors can provide more of those anyone else. The U.S. is at the center of the global financial network, which appears to behave in some ways according to a preferential attachment decision rule. Remember the Leontief paradox: factor-price equalization is not always the norm.

The U.S. government, on the other hand, wants some capital to go South. In other words, it doesn't want deflation, and it does want some dollar depreciation to boost employment via exports. The South, on the other hand, doesn't want capital inflows. Brazil has put currency controls in place, China has a closed capital account and fixed exchange rates, etc. The U.S. is trying to force adjustment through the real exchange rate, meaning higher inflation in exporting economies with managed exchange rates. These choices are political, not responsive to some economic natural laws.

*There's a lot of moving pieces here: budget deficits are a result of tax cuts + spending hikes (Medicare Part D plus wars), and then the recession. This also feeds into the national accounts. And while that is an accounting identity, not a behavioral relationship, I don't think it's a stretch to say that deficit spending is encouraged by low borrowing costs. Indeed this is what the Keynesians are arguing now, and it's one reason why Dick Cheney said that "deficits don't matter". During Bretton Woods II, there's been a huge rightward shift in the supply curve of funds available for the U.S. (either as sovereign, or as businesses and individuals) to borrow. When that happens, we'd expect the quantity demanded and thus equilibrium debt levels of the U.S. to also go up.


Emmanuel said...

Young blogger, this rant makes little sense:

Likely because while the U.S. has some problems, compared to many other large economies they are manageable. They aren't trying to stave off the collapse of a currency union, or a nuclear meltdown, or all the things China has to deal with.

The basis for comparing American creditworthiness is not against that of China (which isn't AAA - yet), the EU (which isn't a country) or Japan (which got downgraded from AAA a long time ago). Besides, the last time I checked, Germany and Japan could borrow rather more cheaply than the US by that simplistic measure. Maybe that makes them even more at the "center" of the global financial network.

Instead, you should compare US fiscal projections against those of its peer AAA countries as I've noted--Canada, France, Germany, and the UK. Maybe you can even do the math while you're at it-- ever heard of discount rates, demographic projections, non-discretionary outlays, etc.? But I've never seen any numbers to back up your USA#1 cheerleading before--and probably never will ;-)

Kindred Winecoff said...

Fiscal projections are all but useless. Care to review the projections from 2006? The GOP and Dems are fighting over what the budget will look like in 2022. It's impossible to know. 11 years ago the US was involved in no wars, there was no tax cut for the rich, and no Medicare Part D.

As far as demographics, the US is in better shape than Japan, China, and much of the EU. And yeah I know all about discount rates, but what's your point? If anything, the logic of discount rates implies increasing deficits now -- while economic conditions are poor -- and reducing them later.

And the US's borrowing costs reflect that (among other things). They're at historical lows:

The inflation-indexed long-term borrowing costs of the US gov remains under 1%:

Explain that one to me, young blogger.

Emmanuel said...

No math, much bluster:

(1) Fiscal projections paint a fairly consistent picture that the US is in dire financial straits. Re-read Laurence Kotlikoff's 2004 book and it already outlines pretty much everything informed and cool-headed commentators know about the American financial situation.

David Walker, former US comptroller-general (I think it's a job for someone who does math and spreadsheets--whatever those are ;-), also has said the same thing for the longest time.

(2) The argument that "you can borrow all you want because rates are historically low" is similarly simplistic. If you actually read the Fiscal Commission report, it doesn't assume significantly higher interest rates for dire projections to materialize.

(3) You evaded explaining why Germany and Japan aren't more "central" to the world economy given that their borrowing rates are lower. Face it: borrowing cheap doesn't alone imply centrality at all.

(4) Obviously since I hold a bleak view of America's finances, I mention demographics in the sense that the US is massively on the hook for its retirees. Don't worry, you'll be paying for your greedy seniors one way or another.

(5) And of course, here's the most damning indictment of USA#1 cheerleading. You say "it does want some dollar depreciation to boost employment via exports." All I hear is "strong dollar" talk and Chinese laughing in Geithner's face when he says China's investments in America are safe.

Face it: America is led by...hypocrites. Never heard about "weak dollar" talk before. Maybe you can show us some instances of it.

No? That's all she wrote, son.

Emmanuel said...

Much bluster + still no math = no surprise:

(1) If you revisit Laurence Kotlikoff's 2004 book, he already explained that the US was in dire financial straits due to its obligations to current generations.

Former US Comptroller-General David Walker (I think this job has something to do with spreadersheets and stuff ;-) has also made similar projections for the longest time--as have most other informed observers who do the math.

(2) Your line of argument that "deficits don't matter because interest rates are at historical lows" doesn't wash. If you actually read the Fiscal Commission report, it implies much trouble for US finances without using interest rates significantly higher than those at present for projections.

(3) You evaded answering why Germany and Japan aren't more "central" to the world economy given that their borrowing rates are lower. The simple answer, of course, is that lower borrowing costs alone don't imply such centrality.

(4) You should disown stimulus packages, Fed Treasury purchases, and so on if you believe in "market forces" working their neoliberal way to remove the distortions of "politics." Pot, kettle, black, etc.

(5) And here's the most damning thing about USA#1 cheerleading. You say "it does want some dollar depreciation to boost employment via exports." All I hear is talk about "strong dollar" policy and Geithner telling the Chinese their US holdings are safe while getting laughed at by college kids who know better.

Face it: America is led by hypocrites. Care to show us some officials talking about "weak dollar" policy? I don't see any integrity there but hooliganism: loose talk and loose money are complementary pathologies.

So hooliganism it is. And that's all there is to be said American "integrity," son.

Kindred Winecoff said...

Emmanuel -

1. I never suggested that the US doesn't have real constraints in the future. All I suggested was that 2011 projections of 2022, much less beyond that, are next to worthless. Yes, the US has problems with an aging population. So does everyone else. But the budget will depend on tons of political decisions made in between now and then. You can't draw a straight line from 2010-2011 indefinitely into the future.

2. Similarly, I didn't say deficits don't matter. But this post is primarily about monetary policy. And the fiscal commission offers clear, and relatively painless, ways to fix the problem. Taxes at the Clinton-era rates, plus eliminate deductions that I've wanted to get rid of forever. Perhaps a low VAT. Some cuts to defense and perhaps means-testing FICA. These do not signifiy the end of the Republic.

3. Regarding centrality, I suggest you review the paper we've written (and linked to) on this topic. Centrality refers to something specific, and what you're describing isn't it. ("Toward a Systemic IPE"... it's undergoing revisions, but you can get the main meat from this version.)

Borrowing costs are of course about many other things. All of the US's debt is in dollars, which we can literally manufacture as needed. Japan's rates are so low because so much of their public sector debt is held locally. The government is, in essence, substituting public consumption for anemic private consumption. I'm not as familiar with Germany's case, but I assume that controlling the EMU's monetary policy has a lot to do with it.

4. You're misrepresenting me. No one's every accused me of being a fundamentalist. I was hugely in favor of TARP at the time, and QE as well. This post can easily be read as in favor of interventionism.

5. Obama declared doubling exports to be a big part of his economic program during his last SOTU address. That could only happen with currency depreciation. Geithner (and many others in the gov't) have repeatedly called for yuan appreciation. Plenty (including Bernanke) have warned about macro imbalances for years. That doesn't mean they want a 50% depreciation a la Iceland, but the "strong dollar" folks are not in the positions of power. The gov't wants jobs.

Or, put another way, the US ain't the one with the pegged currency.

The gov't may be run by hypocrites. That tends to be how politics works. But your arguments are still wrong, son.

Some Politics of U.S. "Hooliganism"

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