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LinkedInAnd I thought I was just a former Treasury staff economist with an unhealthy obsession with how the US is funding its enormous trade and current account deficits, and more willingness than most to spend time rummaging around central bank web pages.
The Marginal Revolution’s Tyler Cowen provide a fair — and remarkably succinct — summary of many of my views, though perhaps not DeLong’s. If only he would now help teach me how to play the options market…
I do worry about a country that imports 15% of GDP and exports a bit less than 10% of GDP — especially if non-oil imports are growing faster than exports even when the the world economy is strong. I worry a bit more about the United States’ rapid external debt accumulation because the US external debt-to-export ratio is already close to 300% (400% is the level that did in Argentina). I generally worry less about current account deficits that stem from a surge in investment, especially a surge in investment in the export sector, and worry more about deficits that stem from rising consumption (relative to income) and structural government budget deficits. Current account deficits of close to 6% of GDP v. exports of 10% are somewhat unusual, deficits of that sized financed in part by selling ten year debt at 4.2% nominal interest rates are even more unusual.
Does that make me an Austrian? Or someone who takes external sustainability analysis seriously?
I think it’s a fantastic joke (and have been back and forth with Tyler in the past about the parallels between Austrian and post-Keynesian economics), but there’s one thing which doesn’t fit into the picture; although the household sector might have overinvested in consumer durables, there doesn’t appear to be any corresponding overinvestment by companies in plant and equipment. That would suggest that a lot of the problem of undersaving in the US is a result of weak animal spirits rather than systematically distorted monetary signals.
“Why would an Austrian malinvestment boom show up only in the market for housing and not as a boom in plant & equipment investment?”
The perfect question. There is no reason to believe monetary policy has been faulty. The Fed lowered interest rates in dramatic fashion from January 2001 in an attempt to lesson the effects of a slowing economy. The result was dramatic real estate investment and a vibrant consumer durables market that bouyed the economic from then till now. The problem has still however been to little corporate investment and this can be blamed on fiscal policy that while giving us a fierce structural deficit was largely focused on tax cuts that have had a relatively minor effect in stimulating demand.
There has been a lot of plant & equipment and other investment in China, which is part of the Dollar zone. That’s where that side of the stimulus has gone, in my view. Similar to how previously certain US states might have lost out compared to others during an investment boom.
American fiscal policy is not set in China, but here. We have needed a fiscal stimulus that was designed to increase domestic demand and investment, but that we have not had. Indeed Japan and China and Brazil and other countries have helped keep our interest rates low and assisted the Fed in policy. Fiscal policy is the problem, not Brazil.
Anne:
“Why would an Austrian malinvestment boom show up only in the market for housing and not as a boom in plant & equipment investment?”
The answer:
The unseen malinvestment caused by the Fed’s credit expansion is in Canada, Japan, China, Germany and Asia in general. These are all regions with large trade surpluses with USA.
Malinvestment occurs when credit creation distorts or falsifies prices.
Generally, the falsified price is the market interest rate. However, the dollar rate is also grossly distorted. Foreign Central bank credit creation has inflated the value of the dollar for years. Recently, the amount of the non dollar credit creation required to keep the dollar stable has gone exponential. Why is China booming? The answer is free markets and a massive credit boom. Japan created a credit boom in the 1980s to deal with the weak dollar. The world marvelled at the miracle that was Japan Inc. After the Japanese bubble burst, the errors were revealed. Austrians understand credit creation is no substitute for capital. Austrians are capitalist, they cherish freedom and free markets. Austrians never applaud the Keynesian policies or supply side policies because they have enough understanding of Economics and praxeology to know those interventions always make matters worse, benefit a minority, and destroy the market.
Happily I am not an Austrian, since I can never make sense of Austrianism and make all sorts of sense of Keynes. Really, now and then I spend a few moments wondering about what Austrian economists are trying to tell me. I find I have no idea other than all is gloom and doom because the Fed changes short term interest rates to limit inflation or spur the economy, and because fiscal policy can also be used to spur growth.
Though the Fed was too rash in tightening by half a percent in May 2000, when a tightening sequence had been well underway and there was no sign of inflation and the stock market had begun to decline, Fed policy strikes me as remarkably sound from Paul Volker on.
The problem we have now stems from a gratuitous set of tax cuts that have left us with a severe limit to federal revenue. We turned a remarkable surplus to a fierce deficit, but did not even use the tax cuts to create an adaquate demand surge.
We have a significant federal deficit and limited household saving. Then, the deficit must be funded in some manner and international capital flows to America is the manner of deficit funding. Though I have no idea how the problem will play out, I know we must either have a fresh approach to fiscal policy or there will be ever growing pressure on the dollar. Where is the mystery?
“Fed policy strikes me as remarkably sound from Paul Volker on . . . The problem we have now stems from a gratuitous set of tax cuts that have left us with a severe limit to federal revenue.”
Sound? Or have the consequences of its failures just been delayed? If the Fed had pursued the policies of the past twenty years – and more particularly the last five years – in a closed economy, I seriously doubt the results would have been considered sound.
How high would domestic inflation be without the safety valve of the current account? How much more private investment would have been crowded out by fiscal deficits running in the 3-5% of GDP range? It seems reasonable to assume inflation and/or interest rates have been considerably higher in that parallel universe than in this one. And what would that have done to our wonderful asset-driven economy? Would Shrub and company still be trying to sell the “ownership society” in a country where the equity PE was closer to 10 than to 25?
But of course we don’t live in a closed economy, and the Greenspan Fed has been quite willing to tolerate massive fiscal deficits and equally massive external imbalances so long as the CPI remained tolerably well behaved. Or, as the saying goes, “It may be our currency but it’s their problem.”
Until now this strategy has paid off well and who knows, maybe it will do so indefinitely. Maybe what goes up doesn’t really have to come back down after all. But the whole point of Brad’s and Nouriel’s work is that gravity has a way of catching up with countries that take their foreign creditors for granted. I guess we’re going to find out if that’s also true of the country that prints the world’s reserve currency.
If and when the Fed’s single-minded focus on domestic price stability stops working, it may stop working in a fairly spectacular way. Which is going to put the policies of the past two decades in an entirely different light.
If I believed in Keynesian economics
1.I would think that the fall in the U.S. savings rate is a good thing, and short term interest rates should be keep low as to force the T Bond yield under 4%. That U.S would soon absorb all the world available savings is great. We will take your savings, thank you, at this paltry yield. Let them eat cake.
2. Investment in real estate is better that factories, because they don’t increase productive capacity. Furthermore, who can say that certain investment is a malinvestment?. All investments are good by definition (they increase demand). Hey, even the master defended putting money bills in bottles underground and letting people uncover them.
3.The level of debt is relevant only in a deflationary environment. The fact is that U.S. wealth is increasing. Looking only at debt loses the other side of the balance.External debt must be counted not against export revenue, but against the agregate wealth of the U.S. In case of problem, Mr Greenspan will cut rates and prop the DOW to 20.000, thus making everybody rich.(He failed in his previous intent with the Nasdaq out of cobardice, this time he will not let things run out of order)
4.Asian central banks wont stop this trend. Japanese public debt is a monster. Coupled with his demographics, Japan cannot afford another recession. As for China, growth is now the official ideology of the communist party. They cant afford a recession, but for political reasons. So in a sense the Asian economies are more leveraged to U.S. growth than ever. As for the losses in the accounts of their central banks, they are only of an accounting nature. If all the reserves of the Asian Central Banks were devalued to 0, tell me what would be the practical consequences? None, because they don’t need the money (they all run c.a. surpluses). As if Mr. Gates suddenly losses 20 billion. Surely he will not turn off the heat in his mansion.
5. I would think that the U.S. economy is great, the most productive in the world and the future is even better. Hey, good times are just around the corner.
6. I would buy calls on Ebay, Tzoo and Google, and become rich.
7. I would believe that Greenspan is the true successor of The Master, and that you don’t need no stinking book on economics, just read the reports from the fed.
8.-Id believe that Mr Greenspan is a good economist, but not as good as Major Douglas, or Silvio Gesell.An ask for a reprint of their works.
http://www.roubiniglobal.com/archives/2005/01/housing_market.html
Housing Market Bubbles and the Fed: The Higher They Blow, The Harder They Crash…or Why We May Need Houdini after Greenspan…
A lot – academic, policy and market-wise – has been written recently on housing bubbles in the US and abroad, the risk of a housing bubble bursting and the relation between asset bubbles and monetary policy. So, not too much original may be said. A missing link between the good Ip dollar piece and the good Ip housing piece is that of the effects of a dollar crash on US bond markets and thus on housing markets. The link is implicit but worth fleshing out: i.e. a dollar crash/hard landing that would be associated with a bond market rout (see my previous blog) would have severe consequences on all other risky and overvalued assets, including housing values.
In that scenario, the Fed would be in a ugly trade-off: to stave off a free fall of the dollar with its inflationary consequences it would have to sharply tighten monetary policy; but such tightening would be recessionary, it would also exacerbate the increase in short and long term interest rates and the fall in housing prices….
Clearly Nouriel Roubini is more critical of Alan Greenspan than I have been. However, I am not at all convinced the Fed should be setting limits to asset prices. Fed policy in the 1990s helped produce a high growth economy with 3% unemployment and fully contained and falling inflation. The response of the Fed to the recession helped assure a short and shallow recession. Greenspan can be faulted for encouraging fiscal policy in 2001 that would set us in deficit, but Greenspan is only Fed chief and not part of Congress.
“Furthermore, who can say that certain investment is a malinvestment?. All investments are good by definition (they increase demand).”
Is this really true? One could invest in a road or a bridge which no one will use (Japan comes to mind). Or one could invest in really big houses and big cars because one thinks that energy will always be cheap, and then suddenly discover that oil has become expensive, so one is now forced to close off some of those rooms to save on heating or cooling bills – effectively nullifying the investement represented by those extra rooms.
re: Fed limits to asset prices
the criticism that i think sticks is they could have raised the margin req! ferguson spoke on this recently
http://www.federalreserve.gov/BoardDocs/speeches/2005/20050112/default.htm
(never mentions margin tightening tho
cheers!
Austrian miss the main point, excessive deregulation of capital and labor market are the cause of our present troubles. These have allowed the lag in wages to productivity and correspondant asset and debt bubbles.
More regulation is needed not less.
And more regulation does not mean more state intervention by the way, just sounder rules.
Silvio gesell indeed has lots to say …
If you are a keynesian you ought to worry about wages and the fact that the credit boom as let consumption goods prices inflate slowly and inflated the hell out of production goods (capital, assets) prices.
THe problem with austrians is that they believe in free markets and rational consumers-producers. So if these people are rational how come the monetary policy can have an impact ?