The factors that have allowed the United States to run enormous, sustained current acount deficits — deflation, globalization, the Asian savings glut — may persist for some time. But sooner or later, the sheer size of America’s external liabilities is going to force foreign creditors to limit their exposure to our reckless financial behavior. Solvency, not relative rates of return, will be the issue on their minds then.
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July 22, 2005
WB: Breaking the Peg
Comments
Nice post, Billmon. I’m sure you saw Krugman’s column too. Here’s a question that has long bothered me: Would the reaction among the Wall Street types (and their handmaidens in financial journalism), who tend to be Republicans, be the same if Gore or Kerry were president now?
I’ve always gotten the sense that the Wall Street Republicans tend to be Chicken Littles when something like this happens under a Democratic administration, but, like Greenspan, they bury their heads in the sand when it happens under a Republican regime.
Keep up the good work on this topic. Most people don’t have a clue what it means and even those who understand it can’t explain it well. You can.
Posted by: Phil from New York | Jul 22 2005 14:33 utc | 1
Here’s the problem I have with what’s comming down. Production = Consumption. That’s a fundamental law of economics, and gives rise to the law of supply and demand (basically, the law of supply and demand have the price of a good or service fluxuate to keep production and consumption equal). So if the US suddenly has to live within it’s means, this could kick off a vicous circle, as reduced consumption gives rise to reduced production- which, in turn, leads to further reduction in consumption. This is effectively what happened in the great depression. I mean, the Chinese aren’t being paid enough to buy the stuff they’re making. What will happen is that the Chinese will simply be the last people laid off.
The problem isn’t that we have a massive debt problem, it’s that we need to run massive deficits to keep demand up to match current supply. This is because wages have not been keeping up with increases in efficiency. Efficiency has been going up 2-3%/year (post-inflation) for the last 5 years, while wages have been stagnant. This means that without large increases in debt to artificially increase consumption, production starts outpacing consumption. Which means we need fewer workers to produce the same amount- which means we laying people off, which lowers consumption, which requires more layoffs. Lather, rinse, repeat.
The last time we got into that situation, we got out of it effectively by having the goverment go massively into debt. The New Deal stabalized the economy, and things were slowly improving, but it wasn’t until the heavily debt financing of WWII was what really got us out of the great depression. That’s the difference between then and now. At the end of WWII, goverment debt was at about 130% of GDP- but going into WWII, goverment debt was effectively 0% of GDP. I don’t think the US goverment could suddenly borrow $13-15 trillion dollars these days (about the same amount of money relative to the current GDP that WWII cost us).
Also, I don’t know how a huge (70-100% of GDP) debt going into a great depression would hinder any goverment response- but it surely wouldn’t help. One example of the problems that could arise- FDR helped allieviate the banking crisis by instuting depositor insurance, basically that the federal goverment backed the banks. This worked becuase the fiscal solvency of the goverment wasn’t in question. In the goverment itself was insolvent, would the gaurentee have had any effect?
The end conclusion here can only be “I don’t know”- and neither can anyone else. But I’ve got a bad feeling that we may be about to find out.
Posted by: Brian Hurt | Jul 22 2005 15:44 utc | 2
Mr. Hurt, never was there an economic system without major, if not fatal, flaws. Communism and capitalism are in many ways two systems that accept the same foundations and seek the same goals. The shame is that proponents of one often see only the faults of the other.
We have yet to reach a balance between government and business. In our allergy to non-national socialism, we’ve turned our government into a corporation. It’s gotten reckless and forgotten that in capitalism there are always winners and losers. I’m scared that the Chinese can go without SUVs and McDonald’s a little more easily than we can.
Posted by: Lennonist | Jul 22 2005 16:23 utc | 3
You should write about economics more often.
This will take a long time to play out but the outcome could not be more certain.
Might be a good idea to get some money into commodity currencies like the Canadian dollar. A little gold might not be a bad idea either.
Good luck.
Posted by: A. Swann | Jul 22 2005 16:33 utc | 4
WOW !
Thats a lot of info..
I’m a regular @ Billomn’s and here, but dont really undertand macroeconomics as well as i’d like to..
Would any of you folks care to sum up what this(and the Bretton Woods in general) it means to the average joe in the US(apart from higher prices @ Walmart)?
Thank You..
Posted by: Chamed Ahlabi | Jul 22 2005 17:02 utc | 5
The Bretton Woods one scenario was a different animal than now. You had several things happen. One, the oil cartels raised prices; two, the Veitnam military spending inflation handover kicked in; three, wirkers wages had been making steady gains causing price inflation, and; four, when the dollar started floating it devalued against the European currencies which usually causes inflation.
How was it cured? By wage supression. It was decided in the mid 1970s to crush labor. Many labor representatives were involved. Read Holly Sklar’s “Trilateralism.” An unholy alliance between Europe Japan and the US delt the blow to American albor by the Globalisation of the US economy. The US reps were more free market than the Japanese and Europeans which meant American labor would take the brunt of the burden in lower wages.
Now, to our current situation. American labor will be and is currently the loser in the current trade and currency regime. Greenspeak said the other day interest rates will continue to go up, but I’m sure the alterior motive is to be able to lure more capital by a better interest payout. We could see another Asian crisis life Billmon says and it is likely the China bubble will burst. Then capital will flee and likely to the US, as the US is the most free of the large markets and capital can then be put work here.
Another issue is elite theory of the future. You will likely see an Iraq pullout in the next two years because the current regime will not want to leave a mess for the dem regime that “will” be elected next. Unlike state governors who leave the next gov massive messes, the current President will want to protect his legacy. Also, elites do not like disorderly transfers of presidential powers.
The reason I say a dem will be elected is, taxes must be raised. The American people know it and so do elites. The estate tax will be re-introduced and the SS tax cap will be raised. Why do I say this? First, the next Prez will be Hillary. Elites have given her the green light, especailly if she shows and is coronated at Bilderburg meetings. The rethugs, if they still control congress will always give the new Prez their economic policies for at least a few years. So over the long term I do believe as Billmon says the elites will find a way to clean up the mess if only for another eight years or until a nother rethug is elected, then the whole shooting match will fall.
The last three paragraphs is all speculation on my part, but it sure seems plausable.
Posted by: jdp | Jul 22 2005 17:30 utc | 6
Billmon – one of the best discussions of the unpeg I’ve read anywhere. Kudos.
Posted by: dryfly | Jul 22 2005 18:54 utc | 8
jdp,
I thought I was entirely alone in believing that a Democratic administration was next because of the tax hike, and the need for the Thugs to save the party. I also go along with your prediction about the Iraq pullout. I just keep thinking that in about three years time we might be facing our internal problems. What I can’t understand is how the elites allowed this to happen.
Posted by: jm | Jul 22 2005 22:35 utc | 9
Another great post, Billmon. I echo others in wanting more on economics, even if we don’t understand it all.
As for a solution, the kids have created it: the intangible economy.
According to a news item I just read a couple of days ago, Japan just passed, in its lower house, legislation to set in motion the privatization of its largest (?) deposit taking institution .. the postal system.
I wonder whether this (added to the breaking of the peg) will have some long term effects in the larger global financial system ?
Posted by: Jon Husband | Jul 24 2005 1:36 utc | 11