Monday, January 05, 2009
can we afford keynesian remedies?
Given the bad fiscal position of the US Federal government and given the vulnerability of the external position of the US and its growing reliance on foreign funding, the scope for expansionary fiscal policy in the US is much more limited than president-elect Obama’s advisers appear to realise. Underneath the effective demand problem is a deep structural rot, especially in household sector and financial sector balance sheets. Keynesian cyclical policy options that would be open to more structurally sound economies should therefore not be tried on anything like the same scale by the US authorities.
whereas the economic mainstream -- indeed perhaps best represented by paul krugman -- are rabid in their advocacy of public sector spending, the effort may not be, as tylen cowen postulates, even remotely effective in the face of a grim survivalist psychology among consumers, lenders and manufacturers alike.
but that it seems to me is of secondary concern -- if it might work and there is no very serious cost, it should be tried. the primary concern is that there may indeed be, as buiter argues, an extremely serious cost in the form of a dollar collapse -- indeed there is a real threat that success, so called, would look like the yet greater disaster of hyperinflation.
while the united states is trying to debase the dollar to reduce the real value of its obligations, so are the other monetary authorities with which the united states trades. japan is intervening against the strengthening yen, china has halted RMB appreciation and has even devalued slightly. this is the beggar-thy-neighbor dynamic, whence everyone attempts to use national finance to slough off the necessary reduction of excess capacity to match the collapse in excess demand onto each other by bolstering their own export sectors to take advantage of external demand. as buiter notes of america:
the US has to shift aggregate demand from domestic demand to external demand. And it has to shift production from non-tradables to tradables - exportable and import-competing goods and services. By how much? At full employment, probably at least six and more likely by around eight percent of GDP.
this will ultimately necessitate a severe weakening of the dollar vis-a-vis the currencies of larger potential export markets -- euro, renminbi, rupee, indonesian rupiah, brazilian real -- even as these countries try to devalue along with the dollar to maintain their own export-based economies. buiter:
shifting resources towards tradables and away from non-tradables will require re-training and re-education as well as a significant depreciation of the US dollar’s real exchange rate - which amounts to a significant cut in real wages.
also implied is the relative strengthening of currencies and domestic purchasing power in those economies, eliminating large current account surpluses.
but for so long as this sort of competitive devaluation remains in effect, the dollar should hold up well against other currencies -- even appreciate smartly, as the greater proportion of the global debt glut is denominated in dollars, and (as the need for central bank swap lines demonstrated) it takes dollars to pay off dollars. private debt reduction will make dollars and dollar-like credit scarcer. as the debt bubble unwinds, dollars will be in high demand and deflation will be prevalent.
it's what happens if government is (very improbably, imo) successful in restarting the dollar-denominated-globally-distributed debt machine -- or, alternatively and much more likely, what happens once the dollar-debt deflation has run its natural course and private demand for dollars dries up. the former would be a potential supply surge as the money multiplier is applies to a massive-multiplied reserve pool; the latter, an international demand collapse. this corresponds, i think, with buiter's assessment:
There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets.
the dollar-supply surge would be inflationary but i think more easily dealt with in the short run -- reserves can be removed, even if belatedly. (long run, it's a return to status quo with the same problems looming.)
a dollar-demand collapse, though, could be hyperinflationary -- the US gov't would have little choice but to monetize the oversupply of dollar instruments, provoking further devaluation and further sales in a vicious cycle, reducing purchasing power, real wages and real savings, furthering economic collapse and implied need of 'keynesian' spending.
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