Willem Buiter Calls for Less US Stimulus, Expects Collapse in Price of Dollar Assets

I am a big fan of Willem Buiter, even on those rare occasions when he is wrong. He is unusually blunt for a Serious Economist, and is willing to take on orthodox views and institutions frontally. He has, for instance, been quite critical of the Fed. He created a firestorm at its last conference in Jackson Hole when, in a presentation, he lambasted the central bank for what he called “cognitive regulatory capture”. That shouldn’t have been a surprise; Buiter had made that observation, forcefully, months ago. But the hosts must have operated under the delusion that Buiter would be deferential rather than speak his mind.

Buiter takes on another bit of orthodoxy today, and it’s a doozy. “Can the US economy afford a Keynesian stimulus?” And the headline is anodyne compared to the text.

It’s important to stress how much Buiter’s post is at odds with conventional wisdom, at least among economists. A whole host of credentialed writers have lined up, shoulder to shoulder, to defend massive deficit spending as the way to get the US out of its economic meltdown. For instance, Paul Krugman, staunch advocate of spending, is so convinced of the validity of his opinion that he adopts a dismissive posture towards opponents (he has elsewhere called them “niggling nabobs of negativism“:

Here’s how I see it: the opponents of a strong stimulus plan don’t really have an alternative to offer. They don’t even have a really coherent critique; as Brad DeLong points out, if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect.

Update 1:45 AM: Krugman makes an even more strident case in today’s New York Times op-ed, “Fighting Off Depression.” Back to the original pos†.

True, there are a few naysayers, like Tyler Cowen, who plaintively contends that the evidence for the effectiveness for stimulus is thin and adds:

My view is the disaggregated one that sometimes private spending can stimulate employment and sometimes it cannot. Private spending has the greatest chance of stimulating employment when a) market psychology is on its side, and b) the financial system is relatively well-functioning. Neither is the case right now.

Note that under standard theory neither monetary nor fiscal policy will set right the basic problems from negative real shocks and indeed the U.S. economy is undergoing a series of massive sectoral shifts. That includes a move out of construction, a move out of finance, a move out of debt-financed consumption, a move out of luxury goods, the collapse of GM, and a move out of industries which cannot compete with the internet (newspapers, Borders, etc.)

I’ve never seen a stimulus proponent deny this point about real shocks but I don’t see them emphasizing it either. It should be the starting point for any analysis of fiscal policy but so far it is being swept under the proverbial rug.

Buiter tackles the problem from a different angle. He looks at the standing of the US in the world, economically and financially. He does not argue the Cowen angle, that deficit spending might not lead to growth. His point is different: the US is pretty close to the end of its rope, in terms of relying on the rest of the world for financing. He sees it as a no-brainer that a massive fiscal deficits, whether they are narrowly successful or not, will relatively soon (he estimates 2 to 5 years) lead to a collapse in prices of dollar denominated assets.

Now that point of view might not seem radical; some investors have spoken for some time of the likelihood of a dollar implosion. But among respectable economists, this would have been treated as a lunatic fringe view. But Buiter makes his argument using data and recognized economic constructs.

I am particularly taken with the intro to Buiter’s piece:

Economic policy is based on a collection of half-truths. The nature of these half-truths changes occasionally. Economics as a scholarly discipline consists in the periodic rediscovery and refinement of old half-truths. Little progress has been made in the past century or so towards understanding how economic policy, rules, legislation and regulation influence economic fluctuations, financial stability, growth, poverty or inequality. We know that a few extreme approaches that have been tried yield lousy results – central planning, self-regulating financial markets – but we don’t know much that is constructive beyond that.

The main uses of economics as a scholarly discipline are therefore negative or destructive – pointing out that certain things don’t make sense and won’t deliver the promised results. This blog post falls into that category.

An elite economist who is willing to say that economists really don’t know all that much deserves a hearing just for his commitment to intellectual integrity. As Will Rogers said, “it isn’t what you don’t know that will hurt you, it’s what you know that ain’t so.” Questioning accepted wisdom is vitally important, yet too often dissenters are ignored and marginalized.

It is going to be very interesting whether Buiter’s comments are addressed by the economists supporting the Obama program, or are politely ignored. His post is quite long, I strongly urge you to read it in its entirety, and I excerpt key sections below:

Much bad policy advice derives from a misunderstanding of the short-run and long-run impacts of events and policies. Too often for comfort I hear variations on the following statements: “the long run is just a sequence of short runs, so if we make sure things always make sense in the short run, the long run will take care of itself.” This fallacy, which I shall, unfairly, label the Keynesian fallacy, compounds three errors.

The first error is the leap from the correct assertion that a long interval of time is the sum of successive short intervals of time to the incorrect impact that the long-run impact of a policy or event is in any sense the sum of its short-run impacts. The second error is the failure to recognise that our models (formal or implicit) of how the economy works are inevitably incomplete. Parts of the transmission mechanism – positive or negative feedbacks and other causal links between actions today, future outcomes and anticipations today of future outcomes and future actions – that can safely be ignored when we consider the impact of a policy over a year or two can come back to haunt us with a vengeance over a three-year or longer horizon. The third error is that, when economic agents, households, firms, portfolio managers and asset market prices are even in part forward-looking, the long run is now. More precisely, the long-run consequences of current policies can, through private sector expectations and through forward-looking asset prices influence consumption behaviour, employment and investment decisions and asset prices today.

Matching the Keynesian fallacy is the view that just because a certain set of policies is not sustainable, in the sense that it cannot be maintained indefinitely, such policies should not be implemented even temporarily. I will call this the sustainability fallacy…..

Yves here. One of Buiter’s weaknesses, having been in elite policy roles at various points in his career, is sometimes to expect more of government than it can deliver. The real danger, in my mind, of policies that ought to be temporary, is that political processes and human inertia mean that they do not get reversed quickly enough. For instance, Janet Yellin today noted (in effect) that the Fed has no exit program for its fancy alphabet soup of facilities even though they were all supposed to be temporary. If the Fed is afflicted with this problem, imagine how hard it is to turn off programs that are implemented via legislation. That does not mean that they should not be tried, but in evaluating them, one needs to take a hard look at what happens if they persist well past their sell-by date.

Back to Buiter (boldface ours):

First, the fiscal policy actions pursued thus far by the Bush administration, but even more so the policy proposals leaked by Obama’s proto-administration are afflicted by the Keynesian fallacy on steroids. They appear to exist outside time, with neither the long-run consequences of the actions like to be implemented over the next couple of years, nor the history that brought the US to its current predicament, the initial conditions, being given any serious attention….

Even before the crisis erupted, around the middle of 2007, the US economy was in fundamental disequilibrium. The external primary deficit (the external current account deficit plus US net foreign investment income) was running at around five or six percent of GDP. The US was also a net external debtor, Its net external investment position (at fair value, or the statisticians best guess at it) was somewhere between minus 20 percent and minus 30 percent of annual GDP. The US economy managed to finance this debt and deficit position quite comfortably because it gave foreigners an atrocious rate of return on their investment in the US – a rate of return much lower, when expressed in a common currency, than the rate of return earned by US-resident investors abroad…..

The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally. Even the most hard-nosed, Guantanamo-bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed. Key wholesale markets are frozen; the internationally active part of its financial system has either been nationalised or underwritten and guaranteed by the Federal government in other ways. Most market-mediated financial intermediation has ground to a halt, and the Fed is desperately trying to replace private markets and financial institutions to intermediate between households and non-financial operations. The problem is not confined to commercial banks, investment banks and universal banks. It extends to insurance companies (AIG), Quangos (a British term meaning Quasi-Autonomous Government Organisations) like Fannie Mae and Freddie Mac, amorphous entities like GEC and GMac and many others.

The legal framework for the regulation of financial markets and institutions is a complete shambles. Even given the dismal state of the legal framework, the actual performance of key regulators like the Fed and the SEC has been appalling, with astonishing examples of incompetence and regulatory capture.

There is no chance that a nation as reputationally scarred and maimed as the US is today, could extract any true ‘alpha’ from foreign investors for the next 25 years or so. So the US will have to start to pay a normal market price for the net resources it borrows from abroad. It will therefore have to start to generate primary surpluses, on average, for the indefinite future. A nation with credibility as regards its commitment to meeting its obligations could afford to delay the onset of the period of pain. It could borrow more from abroad today, because foreign creditors and investors are confident that, in due course, the country would be willing and able to generate the (correspondingly larger) future primary external surpluses required to service its external obligations. I don’t believe the US has either the external credibility or the goodwill capital any longer to ask, Oliver Twist-like, for a little more leeway, a little more latitude. I believe that markets – both the private players and the large public players managing the foreign exchange reserves of the PRC, Hong Kong, Taiwan, Singapore, the Gulf states, Japan and other nations – will make this clear.

There will, before long (my best guess is between 2 and 5 years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury Bills and Bonds are still viewed as a safe haven by many. But learning takes place. The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of ‘dark matter’ or ‘American alpha’ is not credible….

The US Federal government has taken on massive additional contingent liabilities through its bail out/underwriting of the US financial system (and possibly other bits of the US economic system that are too politically connected to fail). Together will the foreseeable increase in actual Federal government liabilities because of vastly increased future Federal deficits, this implies the need for a future private to public sector resource transfer that is most unlikely to be politically feasible without recourse to inflation. The only alternative is default on the Federal debt. There is little doubt, in my view, that the Federal authorities will choose the inflation and currency depreciation route over the default route.

If I can figure this out, so can anyone in the US or abroad who follows recent economic developments. The dawning of the realisation will lead to the dumping of the assets….

I now anticipate a Federal deficit of between $1.5 trillion and $2.0 trillion for 2009 and something slightly lower for 2010…
Those familiar with the post World War I and post-World War II public debt levels will not be impressed with even a doubling of the public (Federal) debt held by the public as share of GDP, from its current level of around 40 percent of annual GDP (gross public debt, including debt held by other government agencies, like the Social Security Trust Fund, stands at around 70 percent of GDP)…..Following World War II public debt stood at more than 100 percent of annual GDP.

That, however, was then. The debt was incurred to finance a temporary bulge in public spending motivated by a shared cause: defeating Japan and the Nazis. The current debt is the result of the irresponsibility, profligacy and incompetence of some. Achieving a political consensus to raise taxes or cut spending to restore US government solvency is going to test even the talents of that Great Communicator, Barack Obama…..

So will the Keynesian demand stimulus work? For a while ( a couple of years, say) it may. When the consequences for the public debt of both the Keynesian stimulus and the realisation of the losses from the assets and commitments the Fed and the Treasury have taken onto their balance sheets become apparent, the demand stimulus will fade and may be reserved as precautionary behaviour takes over in the private sector. My recommendation is to go easy on the fiscal stimulus. The US government is ill-placed financially and fiscally, to engage in short-term fiscal heroics. All they can really do is pray for a stronger-than-expected revival of global demand, without any major stimulus from the US…

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.

There is plenty more here. Go read it immediately.

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92 comments

  1. Waldo

    This financial and soon to be economic typhoon has not yet come ashore here in America.

    But I think the underlying cancer creating its largess and historical implications do not rest simply in economic terms. What I mean is that we as a nation have been so morally just (as compared to the rest of the globe) that we have always benefited from that asset. But in the last 8 years the Administration has extorted that asset away from us.

    This being a truly moral crisis it is very difficult to see this by financial models and economic benchmarks.

    At best we can call it an economic anomally. But it exists and is destroying American capital (hard earned).

    I do not see a true way to stop the economic destruction until our new Administration begins to address the legal infractions by the current Administration. We all know that historical moral abuses have occurred. The enemy is within.

  2. broggler

    In your Will Rogers quote, you left out an all-important “don’t”. (It’s not what you don’t know …)

  3. ndk

    Wow. That was stark, even for Buiter. I feel like I’ve been slapped even though I deeply agree with him. Stepping through with specific commentary and critique…

    He highlights the fundamental imbalances very wisely and well. I’m highly suspicious of the NIIP data, and he even notes that too. One thing he fails to mention is that most of our international investment is in equity, and most of our international liabilities are in debt. Setser did a lot of work on that in sunnier days, but I can’t find the writings now. That might explain prior outperformance, but makes the present more… interesting.

    (and possibly other bits of the US economic system that are too politically connected to fail)

    Possibly.

    There is little doubt, in my view, that the Federal authorities will choose the inflation and currency depreciation route over the default route.

    I continue to lack confidence in our ability to engineer a clean and effective inflation more generally and evenly across the economy. However, when it comes to seigniorage, it’s pretty fcking straightforward, so I’ll second Buiter here. I don’t believe we can get enough of it without a collapse, though.

    it is unlikely that some, not insignificant, resource transfer from the private to the public sector will have to take place.

    He probably means “likely”, and this excludes the fact that seigniorage is just such a transfer, in different clothes.

    public (Federal) debt held by the public as share of GDP, from its current level of around 40 percent of annual GDP

    This still isn’t a great measure. Buiter realizes this, with his earlier points on our off-balance-sheet obligations, so I’m disappointed this section is in here with no explanatory caveats.

    As regards shifting production towards tradables, this will not be easy.

    Major understatement, but a key point. We’re dicking around on the financial side of the economy and throwing together whatever the Presidential soup du jour happens to be as the target. Keynesianism affords that flexibility, since under the theory it doesn’t matter much what you do with the money. Nothing I see in the Bushbama plans improves our export sector much. It might reduce our imports in the longer term(energy/oil), but it might not. Hard to say, since there are so many failed carcasses along the side of the non-ICE car road.

    The effect of quantitative easing and qualitative easing on the exchange rate are ambiguous.

    Excellent point, but I wish he’d mentioned China’s peg and the extent to which they can’t get out from under it either.

    The private sector in the US is, at last, saving.

    Sorta. Not to the mid double-digits yet. Also, pour yourself an extra drink: via mp and Conjure Bag at CR, check the trend in household deposits since 03 and non-financial businesses since 07Q4. There’s a bit of savings(like an 800% increase) to be done, to put it mildly, just to return household checking deposits to ’03 levels. Might have a small impact on spending, too.

    That might be viable if the US private sector and the US policy makers had the necessary credibility to head south when the destination is north, because they can commit themselves to a timely reversal.

    I don’t think it’s just credibility. We’re very close to the firmer limits of possibility. I still disagree about US Keynesian stimulus being even effective in the short run.

    My biggest disappointment is that he talks very little about the practical and technical limitations on “printing” money. “We’ll just monetize it” has become a rallying cry, without any understanding of the limitations, just like “stimulus” is an obvious solution as well.

    The main uses of economics as a scholarly discipline are therefore negative or destructive – pointing out that certain things don’t make sense and won’t deliver the promised results. This blog post falls into that category.

    You should frame that quote on your own damn homepage, Yves. :D

    All in all, a salutory article that will be ignored and savaged in the short run, that might just be seen as prescient in the long run. Funny how that rhymes with his own thesis.

  4. Anonymous

    These Congressional injections of funds are politically motivated. Sleight of hand. Congress is the problem. Blame bankers, wall street, RE for the problems that legislators created.

    Keynesian lived,thought and wrote in an era of a gold backed dollar, not floating currencies. His ideas don’t always apply now.

    Allowing capitalism to function by its natural cycles (boom – bust) is being interfered with which in turn is affecting the dollar’s value.

    Strong dollar equals deflation. Weak dollar equals inflation.
    Can’t make it more simple than that.

  5. ndk

    mid double-digits

    mid single-digits. 2.8% most recently, and 1.2%-ish in 08Q3. Even our newfound prudence is abysmally small from any historical perspective, especially when you look at international rates.

  6. Anonymous

    Does it matter if everyone else pursues the same race to the bottom with their currency? Is it absolute dumbness that counts or only relative dumbness?

  7. Yves Smith

    broggler,

    Thanks for the catch. Have corrected the post.

    ndk,

    Thanks for the commentary. Agree particularly re your doubts whether stimulus will work as advertised. I am amazed at the near universal consensus here, to the point that if you question that, you must be some sort of illiterate (just as those who argued that the runup in oil prices in the spring of 2008 was probably not solely a function of supply and demand were pilloried).

    Also agree re exports. We have ceded skills and infrastructure, like factories. The dollar will not only have to fall, but investors and entrepreneurs will need to be confident it will stay weak before you will see large scale investment, The lead time is larger than anyone is allowing for. And I too am frustrated with the “hey, the Fed can just print” argument, and the lack of consideration of second order effects. This is a huge policy shift, and the discussion has been pretty superficial.

  8. ndk

    Does it matter if everyone else pursues the same race to the bottom with their currency? Is it absolute dumbness that counts or only relative dumbness?

    I’d say both, 1:48, but that’s actually not the key point of Buiter’s story in my eyes. Instead, the US and UK have been sitting in a very unique position in terms of prior privilege, economic configuration, and net international positions. This has led to significant deterioration in our export sector, very high commitments and debt loads, and poor competitiveness internationally.

    As an example, the UK, with very high debt loads, poor international positions, and banking and tea-drinking for industries sits extremely exposed, while a country like Brazil doesn’t. They can afford to make this mistake, and it might even work in their situation.

    When everyone is stupid, the cumulative effect of the stupidity is likely to harm those most vulnerable first. That’s Iceland. Next up to bat…

    And I’m not convinced it’s stupid for everyone. In environments where there is very high private savings, very positive net international investment, and a positive trade balance, Keynesian stimulus actually could make sense. China’s a prime example of this. No shortage of worthwhile projects, savings, unemployed workers, or corrupt local government officials with pet projects.

  9. doc holiday

    Re: "collapse in prices of dollar denominated assets"

    I'm with this maniac, because, very simply, The Treasury & Fed have exchanged a shitload of tangible taxpayer-revenue-backed cash-flow for non-marketable collateral trash from Wall Street — and in so doing, this fraudulent exchange (which abuses The Constitution) on a massive scale has distorted the value of The US Dollar and given a chaotic bias to The Treasury Yield curve ( and the associated and correlated securities instruments) which should obviously be selling at a very steep discount versus the panic-mode we are in — where this trash is being sold at inflated bubble levels never before seen on Planet Earth! It is this hallucinogenic distortion of future value that is unfolding now and then over time, will expose The American Empire as being hairless, naked and as corrupted as Zimbabwian capitalism.

    As some (not in a daze or coma) may recall, expected future dividends define current and future value and thus — if Treasury securities in the form garbage from Bear Stearns or Lehman or Citi or Countrywide, or WaMu, or Indymac or a few thousand junk banks, automakers, insurance scammers or ponzi-masters represent the heart, core and source of America's future value, then I suggest strongly that we are already a bankrupt country, which is relying on falsified and mis-leading valuation metrics, which are no different than those being misused by the barbarians that are running from the chaos of Zimbabwian capitalism.

    If America fails to be honest about the corruption that has gone on with our Treasury & Fed and the inability of these entities to mark-to-market the securities they have exchanged, our future assets will be worth less and less as this recession evolves, and that will result in a death spiral for our economy!

    Other than that, how's it going?

    ♥™ ©

  10. Jon Claerbout

    Loan money to taxpayers, interest free for ten years, payback 10%/year. Amount equal sum of last three years taxes.

  11. ndk

    Here’s one of Setser’s old posts on our international debt and equity NIIP positions. Though the poor guy was totally wrong again, it’s worth visiting just for the graphics demonstrating the scale of the disparity.

    Beyond that, he also makes some very interesting points regarding the (fairly short) duration of international debt held by the US that could prove extremely relevant in a global environment with little inflation and lower policy rates. I’d forgotten about that entirely. It’s another strong NIIP notch against the dollar.

  12. Anonymous

    Well I would expect to see more of this very soon, the veneer is coming off and the true quality of the wood underneath is becoming apparent. First a trickle of realist commentators will turn into a flood, just to save their good name or hides from the mob.

    It begs the question of did the yo-yo machine ever work or was it just a experiment that was continued till it blew up in our face (dam string broke after excessive force). I’m not saying trade is a bad thing, just the people who try and get their slice of the pie by applying their leach like mouths to it, Dutch shipping Insurance at its invention, like.

    There are no guarantees in life so why pay for the illusion of it or better yet that which can not be easily replaced would be treated with more respect, better use and less attachment to our mental state of being (ownership).

    Some very big questions are looming on the horizon, wonder if most will approach it from tried and failed mindsets. About time we get rid of all the arrogant belief systems that enable us to think this world is ours and if we keep breaking the conditions of tenancy we better be able to find new accommodation. This market problem is just a symptom of the larger disease which through globalazation has infected us all.

    Sippy

  13. Anonymous

    the model is broken.

    What the economist include in their little model does not have sufficient detail to describe how the US economy will behave. Not anymore at least.

    1. China’s hard peg to dollar. China is a gigantic economy, second biggest in the world almost and growing fast. And it alter the behavior of US economy, specially in consumer consumption cycle. It’s not possible to describe money flow without putting china in picture. (eg. average joe, walmart, china..etc)

    2. Not only china but country like Russia is altering the behavior of EU. And the middle east with their oil price. (not to mention Israel)

    They are still operating in yesteryear of G7/coldwar. Where they can largely predict the world ecoomy just by considering G7.

    not anymore. China, Russia, and Middle east soverign wealth alone can whoop wall street price. Nevermind bunch of panicking hedge funds. (they are playing with exchange rate too)

    so what you have was the recently crazy exchange rate going up and down some 10% in a week.

    Now, how can anybody predict macro economy when exchange rate is going crazy like that? (nobody can buy commodity, no shipping, etc etc…like everybody have observed)

    … so. I for one don’t believe for a minute they can simply “pump” US economy then everything will be fixed. The world economy is much bigger and more complex than US budget can control.

    $1T means nothing. China change their peg .5% followed by everybody in Asia raising interest 1% will wipe that stimulus out in a week transaction.

  14. vlade

    If this the US situation, what does it say about UK, which doesn't have to struggle with the world's addiction to its currency?

    I have been arguing for a while that the K approach might work even for UK and US, but only if it was directed towards moving the economy to a more balanced one, i.e. supporting base R&D and (small) enterpreneurs. Neither Obama's nor Brown's plan (especially the latter one's) does this.

    On the other hand, the saver countries (you know who you are!) should do something to stimulate internal consumption, at least a bit. It's as simple as that – we cannot have a world where everyone is a net exporter all the time.
    I find it fascinating that the profligate countries want to save themselves by spending more, and the miserly ones by saving more, when probably the best course would be for them to switch to the opposite. How about Obama going to a Chines president for his first term, and Brown doing a switch with Merkel?

  15. killben

    Spot On! How can the reasons for the disease (over-consumption, heavy reliance on debt, ever-increasing asset values, high level of borrowing etc.) be the cure. It leaves you wondering whether the only thing in common between noted economists is sheer incompetence

    But who is listening

  16. bg

    ndk,

    “The private sector in the US is, at last, saving. Sorta. Not to the mid double-digits yet. “

    Probably not double digits, but I suspect savings are going to clock in a lot higher (and may have already).

    “he talks very little about the practical and technical limitations on “printing” money. “We’ll just monetize it” has become a rallying cry, without any understanding of the limitations”

    The blunt instrument of government has few choices, and fundamentally you can either liquidate compromised enterprises (and families) or you can inflate. The second order effects are unknowabale in either case. But it is not hard to guess who’s ox will be gored in each case.

  17. ndk

    If this the US situation, what does it say about UK, which doesn’t have to struggle with the world’s addiction to its currency?

    The UK is vastly worse off than the US. Bigger housing bubbles, higher financial services portion of GDP, declining oil production, limited further natural resources, no reserve currency, and so forth.

    Might explain Buiter’s sobreity: as Yves said earlier, being closer to the chopping block sharpens one’s senses.

    It does nothing, however, to explain Gordon Brown or Alistair Darling. You’ll have to invoke some higher powers for that, I’m afraid.

  18. ndk

    Probably not double digits, but I suspect savings are going to clock in a lot higher (and may have already).

    I’ll actually take the other side of your bet there, bg. Between the recession damping incomes for businesses of all sorts, rapidly increasing unemployment, wage pressures, and very little discretionary spending already for the middle and lower classes(a social scientist from Harvard did great work on this, if I recall, but her name eludes me) I don’t see a particularly dramatic increase in overall private savings.

    I certainly believe the propensity and desire to save will increase, but not the capacity to do so.

    The blunt instrument of government has few choices, and fundamentally you can either liquidate compromised enterprises (and families) or you can inflate.

    But “inflate” is an overly general term which can encompass a very wide variety of effects. Constructive, functional inflation that moves beyond the financial markets is going to be incredibly hard to effect, if not impossible. Prices and wages are sticky in many senses.

    But it is not hard to guess who’s ox will be gored in each case.

    I’m with you there. GBP/EUR cross is getting pretty close to 1:1 this morning, BTW.

  19. Anonymous


    On the other hand, the saver countries (you know who you are!) should do something to stimulate internal consumption, at least a bit.

    They can’t , or they would have long ago. China is not happy about being saddled with 600 billion or so in soon-to-be worthless $’s.

    China’s export market is based on low wages. Japan’s on an artificially low yen, Korea’s on state protected industries. How many years will Honda/Toyota etc. maintain growth if the yen maintains its current strength ? How long will the CCP last if labor-intensive industries leave for Indonesia ?

    Captialism drives certain outcomes, and without addressing the system/the cake all one is doing is looking at the frosting.

  20. Blissex

    «His point is different: the US is pretty close to the end of its rope, in terms of relying on the rest of the world for financing. He sees it as a no-brainer that a massive fiscal deficits, whether they are narrowly successful or not, will relatively soon (he estimates 2 to 5 years) lead to a collapse in prices of dollar denominated assets.»

    Well, this argument has been made repeatedly in a louder voice by Denninger:

    http://market-ticker.denninger.net/archives/709-Why-What-Theyre-Doing-Cant-Work.html

    well before Buiter.

    But it is an obvious argument, and I am surprised that it has to be made.

    “Keynesian” anti depression tactics are not universally applicable, they are based on the assumption that there is underused production capacity due to excessively low demand.

    Whether the USA or the UK and other big consuming, big importing economies have any underused production capacity as opposed to underused consumption is not that clear.

    In particular because the industrial policy of both USA and UK has been to export primary and secondary industries and keep only tertiary industry that depends on demand generated by the former, not by consumers, for its sales.

    Some decades ago the elites of USA, UK and others decided to pursue an unofficial “industrial policy”, which was to eliminate existing unionized manufacturing industries, exporting them to countries with lots of non union labor, and to push instead on non unionized service industries (finance, software, movies, …) as well as keeping some military/space manufacturing sector.

    This resulted in a strategy which I call “headquarterization” where countries like the USA and the UK come “capitals” of the world, with company headquarters, served by typical “capital city” service industries like finance, law, business consulting, marketing, public relations, lobbying.

    “Headquarterization” has happened within countries as well, as productive stages of industry have moved to the periphery of each country (NYC and London used to do quite a bit of manufacturing) and the “headquarters” have moved to the center (there used to be quite a few regional stack exchanges for example).

    The problem with “headquarterization” is: what do “capital” cities or countries export to “production” regions in exchange for the products they consume?

    In a single country with a single currency and a single political system no problem: the “capital” owns the “production” periphery and receives income from it.

    The goal of the industrial policy of the USA and UK governments was based on an international division of activities where 2nd/3rd world countries would have “production” business that would then pay top dollar to 1st world country service businesses to be listed on 1st world country stock exchanges, to be banked by 1st world country banks and stockbrokers, to have contracts drawn by 1st world lawyers, to have marketing plans created by 1st world MBAs, and so on.

    In other words, the USA and the UK to become capital exporting and rentier countries, earning money in the form of profit and rent on the exported capital and the management of that capital.
    The world as a big plantation. Just as in the 18th century London rentiers often lived off sugar plantations in the Caribbean, managed by local agents.

    This plan has some terrible flaw, arising from the fact that it cannot work that well without political and monetary union.

    In particular, Denninger’s and Buiter’s argument can be reinterpreted as follows.

    You can do keynesian stimulus all right in the USA and the UK, as there is manifestly a large unused production capacity for services in banking, stockbroking, marketing, legal advice, and all other “headquarters” industries.

    The problem is that people don’t eat or use derivatives, shares, marketing plans, legal briefs, etc.

    That is, if a country’s economy is based on financial services, one must stimulate demand for financial services, and if the source of demand for financial services is abroad, then it is the economies abroad that must be stimulated.

    If you pump a lot of money into the USA economy, will this lead to unused production capacity being put to work? Sure, but in China and in India, because that’s where the secondary sector is (and in Arabia and Russia and Australia and Chile as that’s where the primary sector is).

    Then maybe as a later consequence the demand for “headquarters” services from China and India to the USA and UK will recover and NYC and London will make a lot of money again.

    But in the meantime the currencies of the USA and UK will collapse, as there will be a significant lag between resurgent demand for imported products and an increase in the demand from abroad for “headquarters” services.

    Now if the USA and the UK and China and India used the same currency and the same central bank and treasuries it would be much easier. But in effect international trade is conducted in yen and swiss francs and euros, and the policies of China and India and USA and have quite different goals.

    But it just happens that this is not the case. Even worse, in the long term neither the Indians nor the Chinese are idiots, and it is far from clear why they should import “headquarters” services from NYC and London instead of having their own in Mumbai and Shanghai.

    So far the only good reason remaining is that both places are “business friendly”, in effect they are to India and China what Switzerland is to them: an offshore postbox where to hide from the Chinese or Indian taxman and politician.

    But in the short term the health of the sector of the USA and the UK depends strongly on exports of service industries, which are only in demand if the underlying production industries in China and India (and Arabia and Russia etc.) sell. For many years this has been arranged by large scale “vendor financing”, where China (and Arabia …) have been lending a lot of money to USA and UK consumers to buy their products and thus generate demand from Chinese and India companies for banking, broking, marketing, advertising services in the USA and the UK.

    But this cannot continue indefinitely without currency readjustment…

    Put another way, the USA and the UK have geared up to earn a living by selling (“headquarters”) services to rentiers owning primary and secondary industries, and their internal base of rentiers is too small for everybody to earn a living servicing them, so they must sell also to foreign rentiers, and foreign rentiers will only buy those services if their primary and secondary industries are selling well, and they aren’t, and stimulating demand for primary and secondary products in the USA and the UK is a very, very expensive way to indirectly trigger demand for tertiary services from abroad.

    Live by the financial services, die by the financial services…

  21. wintermute

    The UK wrecked its currency (and empire) pointlessly on the rocks of World War I.
    The US inherited the world’s reserve currency and obtained decades of higher living standards for its people from this unique position.

    Buiter is 100% right. The US has wrecked its currency pointlessly on greedy consumerism.
    It gorged on the benefits of the reserve currency. All it had to do was run balanced government budgets and it could have clung on for another 100 years.

    The euro, yuan, and even a single currency for the Gulf states will be jostling for pole position while the dollar takes its self-inflicted inflationary punishment.

  22. Blissex

    «How about Obama going to a Chines president for his first term,»

    Let’s be even more effective: very generously the USA could offer China to lend them Greenspan and Paulson as advisors. It worked for the USA :-).

  23. Balmain Bear

    Hi Yves,

    Great blog.

    Buiter’s piece is compelling and he is persuasive for all the reasons you site.

    BUT, even when openly contingent, these economic arguments seem to take place in some pure crucible of numbers.

    On the contrary, the current macro economic imbalance is essentially politically economic. That is the interests of the Chinese Communist Party are best served by buying Treasuries to protect jobs (and its power base) at home. Chinese development is not far enough along to abandon this strategy without severe risk.

    To detach its savings from the US is a vast gamble the Chinese authorities simply won’t take.

  24. Anonymous

    I’m glad you’re not reflexively deferential to Krugman like so many others in the left-blogosphere Yves.

    There is a Keynesian dogma permeating our politics, and of course, politicians love it because it gives them the legitimacy they need to do what they would do anyway: spend like crazy to win votes.

    Does anyone seriously believe one trillion dollars is going to be squeezed into the economy in a year without MASSIVE graft appearing from shore to shining shore?

    Krugman also gave up on economics many, many years ago. He’s turned in to a political operative and an unabashed shill for Keynesian dogma which one would have thought was dead and buried after the 70s. The Keynesians never had an explanation for how inflation and recession could be coincidental. They’re going to be confused again in the next few years.

    Finally, I would suggest that Cowen isn’t a good person to read for dissent to Krugman. He may not get as much exposure in the mainstream media, but I think the best dissent in the blogosphere comes from Mike Shedlock (at the global economic analysis blog), who you occasionally post in your daily links.

  25. Observer

    I don’t understand why Buiter self-consciously identifies a category error as an “unfair Keynsian fallacy”:

    “The long run is just a sequence of short runs, so if we make sure things always make sense in the short run, the long run will take care of itself.”

    It’s readily evident that Keynes rejected any such notion wholeheartedly. It is indeed a fundamental error, and I wonder why Buiter did not call it the Greenspan fallacy, because that is who it belongs to.

  26. mmckinl

    Has Buiter called for a Bank Holiday yet?

    Until he does, he’s just another economist whistling past the grave yard.

  27. Stevie b.

    @ doc holiday – America will remain very firmly in denial until the “death spiral” has actually taken place.

    @ndk – IMO the UK is not “vastly” worse off than the US. In a currency race to the bottom, the UK is leading the way. The UK is gaining traction to avoid severe deflation ahead of the US and eventually Europe, both of whom will follow suit, logically making sterling an interesting speculation around these levels. Achieving inflation is the No.1 priority and the UK stands a better chance of getting there sooner than most. Stopping the inflationary juggernaut once the cat is out of the bag will be nigh on impossible – but hey, politicians aren’t paid to think about tomorrow.

  28. fresno dan

    As usual, great post. Nice to see an island of doubt in a sea of certainty.
    In the end, there is a relationship between what an entity produces, and what it consumes. The idea that these errors in allocation of capital can be corrected by printing money without consequence is something that only an “educated” person could believe.
    BTW, some very good and insightful comments.

  29. Blissex

    «there is a relationship between what an entity produces, and what it consumes. The idea that these errors in allocation of capital»

    In my view above, the misinvestment has been in headquarterization in itself, and especially in doing it across political/national boundaries.

    “capitals” can live off the “periphery” only if the latter is a colony as in England and the Caribbean in the 18th century.

    «can be corrected by printing money without consequence»

    Ahhh, but who ever said “without consequence”? What matters is not the lack of consequence, but which consequence for whom.

    BTW, Greenspan as to this in his magic way has recently argued that after a colossal monetary stimulus has started working it should be drained:

    http://www.economist.com/finance/displayStory.cfm?story_id=12813430
    «Even before the market linkages among banks, other financial institutions and non-financial businesses are fully re-established, we will need to start unwinding the massive sovereign credit and guarantees put in place during the crisis, now estimated at $7 trillion. The economics of such a course are fairly clear. The politics of draining off that much credit support in a timely way is quite another matter.»

    “quite another matter” is a funny way to say “I know it won’t happen”.

  30. baychev

    currency depreciation in the euro zone will have really grave consequences for politicians: guillotnes will be reinstalled and heads will be rolling like many times before.
    please appreciate the difference in tolerance levels towards political incompetence on both sides of the atlantic.

  31. Anonymous

    The Stimulus will be a Political Act subject to all of the Corruption, Influence and Bribery of the Political System. Already Barry O, Nancy P, Harry R and who knows else are salivating over the Stimulus the public and business demands. And then there are those 55,000 Lobbyists and State and Municipal Officials looking for their piece of the action. (Boston residents might see just one GIANT BIG DIG here.)

    So, what will be the Multiplier Affect of numerous Bridges to Nowhere? How many real, productive projects will be in the Gigantic Pork Bill and how much just good ole down home Waste?

    Ok, Economists, where is the Multiplier calculation for Stimulus?

    Of course, the US Political System, Federal, State, Municipal, is so rotten and corrupt no Economist seeking regular employment would analyze Corruption as an economic factor. And the most convincing proof of all the Corruption is the lack of any meaningful Prosecution of the Corruption.

    Stimulate me, Godfather. Therein lies my Prosperity.

  32. Independent Accountant

    Anonymous 7:40 AM:
    “Got gold? Get more”, is my signature line. I expect reasonable royalties by wire transfer.

    YS:
    I read Buiter’s piece. Thanks for the lead. I have been saying similar things for about five years.

  33. Anonymous

    Public Debt: US vs Japan

    Japan’s public debt as a percentage of GDP is more than double that for the US. Perhaps we can scrape through somehow? Playing devil’s advocate…

  34. Anonymous

    IA:

    Only 5 years? I thought that was your other signature line. But normally not restricted to 5.

    :)

  35. Anonymous

    So we see government looking at the short run and easing the economic fall by propping up the failed. This harms the long run which needs a complete clear out of the failed before we can have an upturn. The question then becomes is the feedback mechanism from a short sharp fall or a shallower longer fall more important. Given economic momentum I know which I would pick.

    To bring some balance to the argument while fundamentally if you are looking at the big cities and companies in the US you could perceive that a dollar collapse is inevitable, I am not so sure about the fundamentals of rural areas. These areas are the backbone behind the US and providing they keep faith with the currency and government whether rightly or wrongly then the forecast fall of the dollar may be delayed.

    In a note out today from Deutsche bank one of their analysts asks is inflation a possible escape route with the US most likely to take this route. I think this says a lot about the thoughts of investors outside of the US and I think a 2 to 3 year timeline may be too long. Just by talking about this now we are almost setting in action a self fulfilling prophecy and I doubt that we will have to wait long before the idea picks up pace. Will it be days, weeks or months is the question and just how many will be caught out?

  36. the_collective_unconscious

    One of the best economic models available, based on the yield curve and “animal spirits” or confidence levels, forecasts a turning point in first half 2009. This model was cited in Nature in 2001. See http://home.comcast.net/~elliott.middleton/forecast/ . Isn’t a huge stimulus coming at this point badly timed? Not to mention Buiter’s point that the U.S. may not be able to borrow the money without undue self-damage in the intermediate term? The U.S. is increasingly viewed as bankrupt.

    The Democrats should go back to bleeding heart basics and focus on PEOPLE, providing income assistance (and health care) to those unemployed, dollars that will go directly into the spending stream, and let the economy self-right. Borrow what’s necessary to help the Americans who need help, and forget the back-of-the-envelope Keynesianism. This isn’t 1933–we’re the world’s biggest debtor, with no surplus to cushion.

    For about $200+ billion every unemployed person could be given $20,000, which would all be spent, and wisely, one might presume. We don’t need a tax cut, much of which might be saved. The Feds might also support state budgets to maintain employment.

    If a massive stimulus is undertaken and the world’s capital markets sour on the dollar, the wounded eagle will be tempted to impose chaos on Europe or the Far East to beat down confidence in their currencies. Bad idea.

  37. Anonymous

    Not sure how headmaster Buiter could give the US such a severe lashing while leaving the UK out in the hallway. In several important areas of both residential overinvestment and lax financial regulation, it’s fair to say that the Brits outdid the Yanks. Nice to see it mentioned here by several commenters.

  38. Timo

    6000 billion dollars worth of old US government debt needs to be refinanced (rollover) this year. Add to that about 2000 billion dollars worth of new debt.

    The final bubble bursting is now very very close. That is the bursting of US Treasury market. Then dollar will crash and then, the “fun” starts for real like all-out chaos and food riots.

  39. HoosierDaddy

    ndk said…

    “If this the US situation, what does it say about UK, which doesn’t have to struggle with the world’s addiction to its currency?”

    The UK is vastly worse off than the US. Bigger housing bubbles, higher financial services portion of GDP, declining oil production, limited further natural resources, no reserve currency, and so forth.

    I’ve wondered if the situation is like the old joke:
    Two campers were hiking in the forest when all of a sudden a bear jumps out of a bush and starts chasing them. Both campers start running for their lives, when one of them stops and starts to put on his running shoes.
    His partner says, “What are you doing? You can’t outrun a bear!”
    His friend replies, “I don’t have to outrun the bear, I only have to outrun you!”

    Does the “winner” between the US and the UK get a stay of execution when one collapses and the other is the only “safe” place left standing? Or will the spectacle of the mauling (and the anticipation of another) prompt the world to repatriate its assets from the survivor? IOW Does a dollar/U.S. collapse hasten or delay the reckoning for Sterling/U.K. (and vice versa)?

    To take it another way it is sort of like trying to game what happens in a GM collapse. It could be that facing much less competition, Ford would prosper. It could also be that customers would decide it is only a matter of time before Ford goes too and stop buying Fords.

  40. Anonymous

    Why must there be an alternative to offer…..this assume that some action is positive to no action for which there is very little historical evidence to support and therefore condoning future generations to servitude. Jobs created from government spending are only temporary jobs unlike jobs created by the private sector. Can the government support these jobs and benefits for the lifetime of the employed? If not then what is the purpose? What are the underlying assumptions of creating more public sector debt to employ one private sector job? What are the risks and cost of failure? Some stupid economist such as Krugman would say the cost are well worth it or that they are benign. I would say he is flat out wrong in that the opaque costs will be slower growth and lower employment for generations to come and not just a short adjustment period.

  41. Timo

    Here is a quick calculation how bad this crisis really is:

    Usually in a country production and consumption are close to balance, 50-50 percent in the GDP. Now USA has 30-70 combo and in order to go back to balance that 30 percent must rise close to 50 percent. Roughly 4200 billion dollars out of 13800 will be once again 50 percent and so only about 8400 at best will be the new “balanced” GDP.

    BUT there is one thing making things even worse: even manufacturing sectors are contracting also very badly now. Maybe 3000 billion current dollars could be more realistic, when cut also all that unnecessary imperial military spending that US will not afford soon anymore. 6000 billion dollar will mean whopping 50-60 percent collapse of GDP! And I am not even finished yet!

    Making things even worse most of the US workforce is now geared towards supporting that lovely 70 percent GDP consumption nirvana, meaning their job skills are pretty much useless now. So massive reeducation is needed but where is the money for that?!

    Massive unemployment (30-50 million people) lasting years with no job prospects will finally collapse the USA.

  42. Lars

    Krugman is, like Paulson, a servant of the Devil. Actually, anyone who supports Keynesian measures is either delusional or evil.

  43. Anonymous

    he has elsewhere called them “niggling nabobs of negativism

    This only further proves Krugman’s inability for original thought. The phrase was used by Rick Pitino when he was coach of the Boston Celtics, in regards to sports talk radio. And it wouldn’t surprise me if Pitino ripped off the phrase, too.

  44. Charles Kiting

    One of Buiter’s weaknesses, having been in elite policy roles at various points in his career, is sometimes to expect more of government than it can deliver. The real danger, in my mind, of policies that ought to be temporary, is that political processes and human inertia mean that they do not get reversed quickly enough.

    Maybe I was reading between the lines, but I got the impression Buiter had the same opinion of the real danger as you, Yves.

  45. Anonymous

    Buiter always makes good reading even where I might disagree with him (e.g. on whether the UK should adopt the Euro).

    He has also been even more critical of the UK’s position and policies in previous posts – he certainly hasn’t unjustly singled out the US for criticism and claimed the UK is fine

    IIRC, the “niggling nabobs of negativsm” (or some phrase much like this) was quoted in J. K Galbraith’s The Great Crash, having been used to dismiss people warning of a stock market crash. Anyone know better?

    Canary in teh UK

  46. Anonymous

    Skippy,

    I don’t agree that globalization is inherently bad. I think that Imperialism is bad. I think that greed is bad. I think that belief in Manifest Destiny is bad.

    I think that a version of capitalism with proper regulation and taxation still can work for humanity, just not the fascist version we have now.

    I would repeat my quote from Einstein about needing to think differently then how we got here but doc attacks me for it.

    I also want to say that 2- 5 years out for the ultimate crash is way too far out. 18 months or less….it could come as soon as Obama takes office or soon thereafter.

  47. Shane Taylor

    Willem Buiter wrote:

    “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.”

    Arguably, that concern is Krugman’s blind spot:

    “Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.”

    http://www.nybooks.com/articles/22151

  48. Anonymous

    “Gold is a dollar denominated asset.”

    “The dollar is a gold denominates asset”……fixed it.

  49. eco

    ndk said…

    NDK, you should have your own blog – your cut to the chase no BS approach is a fine compliment the comments made by Yves and the article in question

  50. S

    NDK,

    The real tell may be the Germans are fighting back against the stimulus and Keynesian fold. The old Atalantic Alliance has to be thinking of a strategy? They will no go down that easily. The Saudi’s seem unwilling to break ranks, as well.

    Why the shock? it is a pretty pedestrian view among those that pay attension. Default is coming. It is interesting that when a dollar bull gets on TV and is beaten with the facts they seem always to return to well we have the biggest military and that is the decisive factor.

    The question is if the dolalr falls what does it fall against? other than gold there really is no way to protexct yourself in the fiat /debt system.

  51. Lord

    We should have as large a stimulus as triggers a substantial fall in the dollar. These are not in conflict but two sides of the same coin. The more the dollar falls, the less stimulus will be needed. He may be just too optimistic about its fall though and it is best not to take that chance.

  52. Eric L. Prentis

    I am a Keynesian rather than a follower of Milton Friedman because, in practice, fiscal policy stimulation trumps monetary policy stimulation during a severe economic downturn. Two empirical tests support my thesis: 1) FDR pulled the US out of the Great Depression using fiscal stimulus; and 2) the Federal Reserves’ use in 2008 of $3 to $8 trillions of dollars has done nothing to stop the US from falling deeper into recession. The Fed is only bailing out the financial ruling class who are responsible for this economic catastrophe, talk about regulatory capture! Willem Buiter says that the Fed’s unilateral pumping up monetary liquidity puts the US dollar at great risk, who the hell gave the unelected Fed Chairman the right to put the whole country at risk for the benefit of the plutocracy? Where are our politicians, are they all on the take?

  53. doc holiday

    from wiki, thus it is truth:

    ..some countries have seen the introduction of refundable (or non-wastable) tax credits which can be paid even when there is no tax liability to be offset, such as the Earned Income Tax Credit in the United States and working tax credit in the UK. Under President Richard Nixon, a NIT proposal almost made it though Congress. At first Friedman lobbied hard for it, but when the NIT proposal was going to be in addition to the current system, instead of in place of it, Friedman ended up fighting it.

    but when the NIT proposal was going to be in addition to the current system, instead of in place of it

    but when the NIT proposal was going to be in addition to the current system, instead of in place of it

  54. Anonymous

    Here is a scenario:

    What if part of world region recover first, and they don't need US market to recover? Then suddenly world's investor money rushing out of treasury/bond and into these growing markets…

    Places like China, Indonesia, Brazil, obviously survive the world collapse, no debt, plenty of cash, and ready to grow, albeit very much slower due to imploding external demand. But internally, their massive population is very much in business.

    So…question.. what happen to investment money? Anybody want to put it in US bond at 0% return or 5-12% return in those places?

    As a result, dollar costs will climb!

    http://www.bloomberg.com/apps/news?pid=20601109&sid=ayd7yHjUDd50&refer=exclusive

    The winners will be the Brazilian real, Indonesian rupiah and Polish zloty as investors return to higher-yielding assets, according to Bloomberg News surveys. The dollar may strengthen versus the euro and Japanese yen, while dropping against the British pound.

    “Our strategy for 2009 is to gradually increase risk,” said Maxime Tessier, head of foreign exchange in Montreal at Caisse de Depost et Placement du Quebec, which is Canada’s largest pension-fund manager, with C$155 billion ($130 billlion) in assets. “A year from now, I definitely want to be on the short side on the dollar. We’ll see capital flows out of the U.S. again.”

  55. Charles Kiting

    Two empirical tests support my thesis: 1) FDR pulled the US out of the Great Depression using fiscal stimulus; and 2) the Federal Reserves’ use in 2008 of $3 to $8 trillions of dollars has done nothing to stop the US from falling deeper into recession.

    Your empirical tests rely on insanity.

    1) FDR did NOT pull the country out of depression. Plus, and recovery that did take place was merely kicking the can down the road (aka have the grandchildren pay for it).

    2) is actually a refutation of your thesis. All that money spent, not one positive result.

  56. GloomBoom

    Buiter is correct. The dollar will eventually collapse and the so-called stimulus is a joke. Bridges to nowhere and checks to nobody. Typical government responses to something we just need to let correct itself. Good grief!

  57. Fred

    Blissex has a point, but he is overstating the case with respect to the United States, which still has plenty of manufacturing. Much of the apparent decline in manufacturing as part of the economy over the past 30 years is an illusion. What has happened is that manufacturing companies have outsourced a lot of their work to business services companies, while the total amount of product produced remained the same. As for the primary sector, the decline there is due to depletion of resources or for environmental reasons rather than industrial policy by the government.

    The big problem is not so much that the United States has hollowed out its manufacturing and primary sectors, as that it has a structural trade deficit. Running up a big debt is not a problem if you plan to repudiate it eventually, but if we don’t plan to repudiate it, then we are laying a very heavy burden on the next generation.

    The idea of a dollar collapse is ludicrous. The primary beneficiaries of a dollar collapse would be US exporters–why would the rest of the world wants to help them out? Looked at one way, the Fed has been trying to force the dollar down for a long time, with little success.

    As long as foreigners believe they will not lose their dollars to repudiation (via punitive taxation of some sort most likely, since repudiation via inflation hurts Americans more than it hurts foreigners) they will continue trying to accumulate more dollars. The big US trade deficit can easily go on for another 20 years. It takes a long time for a very rich country to go truly broke running 6% of GDP deficits in its own currency.

  58. Victor

    A few days ago I would have agreed with Buiter. Only I’d have gone farther, arguing for a complete reconstruction of the US (and world) economy, every bit as drastic as Gorbachov’s Perestroika — only in reverse. What I felt was needed was, in fact, a move away from a money-based economy to a socialist style management-based economy.

    Instead of deficit spending what I felt is required is 1. allowing the financial markets to totally fail and 2. a complete government takeover of all major businesses.

    What I now realize is that, by printing money on such a vast scale, we will be in effect accomplishing exactly that. As the printing of all that paper drives the value of the dollar down, it will become increasingly apparent that, ala the Emperor’s New Clothes, it is in reality nothing but meaningless paper. Or, in the self-liberating words of Alice: “You are nothing but a pack of cards.”

    Thus, by destroying our monetary system by printing trillions of dollars we will have accomplished, without actually needing to say so, a de facto socialist system. The “money” will thus revert to harmless script, to be used as a convenience only, in accomplishing short term transactions. Instead of trying to prop up a hopelessly compromised system by building “confidence” in the dollar, we can then focus on fulfilling the basic needs of our citizens: food, shelter, clothing, jobs, infrastructure, etc. Do we really need paper to do that? I don’t think so.

  59. ndk

    NDK, you should have your own blog – your cut to the chase no BS approach is a fine compliment the comments made by Yves and the article in question

    That’s very flattering, eco, thank you. :D But I don’t really have the time nor the personality required to be a good blogger. The world also already has plenty of great economics blogs. I’ll just contribute to the discourse in the forums we already have.

  60. Yves Smith

    Krugman was criticized for saying “niggling” rather than using the original turn of phrase, which is “nattering nabobs of negativism” from Spiro Agnew.

    As for Buiter attacking a “Keynesian” fallacy, he likes to go out of his way to be provocative. But the fairer general point is that Keynesians often advocate policies that Keynes himself would not have approved of. Keynes was much more hands off, did not believe in government pump priming except in the case of big-time demand shocks, as they now call them. His successors have been much more keen to intervene in lesser downturns.

  61. Anonymous

    @Charels Kiting,

    The end of the Depresion came with the troops returning home with years of pay in their fists and like 90% of troops after a long time in the field spend their way back to nomalicy, this with a revamped production industry to sell them goods that their parents could not afford or wanted. One could write a very long book just on that one effect and its repercussions to the American way of life.

    I think that we still are suffering a hangover socialy, econaomicly and politicaly from that one event (the troops comeing home with large amounts of money at one time en mass).

    Skippy

  62. Anonymous

    I agree with ndk on inflation (probably won’t happen) and Fred on the possibility of a dollar collapse (probably won’t happen).

    As I understand inflation, there has to be a wage-price spiral in order for it to set in. However, I do not believe that wages will go up in our current environment of rising unemployment. Ergo, no inflation. If anything, I think certain sectors might see price increases due to the Fed’s stimulus but the economy overall will not. The scenario I’m imagining is similar to what happened with the price of oil in 2008 – price shot up, lots of pundits said it was inflation, and then the price promptly came back down because nobody could afford to pay the high prices.

    As for a dollar collapse, I don’t think this will happen because it seems as if the rest of the world will do its best to prevent it. For example, Brad Setser has outlined China’s continued purchase of US Treasuries in the face of their economic downturn. Obviously, this is not consistent with a declining dollar. And as Fred mentioned, a declining dollar would benefit American exporters greatly – to the great detriment of foreign companies. Think foreign companies make good products and have healthy exports right now? Watch what would happen to them if they face competition from American products and the price for both is roughly the same. Think mainland Chinese would want to buy Chinese milk vs. American milk if they sell at the same price for example?

    In my opinion, the most likely effect from all this stimulus won’t be increased inflation, as much as Bernanke wants that, and it won’t be a dollar collapse. Rather, I think it’ll be an increase in interest rates, possibly a dramatic one. Treasury has to roll over lots of debt in 2009 (I think it’s on the order of 40%, although I don’t have the source), plus fund the second half of TARP, plus fund Obama’s stimulus package, plus fund all the other bailouts likely to occur (e.g. Detroit and state govts to name two). That’s enormous pressure on the bond market. Watch out for fireworks in the bond market if any of this does not go smoothly.

  63. ex VRWC

    Much of the current ‘sea of consensus’ comes from a simple wish being promulgated – that things are bad and we must be near bottom and, so, chin up. Start believing in the recovery. And, for good measure, the government is here to help. We are pouring the fuel now, see, so the fire will burn when it lights. See all this stimulus and liquidity fuel we are pouring on?

    What they miss is, How does increased confidence restore solvency? What money are newly confident consumers going to go out and spend? They spent the the money stored as equity in their homes. Their wealth in the form of 401Ks is down. What wealth do they have left to spend?

    It seems many, including the Fed bankers if I can believe their recent comments, just don’t seem to have any ability to comprehend the facts on the ground. The American and European consumers and many businesses are spent out and insolvent. Having over-consumed on overly high wages and excess debt, they are overleveraged and bankrupt, caught in myriad collapsing bubbles. Their balance sheets are in all-time bad shape. They have no more money to spend, and nowhere to go out and get money to spend. Credit markets might improve, but no one is going to lend to insolvent consumers and businesses. Government steps are aimed at pouring more and more money into the system in the form of liquidity, but there is a fundamental attitude shift going on – consumers and busineses will no longer play the game of pushing themselves further and further into debt in order to keep the good times rolling. Or, if their government succeeds in penalizing them enough for being thrifty and attempts to force them, the resulting hyperinflationary spiral will finish all of us off.

    One must recognize the forces that are at work in this downturn. Global consumption, trade flow, and wage imbalances are correcting themselves in a very powerful way. The way they are correcting themselves is through deleveraging, deflationary forces, and pressure on balance sheets. They are correcting themselves with currency crises and capital flow reversals. Governments are fighting these corrections – tooth and nail. They are fighting with stimulus, bailouts, currency manipulations, market manipulations. They will soon fight with trade wars. If that doesn’t work, they will fight with guns and bombs. They have significant stakes in keeping the status quo, especially because their economic puppet masters in corporations, banks, and the wealthy have so much stake in keeping their rice bowls full at the expense of others.

    But the imbalances are correcting anyway. No five star team in a the US government or governments of the works will succeed, because the imbalances need to correct. No media-hyped consensus of talking heads, ‘pros’, experts, or pundits will succeed in starting anything except a feeble bear market rally at best. We all need to recognize the powerful forces at work here and act accordingly.

  64. Anonymous

    A big bulge public spendingand more debt is not the answer for years of wastrel spending and consumption.

    independent

  65. Anonymous

    I live in the UK and have my savings in US dollar and Euro accounts in a British bank. I’m curious what would you do if you were in my situation. Would you move your money to Switzerland? Would you dump the dollars?
    Ronnie

  66. Anonymous

    I really have a hard time believing a communist nation (China) and a quasi-communist one (Russia) whose populations are mainly comprised of peasants living in near medieval conditions are in a position to overthrow the West anytime soon.

    I was born and raised in a communist nation (currently labeled as “emerging”), and am still shocked by the backwardness of the nation every time I visit.

    Additionally, the United States has more “value” than any other nation on earth. I really don’t see the US falling soon, if for no other reason than that there is nobody out there to replace it, nor will anybody be anytime soon.

  67. ndk

    In my opinion, the most likely effect from all this stimulus won’t be increased inflation, as much as Bernanke wants that, and it won’t be a dollar collapse. Rather, I think it’ll be an increase in interest rates, possibly a dramatic one.

    I think Buiter might be making a nuanced point that many people(including myself, on the first pass) are missing. He might not be calling for a dollar collapse. In fact, he’s very careful to explicitly call out dollar denominated assets. The text in other sections, such as the limits of monetary policy and quantitative easing in devaluing currency, is supportive of that distinction.

    Personally, I don’t believe that the dollar is at any risk of an orderly decline. I’ve long made the useless call that dollars and shorts are the only place to be until they’re not. Likewise, Iceland’s currency did extraordinarily well on a total return basis until it broke sharply.

    At some point, if we do monetize enough debt, or we do run large enough deficits, or the Fed is insolvent enough and people care, the dollar will not be okay anymore. It’s hard to tell where that particular point is, but we’re clearly not there yet. Will we be in the next 2-5 years? Who knows.

  68. Yves Smith

    I hate to say it, but when intelligent people say “X can’t happen” unless is it something physically impossible, like two sunrises in a day, my antenna go up.

    I have too often heard people say certain things were impossible that came to pass, I distinctly recall many highly intelligent people (with no vested interest) saying in all sincerity that the Japanese stock market would never go down (this circa 1987). It was a weight of money argument: the cash flows in Japan were massive, only so much would go overseas, ergo the Japanese stock market was safe as houses.

    And we all know how safe houses are now.

    ndk, you’ve been reading about the Yellowstone caldera. If the middle of the US blew up, I would say that would have a more than slightly negative impact on the dollar. And if it can happen under those circumstances, there are surely ones that are the result of human behavior that could produce the same outcome. If the Fed blew its balance sheet to $5 trillion, say, and we have the expected big increases in the Treasury calendar (oh, as a thought exercise, make it 25% bigger than now envisioned because the stimulus does not take hold by the end of 3Q 2009 and the powers that be panic and embark on more stimulus).

    There is a level where the ROW will anticipate serous inflation and get very nervous about dollar assets. Europeans I know are already, but don’t like the alternatives, save gold, very much. More of the same could lead us past a tipping point.

  69. Yves Smith

    Another wild card: we anticipate what we see as economic rationality out of the Chinese, that they will continue to buy our paper. There is already tremendous resentment in China over our abuse of our reserve currency standing. I recall an FT op ed (I think Michael Pettis) who warned that China (from a policy standpoint, mind you) was predisposed to see the current situation as a morality play, with the Chinese as virtuous and thrifty and the US as decadent and profligate.

    Don’t assume economic rationality. Smoot Hawley hurt us far more than our trade partners, or so I am told. The US also tried to take a punitive stance on sovereign debt defaults in the 1930s, and would have extracted blood from stones if there was any way it could have (and that also would have been bad economic policy). Creditors have this nasty way of wanting to be repaid.

  70. Anonymous

    Not that anyone here has asked for my wish list, but what I’d really like is a non-technical summary of what Buiter was saying, since I don’t know what things like external primary deficits are. I guess it’s a lot to ask for, but, who knows, maybe somebody somewhere has already written it.

  71. RagingDebate

    Great comments and some of the best thinkers I have seen in a long time.

    My take:

    1) continued deflation/inflation later in select commodities, notably oil.

    2) voter revolution occurs as it has since the 1843 downturn.

    3) dollar does not outright collapse during inflation stage. The USA may become Weirmar Germany 1923, but think of this as Weirmar lite…

    4) Next Bull market 2013 but don’t expect the returns of the 80’s and 90’s.

    5) Global fiscal crisis has spurred the last two world wars. In the nuclear age, this is VERY bad. Prepare your family for such contingencies. I do stock 90 days food, water and medicine. I am a believer in home defense. With that comfort, I leave other fears behind.

  72. ndk

    ndk, you’ve been reading about the Yellowstone caldera. If the middle of the US blew up, I would say that would have a more than slightly negative impact on the dollar. And if it can happen under those circumstances, there are surely ones that are the result of human behavior that could produce the same outcome. If the Fed blew its balance sheet to $5 trillion, say, and we have the expected big increases in the Treasury calendar (oh, as a thought exercise, make it 25% bigger than now envisioned because the stimulus does not take hold by the end of 3Q 2009 and the powers that be panic and embark on more stimulus).

    Absolutely. My use of the word orderly was very deliberate. Real dollar devaluation involves a lot of positive feedback loops. Many of the typical negative feedback loops, like a healthy export sector or easily substituted domestic goods, are not really present.

    Denver sits in the center of the projected ash path, BTW. Send a shovel for a belated holiday gift.

  73. Yves Smith

    The elevation would probably spare you the worst, but I’d be thinkin’ gas mask instead. Snow plows can be repurposed, but nasty particulates in the lungs tend to stay there for good.

  74. Independent Accountant

    YS:
    I see the same resentment of the USD’s “reserve status” and abuse in China that I saw in France in 1966. In 1966 we were told, “The dollar is as good as gold. Gold will always be $35 an ounce. We will never devalue the dollar”. Henry Reuss (1912-2002) even said something to the effect, “When the Treasury stops supporting the price of gold, it will fall to $6”. Yes, I remember. It was all lies. When the political pressures within China get great enough, China will pull the plug on the dollar. Bet on it!

  75. Anonymous

    Excellent blog on many levels.

    Btw this question has undoubtedly been asked but what do some of you think of Nouriel Roubini?

    Economic prophet or….?

    AM

  76. Yves Smith

    AM,

    A very quick take: Roubini had the plus and minus of being very early to see the mess coming. However, when it hit, he (so far) has called its trajectory more accurately than anyone (save maybe Gary Shilling, who was spot on with his 2008 recommendations).

    I think it will be hard for anyone, no matter how smart and insightful, to call 2009. We have governments around the world launching all sorts of policies, and we also have efforts to drive currencies lower (Japan is doing it noisily, China quietly). And how effective these programs will be, and how they impact each other, gives forecasting this year an even greater level of complexity than last year.

    Having said that, I tend to default to the what Reinhart and Rogoff have found for past financial crises: they take a long time to resolve.

    Back to Roubini. He writes and speaks in an over-the-top manner, which does not exactly serve him well.

  77. bg

    This has been a great thread of comments, I especially liked the latest dialog between ndk and ys.

    I reread the piece a third time, and it only occurred to me the third time that he kept emphasizing dollar assets, rather than the dollar or even US assets (the last point is a niggle).

    This is not a small point for me, as I am specifically short US assets and long the dollar (both positions have required a bit of pig headedness the last few weeks.)

    But my analysis is along the lines of ndk, (although not precisely). It is easy to see the UK as an exagerated case of the US, as Iceland is a further exageration. In the latter case the asset decline was lead by the currency.

    The dollar is a reserve currency, and the pound is in between. Or so the theory goes. But I view it with a different slant. Europe can tolerate a low icelandic currency, is ambivilant about a weak pound, but is terrorized by a weak dollar. With China and Japan… double that. All other world currencies are impacted by trade a capital restrictions, so will be even further exagerations of the above.

    Thus I see the race to the bottom for currencies and assets alike. The problem is where does the money go? It is almost a riddle. what if every person sold all their assets and all countries debased their currencies. What would happen?

    Of course I do not expect a singularity, but I think Buiters arguments that ‘old habits die hard’ is a short cut for ‘nobody knows what the new habits should be yet’.

    The europeans are blustering about inflation and keynesiasm… and perhaps they have weak system to emulate it… however they cannot, and will not tolerate a euro so strong there are riots. Germany will let the pressure out of the system, and this will support the dollar.

    In short I see a lot of volatility in the dollar, but see a huge number of forces keeping the dollar standard going (as opposed to the gold standard or the oil standard.)

    Asset prices will have to be the vicitm (at least in real terms.) And I agree with NDK, long interest will stay stubbornly high during global debasement.

  78. Timo

    “Germany will let the pressure out of the system, and this will support the dollar.”

    So now it is the Germany who will save the dollar. A couple of years ago “Old Europe” was so uncompetitive and outdated, according to Brits and Yanks. Now it is The Savior of World Financial System!

    This “somebody else will save us” argument is as valid as “Euro tourists will save New York from economic collapse”.

  79. bg

    Timo,

    Thanks for reading my comment. Perhaps I was unclear, and was not trying to have my whole argument fall on Germany. The Germans are dominating ECB policy and resisting keynesian stimulus because it will unevenly fall on them and then leak to other countries. There is a lot of friction within the EU on this, and I am speculating the Germans will cave before they let every other currency race to the bottom. The race has already begun for all other currencies, so that is where my emphasis on the germans comes from.

    So many articles focus on US negative savings, fiscal stimulus and reserve currency shifts. But the traditional conclusions (IMO) are suspect during a global shock.

    Yves correctly posits that the wild card in 2009 is government involvement, and thus future predictions are difficult. There has been a near consensus on the dollar decline, and I was making a counter argument.

    Again, thanks for weighing in.

  80. Timo

    “But the traditional conclusions (IMO) are suspect during a global shock.”

    This financial crisis reminds me about AeroPeru Flight 603:

    “On 2 October 1996, shortly after takeoff just past midnight, the Boeing 757 airliner crew discovered that their basic flight instruments were behaving erratically and reported receiving contradictory serial emergency messages from the onboard computer, such as rudder ratio, overspeed, underspeed and flying too low. The crew declared an emergency and requested an immediate return to the airport.

    Faced with the lack of reliable basic flight instruments, constantly receiving contradictory warnings from the aircraft’s flight computer (some of which were valid and some of which were not), and continuously believing that they were at a safe altitude, pilot Eric Schreiber and copilot David Fernández decided to cautiously begin the descent for the approach to the airport.

    Since the flight was at night over water, no visual references could be made to convey to the pilots their true altitude or aid the pilots in the descent. Also, as a consequence of the pilot’s inability to precisely monitor the aircraft’s airspeed or vertical speed they experienced multiple stalls resulting in rapid loss of altitude with no corresponding change on the altimeter. While the altimeter indicated an altitude of approximately 9,700 feet, the aircraft’s true altitude was in fact much lower. It struck the water approximately twenty-five minutes after emergency declaration, making the pilots realize the true altitude of the airliner; for twenty seconds the pilots tried to make the airliner climb. The airliner then crashed into the water. All nine crew members and sixty-one passengers died….

    The later investigation of the accident revealed that a piece of masking tape accidentally left over the static ports (on the bottom side of the fuselage) after cleaning the aircraft led to the crash….The static ports are critical to the operation of virtually all of those flight instruments that provide basic aerodynamic data such as airspeed, altitude and vertical speed, not only to the pilots but also to the aircraft’s computers, which provide additional functions such as warnings when flight characteristics approach dangerous levels…”

    That is now exactly happening, the economic instruments are fubar (especially those coming from US government). Like “Oh, we have been in a recession already from December 2007!”.

    Level three and other accounting gimmicks have made “private side” instruments equally fubar, especially in the financial sectors. You only will know that things are really clusterf**ked maybe 20 feets above from the ground and then it is way too late. Companies are fine one day and declaring bankruptcy next day.

    Economists are also either trying to push down or pull up. No stimilus or massive stimulus. Bailout here but no bailout there and all the time the plane is descending more and more rapidly with short random bursts upwards, resulting in multiple stalls.

  81. donebenson

    Let me repeat myself: This has been the best blog and comments that I have ever read. My thanks, and congratulations to all who participated [especially ndk, bg, and ys].

  82. Anonymous

    Quote: Here’s how I see it: the opponents of a strong stimulus plan don’t really have an alternative to offer. They don’t even have a really coherent critique; as Brad DeLong points out, if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect….Private spending and public spending are as chalk and cheese. There is a cost to public spending (debt or tax) and it is directed by people in government as to what they think is best. Private sector is the mass of people reacting to market price signals and using their own resources or claim on resources. It is a vastly different ball game (See Road to Serfdom). In the very paras following this quote there is somebody listing the many micro issues that were not being tackled or acknowledged. How many joules of brain power does it take to see all those governors & local politicians rushing to dip their hands in the public cash bowl. What is happening in the US today is an absolute scandal – Paulson, TARP, the US Treasury, et al

  83. Anonymous

    Yves:
    I continue to be amazed by the the quality and timeliness of your posts and the range of intellectual persepctives your readers bring to bear in the discussion. I am a light weight by comparison but have been informed and enriched by those who post with far more knowledge than I can muster.

    Keep it up.
    Rob from Pittsburgh

  84. Juan

    Blissex’ comment moves towards consideration of ‘the economy’ as _combined_ national and not-national, i.e. a real superimposition of the global over the national-state system from which it grew and, within this, contradictions between the two levels. Contradictions which cannot be well addressed by any particular national state but drive towards the impossibility of a singlular global state. Well, impossible other than through self-organized democratization and negation of governments as we know them (and imagine they must always be). A stateless state of the world might also be thought of as a world social formation which to a degree already exists and will never be perfectly even or converged. Sheesh, there I go…

    Fred is correct – In real terms, U.S. manufacturing output has risen more 70 percent over the last thirty years which, through technological displacement and changing composition of trade and transfer, has been accompanied by a very substantial decline in that sector’s employment.
    The capital system in the U.S. became and remains more dependent upon realization rather than production of profit, i.e. more dependent upon circulation based activities such as sales, marketing, the FIRE sector, etc, part of a long-run shift in the global division of labor and correspondingly increased unequal exchange which the present crisis may well destroy along with (the majority of?) fictitious capital.

  85. Anonymous

    Yves — ‘Love your blog. Keep up the good work…

    As regards Buiter’s key point in his long essay (I read the whole thing in the FT), he expects the dollar (more precisely, dollar assets?) to collapse because at some point the foreign holders of dollars will not tolerate the massive inflationary implications of current and expected US fiscal and monetary policies.

    Well, I am rather skeptical about that postulate, since the major foreign holders of US dollars appear to be China and the other Asian-block exporters, plus the oil exporters. For domestic political reasons (such as potential revolution by the masses), these governments willingly support and accumulate the dollar as a basic way to provide VENDOR FINANCING to American consumers — and thus ensure the creation and support of manufacturing jobs in China, Taiwan, Korea, etc. Without that dynamic, how are China, et al, going to provide employment for the hundreds of millions of their people moving from farm to city? Building up their own middle class/internal consumption cannot do the job alone.

    Therefore, the dollar probably will not be “dumped’ in a sudden, disruptive manner —- but instead will erode slowly over a very long time horizon (after an initial sharp sell-off).

    I would appreciate all comments on this topic.

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