William Dudley on Economic Policy

Cross -posted from Credit Writedowns

New York Fed Chief William Dudley gave a speech yesterday called “U.S. Economic Policy in a Global Context” (hat tip Yves Smith). Dudley’s overall aim was to show that one must regard US policy in an international context and not based on domestic factors alone. I think the whole Speech is worth reading but I wanted to highlight this section below on macro accounting identities. I have bolded he relevant parts:

we all have to bear in mind that current circumstances put stress on the support for open global markets in the developed world.

On the U.S. side, the recovery remains distinctly subpar in spite of aggressive monetary and fiscal stimulus. On the monetary policy front, short-term rates remain near zero and the Federal Reserve is just about to complete its $600 billion Treasury purchase program. On the fiscal policy front, the U.S. government has engaged in large stimulus program. This supported demand and employment while the private sector shifted its saving balance into surplus in an effort to repair balance sheets.

However, the large size of the fiscal deficit and the rapid increase in the country’s federal debt-to-GDP ratio means that this is not sustainable for much longer.

Ultimately, the composition of economic activity in the United States needs to be rebalanced. There are two issues here. First, the consumption share of GDP may still be too high. Second, the need for U.S. fiscal consolidation implies that there will have to be offsetting increases in investment and the U.S. trade balance as the recovery proceeds.

To illustrate this second point consider the following accounting identity:

The public sector balance + the private sector balance = the current account balance

Right now the identity holds as roughly:

-10 percent of GDP public sector balance + 7 percent of GDP private sector balance = -3 percent of GDP current account balance.

If the public sector balance must over time move from around -10 percent to around -3 percent to stabilize the federal debt-to-GDP ratio at tolerable levels, then the private sector balance and the current account balance must move by roughly 7 percentage points of GDP to take up the slack.

Assuming that the consumption share of GDP still needs to fall over the medium term, the adjustment in the U.S. private balance will have to occur primarily in terms of rising residential or business fixed investment.

There does seem to be room for business investment to expand significantly when firms become more confident in the economic outlook, provided that the United States remains a competitive location for investment. But residential investment is unlikely to climb very much for some time given the chronic overhang of unsold homes.

If these two sectors cannot take up all the slack created by necessary fiscal retrenchment in the years ahead—as seems likely—then the U.S. trade balance will need to improve as well. This implies that EMEs will no longer be able to rely on expanding U.S. demand as a key driver of their own economic growth.

I said last month:

“I wouldn’t poo-poo these accounting tautologies. They are real. They have value and they help you understand what’s happening in the economy. The reality is the non-government sectors cannot net save unless the government is deficit spending. The only way the private sector can pay down it’s debt burden is through a net negative shift in trade or government balances. The other way to reduce debt burdens is through debt forgiveness and default. With the U.S. household sector highly indebted, these are the choices”

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward http://www.creditwritedowns.com


  1. Ramanan

    William Dudley is talking about global imbalances. He is not the relation between the government and the domestic private sector balances but all “three financial balances”.

    William Dudley is presenting a case for a more grand plan of running the world economy than a simple fiscal expansion.

    “The issue of global rebalancing has received plenty of attention elsewhere. My goal today is not to play the blame game. We all share responsibility for addressing our current set of challenges. Rather, it is to lay out the reasons why it is imperative that the United States and the EMEs collectively move toward arrangements that put us on a mutually sustainable path. I hope I have been convincing.”

    1. Edward Harrison Post author

      Are you just repeating what I said or making a separate point. I said “Dudley’s overall aim was to show that one must regard US policy in an international context and not based on domestic factors alone.”

      So, no, Dudley is not talking about simple fiscal expansion. Nor am I.

    2. Edward Harrison Post author

      Ramanan, the point Dudley is making – that I am also making – is that fiscal consolidation doesn’t happen in a vacuum. It has implications not just on government finances but also on the trade balance and private sector savings and investment.

      What EMEs should understand is that the US wants to improve its external balance to permit this consolidation. And if it cannot, protectionism is likely. At the same time, Dudley is saying that (without a meaningful change in exchange rates and trade balance) much of the fiscal consolidation adjustment is likely to fall onto the private sector. And that is a dead end.

      At a minimum, from a policy perspective it sounds like he is advocating figuring out ways to boost capital investment somewhat.

      1. Cedric Regula

        Right. We need to export government workers.

        Or, EMs need to buy exports from us instead of recycling trade dollars into treasuries. But they say no.

        Or, corporations need to invest in US productive capacity, energy and infrastructure. But they say no, better to invest in EMs. And how can you go wrong with a cheap money policy from the Fed?

        Or, we could call China a currency manipulator, and raise import duties on them, leveling the playing field so that corporations would add local capacity to serve our domestic market. Or a least slow down the rate of exodus. But Geithner says no. We need “foreign investment” to fund the national debt, so can’t PO the Chinese.

        So what are we thinking of doing? The Obama-Immelt brain trust thinks US Multinationals need incentives to invest in the USofA. They are now talking tax cuts and outright subsidies! The US Taxpayer will borrow from the Chinese to pay GE to keep MRI scanner and jet engine manufacturing in the US! GE toaster ovens will still come from China so that China will have the trade dollars to loan us.

        Or, we need to export government workers.

        1. Shadow Inventory

          Right. We need to export government workers.

          Or, EMs need to buy exports

          ~~Cedric Regula~

          Good Show! Then again, we have already big chunks of USA-Federales now inside many enemy countries. Only problem with that is, “They still on our payroll”. As indicated by Edward Harrison, “protectionism is likely.” if external balance is not forthcoming.

          Nothing wrong with protectionist tariffs, import duties, etc. Nothing except retaliation. What options loom ahead? Could we buy from the Greeks their ticket for European Economic Commune Membership? At bargain price? Could we instantaneously stamp out graft, corruption, influence peddling, and the inalienable right of elected officials to grab what is ours then sell it off to foreigners? Should elected officials be denied the right to sell Okinawa to the Japanese Emperor? Sell American Union Jobs to the Chinese? Who knows? One thing for sure, “The locomotive is still blowin’ cool, but the gravy-train has nearly reached the end of the track. The curtain is about to fall on the-prices-prop-up-jobby. About to fall on the QE1, 2, 3, 4, 5 jobby. About to fall on clunker cash. About to fall on foreclosure prop-up-jobby. About to fall on hedge-fund-prop-up-jobby.”

      2. KnotRP

        Some of the numbers plugged into that equation are market-to-fantasy…that makes balancing them a fantasy, or what we like to call the dismal science, which of course is no more of a science than astrological fortune telling.

        I think it is more likely that mark-to-market forces will cause reality to intrude and *replace the fantasy numbers*, which will then show the equation was never out of balance….we just pretended it was out of balance, to make ourselves feel like we are in less of a hole. And lifestyles in the US are ALREADY suffering the declining lifestyle, even as we pretend (via mark-to-fantasy) that it’s not happening already.
        For example, the chart of US citizens relying on foodstamp assistance….that’s not a lifestyle choice.

      3. JasonRines

        Exactly Mr. Harrison. This seemed evident to me and others in 2004. But the China speculative greed fest by financeers which IS the U.S. government couldn’t pry themselves away. Like the leverage run up before WWI and WW2, the CB model is 2 minutes too late in recongnizing and reigning in the party. This time isn’t different in this regard. Hedge accordingly.

        PS: I appreciate your efforts to educate the American people and influence the influencers. Your a true gentlemen Mr. Harrison.

  2. Tertium Squid

    What are the inputs to the system?

    Is my basement full of food “savings”?

    Did the government have to deficit spend because I have a basement full of food?

    1. TC

      Food has value, but it is not U.S. Dollars. You can save food all you want.

      If you want to be able to save in U.S. Dollars – and you’d like your neighbors to be able to save in U.S. Dollars too – the U.S. Treasury must run a deficit of U.S. Dollars.

      1. MyLessThanPrimeBeef

        Love those accounting identities.

        The way I see it, we will make Mikey there the private sector and the rest of us the public sector.

        We will do all the deficit spending and let Mikey over there have all the savings to his super-smart, super-cunning self.

        Ideally, I alone will be the public sector and the rest of you the private sector. But alas, I am no king.

  3. ambrit

    Mr Harrison;
    Please bear with me here, I’m a layman in international macro affairs. However, your analysis exposes a critical stumbling block to a multilateral solution to this problem. If I read it aright, a proper balancing of the forces would require cooperative agreements between the US and the EMEs. Leaving EME politics aside, US politics pose the big obstacle to multilateral agreement. Whether from natural Jingoism or social manipulation, the mood on the US Street is trending protectionist. This bodes ill for the future, if you are an internationalist. Aside from the educational content here, on your blog, and others, the ‘honor roll’ of attentive persons are here because we want to be here. To shift the Streets sentiments, we need a full court press on more “Mainstream” media venues. I must admit bewilderment as to the best way to carry out my ‘prescription’ for improvement, and do apologize. I and the rest of the Choir will sing Hosannas till the cows come home. What we need now is a St Francis to preach to the cows.

    1. MyLessThanPrimeBeef

      Mr. Harrison and other volunteers will be the private sector.

      The rest of us, we will all be moving over to the public sector.

      Thank you very much!

  4. Hugh

    Dudley was Goldman’s chief economist. Everything he has to say is going to be kleptocratic squid-talk.

    What’s funny is that I was writing elsewhere yesterday about the kind of dishonest argumentation Dudley uses here. He throws out axiomatically an unproven, and in fact, false assumption, “necessary fiscal retrenchment in the years ahead”, then immediately draws a conclusion based on it, and moves on, before anyone is supposed to notice.

    But he mucks even this up. After wandering about for a bit, this is about all he can come up with:

    “There does seem to be room for business investment to expand significantly when firms become more confident in the economic outlook, provided that the United States remains a competitive location for investment”

    I mean how stupid is that? US corps are sitting on $1.5 trillion in cash because they see no reason to invest in face of slack demand and what Dudley says is the need to cut back on too high consumption. What’s left is the export sector, or what is generally known as the beggar thy neighbor approach. But as we already know, this is the same strategy everyone else has been pursuing. It is an argument for a reverse bubble or a deflationary spiral because no one wants to be the neighbor to be beggared.

    So what is Dudley really telling us? That the US will be competitive, and a good place to invest, once we get wages down to third world levels in this country? Seriously, reading him is like slogging through a pile of manure. But then what could I or anyone else expect from Goldman’s man at the New York Fed?

    1. Dan Pennell

      I saw an interview with some big trader on WS last week. The guy actually said that things will not get better until people start buying homes and other goods and we become more competative globally on a cost basis. Which of course is nothing more than code for getting wages down.

      I guess that the contradicition of people engaging in long term debt and increased purchases while simultaniously taking a reduciton in income just did not occur to him.

  5. KnotRP

    Clearly, we need to randomly draft citizens by lottery…to fill political seats….and we need to elect people (former politicians, mostly) for military service in the 3 current wars they’ve cranked up.

    Electing politicians through big money advertising campaigns hasn’t been working…we need to change the game rules and make it a citizen duty to do time as a policy maker.

    1. nonclassical


      The military-industrial complex manipulated political money-cha$e excludes citizen oversight of U.S. “warfare economy”..

      as we know, there are more private military contractors in current wars than troops, and the space-weapons-surveillance race is the most expensive-highest tech endeavor in human history. None of associated power will give up to political oversight..

  6. jsn

    Using Treasuries to manage the interest rate, as the US does, allows our trading partners to run accidental Marshal Plans for themselves by purchasing treasuries to push their exports at us.

    Make a tax holiday for working stiffs, cut all the subsidies, direct and indirect to multinational corporations, and anyone else sitting on a cash pile, and quit issuing treasuries to manage the interest rate. Pay a supporting rate on excess reserves instead.

    This would put leave money in consumers hands to stimulate demand and by cutting corporations off from free money it would incentivize them to invest. In addition because our trading partners would have to bid up their currencies to purchase diminishing stocks of available Treasuries, foreign markets would begin to pull our manufactures. This would help Ben unwind his QE positions as well.

    There is a large gulf between creating new money adequate to soak up some of the idle capital and labor in the US economy and the hyper inflation theoclassicists worry about. The government should spend new money into the real, non financial, economy until we get inflation of say 4 or 5% while not covering that money with bonds. We have the power to set our price level and to set interest rates, it is just the people who have benefited from thirty years of run away asset price inflation that do not want to see the relative gains on those assets neutralized.

    1. MyLessThanPrimeBeef

      There will be some rich people who benefit from cheap money.

      They will come in the name of helping the poor, the unemployed and the old, hiding in the crowd of those
      who genuinely sympathize.

      – quoted from The Complete History of Kleptocracy, from The Neanderthals to Now.

    2. JasonRines

      Good comment JSN. It all comes down to human behavior and evolutionary cycles of boom and bust which the CB model exacerbates. The majority that earned large sums through government manipulation actually feel they worked hard and took risks at the same level as a commoner that became a rising star innovator bucking the odds to escape gravity. The simple feeling is “screw you, I worked for it so what are all you little common people bitching about.” The minority of elite that fight for reform do make a difference in loss mititgation in blood and treasure but as I mentioned above it happens at 12:02 not 11:58. Too late to avoid serious geopolitical consequences and military misadventure.

      My loss mitigation idea is to set up global debate which does two things:

      1) Offers opportunity for the citizenship to have a form of non-official dialect (read representation) and method of blowing off steam without violence.

      2) Frame methods of solutions so the citizens can share infomation and solve their own problems. The world is heading toward smaller physical centralized government and digital governance platforms of part time politicos. We’re in a massive decentralization cycle. ‘Wishing’ centralized global government with a monetary union without political union amplifies the pain for all mankind. Welcome to the decade of 12:02. So what are you doing about it? As for me, I have no regrets nor will wonder what more I could have done. I hope Yves feels the same way.

  7. MyLessThanPrimeBeef

    The government doesn’t borrow from the poor.

    The government borrows from the super rich.

    That AAA+++ full faith/full credit deficit borrowing goes into rich folk’s private sector savings, the real rich kind who gets its funding nearly free from the Fed.

    1. MyLessThanPrimeBeef

      That is to say, in order for the super rich to have more private sector savings, the government has to deficit spend more.

  8. Groucho

    Edward, looking out over the rest of this decade I see the rebalancing as mainly a function of energy prices collapsing and a new BWIII agreement with Asian currencies sharply appreciating. Using US debt to drive the system has reached it’s climax. Luckily for the US, AI has reached escape velocity and the US can maintain Technology Hegemony even with the amazing amount of Chinese hacking……. which actually helps the US develop it’s tech capacity. Wars drive technology and cyber-war is no different.

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