September 30, 2003

The Economist's Buttonwood Tree Speaks

The Economist's Buttonwood Tree column speaks, and apologizes to the rest of us for assuming that "George Bush and his administration were not as stupid, short-sighted, parochial and economically illiterate as they sometimes appear. Buttonwood now realises that this was a mistake and retracts this view as hopelessly optimistic and naive."

That's OK. Every young tree is allowed a few mistakes. But don't let it happen again.

Economist.com: Underlying some of this column's cheer these few weeks past has been an assumption that President George Bush and his administration were not as stupid, short-sighted, parochial and economically illiterate as they sometimes appear. Buttonwood now realises that this was a mistake and retracts this view as hopelessly optimistic and naive. Over the past couple of weeks, the risks to the world economy and financial markets everywhere have risen as the full force of their economic myopia has visited itself on the world stage.

The reason for this column's volte face was the outcome of the G7 meeting in Dubai. The communiqué issued by the group of industrialised rich countries on September 20th called for "more flexibility" in exchange rates, which sounds innocuous enough but most certainly wasn't. Whatever other countries thought this meant--and the British and the Japanese denied it--the signal the Americans wanted to send was unambiguously clear: the Bush administration wants a lower dollar. John Snow, the treasury secretary, even called the statement "a milestone change". Perhaps he was even hoping for a new version of the Plaza Accord, an agreement reached by the then G5 in 1985 to drive the dollar lower. Certainly, the currency markets thought something along those lines: since the meeting the dollar has fallen another 5% against the yen, to stand at three-year lows, and has dropped against other currencies as well.

None of the noises coming from Capitol Hill suggest that the markets are wrong in this view. This week, Medley Global Advisors, a consultancy run by Richard Medley, a former advisor to George Soros and a man with strong links to administrations past and present, issued a report saying that it was indeed the government's intention to push the dollar lower. And a junior apparatchik in the Treasury claimed that, specifically, it wanted to lower the value of the dollar against the yen (since the Chinese are unlikely to play ball). Thus has the strong-dollar policy long espoused by Robert Rubin, Bill Clinton's treasury secretary, metamorphosed into a weak-dollar policy. Mr Rubin, a former boss of Goldman Sachs, and as safe a pair of hands as could be wished for in troubled times, is said to be spitting blood at the stupidity of such a move...

Unfortunately, there is no one of Mr Rubin's calibre close to Mr Bush; no one, indeed, in whom financial markets place much trust at all. Mr Bush has surrounded himself with businessmen such as Mr Snow and the likes of Karl Rove, his chief political advisor and a politician to his bones. Mr Bush wants to get re-elected, whatever the cost. One of the biggest threats to this is the "jobless recovery", which is being linked politically (regardless of any economic arguments to the contrary) with the trade deficit. Politically it plays well to bash foreigners (particularly the Chinese, the new whipping-boys) for "rigging" their currencies. Protectionist noises are becoming louder by the day. Legislation has been introduced in both houses of Congress that would slap hefty tariffs on Chinese imports. Congressmen in both parties are in favour and if anything the administration is egging on such sentiment.

Though such rhetoric plays well with voters it has played very badly indeed with financial markets for the simple reason that such measures would undermine growth, not just in Asia and Europe but in America too...

It does seem beyond the intellectual capabilities of Bush administration decision makers to recognize that their are constructive and destructive ways of talking down the dollar. The constructive way is to convince foreign investors that U.S. interest rates are going to stay very low for quite a long time to come: that reduces the overvaluation gap between the dollar's current value and its long-run fundamental value, and reduces the chances that that overvaluation will somehow get us into trouble.

The destructive way to talk down the dollar is to make foreign investors think that the dollar is a risky investment--that the Treasury is not concerned with preserving the capital of those who buy dollar-denominated bonds. This kind of talking-down the dollar lowers both the current and the long-run fundamental value by roughly equal amounts, and does nothing to diminish the degree of overvaluation.

Guess which way the Bush administration chose?

It's been nine months since the Bush administration revamped its economic team. Its time for that revamping to produce results in the form of less incompetence in economic policy making--a real deficit reduction program, or an elimination of the mistaken steel tariff, or a revival of the Doha Round. Failing any of those, it will soon be time for some resignations on principled disagreement with Bush administration policies.

Posted by DeLong at September 30, 2003 08:36 PM | TrackBack

Comments

I keep getting the feeling that the adminstration is going to find a way to backtrack out of its pledge to reappoint Greenspan (if possible delay any decision until after the election) and appoint instead a political hack who would be more than willing to work on inflating away the debt and further eroding the dollar. I would hope that there would be enough of a bulwark present in the Fed to keep that from truly happening, but as things progress in the administration I get fearful of relying on institutional safeguards.

Posted by: Rob on September 30, 2003 09:53 PM

I still don't understand why it matters if the Treasury says the dollar policy is strong, weak, floating, or pink with purple polka dots. It seems to me as if they have been running a floating policy for many years now and will most likely continue that policy. I don't expect them to interfere much with the currency level except to request other nations quit doing so.

Saying that interest rates will be low for a long time is a nice sales pitch for our bonds, but can the Treasury control rates?--Won't they be decided by economic fundamentals? But even trying to talk the dollar down in this way by suggesting dollar returns will be low also implies that the Treasury is not there to preserve capital. They weren't there to limit the dollar bond gains of European investors a few years back, and they didn't do anything to stop their more recent losses, so why would anyone think that anything other than fundamentals stand behind their US investments? Well, perhaps the Japanese believe their government guarantees their US treasuries, but is that really healthy when in the long run there cannot be any such guarantee?

Posted by: snsterling on September 30, 2003 10:47 PM

Nah, it's Alan G (backed by most economists, including BDL) who have created the weak dollar, by its loose money policy. The U.S. Administration has just accepted reality. You're just blaming the messenger and once again trying to escape the inevitable results of policies you have pushed for.

Does a bond trader really see a difference between:
1) Someone cheering for a loose money policy, which mechanically causes a weaker dollar; and
2) Someone who wants a weaker dollar.

I guess it's not just Presidents whom economics professors and journalists think are really stupid; it's bond traders too.

The dollar will go lower, because the fundamentals force it to go lower. The fundamental value of ten- and thrity-year bonds are not likely to depend too much on the say-so of an Administration which probably has barely a year more to go. And interest rates will go wherever they were supposed to go - up or down, don't know, given that Alan G. is lurking in the background threatening to target long-term rates.


Posted by: Andrew Boucher on October 1, 2003 12:06 AM

This one is found quite often nowadays:
>>the overvaluation gap between the dollar's current value and its long-run fundamental value>>
However motivations for it are rare, and then only refers to the current account deficit. But the current account deficit is not a long-run fundamental variable. Productivity and productivity gains are, and they are not pointing to any weakness. Looking back over the past few years, we have not really had a dollar rally. (A US protectionist's conspiracy?)

graphs + more
here -http://blogofpandora.blogspot.com/2003_09_01_blogofpandora_archive.html#106448679397622194
or here if you like -
http://www.economist.com/images/20030927/CFN690.gif

Posted by: Mats on October 1, 2003 12:38 AM

"The constructive way is to convince foreign investors that U.S. interest rates are going to stay very low for quite a long time to come: that reduces the overvaluation gap between the dollar's current value and its long-run fundamental value"

I'm sure I'm being stupid, but doesn't this run counter to uncovered interest-rate parity? In other words if nominal interest rates are going to be lower in the US than elsewhere, won't that push the dollar up, not down? I thought common-currency risk free returns were supposed to be the same in each country.

Fergal

Posted by: Fergal on October 1, 2003 01:24 AM

>>doesn't this run counter to uncovered interest-rate parity [UIP]?>>
Not really, the UIP tells us where we expect the currency to go. Still something unexpected might happen, e.g. we are "convince[d] that U.S. interest rates are going to stay very low for quite a long time". This would then (more or less) momentarily drive down the dollar to a new level. From this new level, the UIP would again tell us where we expect the currency to go - i.e. slowly stronger if rates are lower.

Posted by: Mats on October 1, 2003 01:48 AM

Oh, those stupid bond traders. They have all read the textbook, but oddly have chosen to focus on the paragraph about how there is no good predictor of fx rates in the short to medium term, rather than the extensive treatment of monetary policy, purchasing power parity and other longer term influences. Stupid, stupid, stupid. Silly bond traders, who remember that Treasury Secretary Bentsen managed to set off a gut-wrenching slide in the dollar's value, just by saying he'd prefer the yen to be a bit stronger. Can't they manage to ignore reality long enough to realize that textbooks are what is important, rather than actually making money for their bank?

The thing that determines fx rates in the short term is whatever market participants focus on. Sometimes they focus on textbook stuff. Sometimes they focus on Orange County investment practices. That makes it tricky to assert (though Brad is not the first to do it) that you can know in advance how fx rates will react to different approaches to weakening the dollar, true. However, because fx rates are subject to all sorts of influences, such an assertion is certainly within the realm of reason.

What I find odd about the Buttonwood Tree column is that it is dollar policy, a dollar policy change which is so far only strongly hinted, that has snapped his head around. Fiscal policy, maybe? Trade policy? Tree must have had his/her fingernail dug very deeply into the edge of that cliff to have held on for so long.

Posted by: K Harris on October 1, 2003 04:32 AM

>>realize that textbooks are what is important,
eh?

Posted by: Mats on October 1, 2003 04:54 AM

The fundamental problem is assuming that the Bush administration has ANY economic policy beyond funnelling money into the pockets of supporters, and the expediency of the moment.

Posted by: Chuck Nolan on October 1, 2003 05:04 AM

K. Harris - First if you're replying to my post, you misunderstood it.

But anyway, you added in "short-term", so of course you're right. In the short-term assertions by the Treasury Secretary can impact what happens to the dollar and interest-rates. If BDL thinks it obvious whither the direction of long-term interest rates in the short-term, he should try to do a quick in-an-out on the futures market. And if doesn't want to actually risk money, then he could still easily (since he's making a claim about the short-term) tell us which interest rate we should look at, what time-period he's thinking of holding the virtual position, and we can all check how he's done. Will he?

Posted by: Andrew Boucher on October 1, 2003 06:00 AM

BTW, Prof DeLong, like secretary Snow, you did your bit to talk down the dollar with an article in "Les Echos". As someone living in the US with a large part of my salary denominated in Euros, I cannot but encourage you to continue to do so.

Posted by: fberthol on October 1, 2003 06:12 AM

And just to add in the short-term BLD is wrong, since he first wrote about this Sept 23, and since then long-term US interest rates have gone down and not up.

Posted by: Andrew Boucher on October 1, 2003 06:25 AM

And just to add in the short-term BLD is wrong, since he first wrote about this Sept 23, and since then long-term US interest rates have gone down and not up.

Posted by: Andrew Boucher on October 1, 2003 06:30 AM

Andre Boucher writes:

> And just to add in the short-term BLD is wrong, since he first
> wrote about this Sept 23, and since then long-term US
> interest rates have gone down and not up.

Is there a word to express "shortest-term"? When I look at ^FVX and ^TNX on Yahoo, what I see is the former hanging out at 3% and the latter at 4% except for the period in June when deflation fears seemed to peak (driving rates down) and late-August and early September, when belief that growth would be really strong drove them up. Now they're back hwere they were in April or so, and if BDL or anybody else could tell you exactly where they'd be next week, they wouldn't. :-)

Posted by: Jonathan King on October 1, 2003 07:05 AM

Bond traders do differentiate between a well understood, justifiable, market/fundamentals lead interest rate policy and openess about where that is likely to lead and the uncertainty about the effects of politically lead intervention in the exchange rate markets. In pure short term exchange rate terms the difference will not be pronounced but it will be visible in forward rates. The impact is reduced ability to cut rates.

Roughly speaking the former could lead to rising dollar bond prices but a falling dollar (if interest rate expectations were reduced). The latter causes falling bond prices and falling exchange rates and much lower forward rates. Extra variables and uncertainties, such as possible treasury secretary intervention, especially those that bond traders can't get a clear handle on and can't feed the latest NAPM, say, figures into are just plain expensive and literally destroy value. Minimising this effect is almost the whole point of the FOMC and Bank of England MPC.

Laboured analogy time. Imagine you are being driven somewhere in a car. As you are driving along there are road signs pointing to your destination. Mostly the driver doesn't say much but follows the signs. Occasionally the driver says something like I think the next few signs will say straight on but I think there is a right turn ahead. What do you think if another passenger whose credentials you are not sure of starts shouting "WE'VE GOT TO GO RIGHT! QUICK TURN RIGHT! TELL HIM ED, WE'VE GOT TO TURN RIGHT!" -- is that stressful?

Posted by: Jack on October 1, 2003 07:58 AM

If interest rates climb high enough does this fit into the "starve the beast" theory?

There's an ugly thought for you.

Posted by: Iain Babeu on October 1, 2003 09:02 AM

Andre Boucher writes:

> And just to add in the short-term BLD is wrong, since he first
> wrote about this Sept 23, and since then long-term US
> interest rates have gone down and not up.

Unfortunately this won't do asa hypotehesis test in any case because there is more than one game in town. It is quite possible that rates will fall, they will just be higher than they would have been. Fear, Uncertainty and Doubt are the new ingredients.

Posted by: Jack on October 1, 2003 09:17 AM

It is high time to start looking at linkages between tax cuts for the wealthy investor class, job loss, government revenue loss and foreign trade deficit. The traditional protectionist position has been to slap tariffs on foreign goods. A question to be addressed is who is buying the foreign goods?

The investor class has seamless connections to the global economy and international markets. Traditional tax cuts to investors means they have more money to invest. If that money is as easily invested overseas as domestically and overseas investing is more profitable, then that is where the investments and job creation will go. Thus the tax cuts are doing little to stimulate domestic job growth.

If the money were not spent as tax cuts for the wealthy, where else might it go? During past downturns, it has gone to the states for infrastructure, worker training and health care. All three of these areas require or utilize domestic labor. Sure there are some instances of states buying some goods and services overseas, but most of their spending is domestic. By taxing the investor class more heavily, the dollars they would have invested overseas can now be invested at home where they can contribute to employment.

Instead of tariffs to slow down the purchase of imports, why not use taxation and then direct that spending to improvements at home? Bush tax cut policy is stimulating investment in overseas cheap labor markets while starving domestic infrastructure and worker training that is needed to maintain US competitiveness.

Posted by: bakho on October 1, 2003 09:18 AM

bakho, perhaps a comparison with Russia's oligarchs and their influence on the Russian economy would be appropriate.

Posted by: Jack on October 1, 2003 10:20 AM

bakho, perhaps a comparison with Russia's oligarchs and their influence on the Russian economy would be appropriate.

Posted by: Jack on October 1, 2003 10:31 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:27 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:32 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:37 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:42 AM

October 1, 2003

AP -- The Bush administration, insisting that it is doing everything possible to halt a troubling slide in manufacturing jobs, assured members of Congress on Wednesday that it was continuing to press China to allow its currency to rise in value as a way of boosting the competitiveness of American exports.

Posted by: anne on October 1, 2003 11:44 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:47 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:52 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 11:57 AM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 12:02 PM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 12:07 PM

You're right, of course, Jack. That's why I guess it's great being an economist - one's predictions always depend on possible worlds that don't exist. If one says interest rates would go up and they go down instead, well then they would just have gone down more. No way to test the remark, no nothing. And even better - you get to call everyone else stupid, and no one can ever call you on it.

But on the other hand, given that interest rates did go down since Snow's comments, would you at least agree that more likely than not, BDL is wrong (if indeed his prediction was about short-term rates - I'm still not completely sure)?

Posted by: Andrew Boucher on October 1, 2003 12:12 PM

Jack, How much money did the Russian oligarchs spend on workforce training?? How much did they put toward a manufacturing infrastructure?? End of comparison. I am not suggesting that we build gigantic monuments or large cities in Siberia, only that we appropriately INVEST in our future.

If a town does not have adequate sewage and water and roads, a new factory cannot be sited there. The US has been underinvesting in infrastructure for a long time. To give the investment class free reign to build facilities in cheap labor markets while neglecting our own infrastructure makes no sense to the society as a whole. If we do not do those things that make our labor force an attractive alternative to overseas, we will lose the competition.

Posted by: bakho on October 1, 2003 01:22 PM

I remember way back to the March 9-15 '02 issue of The Economist when it said about the steel tariffs that they were:

"so wrong it makes other kinds of wealth-destroying intervention feel inadequate."

I'd have thought that folks at the magazine would have started to lose their naivety and optimism then. Still, better late than never.

Posted by: Martial on October 1, 2003 01:39 PM

I remember way back to the March 9-15 '02 issue of The Economist when it said about the steel tariffs that they were:

"so wrong it makes other kinds of wealth-destroying intervention feel inadequate."

I'd have thought that folks at the magazine would have started to lose their naivety and optimism then. Still, better late than never.

Posted by: Martial on October 1, 2003 01:44 PM

Andrew boucher:
There's nothing like getting your word in edgewise.

bakho:
Jack was supporting your excellent post-sardonicly.

Posted by: john c. halasz on October 1, 2003 03:59 PM

john, you used capital letters! Nice touch :).

Posted by: Stan on October 2, 2003 08:35 AM

I was so surprized by john I forgot to quibble with Andrew.

Andrew, just because testing theories is harder in the social sciences doesn't mean it is impossible. I question the difference in outcomes in this instance since I'm pretty sure there isn't any, however I make my conclusion based on my knowledge of the field not ignorance of it.

Contrary to your post, the field is pretty good at predicting the effects of quite a few variables. It simply isn't ethical to prove it in most cases. Combined with the economic motivations of so many players, there are plenty of false prophets pushing snake oil.

The answer to this problem isn't to deny the effectiveness of the field, it is to teach everybody economic theory from grade school. The politics of economic exchange are too important to have most of the population ignorant of the major theories and research supporting them in a democratic system. People need a good foundation in history and economics to make rational decisions at the polls. Unless, of course, rational decisions aren't the aim...

Posted by: Stan on October 2, 2003 08:59 AM
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