October 03, 2003

A Dissent on the Dollar

An economist working for a large bureaucratic organization who thus needs to remain anonymous writes:

Brad, Paul Krugman, Kenneth Rogoff and a lot of other people who are much smarter than I am continue to make Econ. 101 level mistakes about the current account deficit and the dollar.

These authors--and the conventional wisdom generally--miss two, closely related points. First, foreign investors' risk exposure to dollar assets has essentially nothing to do with the current account deficit. Second, the ability of U.S. households, firms, and the government to service their liabilities has essentially nothing to do with whether those liabilities are owed to foreign or domestic investors.

Point one. Foreign investors don't hold an asset called "net claims" on the U.S. Rather, they hold various gross claims: bonds, equities, FDI an the like. These gross claims are the source of foreign investors' risk exposure to changes in the value of the dollar and the price of dollar assets. (If the dollar falls, for example, foreign investors suffer a home currency capital loss on their dollar assets; liabilities to the U.S., denominated largely in the home currency, aren't much affected.) The right metric for analyzing foreign investors' risk exposure to dollar assets is the share of dollar assets in total financial wealth. This share--gross exposure--is, ceteris paribus, boosted by a U.S. current account deficit, but ceteris often isn't paribus. Changes in the value of the dollar and dollar asset prices are also important source of changes in gross exposure. Indeed, from end-2000 to end-2002, foreign claims on the U.S. rose by $97 billion, against the two-year current account deficit of $875 billion.

Foreign investors' exposure to dollar assets, rightly measured, is in fact quite small. Roughly 12% of the total  foreign portfolio of marketable equities consists of U.S. equities--against the 47% U.S. share of global market capitalization. This share is no higher than in 1982. Roughly 11% of the total foreign fixed income portfolio is in dollars--against the 44% U.S. share in global market capitalization, and the 59% U.S. share in the AAA universe. This 11% share is up from 7% at end-1989; but all the increase comes from foreign central bank reserves accumulation, not increased private exposure.

In order to claim that the U.S. current account deficit is generating foreign "overexposure" to dollar assets, you need to say what share of dollar assets in foreign portfolios is "too high."

Point two. Essentially all U.S. foreign liabilities are denominated in dollars. Whether a U.S. household, the U.S. government or a U.S. corporation can make good on its obligations thus doesn't depend on whether they are owed to domestic or foreign investors. As it happens, U.S. household debt relative disposable income isn't particularly high by G-7 standards; neither are corporate or government debt relative to GDP. Granted, debt isn't a complete measure of balance sheet health. But the general point is that there's no reason at all to think that large U.S. current account deficits translate into difficulty in servicing U.S. external obligations.

Brad, and others, might justifiably complain that the U.S. savings rate is too low. But that's not the stuff of a dollar meltdown.

The two points above are closely related. In popular dollar meltdown stories, worries about the current account deficit itself is often the trigger for a flight from dollar assets.

Two disclaimers, and two other quick points.

Disclaimer one. I don't know what will happen to the dollar, tomorrow or at any other horizon.

Disclaimer two. Yes, I know the national income and balance of payments identities. With today's current account deficit, U.S. net foreign liabilities will EVENTUALLY reach something like 90% of GDP, and something like 5% or 6% of GDP would need to be shipped abroad as service income every year. But eventually is a very long time, and U.S. per capita income will probably double by the time we get there. As long as U.S. foreign liabilities are denominated in dollars, there's no implied payment difficulty.

Quick point one. Global financial integration means that global investors' exposure to foreign assets is rising, both to current account surplus and current account deficit countries. This simply underscores the fact that focusing on the current account deficit is the wrong way to think about the issue. Second, Obtsfeld/Rogoff-type stories call for a large dollar drop due to "sudden stop" in capital flows to the U.S. But remember, the U.S. is big. The $500 billion has to go someplace else. Maybe non-U.S. investment will grow by 20% for two years running, even as the U.S. tanks. But somehow I doubt it.

Posted by DeLong at October 3, 2003 10:26 AM | TrackBack

Comments

Foreigner saves by lending to the US. For this money the US buys stuff that the Foreigner produce and refuse to consume. I think we agree on that.

And we all clearly see a dollar solution: Foreigner gets a wage hike, US gets lower pay. This is managed by decreasing the value of the dollar vs. other currencies. It makes foreigner buying more and saving less, and if his boss can't afford to pay his higher wage, the foreinger is also forced to work and produce less. So he takes back the money from the US, which he uses to buy things from the US.

But there is also a time-preference solution: Everybody see that the business activity will pick up, so everybody consume more, so the US starts to do some seriuos work, and makes lots of goods by which it pays back the debt in goods to eager consumers worldwide.

Posted by: Mats on October 3, 2003 11:54 AM

I agree with this anonymous economist. As I've said in a couple of previous posts, I think it's more informative to look at the exchange rate as being the servant of the CA balance. The CA balance is negative now in the US because of a national S/I imbalance. The strong dollar is how that imbalance gets translated into lots of imports and not so many exports.

The implication is that the dollar will not weaken until the fundamental S/I imbalance -- and thus the CA deficit -- starts to shrink. And then, the weaker dollar will be the mechanism by which that improving S/I imbalance will lead to more exports and fewer imports.

This economist's emphasis on the solvency of individual firms being what matters for investment flows is exactly right, which is why the dollar will not crash any time soon. If anything, if you think the CA balance will grow next year, you might conclude that the dollar needs to get stronger, not weaker.

Posted by: Kash on October 3, 2003 11:57 AM

"working for a large bureaucratic organization" - refers here to the Federal Reserve Bank of New York, I guess. My first association was University: Can a non-professor openly express dissent at no or little cost at a university. I mean, really?

Posted by: Mats on October 3, 2003 12:29 PM

Agreed. The value or strength of the dollar is not a problem. Now, lack of private saving, the public deficit, a more regessive tax structure, increasing middle class income pressures, not enough demand to generate broad job creation, these are problems. The dollar is not the worry.

Posted by: anne on October 3, 2003 01:00 PM

"Disclaimer two. Yes, I know the national income and balance of payments identities. With today's current account deficit, U.S. net foreign liabilities will EVENTUALLY reach something like 90% of GDP, and something like 5% or 6% of GDP would need to be shipped abroad as service income every year. But eventually is a very long time, and U.S. per capita income will probably double by the time we get there. As long as U.S. foreign liabilities are denominated in dollars, there's no implied payment difficulty."

That long time is not so far away into the future, as far as I can imagine (real projections anyone?). A decade, perhaps, at the rate at which are going? That is what many smart people are worrying about. And 5% or 6% of GDP of required interest payments on principal means that virtually all growth is absorbed by interest, at best.

And if not, then it means that interest payments will be spiraling out of control, as a share of GDP. Regardless of the currency in which US debt is denominated, it's a troublesome prospect.

"Foreign investors' exposure to dollar assets, rightly measured, is in fact quite small. Roughly 12% of the total foreign portfolio of marketable equities consists of U.S. equities... Roughly 11% of the total foreign fixed income portfolio is in dollars..."

The real question is not what this exposure is right now, but what we can expect them to be 5 -10 - or 15 years down the road. I know that this is "the long-run", but at least I will (hopefully) be paying taxes in this not-so-long run.

To me, it is the combination of these two phenomena that is particularly worrying: i.e. foreign owned debt spiraling out of control. At that point, and probably well before that, investors will start to decrease exposure to US assets. And then we're heading to Argentina...

Why would we even consider entering the Southern Heminisphere, if I may say? Why don't we prudently stay away from strong winds and currents? Anyone interested in playing Russian roulette here?

Posted by: Jean-Philippe Stijns on October 3, 2003 01:04 PM

http://www.epinet.org/content.cfm/webfeatures_econindicators_jobspict

Faster growth in the third quarter helped drive the nation's payrolls up for their first gain in eight months.

Payrolls were up 57,000, driven by manufacturing's smallest decline in more than a year and gains in service employment. Yet the labor market remains weak, as unemployment was unchanged at 6.1% last month and the number of long-term unemployed (i.e., those who have been without jobs for at least six months) rose to the highest level in over a decade. The current level of job growth remains well below what is needed to lower the jobless rate....

Posted by: anne on October 3, 2003 01:05 PM

Anne: you're exactly right. The real problem is not the value of the dollar, or even the CA deficit, but rather the underlying national S/I imbalance... which is overwhelmingly due to the federal budget deficit. Fix the budget deficit, and you're 3/4 of the way home...

Posted by: Kash on October 3, 2003 01:13 PM

I think the big sign that The World Has Changed will be the first big US bond issue denominated in Euros.

I dont know when or even if that will happen, but it's going to be a major sign that the world has changed.

Oil prices denominated in Euros will be the other one.

Posted by: Ian Whitchurch on October 3, 2003 01:17 PM

"Second, the ability of U.S. households, firms, and the government to service their liabilities has essentially nothing to do with whether those liabilities are owed to foreign or domestic investors."

Isn't this a stronger claim than what most people are making? As I understand it, the claim is not that the U.S. won't be able to service its debts (i.e. pay interest), but that it will have trouble rolling it over (i.e. replacing the amount it owes now with new borrowings). And here the value of a currency does seem to matter - foreign investors don't lend to countries which look like they're about to devalue. But I guess I may be missing something...

"U.S. household debt relative to disposable income isn't particularly high by G-7 standards." I presume this means net debt, i.e. counting the house as an asset nixes the mortgage. But again I think the point here is that U.S. household debt, counting the house at 80% of its value, is particularly high. But again I may well be missing something, and would gratefully accept corrections...

Posted by: Andrew Boucher on October 3, 2003 01:28 PM

Econ. 101 question. Or, I misunderstood the question you just answered.

The CA can be used as one indicator for determining the future of interest rates. I have seen articles in places such as the Economist and here noting that if foreign investors decide dollar investments are less attractive (for whatever reason) then interest rates will have to rise to make up the shortfall with domestic savings. Now I *thought* that was the concern for the current CA, not the current CA in and of itself. But I didn't notice anything in the article that refuted that. Or rather, there is plenty that refutes that *in the long run* but not the short run. And right now we're worried about the short run and the potential effects on a short term recovery.

So did I misunderstand the question? Or the answer?

Posted by: Iain Babeu on October 3, 2003 01:29 PM

To clarify my position, I am worried about the long term health of a debt ridden American economy. Quite worried, but in the short run I am more focused on getting a spurt of demand that will allow us to grow fast enough to spur significant employment gains for many months. Though we had job creation this month, finally, we need far far more job creation over the coming years, and I am doubtful we will have that. The prime effect of the last tax cut is about gone. What do consumers do from here?

Yes, I am worried about our debts. Now, let's have several million jobs created.

Posted by: anne on October 3, 2003 01:42 PM

Andrew, I do think it's right to say that there is a tendency for "foreign investors ...[to not]... lend to countries which look like they're about to devalue". But there is also a tendency for investors not to lend to households which look like there about to get hit by unemployment.

Again there is no magic with the country border. It is just a way of making wages more flexible in both directions. So I don't think it would be far too much to claim that "... the ability of U.S. households, firms, and the government to service their liabilities has essentially nothing to do with whether those liabilities are owed to foreign or domestic investors."

Posted by: Mats on October 3, 2003 01:45 PM

Of the 57K jobs added almost 60% were part time not permanent. It's tough to convince someone that is unemployed by spinning this press release that things are coming up roses.

Posted by: mlhm5 on October 3, 2003 02:27 PM

Anne: I agree with you that we have a short-term job creation problem. I'm curious to know what you would recommend, if you were the all-powerful policy maker. The reason I ask is simply because my friends often ask me what a GOOD economic policy would be right now. I usually swallow hard and then answer "better tax cuts". Any other ideas?

Iain: You're right that if foreign investors decide they're less interested in investing in the US, then interest rates go up (and the dollar goes down). The issue here is whether today's CA deficit will cause foreign investors to shift their preferences away from US assets sometime in the near-term future. The original post here argues no, and I think I tend to agree.

Posted by: Kash on October 3, 2003 02:54 PM

Kash:

OK, let me put this yet another way. The CA is, essentially, a measure of market forces and the tradeoffs between interest rates, exchange rates, etc. The CA is, however, a very complete and useful measure. The original post argues that the CA does not put out any nehative signals currently regardin the holding of US debt (private, govt, etc.). But to me the evidence cited says that the CA has plenty of room to adjust and in the *long* term we really don't have anything to worry about. Yet what I'm worried about is a short term shock sending financial markets into a panic. Remember the dollar has slid 8% since 2002 (before Snow's little gaffe). Also, the desirability to hold debt is not just measured by risk adjusted returns (or what I like to call "greed - fear = risk adjusted return"), but other things as well. The short term shock possibility remains I think. Check out the following excerpt, especially noting that a large chunk of recent "investment" is short term loans.

From The Economist Sept 18th 2003:
http://www.economist.com/printedition/displayStory.cfm?Story_ID=S%27%298%2C%29PQ%27%20%21%20%23D%0A


Got enough greenbacks, thanks

Investors' recent behaviour suggests that foreigners' appetite for American assets may already be beginning to flag. In the past couple of years, the composition of capital inflows has changed significantly, and in a worrying direction. Private investors, who in the late 1990s were snapping up American shares, bonds and factories, more or less stopped buying anything but bonds in 2001. Foreign direct-investment flows, which reached a peak of 1.6% of GDP in 2000, have turned negative. And as purchases of American securities by private foreign investors have fallen, the current-account deficit has risen (see chart 6). According to Jim O'Neill, head of economic research at Goldman Sachs (and no relation to Paul), private portfolio flows and direct investment in the first three months of 2003 were worth only 1.4% of GDP. The remainder of the current-account deficit of 5.1% of GDP was funded by short-term speculative capital flows and official purchases of bonds by foreign central banks.


Does that make my puzzlement any clearer?

Posted by: Iain Babeu on October 3, 2003 03:17 PM

Ooops... I should have said "the CA can be used as" not "essentially, is..."

Posted by: Iain Babeu on October 3, 2003 03:20 PM

I liked the economist's non-alarmist style. But I do think there is a flaw in his first point. Or at least he does not follow it to its logical conclusion.

I think he is right to draw a contrast between the (roughly) $800 billion cumulative current account deficit recorded during the past two years and the $100 billion increase in foreign ownership of dollar assets over the same period. When the prices of dollar assets fall, foreign ownership of dollar assets will not rise in line with capital inflows, gross or net. Point taken. I do not quibble with the logic of the accounting, although I have not confirmed the numbers.

But is this combination of a large current account deficit and only-slowly rising foreign debt an equilibrium condition? Ought we expect it to continue?

It seems that one of two things are likely to happen.

1) Dollar assets will continue to generate subpar returns to foreign investors. In this case, foreign demand for our assets will eventually decline, thus making it more difficult to finance a presumably-unchanged current account deficit at today's exchange rate. You can fool some of the people some of the time, ... etc.

2) Returns on dollar assets will recover to normal. In this case, an unchanging net exports deficit (%GDP) will imply BOTH an acceleration of the current account deficit (%GDP) and a likely acceleration of the share of ROW financial assets allocated to the US. (Indeed, if the return rises much above the nominal GDP growth rate, America's foreign debt "burden" may go nonlinear absent a decline of the net exports deficit.) At some point, this will put downward pressure on the foreign-currency price of dollar assets, although we cannot say with confidence whether the adjustment will come primarily from a weaker dollar, higher (than otherwise) US interest rates or some other development that rations down US domestic demand.

My money would be on the second development rather than the first, given that US equity prices are no longer heavily overvalued and foreign capital inflows have incrasingly been concentrated in FIXED-income investments,whose returns are less subject to fluctuation. But either way, the status quo balance of payments dynamics are probably not sustainable.

The implication, I think, is probably not that America is screwed. Asset prices will probably change slowly enough to ensure a soft landing for the net export and current account deficits. So I share the author's lack of alarm over this. But I don't think he really presents an argument that gets around those advanced by Rogoff, Krugman and DeLong.

Posted by: Gerard MacDonell on October 3, 2003 04:38 PM

Hey, cool article. I am not an economist, and I've only had economics 101 so be kind to me.

I think I have to disagree with the original article. In and of itself CA don't really mean anything. To me, CA are a general indicator of economic competitiveness.

I believe what is really going on derives from the impact of large M3 growth. What's really happening is that people and companies and public entities have been using the liquidity to sell huge amounts of debt and using it to purchase imported goods of various kinds. And I think you are underestimating just how much the financial creation and exporting are doing to create *localised* inflation of asset values in local currencies, witness the relatively low yeilds on some truly atrocious debt around the world. This effect obscures the amount of american capital that presses up asset values. Monitoring the CA is important because it is a relativly quick and reliable means of judging economic strength. And the simple and bone-tired truth is, most of the money that has been made available has been malinvested. Most, if not all of the productivity gains in service dominated industries are not exportable. And yes, while we have a vast internal market that should be relatively insulated from foreign flows, the impact of a large and growing CA balance is inevitably a break on the ability to grow. And if we were not growing in the first place, then it is an accellerant to declines. To me, this is so because foreigners have demostrated a *capacity* to soak up demand growth. And that is largely so because the dollar is very strong and the cost of living is quite high in the major met. areas. Which means that labor, of the key bases of economic activity automatically prices us out of many markets. A corollary of that means that there is a higher burden for gov't as they pay for services that aid capital that will be repatriated. Also, fewer permanent well paying jobs in the area. -->Higher budget deficits. In the end, CA deficits are a handy way of telling whether a country can grow fast enough to finance debts.

Posted by: shah8 on October 3, 2003 04:52 PM

Hey, cool article. I am not an economist, and I've only had economics 101 so be kind to me.

I think I have to disagree with the original article. In and of itself CA don't really mean anything. To me, CA are a general indicator of economic competitiveness.

I believe what is really going on derives from the impact of large M3 growth. What's really happening is that people and companies and public entities have been using the liquidity to sell huge amounts of debt and using it to purchase imported goods of various kinds. And I think you are underestimating just how much the financial creation and exporting are doing to create *localised* inflation of asset values in local currencies, witness the relatively low yeilds on some truly atrocious debt around the world. This effect obscures the amount of american capital that presses up asset values. Monitoring the CA is important because it is a relativly quick and reliable means of judging economic strength. And the simple and bone-tired truth is, most of the money that has been made available has been malinvested. Most, if not all of the productivity gains in service dominated industries are not exportable. And yes, while we have a vast internal market that should be relatively insulated from foreign flows, the impact of a large and growing CA balance is inevitably a break on the ability to grow. And if we were not growing in the first place, then it is an accellerant to declines. To me, this is so because foreigners have demostrated a *capacity* to soak up demand growth. And that is largely so because the dollar is very strong and the cost of living is quite high in the major met. areas. Which means that labor, of the key bases of economic activity automatically prices us out of many markets. A corollary of that means that there is a higher burden for gov't as they pay for services that aid capital that will be repatriated. Also, fewer permanent well paying jobs in the area. -->Higher budget deficits. In the end, CA deficits are a handy way of telling whether a country can grow fast enough to finance debts.

Posted by: shah8 on October 3, 2003 04:54 PM

The author lost me when he said that foreign investors who suffer a capital loss on their assets do not affect the CA balance. Isn't it somewhat likely that they will limit their potential losses by investing less (or, contrariwise, if they believe that the dollar will strengthen, to invest more)? In other words, in short-term near-equilibrium terms, he may be right, but wrong in a long-term dynamic sense. Jean-Philippe Stijns is correct to point to South America, where there have been currency collapses. While it's true that much of that debt is denominated in dollars, meaning the decline of the currency directly affects the ability to service debt, I believe the principle holds even if the debt is denominated in local currency.

Similarly, his measure of dollar-exposure as ownership of US equities seems inaccurate. Many currencies are pegged to the dollar, so ownership of Korean stocks, for example, carries dollar risk. Furthermore, there is considerable direct ownership of American assets: the inventory Porsche holds in stock in America, for example. My personal experience is that when a currency drops, a foreign investor trims inventory, raises prices and otherwise attempts to wring the same drop of sweat out of a smaller handkerchief.

The author states that "there is no reason at all to think that large US CA deficits translate into servicing US external obligations". Shouldn't a "yet" be appended to that sentence? What would he say if governmental debt rose to 200% of GDP?

Anne and Kash have raised the question of savings and rightly pointed out that federal dissaving is enormous. But even when the budget was in balance, there was a huge CA deficit, and that reflects the failure of this nation to produce goods and services that others are willing to buy. The governmental deficits only make this worse.

Mats says it doesn't matter if a consumer or business owes its debt to foreigners or internally. In principle, this is correct. But what happens if the value of the currency suddenly drops? While payments on existing debt may not change, foreigners will be less willing to lend. In other words, they will expect higher interest rates. Hence,as Kash says, "the ability to service" debt drops with the currency.

I would agree with the proposition that the CA deficit itself will not lead to a crisis. But the CA deficit is symptomatic of a nation that has lost its capacity to produce what others want to buy in proportion to what it wants to consume.

Posted by: Charles on October 3, 2003 07:38 PM

Afterthought. A thought occurs to me. The veracity of many propositions can be tested by using a limit test.

Suppose that a current account deficit were so large that all property in the US were owned by foreigners. At that point, the maximum CA deficit that would be permissible would be that corresponding to the return on investment.

I haven't thought through the full implications of this model, but it seems as if it could help to provide benchmarks for what is and what is not a sustainable CA deficit.

Posted by: Charles on October 3, 2003 09:49 PM

Charles: >>Hence,as Kash says, "the ability to service" debt drops with the currency.>>
Yes, but the currency drops with the domestic houshold's overspending and lack of productivity. So, even under a fixed currency regime, the ability to service debt suffers. Which again de-mystifies the country border - it is mainly a way to change relative wages through flexible currency rates (apart of course from the Nat'l Gov's fiscal dealings).

Broadly though, I agree with the NY Fed Dissenter, anne and Kash. The currency haven't done much for a long time, and recently the dollar has had this slow 20% slide downwards - that's not what a bubble usually looks like:
http://www.economist.com/images/20030927/CFN690.gif
http://blogofpandora.blogspot.com/2003_09_01_blogofpandora_archive.html#106448679397622194

Posted by: Mats on October 4, 2003 04:35 AM

Well, I have read this post 3 times and have no idea what the point is really. I am not worried about a sudden drop in the dollar in the coming months, but I am quite worried about our long term economic condition. I am also worried about this absurd Administration talking down the dollar or treatening trade sanctions against China to mask domestic economic weakness.

Would I bet on some dollar weakening? Already have. We bought Pacific holdings last winter as there were dollar rumblings and Pacific shares became attractive.

What is the point of this essay? I really am puzzled.

Posted by: anne on October 4, 2003 08:15 AM

Mats

Perhaps you answered the question as usual. The writer is only questioning a near term worry over a dollar "collapse." Sure, but what does that tell us.

Also, the strength of Sweden's currency tells me there is sound economic policy at base.

Mats - you should allow comments!

Posted by: anne on October 4, 2003 08:19 AM

anne, a propos >>Sweden's ... economic policy.>>, there is a discussion on redistribution and the Welfare-State initiated by Arnold Kling at:
http://econlog.econlib.org/archives/000260.html
BTW I do allow comments, have posted Swedish birds, you name it, we've got it (try refresh)!

Posted by: Mats on October 4, 2003 11:38 AM

Mats says "Yes, but the currency drops with the domestic houshold's overspending and lack of productivity."

China has successfully pegged its currency to the dollar even though that means it is systematically undervalued. Other countries have managed for fairly long periods of time to hold the peg to the dollar despite forces that tended to depress the currency. The Asian currency crisis was in part because pegs at last failed.

So, I think that it's a matter of long run vs. short run.

I don't disagree with you that currency shifts can help to rationalize disparities in productivity. That's one of the forces that serves to push exchange rates.

Posted by: Charles on October 4, 2003 03:00 PM

Ok a couple of small points. In general I have some sympathy with the anonymous writer since I don't see how the dollar can really go down too far in a world were ex-US OECD growth is so constrained. But the problem is that if the dollar doesn't come down now in a genteel fashion, then there is the risk of a much more disruptive 'correction' later. This I take it is the force of the Roach/Rogoff view.

Secondly, no one is mentioning deflation. Fair enough, maybe it won't happen. But if it does, then this would have to be one of the criteria for assessing all that indebtedness, and especially household indebtedness if there is any kind of important asset price deflation. Just a thought.

Posted by: Edward Hugh on October 5, 2003 03:43 AM

I may not know much about economics, but I know that ceteris never is paribus.

ceteis sometimes _are_ paribus.

your, etc

Posted by: Andrew Brown on October 5, 2003 03:53 AM

Mats

Yours really is a fine blog and growing finer. I sure do like Sweden, in theory and reality. We might borrow more than a bit, but that will be in quite another time. Looking for lots more Swedish birds!

http://blogofpandora.blogspot.com/

Anne

Posted by: anne on October 5, 2003 07:55 AM

A currency peg that results in over-valuation can cripple an economy, but that is not the issue for China. China's currency may be under-valued relative to the dollar, though not necessarily with regard to other currencies. Chinese growth is not being constrained nor is our growth by the currency peg. Better fiscal policy would already have spurred more domestic demand in America, but try and get a fiscal stimulus that is aimed at the middle class.

Notice the EPINET.org jobs picture on October 3. The 33,000 jobs added in September in services that are "temporary" could be a problem, if demand does not lead to permanent employment.

Posted by: anne on October 5, 2003 08:04 AM

Folks, if we focus not on currency value but lack of sufficient private and public saving to avoid importing increasing amounts of capital relative to GDP, the problem is clearer. We should be exporting capital. Increasing amounts of American investment income will be sent abroad in coming years. There is a middle class income and wealth squeeze in the making.

Posted by: anne on October 5, 2003 09:24 AM

Anne, chronic undervaluation of currency has its demerits as well. Undervaluation discourages the purchase of (apparently) expensive, imported technology that might increase productivity, for example. The temptation then is to substitute labor-intensive enterprises.

That's fine in theory in this world in which there is far too much unemployment... but in places like China, labor is squeezed beyond human endurance. While many locally-produced goods are priced according to the local currency, imported goods are not. Those imported goods include things like drugs, oil and gas (and by extension electricity) and other basic necessities. Poor countries substitute inferior fuels, leading to serious problems like the brown cloud over China.

Obviously, currency valuation is a small factor in all of this. But if one witnessed, for example, the massive change in Japanese living standards that occurred between 1980 and 1990, one cannot fail to be impressed at how closely connected are currency valuations and the lives of ordinary people.

Posted by: Charles on October 5, 2003 02:36 PM

Charles

Well argued. I am thinking, and we will continue on another thread.

Posted by: anne on October 6, 2003 09:44 AM
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