September 21, 2004

The Federal Reserve Moves Again

The Federal Reserve raises short-term interest rates to 1.75%:

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly. Despite the rise in energy prices, inflation and inflation expectations have eased in recent months.

I have a hard time imagining a world next summer in which the Fed is sorry that it did not raise interest rates today. But I have an easy time imagining a world next summer in which the Fed is sorry that it did raise interest rates. So I'm having a hard time understanding their thinking.

Posted by DeLong at September 21, 2004 09:08 PM | TrackBack

The banks are sick of cheap lending; now they want their cake.

I'm surprised they didn't wait until Nov. 3.

Posted by: Dragonchild at September 21, 2004 09:24 PM

Debt finance I'm afraid. There have been several sticky points in auctions recently. The buyers are increasingly becoming speculaturs and foreign exchange intervention like the BOJ. In order to finance spending, interest rates have to go up in order to make Treasuries more attractive. If the Fed refused to do this, there could actually be a debt sale crisis.

While economic management has become the raison detre of much theory and speculation about Fed action, first and last they are in the business of selling paper. No paper get's sold, and nothing else happens. The Fed has built up incredible institutional market-moving power by being able to dictate the terms and environment that it markets its paper in- but in the end even it cannot through management techniques wish away the fundamental unsoundness of escalating deficit spending.

Many things have been written about the US debt, but the most obvious point is that someone else must be willing to buy it. If you were looking at US debt, would you consider it an attractive investment purchase? Would you like to bet against long term US inflation in this environment of energy price escalations?

If not, then it shouldn't be a wonder that the Fed is raising rates. It knows it will kill the economy Brad, but it's a simple matter of flogging goods at an outdoor market. The price of that paper must be what the market will bear, and the market is decidely not interested in a declining yeild environment as a purchase.

Posted by: oldman at September 21, 2004 09:29 PM

Chinese take over the Fed!

- a more proper title. The Fed is trying to slow China - through its pegged exchange rate, Fed policy becomes China policy.

Oldman you mix the Treasury with the Fed.

Even as short term rates (set by Fed) are increased, long-term rates (set by the "market") are falling.

Posted by: Winslow R. at September 21, 2004 09:47 PM

Try imagining a scenario with the U.S. dollar !

Posted by: Andrew Boucher at September 21, 2004 10:05 PM

Even with the Fed raising the prime, mortgage rates have been declining of late. 2 years ago the Fed took drastic measures as insurance against deflation. With no threat of deflation, the Fed would seem reasonable to move back to a less drastic position. Besides $400+ Billion in deficit spending should be enough fiscal stimulus to let the Fed raise rates much higher.

Posted by: bakho at September 21, 2004 10:50 PM

Winslow has a view that reminds me of this one:
I'm not sure the playful xenophobia expressed there masks or illustrates a genuine concern.
There is another taker, to answer oldman's question (" If you were looking at US debt, would you consider it an attractive investment purchase?"), according to Pollock here:
detailing the interest rate arbitrage with Japan.
But the most interesting idea comes from poster dd who thinks that we'll shortly see some very interesting developments with Fannie and Freddie. I leave the details to him.

Posted by: calmo at September 22, 2004 12:25 AM

True, the oldman may have been speaking a little loosely, but I can't imagine Greenspan is indifferent to the financing of US debt. We had a big shortfall in 5-year note purchases by foreign banks a couple of weeks ago, which was made up by some masked man, who rode in out of nowhere and untied Polly from the tracks. Seems we've been skating close to crisis here.

Posted by: Martin Bento at September 22, 2004 02:34 AM

This is an exceptional period in monetary policy. The yield on the 10 year Treasury Note is 4.04%. Long term interest rates have fallen from the time is became clear a Fed tightening cycle would begin. I know of no other cycle in which long term rates fell at the beginning of a Fed tightening sequence. Either investors believe there is no danger of inflation or they believe the economy is weaker than the Fed has indicated.

The 4.04% 10 year Treasury Note points to the costs of investment funds and mortgages staying low. As long as this continues the economy grows at least moderately, and that is evidently what the Fed wants. Moderate growth will not help the labor market enough, but may suffice as the Fed gains firm control of the Federal Funds rate as the prime tool of monetary policy.

But, I wish the Fed had not raised the Federal Funds rate until the labor market had clearly improved.

Posted by: lise at September 22, 2004 02:47 AM

Investing in this bond market is especially difficult. Many older investors wish to keep a large percent of their portfolios in bond funds or bonds. But, with long term interest rates near 40 year lows there is little income to be gained from bonds. Income is not easy to come by from bond investments, or from dividends which are still quite low by historical standards.

Posted by: anne at September 22, 2004 04:16 AM

It is very hard to see any real problem with demand at any recent Treasury auction. There was, in fact, a shift from indirect to direct bidding at the most recent 5-year auction, but it is anybody's guess what caused it. One prominent guess among Treasury traders is that an account that typically goes through dealers instead went through the Treasury's new and improved on-line TAPS system. If that's true, notes went pretty much to the same buyers as always, but the statistics reported after the auction showed a marked shift in the path the notes took.

Bid-to-cover ratios at recent auctions have been higher than average. Demand for Treasury paper is quite good.

Posted by: kharris at September 22, 2004 04:52 AM

September 22, 2004

U.S. Seeks Cuts in Housing Aid to Urban Poor
By DAVID W. CHEN - New York Times

The Bush administration has proposed reducing the value of subsidized-housing vouchers given to poor residents in New York City next year, with even bigger cuts planned for some urban areas in New England. The proposal is based on a disputed new formula that averages higher rents in big cities with those of suburban areas, which tend to have lower costs.

The proposals could have a "significantly detrimental impact" in some areas by forcing poor families to pay hundreds of extra dollars per month in rent, according to United States Representative Christopher Shays, a Connecticut Republican. That extra burden could be too much for thousands of tenants, "potentially leaving them homeless," Mr. Shays wrote in a recent letter to the Department of Housing and Urban Development.

The changes would affect most of the 1.9 million families who participate in the Section 8 program, the government's primary housing program for the poor, including 110,000 in New York City. People in the program receive vouchers to help them rent private apartments from landlords who agree to participate.

For a four-bedroom apartment in New York City, HUD has proposed that the fair market rent be reduced from $1,504 a month to $1,286, a drop of more than 14 percent. For practical purposes, that means that a tenant must find an extra $218 to stay in that apartment, or else find something cheaper. A voucher for a three-bedroom apartment would be cut by 7 percent, with smaller cuts for smaller units.

In an interview last night, two top HUD officials - Michael Liu, assistant secretary for public and Indian housing; and Cathy M. MacFarlane, assistant secretary for public affairs - attributed the new national numbers to fresh data from the 2000 census and a new system that averages a city's rents with those of its surrounding suburbs.

Last month, however, the housing secretary, Alphonso Jackson, suggested a somewhat different rationale for the need to change the Section 8 program, which he said was growing too fast and eating away at other programs. In an Op-Ed piece in The New York Times, he wrote that the housing voucher system was broken and wedded to a fair-market-rent formula that did not reflect current conditions. Many rental markets around the nation have softened, he wrote, and vacancy rates in some areas are at their highest rate in decades.

Those trends, however, are not reflected uniformly around the nation, and particularly not in the New York area.

The new proposal, for example, concludes that fair market rents in two fast-growing cities, Las Vegas and Houston, should increase up to 11 and 7 percent, respectively, while rents in two New England cities, Boston and New Haven, should drop as much as 27 and 21 percent for large apartments. And yet, the proposal also suggests that the figure in New York should fall by almost 15 percent for big apartments, even though local data indicate that housing prices are climbing steadily.

Fair market rents function as the statistical benchmark for many housing programs, most prominently Section 8. As such, the dispute over the new formula represents the latest chapter of an escalating struggle over Section 8, which the Bush administration has declared is too expensive.

"Like hurricanes in the Atlantic, assaults on the housing voucher program by the Bush administration have been unrelenting," wrote Sheila Crowley, president of the National Low Income Housing Coalition, in the group's most recent weekly newsletter to its 5,000 members. "Any program will break apart if battered hard and often enough. If the program can be so destabilized that landlords, lenders and developers will give up on it, it will much easier to cut down."

Posted by: anne at September 22, 2004 05:59 AM


"Demand for Treasury paper is quite good."

Agreed. What puzzles me is whether a 4.04% 10 year Treasury Note should be comforting or worrying. Essentially we are still moving through the bull market in bonds that began in December 1981. The Vanguard Long Term Bond Index fund is up about 5.70% this year.

Posted by: anne at September 22, 2004 06:07 AM


Ya, the magnitude of demand and the level of rates go together pretty well - small investors have lots of competition for paper, so they aren't getting much return for their money. The curve has flattened from both ends - typically something seen late in a Fed rate cycle. With 3.0%-3.5% the popular call for "neutral" funds lately, we aren't THAT late in the cycle. Certainly, the Fed has not taken any of the traditional noises associated with signaling it is nearing the end of the cycle. That makes the long end tricky right now, so bond holders may be in for a somewhat better return sometime not to far off.

Posted by: kharris at September 22, 2004 06:16 AM


U.S. Seeks Cuts in Housing Aid to Urban Poor
By DAVID W. CHEN - New York Times

The Bush administration has proposed reducing the value of subsidized-housing vouchers given to poor residents in New York City next year, with even bigger cuts planned for some urban areas in New England. The proposal is based on a disputed new formula that averages higher rents in big cities with those of suburban areas, which tend to have lower costs.

Posted by: anne at September 22, 2004 06:17 AM

Does this strengthen the dollar, or weaken it?

Posted by: nanute at September 22, 2004 07:40 AM

Prof Brad Delong again shows he doesn’t understand ECONOMIC MOMENTUM.
Prof Brad Delong's blog ^ | 9/22/04 | Brad Delong

Posted on 09/22/2004 10:51:28 AM EDT by AdrianSpidle

Alan Greenspan, on the other hand, has shown a brilliant understanding and mastery of the tools he has (interest rates and money supply) to manage our economy’s momentum. He’s mastered the phasing and calibrating of his interventions to keep the US economy on an even keel while growing the national wealth with only one notable exception. And that exception was his unwillingness to reign in the bubble economy of Clinton’s second term with sufficient negative momentum inputs (rate increases).

With that exception, he has shown us how to leverage small rate changes timed early enough relative to the business cycle so as to prevent catastrophic crashes.

Does anyone know the algorithms

continued on

Posted by: Arrogant Adrian at September 22, 2004 07:53 AM

The change in the Fed Funds rate should have no particular effect on the relative value of the dollar. However, were Fed policy to weaken the economy in several months time the dollar could well strengthen. My guess is a fall in American import demand would lead to a stronger dollar.

Posted by: anne at September 22, 2004 08:51 AM


"Certainly, the Fed has not taken any of the traditional noises associated with signaling it is nearing the end of the cycle. That makes the long end tricky right now, so bond holders may be in for a somewhat better return sometime not to far off."

Certainly there is a flatening of the yield curve, and this is usually is a sign that the Fed is nearing the end of a cycle of raising rates. But, the Fed may wish a 3% Federal Funds rate and keep on raising for some time. Such raises might well leave long term rates about where they are now, and bond fund buyers could be facing low returns through this cycle.

Posted by: anne at September 22, 2004 09:01 AM

nanute, the forex market seems mad to me: after the rise yesterday the Euro jumped up more than 1%, when it should have gone down, today it goes down a 0.8 %, so I think nobody really understand how to value currency.


Posted by: Antoni Jaume at September 22, 2004 09:05 AM

I have an answer to these issues up at my weblog,, and it answers the amusing misconception that I might be confusing the Fed and the Treasury.

Posted by: oldman at September 22, 2004 09:19 AM

Anne, while I agree that a fall in imports would strengthen the dollar, it's also true that higher interest rates can help to prevent or slow capital flight. Investors are looking at a US equities market which is flat or declining, a US fixed return market where yields on safe investments-- especially on short-term instruments where Fed policy does effectively set rates-- are awful, and currency risk is on dollar holdings. Especially smaller (US) investors hesitate to invest abroad if there is any way to avoid it (fees, liquidity fears, etc.) But once they cross the threshhold and invest abroad, they might not be so willing to repatriate the money.

The proper way to deal with the current situation is to cut governmental deficit finance in the short term, reduce imports through energy sufficiency and internal development in the medium term, and develop export capacity in the long term. Stronger growth, which can exacerbate current account deficits but also makes the economy capable of financing them, is possible if tax cuts are directed to the bottom.

Quarter point shifts do not significantly affect long-term business planning. They do affect consumers, who should not be incurring more debt anyway, and investors. Smaller investors, especially, could start to take steps that they would be slow to reverse. The importance of the Fed action is, I would argue, to take insurance against a dollar panic, not to strengthen the dollar per so.

Posted by: Charles at September 22, 2004 10:00 AM

Kharris, the drop-off in indirect purchasing of the 5-year bonds was mostly from foreign central banks, as I recall. Would foreign CBs use the direct system? Why? Don't they have to have more transparency than that?

Posted by: Martin Bento at September 22, 2004 10:04 AM

Thanks Charles.

A number of major European currencies were allowed to float within a narrow range through 1992. At that time, currency speculators began to go after several of the currencies. There were balance of payments problems, and it was clear currencies like the Pound were artificially overvalued. When the British and French currencies were forced beyond the set ranges, the currencies were allowed to devalue. The result was a sharp drop in value of about 18%, but there was no economic crisis. The economies were helped by the fall in value of the currencies, and sharp stock market declines were quickly made up. Possibly we worry too much about the value of the dollar. I have heard a couple of Fed Governors say that the dollar was rarely discussed at Fed meetings, and we never a reason for rate adjustments.

Posted by: anne at September 22, 2004 10:33 AM

"When the British and French currencies were forced beyond the set ranges, the currencies were allowed to devalue. The result was a sharp drop in value of about 18%..."

Anne, that must have been the pound. The French franc went from something like 3.42 to 3.55 vs. the DEM, so it was nothing like 18%.

Posted by: Andrew Boucher at September 22, 2004 10:47 AM

Pretty sure Brad is wrong here, at any rate it can't be that hard to see what the Fed is thinking.

1.) If you need to lower rates and you haven't raised them you can't. On the other hand since we have raised rates we have reloaded our monetary options while the reloading was still a safe thing.

2.) Peruse this:

Granted, Berner can be a bit of a supply-sider at times but here is an enlightening exerpt.

"The longer real rates stay low, the more convinced investors will be that they will not change. Fed officials’ speeches in recent days suggest that [some] are warning about the lessons from the first oil shocks about monetary policy that stayed too stimulative for too long. History does tell us that as the funds rate rises in real terms, the Fed can afford to slow the tightening pace, but such a slowing has never occurred with a real funds rate below 1%."

ONE good counterpoint from the Economist this past week is that the price of oil may have more to do with supply bottlenecks and not the health of the dollar but I say better safe than sorry.

3.) A quarter point increase given all the expectations is basically the same as doing nothing. There is really no cause for hand wringing here.

Posted by: Michael Carroll at September 22, 2004 10:56 AM

As I remember, the official range for the franc was broadened to about 15% and then discarded. The European Stock Index lost more than 15% during the period of currency adjustments, then recovered quickly. What impressed me was the ease of economic and market accomodation to sharp currency changes.

Posted by: anne at September 22, 2004 11:29 AM

I can see a couple of reasons why the Fed's move makes sense even with evidence of a continuing "soft patch." The first is that to not raise rates would have sent a terrible message to the markets and business. Businesses are already lukewarm on expansion. Would leaving rates unchanged have helped? I expect that this soft patch could have become a very bumpy road.

The second reason may be related to real estate. Greenspan was castigated for not "popping" the equity bubble a few years ago. One aspect of moderately raising short rates now is that it puts some upward pressure on ARM rates. The usage of ARMs has helped sustain real asset price increases in some of the overheated local markets.

Posted by: Keith at September 22, 2004 12:05 PM

While increasing short term interest rates may slow the housing market, the is no reason to believe that the Fed wishes to see housing prices fall. Alan Greenspan has often noted how important rising home prices have been in preserving asset wealth and sustaining consumption since 2001. A decline in housing prices that is general could be awfully chilling.

Posted by: anne at September 22, 2004 12:31 PM

"As I remember, the official range for the franc was broadened to about 15% and then discarded."

The new bands were chosen to be so wide that speculators wouldn't dare to attack the franc a second time. The franc didn't come close to testing these new bands.

"The European Stock Index lost more than 15% during the period of currency adjustments, then recovered quickly. What impressed me was the ease of economic and market accomodation to sharp currency changes."

Frankly, I don't get your point. The sharpest market movements were in interest-rates, and this wasn't easy. The Bank of France had to close its window and so on. The French equity market had enormous moves, and was down sharply even though local banks were buying equities massively during this period (the Maastricht vote was right in the middle of the first PEAs). The economy was only mildly affected, but again at the end of the day the currency movement wasn't that big.

Posted by: Andrew Boucher at September 22, 2004 12:43 PM


Unless I am mistaken, there is no data series on central bank purchases of Treasuries at auction. The indirect bidder category is presumed to be mostly foreign central banks, but in fact, anybody who goes through a dealer is an indirect bidder. If some typical indirect bidder (big pension or mutual fund, for instance), not a central bank, had switched to a direct (TAPS) bid, it would have led to the sort of drop in indirect bids that would lead to suspicions of a drop in CB bids, but those suspicions would be wrong.

Treasury reworked the TAPS system to encourage more direct bids. There is recurring talk of big domestic accounts getting irritated at the rest of the market finding out when they place big bids with dealers. One way to chasten dealers for talking out of school would be to go direct.

I'm willing to be corrected on the point about there being no category that accurately reflects CB bids for Treasuries at auction, so let me know if I'm off track.

Posted by: kharris at September 22, 2004 12:47 PM

Anne, I agree that a general price decline in real assets would be unhelpful and unwanted. The advantage of a short term raise is that it really only impacts those parties financing with short money. And the use of short money is most prevalent in those areas with the highest prices and increases.

Although Greenspan may argue that real estate price increases have helped pull us along the last few years, do you think he is deaf to arguments that low rates have build some imbalances in the same time frame? Or do you think that he truly perceives that there isn't an issue in some areas? ("All real estate is local?")

On a similar note, when is a good time for us all to discover if Freddie, Fannie and Washington Mutual really know how to hedge? I say that it should be done while long rates are still low. This way we find out when only part of the country is impacted (i.e., those parts that are financing with short money.) Or do you think I am excessively concerned with the risk of some of these new financial titans?

Posted by: Keith at September 22, 2004 01:01 PM

The first worry of Greenspan lay in the weakening demand for Treasuries in Overseas markets, several Countries indicating they were reaching saturation with Treasuries. Esteemed Economists here and elsewhere fail to preceive that outside this Country; there is no perceptional difference between printing Treasuries, and in printing Dollar bills. I will assure foreign Banking institutions recognize the singular lack of difference. Greenspan had to raise rates, or face a flood of Treasuries on the World market.

What is the Economic model We are currently faced with: Government deficits--Federal, State, and Local--are escalating, Consumer Debt is increasing rapidly, average yearly American Job income is going down, American imports are increasing rapidly with a Trade deficit spread going Three-Alarm, and Tax revenues falling.

Answer: We need to tax Imports in a manner which does not adversely constrict Trade-but which reduces it by fifty percent. We need to tax the acquisition of Consumer Debt. We need to penalize Outsourcing and increase Exports. We need to cut Government spending by at least One-Third. We have to reimpose the tax levels present in the mid-1990s. The last thing We need is to curtail Entitlements, not expand them. lgl

Posted by: lgl at September 22, 2004 01:02 PM

Andrew Boucher, found my notes, of course you are right.

Still, I am impressed that for all the defensive activity by the central banks there was no significant problem getting past the sharp currency adjustments. I have trouble thinking the value of the dollar will become our problem.

Posted by: anne at September 22, 2004 01:11 PM

September 22, 2004

U.S. Regulators Question Accounting at Fannie Mae
By Reuters

WASHINGTON - A U.S. government review of the nation's No. 1 mortgage finance company, Fannie Mae, charges it with using improper ``cookie jar'' accounting to smooth earnings and calls into doubt past financial results, the company's board said on Wednesday.

The company's regulator, the Office of Federal Housing Enterprise Oversight, outlined to the company on Monday findings alleging accounting methods that deviate from standard practice, internal control deficiencies and a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures, Fannie Mae's board said in a statement.

Regulators told the company it used an improper ``cookie jar'' reserve to smooth earnings and in at least one instance, deferred expenses apparently to achieve bonus compensation targets, the board said.

Fannie Mae's stock took its biggest tumble in nearly six years on the news, plunging $5, or 6.6 percent, to $70.65 in early trading on New York Stock Exchange. It was the biggest one-day percentage drop for Fannie Mae stock since March 2003.

Posted by: anne at September 22, 2004 01:17 PM

What makes you so sure that the value of the dollar will not become our problem? If there is a real decline in the value of the dollar, and we have to pay more for imports, doesn't this have an impact on consumption here at home? Couple this with the fact that real wage increases have been relatively flat, and I would argue that a weaker dollar does become a problem for a consumer based economy. Granted, the amount of tightening displayed by the Fed yesterday won't have much impact on stabilizing the currency.

Posted by: nanute at September 22, 2004 01:59 PM

A less expensive dollar will slowly raise import costs to the extent that international exporters do not lower prices to maintain market shares. American goods and services then become more competitive both here and abroad. A small domestic rise in prices should be offset by increased demand for American goods and services.

Though I agree with Robert Rubin that a strong dollar is in America's interest, Brad DeLong explained that the dollar needs to be strong as a reflection of a strong economy. Adjustment of the dollar does not worry me given the economic weakness indicative of our debt.

Posted by: anne at September 22, 2004 02:14 PM

Anne, I think the case history more in line with my interpretation of the Fed's move is the Asian currency crisis. The issue, as I see it, is not only the equilibrium value but the path by which it's achieved. In Asia, there was prolonged dislocation and major inefficiencies. This contrasts with the relatively mild long-term effects you describe for the British experience.

Do we care too much about dollar strength? Probably; it is in my opinion a mistake (from the standpoint of national interest) to export so much manufacturing. But Bush has put the dollat on a path to major devaluation. If he succeeds in delaying adjustment long enough, the piper could be expensive.

Posted by: Charles at September 22, 2004 03:49 PM


American international debt is in dollars. The debt and dollars can be sold, which will dirve down the value of the dollar, but that will strengthen domestic godds and services suppliers. Why should I fret about a loss in value of the dollar, if it is correcting a trade imbalance? Imports are not a significant enough portion of the economy to drive prices by more than a bit. Besides, other central banks will wish to keep any decline of the dollar in some check for trade purposes.

Posted by: anne at September 22, 2004 04:24 PM

The value of the dollar becomes our problem if other countries feel our paper becomes devalued as a consequence, lessening demand and tightening terms of transaction and sales. In other words, who the heck wants to hold the debt of a hyperinflationary nation - certainly not the oldman. Nor would history indicate, non-politically motivated investors in international markets.

Posted by: oldman at September 22, 2004 04:41 PM

At a time when the 10 year Treasury Note is at 3.99%, the idea of hyperinflation is difficult to take as seriously as a slowing of price increases.

Posted by: lise at September 22, 2004 04:50 PM

anne, Charles:

As I wrote in another thread, I've been watching the trade imbalance evolve for 20+ years now. My belief is that the imbalance could not exist except for the "vendor financing" in which Asian governments have engaged by buying our bonds to prevent exchange rate adjustments, and that this grossly distorts both their economies and ours by disabling the pricing mechanisms through which "comparative advantage" should work.

From a back-of-the-envelope calculation, one might estimate that the $600 billion current account deficit we are head for represents about 6 million people on our side, and even more on the Asian side, working at jobs other than those they would have if true comparative advantage were revealed through unmanipulated exchange rates. It presumably also represents massive malinvestment on both sides -- they build too many factories, we build too many big-box discount stores and malls.

Posted by: jm at September 22, 2004 04:58 PM

Oldman maybe thinking of the economy as an unstable non-linear system that can go from state to state in the blink of and eye. These systems when viewed by linear approximations can surprise one. Hope this is not the case with our system.

Posted by: dilbert dogbert at September 22, 2004 06:44 PM

So, ~6 million workers employed in distributorship-tasks that could be better allocated than...~>6 million workers employed in gizmo-making tasks for those distributors? Why do you cash this $600B deficit as a market inefficency? Am I misled ( damn not again) in thinking that the TBills really constitute a postponed payment?

Posted by: calmo at September 22, 2004 08:12 PM

Sharp economic dislocations are a possibility to be aware of, but the guess is any sharp dislocation should it occur will be in our domestic markets and spread to our currency market. A decline in the value of dollar should not be a prime worry.

Posted by: lise at September 23, 2004 03:48 AM

Anne says, "The debt and dollars can be sold, which will dirve down the value of the dollar, but that will strengthen domestic godds and services suppliers. "

My point about manufacturing was just this, Anne. Increasingly, there are no producers of certain goods. American-produced shoes and textiles? They aren't to be had. So, as the dollar falls, it simply increases the trade deficit.

It's true that imports are seemingly a small part of the economy. But it's a huge economy. In very good round numbers, imports account for a trillion dollars. The CA deficit, half a trillion. If the dollar drops by 20%, and goods are inelastic, there's another $100 B sucked out of the domestic economy.

Sums of that magnitude are not negligible.

jm, I agree with you that the current situation represents malinvestment. We think we have to be the engine of the world economy. But the best situation is when the work is shared.

Posted by: Charles at September 23, 2004 09:04 AM

Well argued, Charles.

However, we are still a formidable manufacturing power, as well as a services power, and an agricultural and mining power. Relative exports will be bolstered nicely with a weaker dollar.

Posted by: anne at September 23, 2004 10:12 AM

It is precisely because the yeild is so low that we must worry, because we are setting up a situation where we must maintain or manage a continuing and increasingly large demand for our currency. This is inherently an unstable situ. The problem is not hyperinflation today, but should demand prove elastic tomorrow it would come home to roost all at once. Structurally unstable setups are not a preferred method of governance and planning national economies.

Argentina ran a long way before it went under. So long in fact that people forgot that there was any danger at all. This is the basic nature of the situation, that there are few warning signs and episodes of sudden accumulated impact.

Posted by: oldman at September 23, 2004 10:19 AM

There is no comparison between Argentina and America. Argentina sacrificed the domestic economy for the sake of pegging the peso to the dollar. Paul Krugman wrote of the developing problems in Argentina years before they became obvious. Argentina could easily have allowed its currency to fall in value, and avoided what became in effect a depression. We are not Argentina.

Posted by: lise at September 23, 2004 10:38 AM


Re "[Are not] the TBills really constitute a postponed payment?"

Since money is just a medium of exchange, the eventual payment can only come in the form of us sending the Asians goods or services that have real value to them. But due to the distorting effect of the exchange rate manipulation, and its corruption of comparative advantage, we have lost quite a lot of our capability to make things of real value.


Though you are not incorrect in writing that "we are still a formidable manufacturing power, as well as a services power, and an agricultural and mining power," we are not nearly as formidable as we would need to be to truly afford our current standard of living. If we were, we wouldn't be running a $600 billion current account deficit. Low-tech areas such as shoes and textiles (per Charles) are not the only ones in which we have no capability. There are numerous high-tech and "mid-tech" areas in which we have none or very little, and in which so much of the IP is held by foreign firms that it will be very difficult for us to establish any. Agriculture is such a tiny business that even if we were to export everything we grow, that would hardly dent our deficit (check the numbers!); I've never looked at mining, but I'd be very surprised if it's more than a fraction of our agriculture.

Posted by: jm at September 23, 2004 12:38 PM

The end is not near.... There is much to consider about goods and services exports. Simply consider the American drug and medical equipment industry or film or music or finance industries. Consider chemicals, and air craft. Consider software. We are the prime economic power in the world, and a decline in the value of the dollar would easily make us more competitive as an exporter.

Posted by: lise at September 23, 2004 12:59 PM

"Consider software".

You mean there's software that's made in the USA, not India?

(And, before someone says "Microsoft", they're moving R&D to India too.)

Posted by: Jon Meltzer at September 23, 2004 05:00 PM

kharris, I'm just going by what I remember FT saying when it happened. In any case, I would find it very surprising if no one were tracking purchases by central banks in other countries' debt. But then, I am often shocked at the financial opacity we tolerate.

Posted by: Martin Bento at September 24, 2004 03:37 AM