Global Imbalances and Monetary Policy

NY Fed president Tim Geithner gave a speech today on the implications of global imbalances for the conduct of monetary policy. Here's the speech. Brad Setser comments here. I'll update this post later today.

Update: Here's a follow up from the Financial Times. President Geithner believes the trajectory for the current account deficit is unsustainable, and it's not necessarily self-correcting in a smooth, non-disruptive fashion, but we just don't know for sure how rocky the road might be. In his view, the longer the trade gap builds, the larger the risks. Because of this, policies such as reductions in the federal budget deficit are needed to mitigate the risk:

US current account deficit ‘unsustainable’ – NY Fed chief, by Christopher Swann, Financial Times: Timothy Geithner, president of the New York Federal Reserve, on Monday dismissed the view that the US current account deficit was sustainable, suggesting the risk of a sudden fall in the dollar would grow the longer the trade gap widened. ... Mr Geithner said the problem could not necessarily be expected to solve itself. “Time does not necessarily help. The longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany that process,” he said.

“The plausible outcomes range from the gradual and benign to the more precipitous and damaging,” he said. “The size and duration of these [global] imbalances, perhaps the most visible of which is the US current account deficit, present challenges – and risks – for the world economy.” His warning came as Raghuram Rajan, chief economist at the International Monetary Fund, repeated his concern over the risk of a run on the dollar. “You cannot discount a run on the dollar. But you cannot fully quantify that risk at the moment,” he said ...

Mr Geithner ... does not see a role for monetary policy in responding to the current account by raising interest rates to slow domestic demand growth and so the demand for imports. Rather, he believes the risks on the external side make it more important for the Fed to keep inflation under control, to avoid adding to the problems and to preserve the Fed’s flexibility in a crisis.

Many economists have argued that the risks to the dollar from the bloated current account deficit are mitigated by support for the currency from Asian central banks... However, Mr Geithner said this should provide little comfort over the long term. “A prolonged continuation of the exchange rate arrangements that have given rise to the large increase in foreign official investments in US financial assets is unlikely to be consistent with the domestic requirements of those economies and for this reason many are already in the process of change,” he said.

“Even if we could be confident that the world would be comfortable financing the US on these terms for some time, that fact alone does not mean that it is prudent for the US to continue borrowing on this scale.” Mr Geithner repeated his call for US politicians to reduce the budget deficit. The fact that the US is using much of the money borrowed from abroad to finance public spending, he said, increased the dangers. If it was being invested in the productive capacity of the US tradeable goods industries, this would at least help the US to pay back its foreign obligations.

Comments

[Mr. Econotarian]

Don't worry, the current account deficit is offset by FDI dark matter.

[anne]

http://www.nytimes.com/2005/04/10/sports/othersports/10soldiers.html?ex=1270785600&en=f99d2e66e8ac1cb6&ei=5090&partner=rssuserland

April 10, 2005

Two Women Bound by Sports, War and Injuries
By JULIET MACUR

WASHINGTON - For 25 days at Walter Reed Army Medical Center, Specialist Danielle Green wondered if anyone could ever understand. But on the 26th day, a nurse told her: "A new female patient came in today. You have a lot in common."

"Really?" Specialist Green said, and the nurse nodded.

Like Specialist Green, the new patient was a 20-something firecracker, a 5-foot-8 former college basketball player, an Army soldier in the military police serving in Iraq.

Like Specialist Green, she also knew how it felt to have a rocket-propelled grenade shoot through her arm. Specialist Green's left hand had been torn off.

In the intensive care unit one floor below, First Lt. Dawn Halfaker lay in a coma, battered and swollen after surviving an ambush. Her right arm was attached to her body by sinews.

"But it's too bad," the nurse said on this day last June. "She's probably not going to make it."

They had shared a dream of playing professional basketball. Now these two women - one a black enlisted soldier from Chicago's tough South Side, the other a white officer from a pleasant San Diego suburb - were robbed of the natural gift that helped shape their identities.

Specialist Green, alone in her loss, wanted this new patient to live.

The week before, Lieutenant Halfaker was sitting in the back seat of an armored Humvee as it patrolled the quiet, moonlit roads of Baquba, a city 35 miles northeast of Baghdad.

Her vehicle rounded a corner....

[anne]

Darn, sorry, I obviously posted this on the wrong thread somehow. The post was meant for Paul Krugman's synopsis thread. Sorry.

[Emmanuel]

His warning came as Raghuram Rajan, chief economist at the International Monetary Fund, repeated his concern over the risk of a run on the dollar.

“You cannot discount a run on the dollar. But you cannot fully quantify that risk at the moment,” he said at the same meeting.

I'd like to see speculators mount an attack on the US dollar like Soros did on the British pound. It's going to be a massive operation without historical parallel, but speculators would do the world a big favor for once by reducing the dollar to the worthless piece of toilet paper that it of course is. Today's crazy huge imbalances need to be fixed pronto. Maybe famous dollar bears Gates and Buffett can get their chums to pitch in and short the greenback in FX markets worldwide in a sustained assault.

The prize will be a place in history as "the man who broke the Federal Reserve." Any takers?

[anne]

A fall in the relative value of the dollar would not bother me in the least, nor should or would the Treasury or Federal Reserve be bothered. But, the idea that damaging the American economy is needed in order to save the economy is absurd as Keynes taught almost everyone but mad Austrians many years ago.

[anne]

The dollar fell 40% and more against the prime world currencies after the Plaza Accord of September 1985, and there was no ill effect that I can find on the American economy. However Japanese asset inflation became severe as the dollar fell in value and trade losses in Europe combined with relatively high interest rates slowed growth, so I expect other countries to make sure any decline in the relative value of the dollar continues to be orderly and limited. There is every reason to have international assets.

[anne]

Again, if the dollar declines significantly this year as is quite possible there is reason to worry about the currencies or economies of Latin America. I am mildly disturbed about the recent strength of Latin American currencies, even about any strengthening of South Africa's currency.

[Robert]

Spitefully damaging the economy in order to save the economy IS absurd. But continued debasement implying beggar-thy-neighbor policy as an alternative to more prudent, balanced, and therefore sustainable economic policy is almost as absurd.

Contrary to Anne, I would be bothered by a fall in the relative value of the dollar because I am saver and both earn in USDs and retain (albeit a minority) some savings in USD assets. I have mistakenly taken the Fed at its word that it would protect the value of my unit of saved labor. Call me foolish if you like, Anne, for not positioning 150% (leverage of course!) of my assets in hard assets, non-USDs and non-USD assets. But if everyone did that, it would only highlight the unsustainability of the policy of monetization itself.

It would further bother me because the international monetary system is and remains, essentially a cooperative system, and debasement and devaluation "rewards" spineless political avoidance and profligate un-civic-minded behavior forcing adjustment upon other - more civic-minded OECD nations.

Finally, I would lament a much lower USD because it would result in a realization of the pent-up loss of value, since a lower USD will result in further asset price and other more widespread forms of inflationary pressure in the USA thereby crystallizing the implicit loss of purchasing power. Even a "wise asset allocation" would suffer from the pernicious effects of inflation resulting from monetization. And for what?!? What kind of positive allocative economic signals result from a medium of exchange that systematically deteriorates the moment it's created purely as a result of excessive creation? No. In a cooperative system where participants desire the continuance of the cooperative system, either no one cheats or everyone cheats, but its wrong and unsustainable to cheat and then force others to make the decision to bear the burden of adjusting to another particpant's cheating, or forces everyone to join wholesale in the cheating.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=6038&u=99|1|...

Belted Kingfisher
West Sayville, New York.

Fine argument, to balance my smug comments. We do have a problem :)

[anne]

There are signs, hmmm, that the Central Park red and gray screech owls have nested in a larch tree and one or the other, hopefully the female, likely the gray, has laid eggs, and is sitting on them, while the red hunts fat nutritious mice, even though it is January. Signs only :)

[Fred Hapgood]

> Don't worry, the current account deficit is offset by FDI dark matter.

That's a pretty interesting paper. Is there a hole in the analysis??

[Emmanuel]

It's Mr. Absurd here, reporting for duty ;-)

Let's face it: International monetary cooperation is dead. Even in the ol' US of A, the bond vigilantes have long since retired. The result? Deficits as far as the eye can see, stretching to infinity. The worst part is that no one really cares anymore to mount serious action, despite the perils of what may come when everything breaks down (and they will). The prospects for a Plaza Accord among the US, China, and the petrodollar states are distant. They're not in the same G8 clique, and they have conflicting geopolitical interests. In any case, currency issues barely even register during G8 summits.

So, if international cooperation appears to be a mirage, what are we left with? We can either wait for everything to blow up in our faces with ever-increasing stakes, or have someone do the deed sooner rather than later. I choose the latter scenario. The prize is immortality in the annals of financial history--be "the man who broke the Federal Reserve."

[anne]

Be as absurd as you wish, for there is an interesting idea here. You are suggesting that there is need for a market driven accord to drive down the value of the dollar, and whether that should materialize the idea is clever. The accord of 1985, to the extent it was successful, was accompanied by tax increases. Interesting, you are clever :)

[anne]

Remember, during the Clinton Administration there was a significant trade deficit though the budget deficit continually declined after the early tax increase and even turned to a startling surplus. The trade deficit however was large and grew sharply larger from the currency crises of 1994 and 1998. I asked Robert Rubin, who I rather like, about this at lunch. Should we have worried about the trade deficit more? Rubin told us there were deficits due to economic weakness and strength, and ours was then caused by strength. I would argue now the deficit is generally caused by fiscal weakness, as Rubin is arguing.

[anne]

Would, then, a privately driven correction be likely or even in order as might be implied from Paul Krugman to Warren Buffett? The turn here is few few countries wish a significant general decline in the value of the dollar. So, arrogantly, I am a little more sanguine than some awfully savvy observers.

[Robert]

So without policy action, without market enforcement, and without widespread panic amongst the polity, is it our destiny to continue to accrue imbalances until it becomes a mathematical impossibility to rectify? If this be our fate, then when the majority of our oblligations are held by "foreigners" or "the rich", our solution, the populist solution, will sadly lie in demagogic and dishonorable cries for repudiation.

And we'll stick Rob Portman on the case of negotiating a fair deal with our creditors, say 20 cents on the dollar as an opening bid.....?

[Fernando Guzmàn]

Gentlemen: Would be so kind to comment how developing countries can deal with high interest rates steming from the fact that trusts stablished them,regardlless, needs of developing.

Thanks much,

Fernando Guzmàn