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Friday, September 21, 2007

The Wile E. Coyote Moment?

Here is Paul Krugman on recent talk about a fall in the dollar. If you cannot get to the Economic Policy paper cited below, a working paper version is here:

Is This the Wile E. Coyote Moment?, by Paul Krugman: Lots of buzz suddenly about the possibility of a sharp fall in the dollar. The Canadian dollar is back at parity with the greenback; there are rumors that the Saudis are planning to diversify into euros, and maybe even that the Chinese might break the dollar peg. A nice summary at Barry Ritholtz's blog The Big Picture.

I could say that I saw this coming; the problem is that I've been seeing it coming for several years, and it keeps not arriving (and I don't know if this is really it, even now.) The argument I and others have made is that the U.S. trade deficit is, fundamentally, not sustainable in the long run, which means that sooner or later the dollar has to decline a lot. But international investors have been buying U.S. bonds at real interest rates barely higher than those offered in euros or yen - in effect, they've been betting that the dollar won't ever decline.

So, according to the story, one of these days there will be a Wile E. Coyote moment for the dollar: the moment when the cartoon character, who has run off a cliff, looks down and realizes that he's standing on thin air -“ and plunges. In this case, investors suddenly realize that Stein's Law applies - "If something cannot go on forever, it will stop" - and they realize they need to get out of dollars, causing the currency to plunge. Maybe the dollar's Wile E. Coyote moment has arrived - although, again, I've been wrong about this so far.

Much more about all this in a thoroughly incomprehensible paper I recently published in the European journal Economic Policy. Don't bother clicking if you hate funny diagrams and Greek letters.

    Posted by on Friday, September 21, 2007 at 03:06 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (21)

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