Paul Krugman on the Dollar

At the risk of Krugman overkill, this is too good to pass up. Paul Krugman tries to see if he can tell a pessimistic story about the falling dollar:

Thinking about the dollar, by Paul Krugman: I have to do some teaching on the subject of the falling dollar and whether it’s recessionary. So herewith some ruminations. WARNING: FAIRLY WONKISH. [...read full post here...]

Comments

[paine]

WHY YOU GOTTA LOVE PAUL KRUGMAN
WHEN THE FINAL TRUMPET BLASTS

"There’s always the possibility that I’m missing something big,..."

[lonesome moderate]

No need to worry about Krugman overkill, this posting is exactly the kind of thing that I come to this blog to look for. The summary seemed a bit short this time out, I hope the copyright police haven't been coming after you.

[lonesome moderate]

This is of course one of the benefits of having your money as the world's reserve currency. If our foregn debt was denominated in Euros or Yen there wouldn't be any question about whether this was bad for us.

[Amps]

What will Treasury and the Fed do next?

[paine]

lm

its good to be ...the empire state

[Lafayette]

Krugman: Now along comes a change in investor expectations that makes the dollar weaker at any given interest rate. This also, with some lag, makes the economy stronger at any given interest rate, because a weaker dollar means stronger exports and less imports.

A somersault of imagination

OK - let's look at "E minus I" (Exports - Imports). Let's use 2006 numbers even if 2007 numbers are at about the same going rate (US Census Bureau) presently, but incomplete for the year.

US exports in 2006 ($) were at 1.44T (for trillion dollars)
US imports in 2006 ($) were at 2.2T
US GDP in 2006 ($) was at 13.21T
E minus I = 0.76T: (E - I)/GDP = 5.75%

Are we going to grossly diminish imports? Not bloody likely, given the permanent rise of oil import costs. Are we going to greatly increase exports. Somewhat, yes, but the net will not move that much. Methinks. (I too could be missing "something big", but let's assume we are doing "surprise free" forecasting.)

At less than 6% of GDP, is a change in the net E-I really, truly going to affect in any substantial way the US's total GDP? I think not. [I suspect that the "shop-till-you-drop" American consumer could very well come to the rescue - as they have in past recessions. But, miss a recession? Probably not.]

The balance (E minus I) remained fairly constant at around 6T throughout 2005 and most of 2006. They have dived (remember this is a negative number) seriously to about 9T in the past ten months.

I like exports. You like exports. Everybody likes exports. But they are not about save anyone's hide. Unless you can show credibly how either the increase of exports is going to magically outstretch the growth of imports.

Which will take a somersault of imagination. And, I'm no Cassandra.

NB: America is hooked on cheap oil, even if it is no longer cheap. America is also hooked on selling T-notes to cover its CA deficit. I wonder if that cost is not covered in the Government GDP accounts. But, I don't know.

[ken melvin]

How come the weaker dollar didn't send stock prices up, or did it and they are lower than meets the eye?

[lonesome moderate]

I like exports. You like exports. Everybody likes exports. But they are not about save anyone's hide. Unless you can show credibly how either the increase of exports is going to magically outstretch the growth of imports.

Which will take a somersault of imagination. And, I'm no Cassandra.

When I try to think about this, I have to do the somersault when I try to figure out how we won't see a major increase in exports and/or decrease in exports over the next two or three years. To believe that the current situation will continue, you need to assume that the Chinese, the Japanese, and the oil states will continue to buy dollars in the same way that they have for the past ten years. Otherwise, our trade deficit has to fall, since we won't have the hard currency (i.e. not dollars) to keep buying all this stuff.

What am I missing?

[Lafayette]

km: How come the weaker dollar didn't send stock prices up, or did it and they are lower than meets the eye?

Who would want to own an asset with a weakening value?

Once the dollar stops nosediving, stocks WILL BE again an attractive investment, due to the character of the American economy and its historic strength.

Till then, everyone outside the US has pulled off to the sidelines to see how things evolve. The game isn't worth playing.

Most people don't understand the nature of the subprime mess. Neither do I. I am not a finance expert.

But, it would seem to me that until this debt is assumed as a bottom-line loss (and heads roll) and some of it (the moderately good bits) is restructured/repriced/resold, then people will react to the news about financial losses in American credit institutions. That will take till the end of the year and perhaps beyond.

We just got over the initial bit where idiot Talking Heads on TV tell us that the sub-prime scandal is "nothing to get bothered about".

[Lafayette]

LM: I try to figure out how we won't see a major increase in exports and/or decrease in exports over the next two or three years.

Because, though world growth is surging, a lot of that is being met by internal growth. As in China, which is developing (finally) a durable internal consumer demand. That demand will be met, for the most part, internally.

If worldwide growth is steaming ahead at 5% per annum, how is 5% growth in exports going enhance very greatly US GDP, when exports represent a minor percentage of total GDP?

It is American consumer demand that will have to be the recovery's motor. Which is why another interest rate cut becomes inevitable.

To believe that the current situation will continue, you need to assume that the Chinese, the Japanese, and the oil states will continue to buy dollars in the same way that they have for the past ten years.

That is a lonnnnng assumption given that they have been dumping the dollar. Why do you think it has been nose-diving?

Otherwise, our trade deficit has to fall, since we won't have the hard currency (i.e. not dollars) to keep buying all this stuff.

That is not the way the world of finance works. A country like America doesn’t “run out of currency”. But, it can become known as a bad debtor. How?

It simply puts out more T-notes with which to buy currency to pay for the imports. Because it is putting ever more T-notes onto the market, their interest-rates must increase to attract investors – to cover the risk of holding them whilst the dollar has been declining. And because national Treasurers figure they have been holding more than enough dollars in their reserves.

But, those T-notes outstanding must be repaid at interest. Meaning the Treasury must either churn over the debt (by selling even more T-notes) or simply pay it off from the national budget funds. This latter option means increasing taxes to obtain the revenues to pay off the debt.

At a certain moment, the camel’s back may, indeed, break. Nations will refuse to hold dollars (T-notes), as they have refused to hold the currency of other countries that have been in similar debtor situations.

Whereupon, Uncle Sam goes hat in hand to the lender of last resort - the IMF. And, the IMF experts come walking in telling the PotUS how he/she must restructure budget expenditures to bring back the nation’s solvency. (The new head of the IMF is an ex-Socialist from France.)

Wow! I should write that into a Hollywood scenario – then I could go on strike too! ;^)

[Movie Guy]

Is there a clear concensus on where the U.S. is headed economically? I read conflicting so-called expert opinions.

If we're in such a mess, when do the shoes fly off? And how do they put everything back together thereafter?

And what should U.S. citizens consider doing to counter the effects of whatever is supposedly going to happen? I'm not ignoring the effects on citizens of other nations, rather I am trying to understand how much damage will actually be felt in the USA and what actions American citizens should undertake to minimize risk exposure to whatever level of economic upheavel may or may not occur.

[Lafayette]

MG: If we're in such a mess, when do the shoes fly off?

You looking for a smoking gun, along with its culprit? Look in the mirror.

The sub-prime mess is a shameful scandal, borne on the wings of the credulity of Americans who thought they could get something for nothing and agents who sold them such fool's gold. Flip a condo in three months and make a million. Flip a house in a 12 months and make 50% (in some places).

It is of the same stuff as the dot.com boom; which consisted of an hallucinatory belief in a technological wonder, supposedly a money spinner that spun only misery for most. Billions in savings were wiped away, belonging to credulous people who believed the unbelievable. Whilst a select group of those "in the know" IPOed themselves into a fortune.

When are we ever going to learn? Because until we do, this sort of naive madness will only repeat itself.