Comments
As the WSJ is forever pointing out, there are two methods of reducing national debt to GDP ratios: either stop bingeing, or grow the economy.

One method is preferred by Pessimists: restrict bingeing. The other method is preferred by Optimists: grow the economy. The Pessimist’s view loves government solutions; the Optimist’s view likes open-market solutions.



Written By: a Duoist
URL: http://www.duoism.org
This has been inevitable for some time, and I’m still amazed how many people ignored the warnings and warning signs, and didn’t see that the massive debt increase after 1981, combined with the unsustainable current accounts deficit, created an economy built on illusion. It’ll be painful, but really, a recession is probably the only way to re-balance the economy. After 9-11 the Feds decided to continue cheap credit to avoid economic disaster after a terror attack. Understandable, but what that did is it allowed the property bubble to grow to replace the stock bubble, all of it based on debt. The real story here is why more people didn’t see it coming! It may be that those of us who did were making warnings about this back in 1999 and 2000, and we appeared to be wrong as the economy kept appearing healthy — it was easy for people to get used to things going well, and not see the extreme weakness in the fundamentals of the economy. (People are doing the same thing with oil, not accepting the reality that the Mideast is near or at peak production now, meaning problems will come there too). This rebalancing is going to alter world power distribution and the nature of global politics in coming decades. The great boom of 1945-2008 is over, we’re entering a new era.

To the first comment: of course growing the economy would be good. How do we do that and cut debt? How do we fix credit markets, since credit is needed for economic growth. "Grow the economy" sounds nice, but without a practical plan that deals with the realities of the current structural imbalances it’s just a slogan.

http://scotterb.wordpress.com



Written By: Scott Erb
URL: http://faculty.umf.maine.edu/~erb/blog.htm
I mostly agree Scott, but there is a lot more to it. While Greenspan and our government have repeatedly purposely encouraged debt expansion to avoid eliminating levered players, and thus encouraged excessive risk taking in the financial sector, we also had a grave underestimation of risk and overestimation of potential returns to various assets across the spectrum. That is an intellectual failing more than a policy failing.

In addition I don’t think it is right to say the US economy was fundamentally unsound. The price we gave to assets was ridiculous, and thus the risk in those assets was way above what we thought it was. Just listen to the legions of very smart people who claim that assets are generally severely under priced, rather than finally priced appropriately (or in the case of housing, on the way there.) They still think of this as an aberration, a "black swan," that has not changed fundamentally how they price assets.

Most of the economy was fundamentally sound, and the US had enormous strengths, which allowed the game to go on much longer (and thus much more dangerously) than otherwise.

Interestingly two schools of thought come to similar conclusions here, which I think are right. The Minsky followers note that stability is inherently destabilizing. Stability (which both our fundamental strengths and our policies encouraged) leads people to believe the risk of leverage is relatively small, thus encouraging more and more to be applied.

Sadly, as leverage increases in the economy it skews the distribution of our economies fruits toward the users of leverage (the financial industry most obviously) and away from the rest of the economy (especially workers.) This explains a large part of the distribution of wealth issues people have been harping on (though it is less of a problem than many suppose.)

Also sadly, and here the Austrians come in, it doesn’t actually increase the total returns of our economy. As leverage explodes the economic return to leverage declines in theory (and declined in fact.) Thus our economy produced inflated assets, but grew no faster, and at the end slower, than under less leveraged conditions. Thus we have the illusions of the late term Clinton boom. Lots of consumption and investment based on debt and overpriced assets. Earnings were actually poor during the late ’90’s, and economic growth just a bit above average. I am not blaming Clinton for that, but that is what we had. When those assets deflated we inflated other bubbles, due to policy and intellectual confusion.

Duoist:

We will have to grow out of it whether we binge or not. However, if we are deleveraging and not binging (not that I think binging will help near as much as Krugman and others believe due to a lower return on leverage with leverage at these levels) but if we are paying down debt and saving more, then economic activity has to adjust to that reality. That means slower growth. That means more defaults and write downs. Generally when there is little leverage, increasing it adds to economic growth. When there is a lot it adds little. The opposite is true as well. When there is little savings relative to debt reducing leverage crimps growth, with diminishing effects as leverage decreases.

We are at the level of major dislocation from reducing leverage. In effect we are reducing the supply of money dramatically, while before (through leverage) we were increasing the money supply. Whether one is a Friedman disciple, Keynesian, Austrian or any other kind of economist, all will say decreasing the money supply hurts growth. With lots of levered players the impact is massive because their assets and cash flows decrease, but their debts remain the same. Thus someone is likely to blow up. The opposite with inflation (which is what we are likely to eventually attempt) assets and cash flows increase, the debt obligations do not.

The question is likely to be, do we inflate our way out of this through increasing leverage or through the printing press? Either is unfortunate (nor are they really that distinct) but I would prefer the latter if that is what it comes to. We already know where increasing leverage leads.

Better would be triage, let many go under, keep some afloat, inflate the money supply to match the deleveraging as best we can and endure a painful recession (in earlier parlance that would be a depression, but that term is out of fashion these days.) The way we are going now we are risking a Japan like decade with inflation thrown in.

Written By: Lance
URL: http://asecondhandconjecture.com
Thanks for the well written explanation in your comment, Lance. I see your point about the fundamentals of the economy having maintained considerable strengths, the weaknesses I refer to are current accounts deficits that reached 6% of GDP at one point, the dramatic increase in debt, loss of manufacturing jobs, and reliance on foreign funding of our debt. I also find it interesting that many of these imbalances begin in the mid-80s, also the point where the world economy became defined increasingly by globalization. Perhaps we have economic regulations and institutions built for an international system in which national economies compete and trade, while the world has become one where borders are less important.

Written By: Scott Erb
URL: http://faculty.umf.maine.edu/~erb/blog.htm
" Lots of consumption and investment based on debt and overpriced assets"

I would not classify this as investment anymore than I would government transfer payments which go to subsidize consumption, although there are some who do. This ’investment’ was, in reality, the private sector analog of transfer payment. The greatest beneficiaries in both cases are the bureaucrats who process the paperwork.

Written By: timactual
URL: http://
Tim,

True.

Written By: Lance
URL: http://asecondhandconjecture.com
the unsustainable current accounts deficit

It’s incorrect to include this in this particular discussion, when only a fraction of it is in fact "debt." It is correct that it was "unsustainable" in that it couldn’t continue to increase at the rate it was, but by and large it’s not debt. There’s no debt created just because I buy a Chinese-made toy, Korean-made electronics or Swiss chocolates.

Moreover, current account deficits are not inherently bad. Regardless of what you may have heard from Warren Buffett, international trade is important, and it exists because domestic producers are not competitive.

(People are doing the same thing with oil, not accepting the reality that the Mideast is near or at peak production now, meaning problems will come there too).

The Middle East was, but now they’re looking at production cuts. The reason we saw oil prices spiking was because, at the time, global production was right at the limit.

Of course, the limits in the Middle East were a matter of availability, and in the U.S. the limits are what government sets. There are plenty of oil and natural gas deposits here, but the chief anti-growth party doesn’t want Americans getting at them.

loss of manufacturing jobs

This is far more the result of technology than foreign trade. American manufacturing output is producing more than ever with fewer workers.

And do you know that China itself has lost millions of jobs over the last couple of decades, because of productivity increases?

and reliance on foreign funding of our debt

Not to say that any amount is debt is fine, but foreign financing of national debt is not inherently a bad thing, and our relationship with China is very much a two-way street. China needs foreign reserves as collateral for its teetering banking system, and it’s easy, efficient and safe to take all the dollars from American buyers and use quite a lot to buy U.S. Treasury securities.

An old joke has recently been resurfacing: if I owe you a hundred dollars, I have a problem, but if I owe you a million dollars, you have a problem. Right now it’s China who has the problem, and they’re the first (apart from the U.S.) to breathe a sigh of relief that the dollar is strengthening.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
Perry - I agree in general that current accounts deficit and borrowing from foreign lenders is not in and of itself bad. But when the current accounts deficit gets over 5% of GDP, that’s a sign of a major imbalance. Also, though the discussion was about debt originally, I mentioned "weak fundamentals" of the economy. Lance correctly noted that there were fundamental strengths as well, and I responded that this deficit was an example of where the fundamentals are weak. Over 6% of GDP, as it was for awhile, just can’t last. I also doubt very much that we have that much in the way of oil and natural gas — at least not enough to make a long term dent in world production numbers. I’ve not seen anything really suggesting we could, clearly known Alaskan and off shore oil finds are nothing spectacular.
http://scotterb.wordpress.com

Written By: Scott Erb
URL: http://faculty.umf.maine.edu/~erb/blog.htm
Perry,

Good comments, but some further discussion is necessary.

Current account:

While it is not debt in the sense of leverage, it does represent a claim on future production. A dollar is a form of debt, it just claims no interest. When the Chinese (or whoever) sell us something, the dollar is a debt that must be honored, though fluctuating exchange rates make the worth of that future claim variable.

Thus:
An old joke has recently been resurfacing: if I owe you a hundred dollars, I have a problem, but if I owe you a million dollars, you have a problem. Right now it’s China who has the problem, and they’re the first (apart from the U.S.) to breathe a sigh of relief that the dollar is strengthening.
I have used that same joke about China and the idea that foreigners funding our debt gives them some enormous power over us. The problem is that whether there is a dollar crash or not, we have to honor those claims. I would love it if we could keep on consuming Chinese goods at the cost of sending over little bits of green paper, and then funding our borrowing by having them lend those same bits of paper back to us.

Unfortunately we know that cannot go on forever.

Thus, when those dollars are repatriated they will be buying our production and we will not be importing as large (in relative terms) a quantity of theirs. If we export more and import less that means we are consuming less. Thus our standard of living is by definition declining, the reverse of our situation now where we are consuming more than we produce. As Dale and I suggested in the podcast, we are likely to get those trade surpluses everybody has been asking for "good and hard." When framed that way, as a claim on future production you see that it is a form of indebtedness.

I agree that it is not inherently a bad thing, and have argued that many times. Especially when as the reserve currency we should have a structural trade deficit so that other countries can use our dollars to back their own currencies. We function as gold did in the past. Just like with gold as a currency, producer countries (in this case just us) can export that currency for goods. My belief is we have exported far more than was needed to function as a reserve for other countries several years ago.

There are plenty of oil and natural gas deposits here, but the chief anti-growth party doesn’t want Americans getting at them.
True. In fact, we have enough oil in tar sands and shale to power the world for a long time right here in the US. Brazil may have deposits as large or larger than Saudi Arabia, and who knows how much is off the coast of Africa. It is more expensive oil though, and thus oil will generally be more dear in the future.
This is far more the result of technology than foreign trade. American manufacturing output is producing more than ever with fewer workers.

And do you know that China itself has lost millions of jobs over the last couple of decades, because of productivity increases?
Very good. Once again, arguments I have made. China is fast outsourcing large numbers of manufacturing jobs to other countries as well. Still, we will likely have to manufacture more in the future to cover our liabilities (including the current account deficit.) If we are not competitive enough to do that then the dollar will adjust until we are.

Written By: Lance
URL: http://asecondhandconjecture.com
1. Running current account deficits can also occur when you have foreigners investing in your country.

2. China only buys the Treasuries because it wants to sterilize all the dollars its getting to avoid having the RMB appreciate too fast. They have let it slowly appreciate though, from 8.2 to 6.8. Oh, and for everyone who moans about a weak dollar in America, I would guess there are ten times that many Chinese moaning about the strong RMB. (I have argued with my Chinese colleagues that they should have also opened up more to trade instead of demanding joint-venture investment for market access, but that’s too late.)

3. I agree that the US will have to do a lot more manufacturing and this will come about when the RMB is correctly priced and the China market more open.

4. Technology is absolutely the biggest killer and creator of jobs.


my four cents.

p.s. supposedly the entry of the Chinese into world markets created an extra trillion dollars of wealth. (I forget exact number from This American Life podcast) This would have started around the 1985 period in your graph, and have really taken off in the late 90’s to now...are these things related? It seems to me they are, and we are seeing that too much liquidity too fast goes to stupid things.

Written By: Harun
URL: http://
Anecdote on Chinese manufacturing have to outsource:

We were talking with a Chinese sofa factory that is now opening a Vietnam plant. This company did not exist 10 years ago, and already they are forced to move to another country. It used to be that it took decades for industries to move. Now its done within a decade.

Eventually convergence will occur and sofa making will end up back near the consumer or the last place it lands that keeps some kind of comparative advantage.

I’m saying buy Ethiopian land now, while its cheap.

Written By: Harun
URL: http://
"many of these imbalances begin in the mid-80s,"

I think you will find most of them predate the ’80s.


"it [a dollar] does represent a claim on future production"

Does not a dollar spent domestically also represent the same?


"If we export more and import less that means we are consuming less. Thus our standard of living is by definition declining"

Assuming, of course, that domestic production hasn’t kept pace and doesn’t make up the difference.

Written By: timactual
URL: http://
Harun,

Your four cents are worth a lot more than that. All of that should be considered in the mix.

The investment point especially, as the investment actually leads to production that the dollars can eventually be used to claim. Unfortunately most of the "investment" has been in our governments ability to tax future earnings (treasuries)or guarantee the service of mortgages (Agency debt)than in productive investments. Though arguably some percentage of government debt finances projects which will lead to increased production in the future. I am somewhat dubious that much of it does that, but others mileage may vary.

The connection to the desire of the Chinese (and others) to avoid appreciation of their currency is exactly right, and that dynamic explains a huge amount of what is going on here. Hopefully the Chinese realize they have to make that adjustment for their own sake.



Written By: Lance
URL: http://riskandreturn.net
Tim,
Does not a dollar spent domestically also represent the same?
Sure, but by definition it is claims that are exchanged here, thus accrue to our benefit collectively.

When carried out with other nations deficits accrue to our benefit, once we run a surplus to pay that claim back it accrues to others benefit.

Domestically if I spend more than I make, borrow the rest to fund it from a bank, eventually I have to pay it back. Same basic principle. My current lifestyle increases, my future lifestyle has a lien on it eventually.
Assuming, of course, that domestic production hasn’t kept pace and doesn’t make up the difference.


Good point, and my language was imprecise. I should have said a lower standard of living than otherwise. In absolute terms it may increase. The point is that our consumption of goods and services will increase slower than our production of those same goods and services, just as our consumption of goods and services grew faster than our production over the last few decades.

As a practical matter the adjustment of large reductions in leverage, currency adjustments and the shifting of productive capacity and capital leads to recessions, always, and slower overall growth. How long that process lasts is more variable. Thus we are seeing a reduction in our standard of living in real time at this point.

Written By: Lance
URL: http://riskandreturn.net
"the adjustment of large reductions in leverage, currency adjustments and the shifting of productive capacity and capital leads to recessions, always, and slower overall growth"

Any suggestions where I could find some math. models on that?

Written By: timactual
URL: http://
Actually there a number of sites that do that, econbrowser is a good source, but I find most models very unreliable. They assume equilibrium as the norm, or at minimum the tendency to move towards it. In reality the world is far messier than that. It is late, but I may delve into why later. My own opinion is that any large shift does that, regardless of reason. Capital (financial, physical or human) does not move typically in rapid fashion unless forced to. It has to be liquidated. Thus, if that is happening across an economy it leads to economic dislocation. That isn’t necessarily a long term bad, just necessary.

Written By: Lance
URL: http://riskandreturn.net
"The connection to the desire of the Chinese (and others) to avoid appreciation of their currency is exactly right, and that dynamic explains a huge amount of what is going on here. Hopefully the Chinese realize they have to make that adjustment for their own sake."

I doubt it will happen fast, because they have a very mercantilist attitude (or maybe more charitably they worry about killing the jobs machine.) Plus they now have a very robust industrial base that is still attractive for foreign investment...why build a factory in Kansas when China beckons? Until its becomes a "no brainer" to build it in Kansas. Oh, for a while this year all of our customers got excited about Vietnam, but I think that’s about over too.







Written By: Harun
URL: http://
Hmmm, I have not had any beer yet, but my writing and editing in the comment approached at least a 3-beer level of un-intelligibility.



Written By: Harun
URL: http://
Perry - I agree in general that current accounts deficit and borrowing from foreign lenders is not in and of itself bad. But when the current accounts deficit gets over 5% of GDP, that’s a sign of a major imbalance.

Historically, yes. Other OECD nations tend not to carry current account deficits of our magnitude for very long, but:

1. None were the source of the world’s premiere currency.

2. None were a quarter of the world’s economy.

3. None were the world’s single largest debtor nation, as well as the most attractive place to invest.

For these three reasons, the U.S. could maintain a larger (as a % of GDP) current account deficit than any other developed country.

This is where free markets have the power to judge "unsustainable," and where individuals have no such ability. How do you know that it isn’t at 4.9%, or 5.1%, or 7%? Macroeconomists were saying that 3.5%, then 4% was "unsustainable." Today I look back on my senior thesis on the current account, proclaiming "unsustainable" and mischaracterizing it as debt, and I shudder at how Keynesian I was in my approach. Since then I not only solidified my nascent libertarianism but became an Austrian.

"Unsustainable" can be judged by millions, if not billions of people. It’s when a currency appreciates to a certain point (based not on central bankers’ decisions but simple supply and demand stemming from international trade), at which point that country’s exports stagnate and then fall, leaving its producers with less income to invest in a foreign country. Again, the quantities exported are determined by individuals who want to buy, not a government or central bankers. Or, a country’s producers stop liking a foreign country as an investment destination, which reduces demand for that foreign country’s currency, which will close any "trade gap." The important thing to remember is that you and I don’t have all the information to decide at what point it’s all "unsustainable."

I always liked how Catherine Mann put it: "A current account deficit is “sustainable” at a point in time if neither it, nor the associated foreign capital inflows, nor the negative net international investment position are large enough to induce significant changes in economic variables, such as consumption or investment or interest rates or exchange rates."

I also doubt very much that we have that much in the way of oil and natural gas — at least not enough to make a long term dent in world production numbers. I’ve not seen anything really suggesting we could, clearly known Alaskan and off shore oil finds are nothing spectacular.

Gulf of Mexico. Continental shelf deposits. Shale oil deposits. The technology may not be feasible now, but someone creative will eventually design a way.

Look where China is seeking oil: Albertan tar sands and off the coast of Cuba. That should give us a big clue.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
While it is not debt in the sense of leverage, it does represent a claim on future production. A dollar is a form of debt, it just claims no interest. When the Chinese (or whoever) sell us something, the dollar is a debt that must be honored, though fluctuating exchange rates make the worth of that future claim variable.

Money isn’t inherently debt, only a medium of exchange. There can be "debt" if it’s paper money that can be redeemed for hard currency, like when U.S. dollars could be redeemed for gold and silver, but money in and of itself is not debt. Consider: if I buy a Chinese-made toy with my American dollars, who becomes indebted to whom? Certainly not I, nor Toys R Us, nor the importer. What happens is that someone or some group in China now has a few dollars. They can exchange it for other currency, or buy crude oil, neither of which is debt.

If they buy U.S. Treasury securities, now that is debt, but only because of the specific transaction, not because of the money or that it crossed international borders.

I have used that same joke about China and the idea that foreigners funding our debt gives them some enormous power over us. The problem is that whether there is a dollar crash or not, we have to honor those claims.

Not necessarily. If it came to war, we could tell the Chinese that their claims will not be honored. Modern technology will allow us to track what their government specifically bought, so that they can’t sell it to someone else. Would this cause financial chaos? Of course, but no more than war. This wouldn’t necessarily impact the U.S. government’s creditworthiness, either, because other nations would realize that their Treasury securities will still be honored so long as there’s peace. That’s partly why I suspect the Chinese want to avoid all-out war against the U.S., lest all their savings be for nothing. They want to have enough muscle to make a war so bloody, so costly that the U.S. government will instead throw up its hands and say, "Go ahead, have Taiwan."

I would love it if we could keep on consuming Chinese goods at the cost of sending over little bits of green paper, and then funding our borrowing by having them lend those same bits of paper back to us.

The debt isn’t produced by Americans’ personal consumption, however, only by our government. But don’t forget that the Chinese are more than happy to lend the money back, and they need us more than we need them. The little bits of green paper don’t do them any good.

Thus, when those dollars are repatriated they will be buying our production and we will not be importing as large (in relative terms) a quantity of theirs.

The dollars are in fact repatriated once they buy our assets. The dollars come home very quickly. Even if the Chinese use ? Some Saudi oil sheik buys a new Boeing airplane, or another American-made product, and the dollars come home only a little bit slower.

If we export more and import less that means we are consuming less. Thus our standard of living is by definition declining, the reverse of our situation now where we are consuming more than we produce.

Not necessarily. While consumption is two-thirds of the U.S. economy,

As Dale and I suggested in the podcast, we are likely to get those trade surpluses everybody has been asking for "good and hard." When framed that way, as a claim on future production you see that it is a form of indebtedness.

That "claim on future production" is only because my government will coerce me into paying its debt (not all of which is to foreigners, btw). But the mere fact that I buy things from China, Japan, Korea and European countries does not mean I go into debt.

I think we should worry if Warren Buffett gets into any sort of advisory position, because then we’ll have the ultimate bureaucracy to make sure we don’t import a dollar more than we export. That would be the feasible way to achieve the trade surpluses that some people foolishly want. It would otherwise take a massive depreciation in the dollar, combined with a massive fall in U.S. investments assets’ attractiveness (including Treasury securities and the federal government’s ability to meet debt service payments), for foreigners to stop selling us so much stuff because they wouldn’t have much use for the dollars.

I agree that it is not inherently a bad thing, and have argued that many times. Especially when as the reserve currency we should have a structural trade deficit so that other countries can use our dollars to back their own currencies. We function as gold did in the past. Just like with gold as a currency, producer countries (in this case just us) can export that currency for goods. My belief is we have exported far more than was needed to function as a reserve for other countries several years ago.

As an Austrian (economist), my perspective is that if it happens, it happens, but I don’t believe government should plan such things or have any power to.

But again, the dollars don’t stay abroad for very long. They eventually come home, and what the Chinese and others hold are our obligations. On a macroeconomic level, the American consumer thinks it’s worth it, particularly when Treasury yields are relatively low. John Q. earns his income, buys some Chinese-made things, and only a fraction of the purchase price winds up in Chinese hands. Their government returns the money to us in exchange for our Treasury securities, on which we pay a few percent a year. It means John can enjoy the products while his government borrows money — instead of taxing him — to provide services.

The game can’t continue forever, but life is good while the game lasts. And just because something is unsustainable doesn’t necessarily mean we shouldn’t have gotten into it in the first place. Similarly, just because it will be unsustainable doesn’t necessarily mean we shouldn’t avoid it altogether. It’s a matter of total benefits outweighing total costs. Right now the American consumer and federal government, by their actions, are judging that the benefits are greater. If there comes a time that they’re proven very wrong, I’d still rather be American than Chinese, because they’ll be hurting more. Our economy can absorb it, not without pain, but better than theirs.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
Harun:

1. Running current account deficits can also occur when you have foreigners investing in your country.

This is in fact a necessary half of a current account deficit. A trade gap is balanced by capital inflows.

When country A imports more from country B, then B winds up with A’s currency. B has to do something with it, otherwise it’ll be like 19th century Britain, slowly losing all its silver for Chinese tea until British merchants start selling opium to Chinese for silver. In modern times, B will simply buy assets denominated in A’s currency.

Oh, and for everyone who moans about a weak dollar in America, I would guess there are ten times that many Chinese moaning about the strong RMB.

Certainly. This is part of the rise in consumer prices due to the weaker dollar, a.k.a. "Be careful what you wish for." Thanks, Lindsey Graham and Chuck "The Schmuck" Schumer!

3. I agree that the US will have to do a lot more manufacturing and this will come about when the RMB is correctly priced and the China market more open.

But how do you know when the yuan will be "correctly priced"? You and I won’t know. See above in my reply to Erb, about no individual having that kind of knowledge.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
Lance:
Does not a dollar spent domestically also represent the same?
Sure, but by definition it is claims that are exchanged here, thus accrue to our benefit collectively.
Your definition of "benefit" is based on...what? Nationalism? Real economics doesn’t recognize borders. There’s no greater "benefit" than if Chinese factory workers benefit from selling to me than a Belgian confectioner or American farmer.

When carried out with other nations deficits accrue to our benefit, once we run a surplus to pay that claim back it accrues to others benefit.

By definition everyone believes he benefits from a voluntary exchange, regardless of deficits and surpluses. The American consumer likes cheap Chinese goods and doesn’t mind that his government becomes indebted as part of the transaction. But what about if we ran a trade surplus with China, would its workers think that was a "benefit" then? I doubt it: they much prefer the situation right now.

As a practical matter the adjustment of large reductions in leverage, currency adjustments and the shifting of productive capacity and capital leads to recessions, always, and slower overall growth. How long that process lasts is more variable. Thus we are seeing a reduction in our standard of living in real time at this point.

Do not forget that the culprit in cases of mispriced currency or misallocated capital is not the consumer, but government. Austrian economics has really been vindicated by this whole crisis, because for decades it’s taught that government interference in markets only introduces errors into decision-making, and recessions must necessarily follow as market forces realign themselves. Unfortunately it’s the consumers that must suffer for what government has done.

That last sentence may be so, but then the American consumer receives no benefit from cheap Chinese goods in the meantime, and Chinese workers don’t receive the benefit of a far greater income than were they rural farmers. As someone once taught me, should a runner never sprint when circumstances mean an overall faster time? An even pace isn’t always practical, let alone possible or plannable.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
Perry,

The important thing to remember is that you and I don’t have all the information to decide at what point it’s all "unsustainable."
True, and I am not saying otherwise. I am saying the market at some point will decide, and it looks to me as if it has. We have crossed that point. Feel free to disagree, but you are arguing with someone who does not disagree about your fundamental points. Or, more accurately, you are arguing with someone who isn’t involved in this discussion. You might try and find him.

I do love this quote by the way, Catherine nails the issue:
I always liked how Catherine Mann put it: "A current account deficit is “sustainable” at a point in time if neither it, nor the associated foreign capital inflows, nor the negative net international investment position are large enough to induce significant changes in economic variables, such as consumption or investment or interest rates or exchange rates."
Feel free to believe we have probably not crossed that line, I think we have. I think we are going to go through just that kind of adjustment process.
If they buy U.S. Treasury securities, now that is debt, but only because of the specific transaction, not because of the money or that it crossed international borders.
Fine, it isn’t debt if that is your definition, but it is a claim on production either way.

The problem is that whether there is a dollar crash or not, we have to honor those claims.


Not necessarily.
Okay, if we want to maintain a functioning system of trade we would be strongly advised to honor those claims then. Good enough for you? I wasn’t counting the "war" option. Also, I have already agreed that we are more important to China than the other way around, so can we stop going around that mulberry bush? Outside of war or some other stupid trade limiting option we need to honor the claims those dollars have. Nothing you are saying alters one whit about the desirability of limiting our indebtedness whether it is the government issuing the debt or not. Also, a lot of it went to fund the housing boom (private investment) and in order to avoid the chaos of defaults on government backed debt we turned that implicit guarantee into an actual guarantee. We are all on the hook to pay back stupid foreign debt purchases to fund housing in a bubble.

Are you sure you are an Austrian?
The dollars are in fact repatriated once they buy our assets. The dollars come home very quickly. Even if the Chinese use ? Some Saudi oil sheik buys a new Boeing airplane, or another American-made product, and the dollars come home only a little bit slower.
Here, rather than imagined disagreements we have a real one. While it is not in their interest to sell treasuries en masse and cause interest rates to sky rocket those treasury holdings have not been used to buy goods yet. They could, and eventually likely will if we continue to run trade deficits, be used to do just that. Earning interest for the sake of interest is not a good deal if it doesn’t lead to consumption possibilities down the road. That money will come home and purchase goods eventually if they have all the reserves they want.
As an Austrian (economist), my perspective is that if it happens, it happens, but I don’t believe government should plan such things or have any power to.
Who are you arguing with? That is exactly my position. The point of my analysis is to show that it will happen, and that happens to be most Austrians position as well.
The game can’t continue forever, but life is good while the game lasts.
Wow, isn’t that exactly what I have been arguing?
And just because something is unsustainable doesn’t necessarily mean we shouldn’t have gotten into it in the first place.
Who claimed otherwise? My point is that along with massive consumer, financial and other debt we have created a game that at minimum will lead to suffering now as all those borrowed and repatriated dollars led to an asset boom. As that boom crashes we will be worse off than if it had never gotten into it in the first place, not that such games always have to end this way (though I know of none that hasn’t ended in tears.)

Right now the American consumer and federal government, by their actions, are judging that the benefits are greater. If there comes a time that they’re proven very wrong, I’d still rather be American than Chinese, because they’ll be hurting more. Our economy can absorb it, not without pain, but better than theirs.
Yeah, and my assertion is they both were wrong, and now the market is proving it. As for the second part of the quote, once again, who is arguing otherwise?

But how do you know when the yuan will be "correctly priced"? You and I won’t know. See above in my reply to Erb, about no individual having that kind of knowledge.
Hmm. Use Hayek to defend a position Hayek wouldn’t take.

We know it isn’t correctly priced because it isn’t priced, its exchange rate is controlled by the government. We also know it isn’t priced because a host of market factors demonstrate that it is too low. The Chinese know this, they are trying to keep it from rising in spite of market forces. Once again, are you sure you are an Austrian?
Your definition of "benefit" is based on...what? Nationalism? Real economics doesn’t recognize borders. There’s no greater "benefit" than if Chinese factory workers benefit from selling to me than a Belgian confectioner or American farmer.
I agree, and I am not arguing otherwise. I am pointing out that it means a decline in our standard of living moving forward to make good on those claims. Whether we should care about it is a different question. Also I am arguing that the reversal of that process in a rapid fashion leads to additional losses from economic adjustments engaging in a positive feedback loop that results in lost output.
By definition everyone believes he benefits from a voluntary exchange, regardless of deficits and surpluses.
Exactly, but the timing of that benefit is what I am pointing out. We benefited in terms of consumption as deficits accrued, now we will suffer in terms of consumption as we send goods back in exchange for those dollars (plus interest on the government and agency debt in which they have held those reserves.)
But what about if we ran a trade surplus with China, would its workers think that was a "benefit" then? I doubt it: they much prefer the situation right now.
Probably not, mercantilists always prefer surpluses. Consumption however suffers in such a situation. That isn’t a moral or preference statement, that is pretty much an accounting identity.

You seem to be under the impression that I am arguing against the merits of free trade. If so, you are misreading what I am writing. As for the Austrians, yes they have been vindicated, and while I am a heterodox in terms of economic thought, the Austrians figure very prominently, in fact more than any established school. That is one of the most important factors in my seeing this coming. I am not arguing that trade isn’t beneficial, but that resolving our overall economic situation necessarily involves paying back the claims others have on us (or at least not taking on many more.) That is true in terms of debt and outstanding currency reserves of other nations.

In fact, my analysis is pretty much squarely in line with how most Austrians feel. Many are far more pessimistic than I am and have pointed out the potential disaster of a currency crisis due to our large current account deficit and fantastically exploding debt obligations for years.




Written By: Lance
URL: http://asecondhandconjecture.com
Perry,

I am sorry about that last post. I got a little exasperated, and that has to do with things other than just responding to your comments. Still, I really think you came into this thread with assumptions about what people were arguing that you read into the arguments.

My snark however was unwarranted, I have done the same myself many times and thus patience is warranted. I should have just said "pretend Mises wrote this post and figure out what I am saying based on that." I could have saved quite a bit of typing.

Look, analyzing a situation and decrying it does not mean I am endorsing some government program to "fix" it. I am doing an economic analysis, not pointing out things for government to "solve." That a great many of the people who point out the things I do have fundamental disagreements with you doesn’t mean all of us do. Your blog is filled with common sense free market commentary. This post and others I write are intended to be in the same vein.

So in reading them I suggest that you assume a market based, Austrian influenced outlook in interpreting them, not that I am Chuck the Schmuck bemoaning things to justify some meddlesome scheme unless I specifically say I want a meddlesome scheme (rare, but occasional.)

It will save us both a lot of time.

Written By: Lance
URL: http://asecondhandconjecture.com
True, and I am not saying otherwise. I am saying the market at some point will decide, and it looks to me as if it has. We have crossed that point. Feel free to disagree, but you are arguing with someone who does not disagree about your fundamental points. Or, more accurately, you are arguing with someone who isn’t involved in this discussion. You might try and find him.
I never said you were arguing against markets, but it was a point I wanted to emphasize. You say I’m reading too much into others’ words, but you’re the one reading too much into mine.
Feel free to believe we have probably not crossed that line, I think we have. I think we are going to go through just that kind of adjustment process.
Perhaps. The current account might be "correcting," but the U.S. is such a unique case that all historical examples, and concepts like the J-curve, don’t apply here.
Fine, it isn’t debt if that is your definition, but it is a claim on production either way.
It’s important that we remain on the same page. "Debt" has a very specific meaning in economic circles.

What about when we buy oil from Saudis and Kuwaitis, and they buy American-made aircraft and machinery with the dollars? Where is the debt there? That’s because trade in and of itself does not produce debt.
Okay, if we want to maintain a functioning system of trade we would be strongly advised to honor those claims then. Good enough for you? I wasn’t counting the "war" option.
Military "tension" will continue to a very real part of Sino-U.S. relations. The point was that China may be holding debt obligations of the U.S. government, but they don’t exactly hold all the cards. In fact, their hand is quite weak.
Also, I have already agreed that we are more important to China than the other way around, so can we stop going around that mulberry bush?
And I never implied you said otherwise, but it’s a good point for all to remember.
Outside of war or some other stupid trade limiting option we need to honor the claims those dollars have. Nothing you are saying alters one whit about the desirability of limiting our indebtedness whether it is the government issuing the debt or not.
Of course, and we are...at extremely low interest rates right now.
Also, a lot of it went to fund the housing boom (private investment) and in order to avoid the chaos of defaults on government backed debt we turned that implicit guarantee into an actual guarantee. We are all on the hook to pay back stupid foreign debt purchases to fund housing in a bubble.
Are you sure you are an Austrian?
If you want to insult me, then here’s my challenge: take a non-Austrian view on anything, and I’ll rebut. I think what’s confusing you is that I can be an Austrian but also discuss the non-free-market world as it is, and examine things in the context of government interference.

How about something specific: read this and tell me I’m not an Austrian.
Here, rather than imagined disagreements we have a real one. While it is not in their interest to sell treasuries en masse and cause interest rates to sky rocket those treasury holdings have not been used to buy goods yet. They could, and eventually likely will if we continue to run trade deficits, be used to do just that. Earning interest for the sake of interest is not a good deal if it doesn’t lead to consumption possibilities down the road. That money will come home and purchase goods eventually if they have all the reserves they want.
And do you know why China is holding massive amount of U.S. Treasury securities? Unlike Japan, South Korea, the UK, et al, it’s not about foreign reserves or pure saving. Because China is not concerned with earned interest so much as using the safest dollar-denominated assets as collateral for its banking system.
Who are you arguing with? That is exactly my position. The point of my analysis is to show that it will happen, and that happens to be most Austrians position as well.

...

Wow, isn’t that exactly what I have been arguing?
OK, cool. We reach.

You evidently are looking for an argument where none exists. I’m merely clarifying things and bringing up points to emphasize, with no implication that you agree or disagree. Since this is the start of our discussion, do you not agree it’s beneficial to lay out a foundation so we know where each other is coming from?
Who claimed otherwise? My point is that along with massive consumer, financial and other debt we have created a game that at minimum will lead to suffering now as all those borrowed and repatriated dollars led to an asset boom. As that boom crashes we will be worse off than if it had never gotten into it in the first place, not that such games always have to end this way (though I know of none that hasn’t ended in tears.)
And when did I say I disagreed with that particular scenario? I can play your same game too.
Hmm. Use Hayek to defend a position Hayek wouldn’t take.

We know it isn’t correctly priced because it isn’t priced, its exchange rate is controlled by the government. We also know it isn’t priced because a host of market factors demonstrate that it is too low. The Chinese know this, they are trying to keep it from rising in spite of market forces. Once again, are you sure you are an Austrian?
That’s patently insulting and either misrepresenting of what I said or a complete misunderstanding of what I said. What I said applies to everyone, you, I and any government on the planet: nobody knows, only society as a whole.

My point isn’t a matter of "lower" or "higher," but the precise value. Whether the yuan is at par, 6 or 2000, none of us still know. We can’t even judge it against the dollar, whose value wasn’t determined by a free market even in pre-Fed days.

If you’re really an Austrian or otherwise familiar with Austrian economics, you’d realize what Israel Kirzner developed on market processes. They exist because information is fundamentally imperfect; we can’t be certain, and even current market prices may not represent equilibrium. But if you want to accuse me of not being an Austrian, there’s plenty on my blog for you to challenge. In particular, check out what I’ve written on market processes. I’ve been taught by some of the best Austrians on the planet and am privileged to call them friends.

So what’s your Mises quiz score?
I agree, and I am not arguing otherwise. I am pointing out that it means a decline in our standard of living moving forward to make good on those claims. Whether we should care about it is a different question. Also I am arguing that the reversal of that process in a rapid fashion leads to additional losses from economic adjustments engaging in a positive feedback loop that results in lost output.
Sure, and, uh, where was I arguing otherwise? Of course it will be a problem if the U.S. government amasses so much debt that it can’t repay without higher taxes and/or a reduction in regular spending.
Exactly, but the timing of that benefit is what I am pointing out. We benefited in terms of consumption as deficits accrued, now we will suffer in terms of consumption as we send goods back in exchange for those dollars (plus interest on the government and agency debt in which they have held those reserves.)
Think of a child being asked which he prefers, $1 today or $2 tomorrow. Ordinarily it would be better to wait until tomorrow, but what if the ice cream truck is coming by at that moment? If the child chooses $1 today, that means he valued the ice cream as worth foregoing an additional $1 tomorrow. By the same principle, American consumers have valued international trade, and any government debt that they’re on the hook for, as future debt service payments being worth having things now. It’s all according to subjective value systems, and you nor I have any standing to say it’s correct or incorrect. Where we do have cause to object is when fellow Americans make me obliged to pay my "fair share" of debt I wanted nothing to do with, or compel me to use a currency I find unsound — that is the real problem, and it’s more fundamental than talking about unsustainable current accounts or currency manipulation.
You seem to be under the impression that I am arguing against the merits of free trade. If so, you are misreading what I am writing.
I’m not implying otherwise, only throwing out certain things as part of the discussion. We don’t know one another and it’s good to establish where we’re coming from.
As for the Austrians, yes they have been vindicated, and while I am a heterodox in terms of economic thought, the Austrians figure very prominently, in fact more than any established school. That is one of the most important factors in my seeing this coming.
Some Austrians like Russ Roberts admitted they didn’t see this coming. Schiff, I think, was right but more in the sense of a broken clock, because he was also encouraging clients to go into European stocks. But he was certainly right earlier this year when warning this could be another Great Depression — not because of natural factors, but because of what the government can do. I’m generally optimistic on the economy because of American workers’ resilience, but I’ve been worried for about a year because that’s when the Fed and feds started deciding they can "fix" things. Remember that Austrians are THE school that developed the concept of governments introducing systematic errors into economies.
I am not arguing that trade isn’t beneficial, but that resolving our overall economic situation necessarily involves paying back the claims others have on us (or at least not taking on many more.) That is true in terms of debt and outstanding currency reserves of other nations.
That can certainly be a problem, but right now most major creditors of the U.S. government are willing to roll over their Treasury securities indefinitely.
In fact, my analysis is pretty much squarely in line with how most Austrians feel. Many are far more pessimistic than I am and have pointed out the potential disaster of a currency crisis due to our large current account deficit and fantastically exploding debt obligations for years.
I wouldn’t disagree that big problems will arise, only the source. The current account deficit is only a symptom, not the cause. The real cause is manipulation of currency (and hence exchange rates) on both ends, and restrictions on the free movement of capital, labor and goods.

I tend to be more optimistic than most Austrians, because I know that no matter how much governments meddle and tyrannize, human civilization tends to survive one way or another. But if you did check my blog, you may have noticed that my observations of what the federal government is doing with the "bailout" bait-and-switch is more pessimistic than most Austrians think.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
What about when we buy oil from Saudis and Kuwaitis, and they buy American-made aircraft and machinery with the dollars? Where is the debt there? That’s because trade in and of itself does not produce debt.
I called it a future claim, which is what it is, whether you want to call it debt or not. Those claims will be used just as in the case you describe. Since we have an enormous number of those claims outstanding we will have to produce for their benefit. There is an enormous amount of formal debt to reckon with, and it will be a large adjustment to bring our total debt down to a more sustainable range. Mises described what that leads to very well. I am less pessimistic than he might have been, but the general thrust is correct.
Military "tension" will continue to a very real part of Sino-U.S. relations. The point was that China may be holding debt obligations of the U.S. government, but they don’t exactly hold all the cards. In fact, their hand is quite weak.
I agree.
My point isn’t a matter of "lower" or "higher," but the precise value. Whether the yuan is at par, 6 or 2000, none of us still know. We can’t even judge it against the dollar, whose value wasn’t determined by a free market even in pre-Fed days.
Okay, but Harun’s point was that it is incorrectly priced, in the sense that it isn’t priced according to the market. Neither Harun, I or you know that price, true, but we could know what the market price is if it were allowed to adjust, and we do know that it is higher than now.
The current account deficit is only a symptom, not the cause. The real cause is manipulation of currency (and hence exchange rates) on both ends, and restrictions on the free movement of capital, labor and goods.
True, which is what I have been arguing for years. As I said, your argumentative tone obscured vast areas of agreement and were phrased in such a way as to imply things about what Harun and I were saying that isn’t where we are coming from. My analysis was about the consequences of those manipulations leading to certain symptoms which were going to have certain effects. I stand by that analysis.

I also am more optimistic that many Austrians, I think we will muddle through, but I do think we are going to pay a heavy price.

That being said, your tone is no excuse for mine, and as my last comment said, I realize that. I am not criticizing your Austrian bona fides, I was just being snarky, and it was uncalled for.

Written By: Lance
URL: http://asecondhandconjecture.com
I called it a future claim, which is what it is, whether you want to call it debt or not. Those claims will be used just as in the case you describe.
Again, my point was only to emphasize that the mere act of international trade does not generate debt. I may buy something from the local grocery store, who will pay an employee, who will later purchase a bond from the county, which I’ll be partially liable for repayment, but my initial purchase isn’t debt, nor does all of it wind up involved in any debt creation. So I’m not really worried what happens to any dollars I pay the Chinese et al for their products: I’m worried about the fundamental problem of the government’s power to borrow. Similarly, I can criticize that government wastes this money or commits to some program that is the antithesis of liberty, but the fundamental problem is that government can take money from me.
Okay, but Harun’s point was that it is incorrectly priced, in the sense that it isn’t priced according to the market. Neither Harun, I or you know that price, true, but we could know what the market price is if it were allowed to adjust, and we do know that it is higher than now.
Certainly, and we know the Chinese were keeping their currency artifically devalued. So, somewhat similar to Heisenberg’s principle, we know the direction, just not the precise value.
True, which is what I have been arguing for years. As I said, your argumentative tone obscured vast areas of agreement and were phrased in such a way as to imply things about what Harun and I were saying that isn’t where we are coming from. My analysis was about the consequences of those manipulations leading to certain symptoms which were going to have certain effects. I stand by that analysis.
I don’t disagree that your analysis is less probable than any other scenario, impossible, but you misunderstood my general comments that expanded on the discussion. Where I left invitations for you and Harun to comment so that we can have a good dialogue and know where we’re all coming from, you took it the wrong way. Moreover, I was not the one who accused the other of not being what he claimed (e.g. I never said you were anti-free market). It was discovering the Austrian school that taught me real free market economics, not the watered-down version that a lot of professed libertarians believe in, and my principal teacher was taught by Kirzner himself. So being an Austrian is something I take great pride in, and always did even before this year completely vindicated ABCT (the true "phlogiston" is Krugman’s state-worshipping). Being questioned about it was quite an insult.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
" Consider: if I buy a Chinese-made toy with my American dollars, who becomes indebted to whom?"

Perhaps more like an exchange of assets? Barter? After all, money is a commodity.

Written By: timactual
URL: http://
Perhaps more like an exchange of assets? Barter? After all, money is a commodity.
Precisely. It’s an exchange, and it in and of itself produces no indebtedness. Voluntary exchanges occur because people judge that they’re receiving more than they’re giving.

Written By: Perry Eidelbus
URL: http://eidelblog.blogspot.com
We know that a business risk is part of it. It is either net loss or net income in a fiscal period/year. The economy might not perform well or operate successfully. There are determinants why all these happenings in the economy. The collapse of the housing bubble is also having an enormous impact on California’s revenue from property taxes. Then there are the losses of both industrial output and jobs. All of this leads towards a recipe for disaster in the most populous state in the union. The state budget of California is already running a several billion dollar deficit, and, if something doesn’t change, is set to hit over $11 billion by the year’s end and may even balloon to up to almost $30 billion by summer next year. Governor Schwarzenegger, it has been reported, has called legislators into a budget meeting to slash spending and increase taxes. Gov. Schwarzenegger admonishes lawmakers for not only failing to act in a timely fashion, but also tells them that they had best get something done about this quickly. Click to read more on Installment Loans.



Written By: lisap
URL: http://

 
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