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Home Publications Blogs Beat the Press Competent Economists Were Not Kept Awake Worrying About "a collapse in the value of the dollar and of U.S. government securities"

Competent Economists Were Not Kept Awake Worrying About "a collapse in the value of the dollar and of U.S. government securities"

Friday, 09 July 2010 06:15

In a discussion of trade imbalances the Washington Post told readers that: "it was that risk -- of a collapse in the value of the dollar and of U.S. government securities -- that kept many economists up at night."Actually, competent economists were not terribly worried about this nearly impossible scenario.

China and other countries were deliberately propping up the value of the dollar in order to sustain their exports to the United States. While these countries may at one point back away from this policy because they decide it is no longer in their interest, it is almost inconceivable that they would flip overnight to the opposite policy of allowing their currencies to soar against the dollar. The idea that China would allow an exchange rate of say 4 yuan to the dollar or that Europe would tolerate an exchange of 2 dollars to the euro is almost absurd on its face. The market for these countries' exports in the United States would collapse at these exchange rates, while U.S. exports (we still export more $1.7 trillion annually) would become hypercompetitive in other countries, wiping out domestic competition.

Since the story of a dollar collapse was so far-fetched, competent economists did not lose sleep over it. They did lose sleep over the housing bubble, the collapse of which produced the economic disaster the country is now witnessing. (Unfortunately, the folks running economic policy were not among the group of economists paying attention to the housing bubble.)

Strangely, currency prices receive only passing mention in this piece on trade imbalances. This is the mechanism for adjustment. In order to move the U.S. trade deficit closer to balance, the dollar will have to fall against other currencies. There is no other plausible mechanism. It is difficult to understand why this point was not mentioned.

It is worth noting that the savings rate has increased by about 2.0 percentage points more than is implied in this article. This is the result of the statistical discrepancy in GDP accounting. At the peak of the bubble, capital gains income was showing up on the income side as ordinary income. This overstated true income and therefore overstated the savings rate. With the collapse of the housing bubble and plunge in stock prices capital gains income is no longer showing up as income in GDP accounts to the same extent. Therefore the savings rate is no longer overstated. This adjustment means that the savings rate has risen by about 2.0 percentage points more than the official data show.


[Addendum: In response to comments about the capital gains issue -- I am referring to the NIPA measure of income and savings, which is not supposed to count capital gains income. However, capital gains income did show up in this measure during the years near the peak of the stock and housing bubbles. The statistical discrepancy turned strongly negative during these years, which means that measured income side GDP was larger than measured output side GDP. (By definition, they should be equal, although measured output side is usually larger.)

We regressed the statistical discrepancy on lagged increases in stock and housing prices. The fit was extremely strong, with a very simple regression explaining almost 60 percent of the variation in the statistical discrepancy. Based on this analysis, I think it's pretty clear that the official data substantially overstate income and therefore the saving rate both at the end of the 90s and the years 2004-2007.]

Comments (6)Add Comment
written by HC10, July 09, 2010 8:05
Don't you have the stuff about capital gains backwards? In periods of high capital gains income, the savings rate is understated because personal income in the NIPA accounts does not include capital gains. But the taxes paid on capital gains income are included in the calculation that gets to disposable personal income. And DPI less personal outlays is savings.
written by skeptonomist, July 09, 2010 9:01
I don't think that currency adjustment is the only possible way to change trade imbalances, though maybe it is somewhat more plausible politically than others. U.S. products could be made more competitive by reducing either profits and executive compensation, or wages, or both. Obviously U.S. capitalists want to reduce U.S. wages and they continue to be successful, though U.S. wages are still much higher than China's. The stock market and its supporters in the media are with executives in wanting to maintain high profits and low wages, and they are more powerful politically than wage-earners.

Of course imports can be reduced with tariffs etc. On the whole, the effect is similar to currency adjustment, but tariffs can be adjusted to favor those industries with most political clout.
written by Ellen1910, July 09, 2010 11:24
Presumably, Baker's using the FFA methodology and not NIPA, but it would be helpful if he'd state which one he is employing.
The "Blazing Saddles Scenario" Again
written by jm, July 10, 2010 2:51
The people who believe that someday the Chinese (used to be the Japanese) are going to cause a collapse of the dollar by selling off their bonds (or refusing to buy more) are like the townsfolk in "Blazing Saddles" who quaked in fear as Cleavon Little held his revolver to his head and took himself hostage.

But as Mencken said, nobody ever went broke underestimating the intelligence of the American public.
No gain without pain
written by skeptonomist, July 10, 2010 8:41
It should be kept in mind that both currency adjustment and higher tariffs would enforce a kind of austerity, more or less across classes. Rich people would have to pay more for their vacations in Europe (though not so much if the euro also declined in relation to the yuan - not so many of them vacation in China or buy prestigious Chinese products) but low-income people would pay more for things at Walmart. Hopefully jobs in the US would be created and wages would increase but this would take time - price increases would have to come first. Adjustment would be painful at first, and the public should be prepared for this.
people want to be STRONG
written by FGS, July 12, 2010 3:02
People get confused about the meaning of strong dollar. Strong is normally a good thing: strong back, strong military, strong performance. But in the context of economic growth for the United States, is should be more like "strong smelling. "

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.