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Home Publications Blogs Beat the Press Currency Devaluation Is More Essential Than Entitlement Reform

Currency Devaluation Is More Essential Than Entitlement Reform

Tuesday, 12 April 2011 05:01

The Washington Post had a piece on the reaction of financial markets to the debate over the budget. It included a comment from William Gross, the manager of the Pimco bond fund, complaining that if the United States did not reform entitlements then a default is inevitable. He then said that the default would take place through "inflation, currency devaluation and low-to-negative real interest rates.”

This sort of "default" probably does not sound too bad to the overwhelming majority of the public who do not hold large amounts of government debt. More importantly, the devaluation of the currency is essential if the United States is to stop being a huge net borrower from other countries.

Changes in the currency value are the main mechanism for adjusting trade balances in a system of floating exchange rates. If the dollar is over-valued by 20 percent then this has roughly the same effect as subsidizing our imports by 20 percent and placing a tariff of 20 percent on all our exports. The over-valued dollar has far more impact on our trade balance than all of our trade deals put together.

If the value of the dollar does not fall substantially, then the United States will continue to run large trade deficits. This logically implies that we will have negative domestic savings (i.e. it is an accounting identity, there is no way around it). Low private savings means either large budget deficits or very low private savings or some combination.

In other words, if Mr. Gross does not want the dollar to fall, then he either wants to see large budget deficits and/or very low private savings. Or alternatively, he doesn't understand basic economics.

Comments (9)Add Comment
written by David S., April 12, 2011 6:35
I found Mr. Gross's comment bewildering for an additional reason: How would such a "default" express itself through "low-to-negative real interest rates?"

Assuming the potential buyers of government securities believed that the value of such securities had been reduced (isn't that what "default" is all about, to say the least?), then they would demand higher real interest returns rather than lower. Gross has it totally backwards.

Am I missing something here? If so, commenters, please advise. Otherwise, Gross's error, combined with the one Dean has noted, demonstrates a truly chilling ignorance at odds with Gross's reputation.
written by Sherparick, April 12, 2011 7:55
I think that Mr. Gross would prefer a steady deflation, such as Japan has had these last 20 years as that would increas the principal value of his bonds even with very low interest rates. Of course, the only way the U.S. current account deficit could then go into balance or surplus would be for U.S. real wages to decline by by 20%, which would of course also lower U.S. demand, increase the debt to income burden, lower consumption, lower house asset values, and of course lower Governnment revenue. But it would be good for the creditor classes unless and until it resulted in general defaults and bankruptcies, all the fault of the shiftless classes who borrow.
Dean and I agree
written by Floccina, April 12, 2011 8:03
Negative interest rates on USA bonds would be a good thing for USA citizens and I think that would not harm the relatively poorer Chinese citizens though that is a concern.
written by skeptonomist, April 12, 2011 8:43
I suppose Gross means that if the Fed continues to hold interest rates low and there is high inflation, the ensuing negative interest will make U.S. Treasury bonds unattractive, they will would go unsold and the Federal Government will have no money to pay the interest on bonds already sold. If this sounds confused, it is, since the only way interest rates can be held low is if the Fed buys Treasuries. Dean has often pointed out that the Fed will buy any Treasuries the market does not want.
Gross is Just POed that Bond Returns are in the Toilet
written by Paul, April 12, 2011 8:47
He is losing investors by the boatload in his Total Return Fund so his fees have collapsed thanks to Bernanke and QE.

A falling dollar will mean millions more U.S. jobs which is good for the economy and therefore bad for bond returns.
William Gross Has Gone MAD (Mutually Assured Destruction)
written by izzatzo, April 12, 2011 12:35
... William Gross, the manager of the Pimco bond fund, complaining that if the United States did not reform entitlements then a default is inevitable.

Any economist knows that since bond prices are inversely related to interest rates, entitlement reform would obviously increase the capital value of bonds, the value of the dollar and exports all at the same time to prevent large budget deficits and low private savings.

Therefore entitlement reform should proceed immediately to reduce the huge flow of unearned transfer payments extracted from the lower 99% in order to make welfare payments to the upper 1%.

Anyone who doesn't understand this doesn't understand the economic game theory of MAD (Mutally Assured Default) derived from the nuclear cold war.

The default war started with home owners and spread to bond owners. At least under MAD homeowners know if they're taken out then the lenders who caused the housing bubble and recession will be annihilated as well.
written by purple, April 12, 2011 10:10
Currency devaluation is no elixir when a country has to import energy.

The U.S. has been in trouble ever since it became an energy importer, well before China became integrated into world trade.
If I wrote that, I would not sign my name to it either.
written by skeptical, April 13, 2011 9:48
Hm..., Bill gross maybe doesn't understand basic economics, or the unsigned article writer makes it ups as he scribbles. Since US is now post industrial economy (thanks, Regan and later), devaluing dollar means less consumer spending and for the bottom 90% even less left over for savings.
I guess the author is saying that some of the top 1% will save money by buying Chevy, since Mercedes will be even more expensive.
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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.