September 16, 2003

Krugman is....Gulp....Right

Interesting transcript of an interview with Paul Krugman you can find here. I'm reluctant to say in public that I agree with Krugman. He's gone of the deep end with his "everything Bush says is a lie." Bush, like all polticians, does lie. But not about everything, at least I don't think so. Still, if he's just talking the economics of deficits, he sounds more sane. Here's the money section from the interview. And by the way, I disagree with Krugman that the Chinese might not someday attempt to use owernship of U.S. assets as a way to influence U.S. foreign policy. Emphasis added is mine. Krugman: Train wreck is a way overused metaphor, but we're headed for some kind of collision, and there are three things that can happen. Just by the arithmetic, you can either have big tax increases, roll back the whole Bush program plus some; or you can sharply cut Medicare and Social Security, because that's where the money is; or the U.S. just tootles along until we actually have a financial crisis where the marginal buyer of U.S. treasury bills, which is actually the Reserve Bank of China, says, we don't trust these guys anymore — and we turn into Argentina. All three of those are clearly impossible, and yet one of them has to happen, so, your choice. Which one? Kevin Drum (http://www.calpundit.com): How does all this feed in to the current account deficit? Will China keep financing that forever? Krugman: They're financing both the current account deficit, and, as it turns out, directly financing the government deficit. We were running a big current account deficit that accelerated through the late 90s, but there you could say that it was due to the strength of the U.S. economy, it was all this investment demand, technological revolution, and after all, the government was in surplus. Now, we're back in twin deficits territory, and there are two related issues, the solvency of the federal government and the solvency of the United States per se, and both of them are now somewhat in question. Maybe I'm a captive of my own model, but I think that what happens when the world loses faith in the U.S. as a place to invest is that the dollar plunges, but that in itself is not so bad because the lucky thing is our foreign debts are in dollars, so we don't do an Indonesia or an Argentina. But the federal government's solvency is a much more critical thing because it needs to keep on borrowing more and more just to pay its bills Drum: What happens if these foreign countries do stop buying U.S. bonds? Is this a real concern, or a tinfoil hat kind of thing? Krugman: Oh, I don't think China is going to do it to pressure us. You can just barely conceive of a situation where they're mad at us because we're keeping them from invading Taiwan or something, but more likely they just start to wonder if this is really a good place to be putting their money. So what happens is a plunge in the dollar when they decide to stop buying and start cashing in, and a spike in U.S. interest rates. But you might also get in a situation where the interest rates the government has to pay to roll over its debt become so high that you get an accelerating problem, which is what happened in Argentina. What happened was that suddenly no one would buy Argentine debt unless they paid a twenty something percent interest rate, and everybody says, but if they have to roll over their debt at a twenty percent interest rate, there's no way they can pay that back. So the whole thing grinds to a halt and the cash flow just dries up. Drum: And do you think that's a serious possibility for the United States? Yeah, just take the numbers as they now look, and that's where it heads. And you might say, OK, we can easily handle it. U.S. taxes are 26 percent of GDP in the U.S., in Canada they're 38 percent of GDP. If you raise U.S. taxes to Canadian levels there's plenty of money to cope with all of this. But politically we've got a deadlock, and it's hard to imagine that happening. So you say, but this can't happen, this is America, and I guess my answer is, is it? Is this the same country that we had in 1970? I think we have a much more polarized political system, a much more polarized social climate. We certainly aren't the country of Franklin Roosevelt, and we're probably not the country of Richard Nixon either, so I think we have to take seriously the possibility that things won't work out this time.

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