May 12, 2011
What Would Really Bring about a Dollar Dive?
One of the things about reading the op-eds and various articles in the blogosphere is the tendency to hype the possibility of the collapse in this, or the collapse in that. The most recent "bubble" in this type of writing involved hyper-inflation, commodities (silver, anyone?) and the dollar. Now I read things like QEIII would bring about a collapse in the dollar  (as if anybody really thought QEIII was politically likely, even if it were advisable on economic grounds); or easy monetary policy would be the culprit. Here's a choice quote from Jim Rogers:
"I would expect to see some serious problems in the foreseeable future.... By 2011, 2012, 2013, 2013, I don't know when, we’re going to have an economic slowdown again," he said. "This time it’s going to be a real disaster because the US cannot quadruple its debt again. Dr Bernanke cannot print staggering amounts of money again."
"How much more can they print without a serious collapse of the US dollar?" he said.
I can't figure out where that cited "quadruple" comes from. Debt held by the public (in current dollars) has not even tripled since G.W. Bush came into office, and has not even doubled since Obama came into office (see FREDII if you don't believe me). As a share of GDP, it rose from 0.49 to 0.63 from 2009Q1 to 2010Q4. Oh, well. Time to drop the hyperbole, and look at some data.
To begin with, I think it useful to ask whether we've actually printed a lot of money, where money is defined as currency plus checking deposits, or currency plus savings deposits (what we who teach macroeconomics, or teach money and banking, call M1 and M2).
Figure 1: Log ratio of M1 to real GDP (blue) and M2 to real GDP. NBER defined recession dates shaded gray. Source: Federal Reserve Board via FREDII, and BEA, 2011Q1 advance release, NBER, and author’s calculations.
As I've noted before, the Fed has more than doubled the money base, but this is not the same as doubling the money stock. That could happen if the banks lend out the excess reserves, but that hasn't happened as of yet. For a discussion of the correlation of money base growth and inflation, see this post.
Thinking about Stimulus, Monetary Policy, the Dollar, and Timing
I've read a lot about how deficits threaten the dollar. And certainly they can, but I think one has to have a more nuanced view than "reduce the deficit immediately, or the dollar crashes today". To think about this in an organized fashion, it's useful to consider the dollar's value in the context of several models. First, think about the dollar in a portfolio balance model  . In a static model version of the model, the current stock of US government debt relative to that of other countries’ stocks of government debt drives the risk premium on dollar assets. A stable relationship obtains if (1) preferences for government debt are constant, and (2) the correlation of relative returns are constant. But the story of the 2000's, and in some sense the "saving glut", is that the preference for US government debt has not been constant (e.g., [Caballero et al.]). Rather central banks have exhibited an upward demand shock for US government debt.
It is entirely possible that there will be a negative demand shock for US government debt, going forward. But the story of the last three years has been a series of shocks that have impelled flight to, not away from, US government debt. So, while it is conceivable that there will be no further sovereign debt shocks in the rest of the world (in which case the increase in US debt might very well induce a weakening of the currency), right now, with 2011 US net debt at 72.4% of GDP (IMF WEO April 2011), it is unclear why we should have a dllar crisis when the Euro area has a 66.9% ratio, UK at 75.1% and Japan at 127.8%.
This is not to deny that the debt trajectory is worrisome, with net debt approaching 85.7% in 2016. But that means one needs to do serious entitlement spending restraint and tax revenue increases that will take effect in the future, not nickel and dime-ing the one-fifth of total current budget accounted for by discretionary non-defense spending today.
That leads to the second point, that spending restraint and the early withdrawal of monetary stimulus now would exert a drag on growth, which would also weaken the dollar. A relapse in growth would also worsen the depression in tax revenues which accounts for a large part of the accumulation of debt during the Great Recession; hence, even in a portfolio balance model, too-early fiscal contraction could actually instigate a dollar dive.
There are other drivers for the dollar's value. Figure 2 highlights the correlation between GDP and the dollar’s strength, over the last 28 years.
Figure 2: Log real value of USD against broad basket of currencies (blue) and log ratio of US real GDP against RoW (export weighted) real GDP, detrended with quadratic in time. Source: Federal Reserve Board via FREDII, and BEA, 2011Q1 advance release, Federal Reserve up to 2009, updated using data from Economist thereafter (for RoW GDP), and author's calculations.
Clearly, the strength of the dollar is correlated with the strength of the US economy relative to the rest of the world. (A DOLS(2,4) regression of the real dollar on relative GDP with a quadratic on time yields an elasticity of 1.82; however, the series do not appear to be cointegrated except at about the 20% msl.) There are a variety of reasons this correlation arises. The first is from the monetary approach  -- higher income induces a greater demand for money, and in the monetary approach to the exchange rate, that leads to a stronger currency (when prices are sticky, as in the Dornbusch-Frankel model). Contractionary monetary and fiscal policy implemented now which leads to a lower GDP in the future would mean ultimately a weaker currency.
Second, the higher income is typically associated with a higher real interest rate differential, partly due to Taylor rule fundamentals (see    ) and partly because higher income leads to greater investment in physical plant and equipment (that's how government spending could "crowd in" investment ), and hence demand for credit. That draws in capital leading to an appreciated currency.
The foregoing analysis places into context the proposals for fiscal retrenchment and monetary tightening now. The latter might induce a short term boost in the dollar's strength, but both would almost surely induce a medium-term weakening.
It must be remembered that the dollar in and of itself is not usually thought of as a target variable. The dollar is a relative price that is key to re-allocating aggregate demand, and at the same time allocating capital, across borders. Drastic moves in the dollar's value could indeed destabilize the financial system. But policy should not single-mindedly focus on the dollar's value. That's key for remembering why we want to stabilize the debt-to-GDP ratio -- it's to establish a sustainable path for output per capita over time.
How to Engineer a Dollar Crash
For certain, what would be key to causing a crash in the dollar's value would be a failure to raise the debt ceiling in a timely fashion. In almost any model I can think of, that would either cause a flight from US government debt, or -- even if we only go to the brink -- elevating the risk premium, and hence total interest payments, on US Treasury debt indefinitely. Thus, it's the height of irresponsibility to make unrealistic demands for deficit reduction based solely on spending cuts, thereby risking a crisis. [E.Klein] [M.Thoma]
Update, 9:30am: And Bernanke agrees that playing with the debt limit is ill-advised.
Update, 8:30am, 5/13: This article makes you despair of finding any signs of intelligence in certain quarters.
Posted by Menzie Chinn at May 12, 2011 07:40 AMdigg this | reddit
As erudite as Mr.Chinn's observations are they are not particularly useful when considering current fiscal circumstance. The territory of "unrealistic demand and heights of irresponsibility" is too vast to be encompassed by just deficit reduction. The monetary fiasco has many authors and represents decades worth of unrealistic demands and heights of irresponsibility.
Posted by: brad at May 12, 2011 07:51 AM
As long as Europeans can just scare the euro down by murmuring something in Greek or Portuguese, the dollar will be "fine", i.e. too high and therefor a drag on the economy and the trade balance. And just in case that doesn't do the trick, I'm sure there will be an actual restructuring of greek debt. That might backfire - when people realize that this actually doesn't really make a big diff - and that could cause the dollar to tank.
Posted by: endorendil at May 12, 2011 08:53 AM
Chinn laying groundwork for QE3??!
Posted by: bankrchick at May 12, 2011 09:26 AM
The US$ value is determined primarily by the amount and rate of growth of US supranational firms' investment and production abroad and the associated rate of growth of foreign economies, as well as the rate of growth of demand and the price of oil worldwide.
The trade-weighted US$ Broad Index is around par; no crash there.
The euro value is "strong" against the US$ because the demand for the US$ in the EU is comparatively weak in terms of trade flows and demand for US$'s outside of the US and EU to purchase commodities. Most of the EU's exports come from Germany, and the bulk of Germany's exports (40% of GDP) go to other EU countries.
Moreover, since '00-'02, adjusted for CPI and the price of gold (adjusted for CPI and the US$), the US$ has already crashed 75-80%.
However, the long-term trend for all fiat debt-money currencies is to converge to and around par in trade-weighted terms, as trade and investment flows, GDP growth (or eventually no growth and contracting real per capita GDP), and demand and imports of oil have reached relative parity between the three major trading blocs (Americas, EU, and Asia).
Posted by: Nemesis at May 12, 2011 09:43 AM
The debt ceiling should be abolished. It is an anachronism imposed in 1917, although raised many times since then, usually without any fuss. Now it has become this dangerous bomb that threatens to blow us all up. And, furthermore, no other country has such a debt limit (and as near as I can tell, no other even ever has had one).
Yes, some have limits on annual budget deficits (EU rule on 3%, regularly violated), and most US states have balanced budget rules, at least for current accounts (and many sub-national units in other countries do so as well). But nobody, not nobody, has a maximum allowed nominal amount of debt, which must be raised periodically, nobody.
Posted by: Barkley Rosser at May 12, 2011 10:07 AM
Yup, you want to kill the dollar, you kill the economy through a deflationary spiral as it causes the currency to collapse.
US debtholders need a productive US economy. If the US does enter a period of strong deflation, all long term interest rates will head to 0 begging the government to borrow, even at interest free just to boost the economy. Finally, if US debtholders don't feel that will work, they will spike short term rates such as the 2 year note. Lets say it will rise to 10% overnight while the 10 year is 0%. The economy will be full dead. It will die as debtholders flee.
I think it is even possible it happens before long term rates fall to 0% if the current regime doesn't inspire confidence. With a government unwilling to do anything about global trade and lack of public investment, the path is coming down the pike. The little "oasis" is nearing its end by the 3rd quarter and all state economies will struggle.
Posted by: The Rage at May 12, 2011 11:39 AM
Since "quadrupling" is used by Jim Rogers in the same sentence with "Bernanke" and "print", presumably, when (or if) he says "debt", he really means "monetary base". Which tripled since 2008 and quadrupled since 2001.
There's a different version of his words in some news sources, apparently in a different context: "we can't quadruple the amount of money in the next slowdown."
Makes me wonder, did he really say both these things? Does he fail to distinguish between federal government debt and monetary base?
Posted by: Nameless at May 12, 2011 11:56 AM
For certain, what would be key to causing a crash in the dollar's value would be a failure to raise the debt ceiling in a timely fashion. In almost any model I can think of, that would either cause a flight from US government debt, or -- even if we only go to the brink -- elevating the risk premium, and hence total interest payments, on US Treasury debt indefinitely.
I agree with you here because if interest rates are allowed to return to normal it will blow the budget without any new spending. That being the case how can Senate Democrats even entertain the idea of not passing an increase on the debt ceiling as well as cuts in government spending? The two go hand in hand if we are serious about solving the problem.
Republicans have already gone on record saying they will pass a debt ceiling if the Democrats will agree to cut the budget so we are not right back in this same position in 12 months like they did last year. The Democrats seem to be begging suicide and playing with fire.
Posted by: Ricardo at May 12, 2011 01:19 PM
What would cause the dollar to crash? The prospect of chronically negative real s.t. interest rates.
So, I would put the question to you:
Assuming a sluggish recovery (1-2%, start-stop growth), when would you expect the U.S. to have positive real interest rates? That kind of growth may not be a "base case" forecast, but it is certainly possible.
Posted by: David Pearson at May 12, 2011 02:02 PM
No Ricardo, that's not what Menzie is saying, that's not what Bernanke is saying, and that's not what most economists are saying.
Like the Republican congress, you're purposely conflating the issue for political gain.
Posted by: edgolb at May 12, 2011 02:04 PM
If Republicans were really concerned about the effects of debt they would be willing to offer tax increases with their cuts—THEY won't, and it's proof that for them it's all an issue they want to exploit for future elections. WHEN they do offer tax increases with spending cuts, THEN we will know it's about AMERICA, not politics.
Posted by: edgolb at May 12, 2011 02:11 PM
Barkley Rosser The debt ceiling should be abolished. It is an anachronism imposed in 1917
Yep. It's probably not even constitutional. The Constitution says all debts authorized by law shall not be questioned: The validity of the public debt of the United States, authorized by law...shall not be questioned. The last time I checked every dime that Congress appropriated in the budget was "authorized by law." That's what budget "authorization" means.
Ricardo If Congress actually took those budget cuts seriously, then it would pretty much doom the economy. So the real world alternative is that Congress passes the debt ceiling with fake budget cuts that everyone knows should not and will not happen. And that's supposed to inspire confidence in the markets? So it's good policy to support cynical legislation that will be abrogated the next day? Look, Republicans are the ones who are always whining about Congress not listening to the markets. Okay, what are the markets telling us? It's loud and clear. They want a clean debt ceiling bill. This stuff where Republicans want two bites at the same apple (one to appropriate funds and authorize Treasury payments) and a second bite to have a chance to renege on those debt payments is bad public policy.
Posted by: 2slugbaits at May 12, 2011 02:41 PM
And the Republicans are to be obeyed in their demand that there be no tax increases? The Senate Dems must go along and have it all be spending cuts? Really? Is Grover Norquist the dictator of the United States?
Posted by: Barkley Rosser at May 12, 2011 02:54 PM
You ought to point out to your readers that a dollar crash would be helpful not harmful, since the US has plenty of excess capacity for job-creating exports. Currency crashes in countries that neither borrowed in foreign currency nor had high (more than 7 or 8 percent) inflation before the crash have always had beneficial effects. Amazingly, these currency crashes have not even caused noticeable increases in inflation.
Posted by: Joe Gagnon at May 12, 2011 03:52 PM
Sharp ones are often very damaging in the short run, even if aiding growth in the longer run. See the East Asian financial crisis of 1997, not to mention what went on in Argentina in 2001.
Posted by: Barkley Rosser at May 12, 2011 04:32 PM
Monetary base velocity has fallen *because* the Fed printed gazillions of dollars, not the other way around. The true reason for printing all those gazillions of dollars *was not* to avoid the "collapse" of M1 or M2 that never happened, as seen in the graph above.
What's the true reason then? Literally, follow the money. Start by giving an answer to the following question: why are banks seating on such huge pile of reserves?
Posted by: Badger at May 12, 2011 04:53 PM
Joe Gagnon: That's a good point, and I know your empirical work indicates currency crashes under certain conditions do not have a deleterious impact. However, I worry in the case where the US has a lot of government debt outstanding that the dollar crash is accompanied by a jump in borrowing rates -- the effects on output are then offsetting. In other words, there must be better ways of getting a depreciated dollar, which I agree would be a good thing on net.
Posted by: Menzie Chinn at May 12, 2011 05:11 PM
Joe Cagnon seems to believe a reserve currency can "crash" and still retain its reserve currency status.
I imagine those foreigners will realize that it was just a one-time crash, and that, thenceforth, we would promise not to do it again.
Posted by: David Pearson at May 12, 2011 05:28 PM
One thing I don't understand about the debt ceiling is that it's a case of congress passing mutually incompatible laws.
First, you have the debt ceiling, which says the US cannot borrow more than $X.
Second, you have the appropriations laws, which says the US must spend $Y.
How can such completely incompatible legislation exist? If the administration were to just ignore the debt ceiling, what would be the consequences? If congress wants a debt ceiling, then it should be bound, itself, to passing budgets and appropriations bills that are consistent with that debt ceiling. The appropriations bills, if nothing else by simple recency, should supercede the debt ceiling.
Economically speaking, events like Pearl Harbor and the 9/11 attacks wouldn't be nearly as devastating as a default on the debt. The far reaching consequences could feasibly lead to the dissolution of the government. So, how does a default on US debts not represent a Clear and Present Danger to the survival of the Republic? I'd like to see the Treasury skip all their silly emergency actions and just keep operating as if no debt ceiling existed and let the courts hash this one out.
Posted by: Tudor at May 12, 2011 05:57 PM
Menzie, you might want to look at the debt maturities for different countries. Portugal, for example, has debt that rolls while Britain's debt is longer term. Some argue that difference is meaningful in the way markets have treated the two, though obviously there are other differences (like size).
Posted by: jonathan at May 12, 2011 06:54 PM
Tudor The 4th clause of the 14th Amendment addresses the issue of debts that the Union Army incurred during the Civil War. For example, the "foraging" provisions allow an army on the march to obligate the US government even though Congress may not have specifically authorized appropriations. This part of the 14th Amendment says that the US will honor all of those debts, even ones that were not authorized. So if the Constitution says the US Treasury will make good on unappropriated obligations, surely we can assume that the framers of the 14th Amendment intended that congressionally authorized debts would also be honored. Bottom line is that the debt ceiling seems like a dead letter. The 14th Amendment directs the Treasury to make good on all debts irrespective of statuatory laws establishing a debt ceiling.
The irony is that it's the GOP that insists all legislation must contain a provision citing the basis in the Constitution for the proposed law. So when it comes to the debt ceiling, where does the Constitution say that the debt ceiling is binding and legally relevant?
Posted by: 2slugbaits at May 12, 2011 07:14 PM
Banks don't "lend out" reserves. They don't need reserves at all. Reserves are an innocuous side effect of Fed purchases, and Fed purchases (except under panic conditions) have little effect. Monetary policy is dead. That leaves fiscal policy, and the political environment is hostile to an easy fiscal policy.
So...short term rates will stay low, long term interest rates are likely to sink lower, and the dollar will be negatively correlated to risk because it's a funding (low yield) currency.
Posted by: Max at May 13, 2011 12:44 AM
We will end up with a compromise that neither side likes, so to me, that's a good thing.
Most of the analysis above ingores the positive signal that failing to raise the debt ceiling sends to the market:
*Interest rates will fall not rise. Markets will expect a short term slow down in growth,
*they will expect a decrease in the supply of government debt, or at least its growth rate, *they know interest on the debt will still be paid, so no technical default.
*most importantly, they realize that the debt ceiling will eventually be raised to accomodate growth.
I worry for most of you. You let your political leanings force you to the most extreme assumptions about the impact of government policy. What do you the think the conservative position should be? Raise the debt ceiling, raise spending and raise taxes? That's what progressives want. In your world we should have a one party system with Greece as our economic poster child.
Posted by: tj at May 13, 2011 05:32 AM
(1) Monetary base money affects inflation with a long lag. But base money can affect inflation in its powerful direct way of enabling growth of traditionally-measured money supply only if it is activated by bank lending. Unfortunately, the standard (m1 or m2) money supply intermediary between base money and inflation is all but worthless as an analytic concept as it does not measure true moneyness. True moneyness is the correct concept, but I know of no good empirical measurement of it. True money is a blend all the way along the spectrum from currency to gilts of the weighted moneyness of each of the artifacts in a modern technological economy that impart a psychological sense of liquidity which can then be exercised in spending. The moneyness in MBS out at the long end of the spectrum collapsed when in 2007 two Bear Stearns hedge funds were revealed to be insolvent, cascading into a systemically wracking loss of moneyness all the way down the spectrum. The QEs rightly countered this implosion. And by aiding the economic recovery, in its initial phase and again last year, the QEs supported the value of the US dollar. A strong economy makes for a strong currency.
(2) Because the entire financial system is still wounded, moneyness has not yet revived to where it was before the crisis. The primary bottleneck to a more rapid healing is the misguided regulatory capital constraint on the second tier of banks, the vast majority of which are prudentially run in contrast to the first tier Wall Street banks. Lower the capital requirements on prudentially run institutions and lending will increase, and with it the amount of true money.
(3) Jim Rodgers is almost certainly correct that during the next four years we are going to experience a serious slowdown. (Of course he can’t know the exact timing.) The most likely cause will be the regime of higher interest rates the Fed will be forced to implement as inflation starts picking up. Otherwise, bye bye to the inflationary expectations anchor. A big output gap is not going to stop this inflation pickup. The process has already begun as of last October (look at the core CPI). But the QEs have thus far set the inflation pot on low simmer, whereas for the dollar to collapse the pot would have to be boiling. Ergo the importance of moneyness and the path that true money growth takes. Knowledge of this remains mostly in analytic darkness, as convention is on hands and knees under the lamppost looking at the Ms for clues that aren’t too helpful since the keys are elsewhere. This, by the way, explains why there is so much controversy and wide diversity of opinion. If you are looking under the lamppost, you don’t have a clue. At least Jim Rodgers knows the keys are out there in the darkness somewhere, though that doesn’t mean he’s found them.
(4) I believe Menzie has it modulated about right on the sovereign debt shock aspect. The projected debt trajectory is worrisome, but over the near-term this trajectory is not going to collapse the dollar. And certainly it is unambiguous that strong US GDP growth supports the dollar. Where I see it 180 degrees different is on removal of fiscal stimulus. If Congress were to fail to raise the debt ceiling – for the right reason which is to let markets know that it is no longer business as usual in regard to profligate government spending, meaning that the holdout will be for cutting spending and not raising taxes – then markets will react in a way that strengthens the dollar. The opposite of what Menzie thinks. For a host of reasons you may disagree. How to decide? Observe the day-to-day reaction of markets in the days ahead to what goes on in Congress regarding the debt ceiling; as time goes by you will find that my essential point about global investors and fiscal restraint will be borne out.
Posted by: JBH at May 13, 2011 07:20 AM
And the Republicans are to be obeyed in their demand that there be no tax increases? The Senate Dems must go along and have it all be spending cuts?
No, I have written here over and over that they are both wrong. The result will be just what England and Germany are experiencing. Cutting budgets while raising taxes is a recipe for disaster.
BUT ... can you give me one instance in history when raising taxes created growth? What we know is that our economy needs growth first and foremost, but we also know that growth has always followed supply side tax cuts. When we know the answer why are we insisting on policies that have not worked in the past and are not working now.
What we are doing is not working. Let me repeat, what we are doing is not working. Let me repeat, what we are doing is not working. You see no matter how many times I keep saying it nothing changes. What we are doing is not working.
Posted by: Ricardo at May 13, 2011 07:56 AM
I was not talking about Menzie. I was talking about the Senate Democrats. They are the ones talking about turning back a House Republican plan to extend the debt ceiling. The House Republicans are all talking about what to submit. It is the Democrats who are talking about rejecting the plan. The Republicans will not be responsible for no increase in the debt ceiling. If it doesn't happen it will be because the Senate turns the plan down.
Posted by: Ricardo at May 13, 2011 08:00 AM
Just for the record Grover Norquist is a media hound and a tool of big business.
Posted by: Ricardo at May 13, 2011 08:02 AM
"As I've noted before, the Fed has more than doubled the money base, but this is not the same as doubling the money stock. That could happen if the banks lend out the excess reserves, but that hasn't happened as of yet. "
The Banks aren't lending out excess reserves IF you define lending here as commercial lending. But there is plenty of reserve lending between banks in the Fed Funds market. And when that kind of 'overnight' lending is combined with securities lending/repo agreements reserve lending provides much grist for banks and bank clients like hedge funds to fuel stock and commodity speculation, which in turns fuels price inflation in those products.
The notion that the now $1.5 trillion in bank reserves are sterilized via Fed interest payments is the overly academic cover story whereby the FED conceals the price inflationary impact of its policy, which is not to print the money. They 'type' it into existence.
Posted by: davepowers at May 13, 2011 08:07 AM
I can't see a "dollar dive" anywhere in the immediate future until the global deficiency of AD is gone.
Posted by: don at May 13, 2011 11:14 AM
Rarely do I agree with Menzie, but in the case of the dollar, there is not going to be extended weakness. Since still over 60% of the U.S. economy is driven by consumer spending and the consumer is hunkered down and paying for the debt hangover from the binge of the 90's and 00's, a buck is still going to be hard to come by. So... the dollar is going to continue to be king for atleast 2 or 3 more years. At that point, the economy will begin to revive and grow at 3% to 5%, annually. One more slow even mildly recessionary period is at hand. Mr. Obama will lose re-election on account of it, but that's not a bad thing. Is it?
Posted by: Steve at May 13, 2011 01:12 PM
All of that does not mean that he does not have enormous influence over politicians with his oaths not to raise taxes, most recently invoked to mess up a budget agreement in California. His power extends far beyond Washington into even state government affairs, a thoroughly noxious influence.
Posted by: Barkley Rosser at May 13, 2011 01:58 PM
Ricardo can you give me one instance in history when raising taxes created growth?
How quickly we forget: 1993.
Posted by: 2slugbaits at May 13, 2011 02:22 PM
The crises you mentioned were costly because those countries had large debts in foreign currency.
Fed will not let short-term interest rate rise and can control longer-term rate if it wishes to. The trick is to hold down rates until exports are growing strongly. Certainly the Fed could screw up, but I would prefer that path to the one we are on.
Posted by: Joe Gagnon at May 13, 2011 02:26 PM
The Fed can, as you say, set rates across the yield curve. The problem is not entering into that policy; the problem is exiting it. Imagine that weak (1-2%) rgdp growth ensues following a $2tr across-the-curve QE plan. Real interest rates are negative, and the Fed is indirectly financing large Federal deficits. Exit becomes impossible: the economy would not be strong enough to absorb positive real interest rates -- at least not without sparking a recession and/or a fiscal crisis. So in one (very plausible) scenario, we end up with a Fed that is trapped into more-or-less permanent financing of chronic fiscal deficits. This is a recipe for un-anchored inflation expectations.
You might say, "oh, but we would force the S&P up with that much QE." Just like QE2, and how much (self-sustaining) business investment and employment growth did that produce? We'll find out soon...
Posted by: David Pearson at May 13, 2011 04:40 PM
People shorting gold. I plan on doing it soon.
Posted by: aaron at May 13, 2011 07:15 PM
Or looking at things from another perspective...
Posted by: aaron at May 13, 2011 07:23 PM
For those that prefer the thoughts of a registered independent, Stanley Druckenmiller shares his thoughts in today's WSJ, page A13. He thinks the biggest negative for markets would be if the republicans cave and we don't get spending and entitlement reform. He prefers to have 1 of his bond payments delayed today in exchange for greater certainty that he we will receive future bond payments. Whether you agree or not, he raises several interesting points in the article.
Posted by: tj at May 14, 2011 07:52 AM
All hitting the ceiling would due is force a partial shut down and a real budget resolution.
Posted by: aaron at May 14, 2011 09:47 AM
Signs of imminent default in few years.
Posted by: Ivars at May 15, 2011 01:16 AM
Posted by: 2slugbaits at May 13, 2011 02:22 PM
Ricardo asks: "can you give me one instance in history when raising taxes created growth?"
2slugbaits replies: "How quickly we forget: 1993."
Clinton and his tax increase/spending cuts was not the sole reason. The bubble economy created a red hot labor market which brought people, who normally wouldn't work, back into into employment.
Fed policy played a role.
The fear of inflation fell as did interest rates. Borrowing for homes, cars & investments increased. We were also lucky in that the price of oil decreased.
Posted by: Babinich at May 15, 2011 04:26 AM
Babinich Ricardo didn't ask for a complicated exegesis; he simply asked for "one instance" when raising taxes led to higher growth. I gave him an instance. Now it's certainly true that "Fed policy played a role," but the Fed was only able to follow a growth policy because the 1991 and 1993 tax increases went a long way towards putting the country's fiscal house in order. If Bush #41 had not broken his no tax pledge and if he had been re-elected in 1992, it's pretty hard to see how the Fed would have had the room to keep interest rates relatively low given how hot the economy was. A re-elected Bush #41 along with a GOP Congress in 95-96 would have given us a very different economy in the 90s than the one we actually had. Clinton's fiscal policies do not explain all of the 90s boom, but they probably explain about 30% of it. In any event, I'm pretty sure that in 1993 Ricardo would have been one of those pounding his shoe on the table warning us all that Clinton's tax hike would send the economy into a deep recession. And now I suppose Ricardo will try to convince us that due to Austrian "roundabout" and concertina cycles there was a 15 year lag and he was right afterall.
Posted by: 2slugbaits at May 15, 2011 06:12 AM
Bill Clinton signed his tax increase in August of 1993. It was effective in 1994. In 1995 GDP was the lowest it had been since George H. W. Bush raised taxes in 1989. Surely you can do better than that.
After the Republicans were sworn in 1995 by signing welfare reform and capital gains tax cuts all while holding down spending by reducing defense from 5% of GDP to 3.1%, Bill Clinton proved to be one of the greatest supply side presidents in history.
All of that without even considering that Greenspan held the dollar more stable than any time since Nixon broke with gold resulting in a 1% drop in interest rates.
Posted by: Ricardo at May 16, 2011 10:11 AM
If Bush #41 had not broken his no tax pledge and if he had been re-elected in 1992, it's pretty hard to see how the Fed would have had the room to keep interest rates relatively low given how hot the economy was.
The quote above tell us exactly why we are in trouble as long as Keynesians are running things. The only way out of our current problems is through economic growth, but as you can see above Keynesians will not allow the government to grow at a level that will lead to recovery becuase they are deathly afraid of a growing economy. Hey, the Japanese have been successful in preventing a hot economy for almost 30 years taking the advice of our brilliant economists.
Posted by: Ricardo at May 16, 2011 10:18 AM
Ricardo: "Bill Clinton signed his tax increase in August of 1993. It was effective in 1994."
But it may have been "effective" well before that, as expectations of bond traders may have been influenced when the legislation was introduced. I don't recall seeing the arguments that Rubin gave to Clinton about this, but Clinton's response made clear that the message got across when he said "You mean the economy, and the fate of my domestic programs, depend on what a bunch of blankety-blank bond traders think will happen to interest rates?"
Posted by: don at May 16, 2011 01:09 PM
Menzie--does the article linked below makes you despair of finding any signs of intelligence in certain Keynesian quarters?
Posted by: All that Keynesian Stimulus drivel at May 16, 2011 02:35 PM
Menzie, you've pretty much been wrong on everything else (e.g., Obama stimulus will work) so why should we buy any of your new twisted Keynesian logic?
Posted by: bob29 at May 16, 2011 02:39 PM
Ricardo In 1995 GDP was the lowest it had been since George H. W. Bush raised taxes in 1989.
Huh? In 1989 real GDP was $7885.9B. In 1995 real GDP was $9093.7B. By my arithmetic the 1995 number is bigger.
Keynesians will not allow the government to grow at a level that will lead to recovery becuase they are deathly afraid of a growing economy.
What are you talking about? The Fed's job is to keep aggregate demand in line with potential GDP. Roughly speaking, aggregate demand management is about containing deviations from potential output over the short-run. Over the long run the growth rate of the economy is driven by supply side factors, such as labor productivity, capital/labor ratios, population growth, etc.
Posted by: 2slugbaits at May 16, 2011 02:58 PM
Next 2slugs will be telling us the Clinton tax hikes fueled the information/technology revolution! Rosser will get his "I agree, I agree" panties in a bunch and put up another silly post.
What a hoot!
Personally, I think its all the fault of the Koch brothers.
Posted by: Bob29 at May 16, 2011 03:13 PM
For certain, what would be key to causing a crash in the dollar's value would be a failure to raise the debt ceiling in a timely fashion
And yet even at this late date concern on the part of the bond vigilantes is notably lacking.
The bond and currency markets seem totally sanguine.
Posted by: Jim Glass at May 16, 2011 03:20 PM
All that Keynesian Stimulus drivel
I don't know about Menzie, but the paper makes me despair of the general public's ability to understand the meaning of confidence intervals. Look at the regression results. In most cases, except for the HELP services estimates, the 90 percent confidence intervals range between negative and positive.
But even beyond the econometric stuff, the narrative of the paper does not describe a situation in which Keynesian stimulus doesn't work, but rather a case in which states act to consciously defeat the stimulative effects of ARRA by reducing planned spending. In other words, even if you set aside the statistical issues and accept their point estimates, the narrative isn't what you seem to think it is. The conclusions are not about economics, but rather about the machinations of state and local politics and how those governments react to windfalls from the federal government. It's political science, not economics. And bad political science at that.
It's something of a goofy paper and doesn't deserve a lot of attention, but it does serve a useful public service in highlighting the general public's ignorance about the meaning of "statistical significance."
Posted by: 2slugbaits at May 17, 2011 05:56 AM
All that Keynesian Stimulus Drivel aka Bob29 aka Bob aka Robert aka Union Power: First, I'm thankful you learned how to spell my name. Second, do you understand what you purport to read, and/or do you believe in critical reading? I have only two words for you -- "standard error".
Posted by: Menzie Chinn at May 17, 2011 12:45 PM
I miss Brad, but take some solace that he is an insider now.
Posted by: Glen at May 18, 2011 06:02 AM
Two words for you -- "Keynesian drivel".
Keep on pedaling......
Posted by: Bob29 at May 18, 2011 07:49 AM
You are a hoot!!
Read my post again. I said that GDP growth was the lowest it had been since 1989, not that it was lower than 1989. After the economy began to adjust to the horrible GHW Bush tax cuts the economy began to grow again. 1992, 1993, and 1994 were all higher. When the impact of the Clinton tax increases hit in 1995 Growth begin to fall. The Clinton tax increases did not increase growth, they halted growth.
Now I agree that Clinton was a good economic president and he should get credit for the growth during his 8 years; he signed some important legislation that allowed for economic growth. But his tax cut was not one of them.
Posted by: Ricardo at May 18, 2011 08:18 AM
I think we agree on Norquist.
Posted by: Ricardo at May 18, 2011 08:22 AM
The US$ has already crashed 80%+ since '00-'02 in terms of gold adjusted for CPI and the US$.
A MASSIVE cyclical US$ rally of 50% or more is much more likely than a further crash, particularly with the increasing risk of a EU sovereign debt wipeout hitting the euro coincident with another global debt-deflationary contraction and financial markets crash in the next 6-18 to 24-30 months.
Moreover, China is on the verge of a monumental post-bubble crash, with dozens of US supranational firms having hundreds of billions of dollars of capital captive in China, requiring the PBoC to facilitate the selling of US Treasuries to the Fed via liquidity swaps or other book entry transfers in order for US firms to repatriate US$'s when the China Crash occurs.
The US$ will surge against the euro and commodities-based currencies with the coming deflationary global contraction and commodities price crash.
Posted by: Nemesis at May 19, 2011 08:23 AM
You are a hoot!!
Read my post again. I said that GDP growth was the lowest it had been since 1989, not that it was lower than 1989.
That may have been what you intended to say in your post, but that's not what you actually wrote. I did not misquote you. It was a simple copy/paste of your own words. I suggest that you go reread what you actually wrote, not what you imagine you wrote.
Posted by: 2slugbaits at May 19, 2011 02:46 PM
I will stop after this because it is getting to be childish but do you know that the word since means?
In 1995 GDP was the lowest it had been since George H. W. Bush raised taxes in 1989.
You did copy and paste my quote correctly, for that I give you credit.
Posted by: Ricardo at May 20, 2011 07:04 AM
Ricardo: You always amaze me with your innumeracy. Go to FREDII, download the real GDP series, and you will see that every year since 1989, GDP is higher than 1989. The only year in which GDP dropped was 1991. Every other year, GDP is higher than the preceding year. So there is no way in which to make your assertion correct. Even if you you insert the key and consequential word "growth", the lowest growth rate is in ... 1991.
Do you know how to read data?
Posted by: Menzie Chinn at May 28, 2011 10:56 AM