Tuesday, April 15, 2008

Tory MLA on the "US Slowdown"

" In the US there is a market correction going on that has been amplified by the sub-prime mortgage mistake. People who couldn't afford a house were given mortgages at below prime..."

As Wikipedia explains, "Subprime lending (also known as B-paper, near-prime, or second chance lending) is lending at a higher rate than the prime rate. ... A subprime loan is offered at a rate higher than A-paper loans due to the perceived increased risk." What's "less than prime" is the credit of the borrower, not the rate!

"they have a devalued/devaluing dollar that is creating subsector inflation (all goods imported will grow more expensive..."

This has the causal relationship backwards. As noted by the Bank of Canada "the value of the Canadian dollar is determined by economic forces (fundamentals), such as the rate of inflation and the level of interest rates in Canada..." not the other way around (aside: that BoC webpage contemplates intervention, but my former boss at the Finance Dept and fellow Edmontonian Mark Carney says that the Bank won't be intervening while he is Governor). I appreciate that the reference here is to "subsector" inflation but I don't see what the problem is if it is necessarily accompanied by "subsector" deflation such that you don't have macro inflation, period.

"the US has a national debt that is growing rapidly ... (and that in turn leads to further depreciation against world currencies.)"

Of relevance for currency level is the fact that the United States has a massive current account deficit. The vast majority of that deficit is accounted for by the merchandise trade deficit, although the flow of greenbacks out of the US is increased by unilateral transfers (US foreign aid or immigrants in the US who send dollars back to their families) and factor income (foreigners who receive interest, dividends, or rent from the assets they own in the US).

As long as foreigners continue to "finance" the current account deficit, the dollar's value will remain stable. Foreigners can use the dollars that arise from their current account surpluses to purchase US assets, whether it be property and plant on US soil (foreign direct investment or FDI), shares in US firms (portfolio investment), or US Treasuries. China and Japan in particular have bought enormous amounts of US government securities.

The mirror image of the massive US current account deficit is thus the massive US capital account surplus.

To what extent does increasing US national debt dissuade foreigners from continuing to finance the current account deficit? One study suggests that a $1.00 reduction in the federal budget deficit would cause the current account deficit to decline less than $0.20. Also, the US current account deficit expanded by about $300 billion between 1996 and 2000, a period during which the US federal budget was in surplus. See also "How I Learned to Stop Worrying and Love the Current Account Deficit".

Besides, if you have a project that will return 10 cents on an invested dollar every period, why stop investing with just the money you have on hand, if someone is willing to lend you more for just 2 cents interest on every additional dollar lent to you? This is to say, the expanding US debt might be the rationally responding variable to international investors who are falling over themselves to finance the US. Indeed, no less a personage than Ben Bernanke says he wishes to:
... take issue with the common view that the recent deterioration in the U.S. current account primarily reflects economic policies and other economic developments within the United States itself.

Non-Americans aren't just the drivers on the capital account, either. If the Chinese weren't happy with their current account situation vis-a-vis the US they'd let their currency float.

Note that while one of Bernanke's predecessors, Paul Volcker, points a worried finger at the fact that "What holds it all together is a massive and growing flow of capital from abroad, running to more than $2 billion every working day, and growing," he acknowledges that "As a nation we don't consciously borrow or beg. We aren't even offering attractive interest rates". In any case, "Bernanke" has declared "Paul Volcker an enemy combatant to the economy" and as for Greenspan, well, evidently he isn't especially worried about the current account deficit.

I certainly agree that spending should slow and the net asset position be improved. But the declining US dollar isn't the US' problem. Rather, it's the solution! Current external imbalances can be unwound either by future trade surpluses or by future favorable returns on the net foreign asset position of the US. A declining greenback increases the dollar value of US assets currently denominated in foreign currencies and helps to increase net exports as well. This study finds that "a 10% depreciation of the dollar represents, ceteris paribus, a transfer of around 5.9% of US GDP from the rest of the world to the US."

"... slow spending, slow borrowing, and encourage savings and debt pay down... [otherwise] ... the only way it will turn around at that point is for interest rates to rise to 15 - 20% for close to a decade..."

It's remarkable that a member of the Alberta government can wag the finger about slowing spending and improving the net asset position with no apparent sense of irony.

As I observed during the campaign: "most absurd of all is [the premier's] contention that a vote for anyone other than Ed is going to lead to '22% interest rates'."

Apparently our MLA here has been or is a member of the Standing Committee on the Alberta Heritage Savings Trust Fund. As I noted a month ago, Jack Mintz told the Calgary Herald on Jan 21 that the Alberta government "needs much more fiscal discipline" and "[t]he most important message that will come out of our report will be why Albertans should save." Why is the government continuing to sit on this report? There was ZERO indication in Tuesday's Throne Speech that the Alberta PCs will be giving any consideration to taking the medicine one of their number is prescribing for another government.

At bottom, I entirely agree with the thesis that government should be moving out the long run supply curve instead of juicing short term demand. But at least the US is contemplating more fiscal stimulus when the economy is far from running at full tilt. If the Alberta government wants to lecture anyone about stoking inflation, they just need to find a mirror!

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