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Another essay with an organization of thoughts regarding a commonly misunderstood economic phenomenon regarding the trade deficit and $ hegemony, please criticize at will!:


Smothered by all of the hysteria over spending and government debt, we almost never hear an honest discussion about the driver of economic imbalances in the United States: the trade deficit.

The deep trade deficit fueled by a nearly-unspoken policy of providing the world with a reserve currency, perpetuates imbalances in the public and private sector that are largely misunderstood. Consequentially, this nagging perpetual current account imbalance has been central to the perceived problems regarding the “national debt” and private deleveraging.

History of the Trade Deficit

Figure 1: Current Account Balance

For decades after World War II, the United States valued a more balanced economic position. In the post-war period up to and beyond the removal of the gold standard, the government was focusing on paying war debts (after all, the debt was essentially gold-based, which set a constraint on them that we don't currently have) as the private sector was producing small trade surpluses and fostering growth through bank credit, leading to a rather stable path to prosperity.

However, after Richard Nixon removed the US economy from the gold standard, the dynamics of how policymakers believed the future of the economy would be composed shifted drastically. The new system driven by fiat currency mechanics and globalization policies focusing on “free trade agreements” with developing economies led to opportunities where the US could import cheap goods and finance it with outflows of dollars, By the 1980's under Ronald Reagan, the realization of this phenomenon led the trade deficit to explode as the United States poisitioned itself as the dominant world economic super power and demand for the dollar as a world reserve currency surged.

The trend continued after a brief trade balance was reached under George HW Bush, and reached critical levels under George W. Bush. The dollar has now become the standard currency of trade and investment in demand all around the world, with foreign entities transacting using dollar-denominated assets, meaning the American economy has needed to run a current account deficit to fuel this ever-growing demand.

But what are the effects of such a deep deficit?

Macroeconomic Flow Accounting Identities

The trade deficit has consequences on private and government finance that are unappreciated and often times completely ignored by the media.

To understand the mechanics behind this, it's important to note one rock-solid accounting identity in macroeconomics, that is:

Private Sector Balance (Income-Spending) = Trade Balance (Exports-Imports) - Fiscal Balance (Taxes-GovSpending)

Let's rearrange this for illustrative purposes relative to the Trade Balance:

Trade Balance (Exports-Impports) = Private Sector Balance (Income-Spending) + Fiscal Balance (Taxes-GovSpending)

And we know that this massive trade deficit (based on a number of factors as discussed earlier) is harming the overall economic balance. If the trade balance is in a steep deficit, that means that either the fiscal balance or the private sector balance also has to be in a deficit (or, one of them must be in a larger deficit than the Trade Deficit and then get offset by the other sector).

The Great Recession of 2008-present was an offshoot of the housing bubble made possible by overly-loose credit market conditions, which led to a completely unsustainable path of private debt accumulation:

Figure 2: Private Sector Debt Outstanding

Since the beginning of the official technical recession, the private sector has been paying down debt that was taken on during the boom times. This is the same as running an annual private surplus.

So, going back to our accounting identity:

Trade Balance (Exports-Imports) DEFICIT = Private Sector Balance (Income-Spending) SURPLUS + Fiscal Balance (Taxes-GovSpending) ???

This leaves only the fiscal balance. If we're running a trade deficit as large as in present conditions, and the private sector is busy paying down debt accumulated during the housing boom, then the fiscal balance MUST be in a deficit. That is to say, the government must be running a deficit in order to fulfill the accounting identity.

Address The Trade Deficit, and The Rest Will Fall In Place

The answer to this obvious imbalance is not to attempt to first balance the government's books, but to instead focus on reducing the trade deficit. With that, a more balanced government budget and a less-indebted private sector become much easier goals to reach. There are many who wish to perpetually fuel the dollar as the reserve currency, but this is not a viable long-term strategy by which to base assumptions. China and other powers will rise with opposing systems and we have to craft the foreign exchange policy of the dollar with this in mind. I take issue with the proposition that we should just be running deep deficits into perpetuity, as this will undoubtedly come to an end when the regional titans of Asia and Laitn America rise up and grow their own independent systems that we have to compete with the international capitalists for investment into.

The private sector will not have the capacity to take on the debt necessary to offset a more balanced fiscal position, not any time soon at least. Given this constraint in the identity discussed above, the only way to offset a trade deficit is with a government deficit.

In this sense, the trade deficit is the dog wagging the tail of government and private finance. To attack the government imbalance or the private sector imbalance, one must first focus on trade deficit reduction, which is mathematically required to help offset government leveraging or private debt accumulation.

It all boils down to one strange issue with American economic policy: we ignore the power of the foreign exchange value of the dollar and choose to take a “hands-off” approach, which is contrary to what the vast majority of economies in the world choose to do. By fueling current demand for the dollar as a world reserve currency, in the future if this status is challenged then the United States will be faced with an ever-declining dollar anyway, as people sell their dollar holdings to diversify into other currency assets.

There are numerous solutions, (depending on how one feels about the dollar being a world reserve currency) which I won't go into detail with in this essay (this is for a later time), but I will mention the options briefly:

1) Devaluing the overvalued dollar. We should ask ourselves, why is our trade deficit so steep? It's not Chinese currency manipulation, because they've strengthened the Remnimbi significantly over the years, and it can't be blamed on any other misbehaving market actors, so what's going on?

If we are importing a lot more than we are exporting, clearly our dollar is over-valued and hurting American manufacturing and exports. The simplest way to offset this imbalance would be to engage in a “competitive dollar” policy that would help improve the trade position of American exporters and make imports less attractive to domestic consumers. However, “currency wars” bring up rather nasty thought experiments where countries continuously slash their foreign exchange value, undercutting one another with no end in sight.

2) Classic protectionism. We can engage in protectionist policies through tariffs or subsidies. The problem here is that we have an international organization that governs these sorts of things, called the World Trade Organization. Any explicit support of export markets is monitored closely by competing nations, and cases are regularly brought to the WTO as a way of mediating problems and promoting free trade as a successful mutually-beneficial principle.

3) Capital controls. This is a bit of a mixture of the first two options, and probably the most extreme. By forcing a limitation of fund flows that essentially produce an artificial trade balance, it would then address the root problem, only to cause numerous other ones.


There's no law anywhere stating that a perfect balance in Trade, Private, and Public accounts is required for optimal economic growth. In fact, the United States has had rather impressive growth despite a relatively unbalanced set of economic fund-flows.

Given the modern reality of the United States producing the world's reserve currency, a current account deficit and over-valued currency is an implicit Treasury policy. As Triffin warned decades ago, a nation that positions itself as the supplier of the world's reserve currency will necessary need to run a current account deficit in order to finance the demand for its currency.

It's worth noting that so many of the dollars flowing out from the trade deficit are invested in Treasuries. In my other essay “The Case For Stimulus” I detail how the debt is easily sustained when the demand for Treasuries is high enough to maintain a stable rate of return.

Since it's an unofficial Treasury policy to promote the US dollar as a reserve currency, it's possible that the trade deficit will never close to levels that people may be more comfortable with, but that's not necessarily a suboptimal set of circumstances.

People should not blindly be calling for a balanced government budget without considering the mechanics of the dollar as a reserve currency necessitating net outflows of dollars to meet international demand, as well as the accounting identity that shows if we do not run a government deficit to meet the trade deficit, then the private sector must go into a deficit (net borrowing), which the economy currently is not in any position to begin.

There is thus a decision that should be made by those who are promoting the idea of a balanced budget: if you support the dollar as the reserve currency, while desiring the goal of a balanced budget, this is an implicit call for the private sector to be running a deficit, rather than the government. However, if you believe there are negative long-term consequences to the dollar as a reserve currency, particularly regarding future potential volatility in FX value when competing currencies gain prominence, then winding down that effect would make the management of the tradeoff between government and private sector balance much more politically feasible to address.

Under a smaller current account deficit with an unwinding reserve currency status,  the more optimal policy would be for the government to run a perpetual structural deficit (exceeding the trade deficit), which leads to a stable and sustainable building of private wealth, a long-run equilbrium for a healthy economy. The current American hegemony will not be something we can extract rents for forever, and responsible policy would be to position ourselves for change.

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Comment Preferences

  •  That balance is a good thing is an illusion. (4+ / 0-)
    Recommended by:
    aguadito, cal2010, Habitat Vic, katiec

    The principle arose out of double-entry book keeping, which presumed that if something was counted two ways and the sums came out the same, the count was more likely to be correct.
    Also, balance refers to a static point in time -- i.e. no motion. This is the point that accountants not only prefer, but the only one they have figured out how to capture. Which is why they like it.
    But, the reality is that the system of exchange and trade is dynamic -- i.e. changing from minute to minute and hour to hour. So, whatever gets captured at a point in time is no longer valid by the time the numbers get issued. To get around this fact, economists have tried to devise models to suggest that trends over time tell us something important. But, here there's the problem of which factors to consider to avoid being swamped by the variables. So, for example, they select "representative" entities to track, like industrial stocks or imports or exports, or whatever. But, their time-frame is still limiting. The models can't, for example, take into consideration that a debt incurred today will be paid back five years later -- a transaction that is balanced after five years.
    And Congress, for some reason, can't even comprehend that dollars are nothing but certified IOUs, which we all use to signify our debts to each other, much as we use the letters of the alphabet to signify (make visible) our words and thought to each other. Or, for that matter, that dollars are certified monetary obligations, much as marriage certificates attest to marital obligations.

    It should be noted that some legislators are convinced that a marriage doesn't exist, unless it is certified by the state and that obligations don't exist unless somebody gets paid, but they're wrong. It's what they'd like to believe because, if it were so, then the people who issue the dollars, certificates of debt, could exercise control by simply withholding the certificates. They'd like to think "people can't get married without my say-so and they can't get paid without my say-so and I'm going to withhold (seuqester) the dollars to prove it."

    Imagine a see-saw in balance. Is that a good thing?

    We organize governments to deliver services and prevent abuse.

    by hannah on Sun Jan 27, 2013 at 01:31:12 AM PST

    •  Balance wrt to Trade/Gov/Priv flows... (3+ / 0-)
      Recommended by:
      hannah, cal2010, katiec actually not a reference to a static point in time, but rather a "movie clip" of a period in time.

      Business-wise it's like viewing an income statement versus a balance sheet.

      The key is stocks and flows -- these aren't illusions but realities of accounting. Just because a debt is paid back doesn't mean there won't be writedowns and cash deficiencies, which all end up being caught up in the system anyway.

      It may be a bit of a crude, even archaic system given the capacity we have now to more reliably track flows and accounts, but it's still very relevant.

      Imbalances still need to be considered for effects in the short and long-run, the micro incentives of those who are engaging in trade have to be understood.

      •  People engaged in trade have an incentive (3+ / 0-)
        Recommended by:
        cal2010, aguadito, katiec

        to take a "cut" of things they haven't made. They are middlemen. Middlemen are a vanishing breed for the simple reason that electronic communications are making direct interactions even over great distances much easier. When producers and users are directly connected, there's no need for the middlemen. They are reduced to being nothing but highwaymen -- persons who intercept a transmission or exchange in order to extort payment for themselves.
        Highwaymen perceive themselves to be in competition with the tax man. In fact that is not quite correct, because the tax man funnels most of what he collects into necessary public goods and services, one of which is keeping the highwaymen in check.
        What is ironic is that the production of goods has always been stressed by the fact that, although they are easy to count and assess as to their usefulness, high quality goods are counter-productive because, being long-lasting, their marketability shrinks. So, in order to keep production going at a steady rate and profits stable, producers resort to planned obsolescence and failure by design. The quality keeps decreasing until buyers revolt and the market collapses. The reason this is ironic is because services, which have always been considered less favorably by economists because their value is more difficult to quantify, actually follow the reverse trajectory. The market for services is never saturated and increasing quality increases profits almost automatically. So, if the revenue stream is to be sustained indefinitely, services are the way to go, even though quantifying them is hard.

        The only real problem is that people who are resistant to paying for labor tend to get ever more resistant when they are forced to pay up. Goods provide services. But, after the initial expense, they appear to provide them for free. It's an illusion, but it's all some people see.

        We organize governments to deliver services and prevent abuse.

        by hannah on Sun Jan 27, 2013 at 02:55:56 AM PST

        [ Parent ]

  •  Thoughts (2+ / 0-)
    Recommended by:
    cal2010, aguadito

    1. The problem is that the flexible currency regime which should provide a balancing mechanism for trade deficits/surpluses is broken. The massive accumulation of FX reserves by the likes of China, Japan etc makes adjustment impossible. Therefore the US can not get the currency depreciation it needs to balance the trade position.

    2. What is now happening in fact is that the FED by printing dollars is trying to weaken the currency (by massively boosting supply). This forces countries that are accumulating US$s to essentially import inflation (they buy up dollars from exporters but are forced to print their own currency in excessive amounts which creates inflation).  This WILL lead to problems when the dam does eventually break.

    3. A side effect of 2. above is that Chinese nationals for example are shifting their money overseas, primarily in buying US and other foreign assets, like homes etc. So at least some of the trade deficit is being recycled back into the US through alternate channels.

    4. In recent years about 1/2 of the trade deficit has been due to imported oil. The US is now increasing supply which will help, but it could have, and still could, easily cut the trade deficit by rising gas prices at the pumps with higher taxes (as most other nations do). This would cut consumption, and slow the economy , even further reducing the trade deficit. (Had Bush done this after 9/11 instead of telling everyone to go shopping, and lowering interest rates (which together boosted imports), it is likely the whole housing bubble could have been avoided. Yes the economy would have slowed but it would have reduced the trade deficit (fewer imports) and taken the froth out of the housing market.)

    There's room at the top they're telling you still But first you must learn how to smile as you kill If you want to be like the folks on the hill

    by taonow on Sun Jan 27, 2013 at 02:46:58 AM PST

    •  Regarding QE (Fed's recent base expansion/money... (1+ / 0-)
      Recommended by:

      ...printing), I must object to your statement that it is "trying to weaken the currency".

      The Fed minutes and beige book and other statements clearly show a policy of "benign neglect" with respect to the currency's fx value). thus QE is more a way of cleansing the MBS market and trying to reduce long-term interest rates to promote growth. If the aim has been to weaken the currency, it's done a horrible job of that!

      Also the accumulation of FX reserves by China, Japan doesn't make adjustment impossible, but it definitely makes it more difficult. The Fed can engage in foreign asset purchases to help offset such things.

      Accumulated surpluses by our trading partners apply lots of upward pressure on their currencies, so the management of their surpluses is key to offsetting this pressure and maintaining a beneficial trade position (fx wise at least). The Chinese and Japanese are deathly afraid of unwinding their positions, the flood of dollars into the market from such an attempt would do disastrous things to their export markets (the drivers of their growth and employment).

      There's a lot of parallel phenomena at work here, and I still can't exactly figure out what is causing what and how things will play out in the future, but one thing is sure: the dollar is overvalued and the deficits being run are forcing an oversupply of dollars, which threaten this "overvaluation". And i think the US should be focusing more explicitly on the dollar's exchange rate, because as we continue to run trade deficits, the rising stock of foreign holdings of dollars threaten aspects our sovereign control over our currency -- that is, the market will decide when to devalue the dollar, not us.

      •  How will the markets decide to devalue the dollar? (0+ / 0-)

        The Fed Reserve is now paying nominal interest on reserves.

        What if they increased interest on reserves, and decreased demand for bonds?

        And Treasury issued a high value coin to pay off bonds as they came due?  And maybe even used non interest bearing money to pay for future spending?

        In other words, isn't there some creative stuff we could do to satisfy China's desire for interest on it's dollars without issuing bonds?

        Even if it would piss off the bond markets, cuz they always want more debt?

        •  The market... (0+ / 0-)

          ...will only get more and more alternative currencies to choose from. As foreign holdings of dollar assets, particularly Treasuries (by far the largest and most liquid dollar market), increase and they see rising economies with sovereign currencies that offer better opportunities, there are incentives to divest from lower-growth-rate dollar assets and get into others.

          We should be devaluing the dollar now and maintaining control by expanding the Fed's role and intervention the FX market.

          Foreign market holdings of dollars give them more power to dump the dollar and shift markets. I just think we should be more proactive than reactive.

      •  exactly (0+ / 0-)
        as we continue to run trade deficits, the rising stock of foreign holdings of dollars threaten aspects our sovereign control over our currency -- that is, the market will decide when to devalue the dollar, not us.
        Countries can run deficits for some time, and in effect the reserve currency status allows the US a whole lot more rope than most, but there will be a price to pay, at some point, and the longer this goes on the greater the price.

        By being unwilling to live within its means (trade deficit/budget deficit) the US is slowly losing control over its future destiny. There are choices that it could make to change the situation - but they are politically unpopular, so they will only happen once an FX crisis arises, by which point the pain will be much worse.

        As for the FED I have little doubt that they want to weaken the currency - but they can not say this without starting a waterfall that they can not control, so they say one thing but do the other.

        There's room at the top they're telling you still But first you must learn how to smile as you kill If you want to be like the folks on the hill

        by taonow on Sun Jan 27, 2013 at 06:49:55 AM PST

        [ Parent ]

  •  It *will* come to an end, one way or another. (0+ / 0-)

    It's almost self-evident that the tipping point will be when rapidly rising oil (and hence transportation) costs and the inevitable rise of wages in China finally eliminate the current cost advantage of outsourcing manufacturing. China's coming water crisis and ecological collapse may also be relevant.

    The question to me is whether the U.S. will have enough of a remnant middle class and functioning society to begin rebuilding at that point, or if we'll be too far gone toward the Spanish/Greek meltdown models to recover.

  •  Another great diary! (2+ / 0-)
    Recommended by:
    katiec, aguadito

    I am enjoying your diaries. I wrote a long response to you last piece dealing mostly, I recall, with Michael Hudson's formulation of the problem of compound interest, and to argue that interest rates on the debt are under far more control by the Fed than your diary suggests. Unfortunately, I was stupidly composing on line and it was all swallowed up by the ether before I got it to post. It wasn't meant to be. There are a couple of points I would like to add to your current offering.

    The adoption of the dollar as the world reserve currency really arose out of WWII and the 1947 Bretton Woods Agreement where member currencies were fixed to the dollar and the dollar to gold. When we walked away from that in 1971 the dollar was already well ensconced in reserve status. The real change was that in q4-1979 the Fed changed to a high interest rate stance. They targeted average interest on the debt (which the fed completely controls through the banking reserves) greater than the average growth of GDP, knowing that it was an unsustainable path from work going back as far as 1944.

    Even formulations of the error-filled neoclassical paradigm concede that, if the average rate of GDP growth is greater than the average interest rate on the debt, persistent deficits, even of large magnitude, are perfectly sustainable. They then go on to argue that average interest is generally greater than average growth "in the long run" and  that market forces govern interest rates and the confidence fairy and all that comes into play. It is all fallacy. From 1953 until 1979-q3 growth rates were greater than interest rates and small persistent deficits allowed the debt to gdp ratio to decline. From 1979-q4 to 2000-q4 the Fed set interest rates high enough to exceed growth and the debt ratio skyrocketed. From 2001-q1 until present the Fed has maintained low interest rates and, except for the period 2008-q4 to 2009-q3) gdp growth has been greater than interest. Under the current conditions, we could sustain current or larger deficits without difficulty and with debt service bounded to a fixer percentage of GDP in perpetuity. This is fully explored in a paper by Fullwiler available here (pdf).

    I see the problem of going after the trade deficit is that we are really on the advantaged side of the trade equation in that we receive real goods and services that constitute real costs to the exporter in labor, materials, social and environmental costs and all of the other externalities the they conveniently package for our consumption. For all that we give them purchasing power in dollars. They buy what they want from us (if it is for sale in $) and save the rest. The Fed gives them a choice, checking or savings. Checking is reserves, savings is treasuries and bears interest (now the fed is paying 25bp on reserves and they are peddling fewer treasuries and allowing excess reserves to build.

    Here is a chart from Fullwiler (2006) that tracks the historical bond - GDP. He has updated that paper in a 5-part series at New Economic Perspectives that is a little easier read than the 2006 paper.

    •  Excellent point (0+ / 0-)

      Regarding the effects from the difference in rate of GDP growth and interest really does hammer home the point regarding sustainability and how beneficial our current position is in that respect.

      I very much appreciate your thoughtful comments and discussions.

      I've read Fullwiler's work regarding seignorage and monetary policy in a permanent ZIRP environment (he's also been extremely patient with me in tweeting back and forth discussing issues with me), as well as alternative risk-free dollar-assets to meet international demand. I respect his work immensely, but I'm a bit more attached to NGDP targeting and having a normal rate environment and winding down the dollar's reserve currency status.

      The way I look at it, the permanent-ZIRP path fits more with the idea that we should be expanding or at the very least maintaining the reserve currency status and just run perpetual deficits across all sectors managed through IOR adjustment.

      The problem I see with expanding the reserve status is the FX effects of putting so many dollars out there, and as rapidly-growing economies arond the world become viable alternatives to asset managers, we may have trouble controlling the swings.

      I'd be interested to hear your opinion on this risk, as I'm struggling with reconciling the proposals of Wray, Fullwiler, Kelton, etc. regarding permanent ZIRP and this potential risk for future FX market volatility.

      Where I am right now is closer to the likes of Beckworth and DeLong (and sort of Krugman), to return to a normal rate environment, take an ACTIVE role in FX management for the dollar by Treasury/Fed, and target NGDP as the primary monetary policy tool.

      And I do understand how the trade deficit is viewed as an advantage to us, but I see it as their dollar-assets are very real, as real as the resources they use to produce the goods we give them the dollars for, and they could be rolling that dollar-denominated wealth they are building up over into better opportunities than we can offer. They'll ditch us just as easily as we have been taking advantage of them, and then we're stuck with a weak currency and playing catch-up producing for the new regional titans that are emerging.

      •  My view is more general and maybe long term... (0+ / 0-)

        but I just don't see how Democracy survives the financialization of the world economy.

        GDP seems like a crappy tool.  And one that only benefits the top of the heap.

      •  BTW, you dont have to expand on your response (1+ / 0-)
        Recommended by:

        at my other comment requesting you do so.

        this is the expansion


        •  Okay cool.... (1+ / 0-)
          Recommended by:

          ...I hope it was satisfactory.

          But if not let me try and put it in one more short explanation:

          - Running perpetual current account deficits is basically giving dollars to others.

          - The larger those deficits get relative to our own domestic dollar holdings, the more relative market power foreign entities have over the dollar's foreign exchange value relative to emerging economic powers (all of which are using sovereign currencies)

          - The growth rates of these emerging powers dwarf ours in the US, meaning that investments in those nations denominated in non-dollar assets begin to look attractive to all those foreign holders of dollars (and domestic ones, but this is more than offset by third world wealthy individuals/entities who prefer the safety of dollars at least right now -- look at the BoP details from the BEA for the country-level breakdown).

          - The Treasury and Fed's non-existent FX policy for the dollar is not helping us to position for this change in the global economy, and that's why I think we need to stock up on some reserves (yes, we do this already indirectly through the IMF, but it should be on the Fed's balance sheet)

          The reason for this "benign negligence" is a stubborn old idea, or even the mantra, that the US would always be the world economic power and everyone else would be coming to us for financing to do anything. Clearly this is not a valid outlook in the 21st century, and I compare it to the persistant ignorance of individuals who treat our system as if it's still a gold standard-constricted economy.

          •  I have to read this through again, it went a (0+ / 0-)

            little over my head, -- IMF, reserves, should be on Fed balance sheet, and non-existent FX policy.

            I don't understand these relatoinships well enough.

            If you'd like to expand, I'm a willing student.

            If it's too much of a pain, I understand :)

            •  Okay (1+ / 0-)
              Recommended by:

              The IMF = US proxy, so they hold a lot of FX reserves. I only mentioned this to say it wasn't sufficient becasue that's a typical response people have when it is mentioned that the US doesn't really hold reserves, they just offer swaps to other central banks.

              Reserves = the US, if it's to have a competitive dollar policy, needs ammo, that is, it needs a nice stockpile of various other currencies so that it has firepower to beat down the dollar if necessary, and by merely holding other currencies it's a depreciating effect (by taking off other currencies from the market, it strengthens their value relative to the dollar).

              Fed Balance sheet = the fx reserves should be something that the Fed holds a good amount of so that there's clear sovereign control over them (again, as opposed to the IMF)

              Non-existent FX policy = the Fed barely intervenes in the FX market, to the extent it does it's just to provide dollars to other central banks for liquidity purposes. There's no direction, guidance, or official policy toward the dollar's value by Treasury or the Fed. A lot of people refer to this as "the policy of benign neglect".

              The problem is, if the Fed starts expanding the base to fund acquisition of foreign currencies (selling dollars out on the market to buy euro, yen, remnimbi, real, etc) this will upset a lot of trade partners and it would incite a currency war.

              I'm still researching alternative policies to this, while still achieving the same general idea of reducing the overvalued dollar (making our exports more competitive). It's a tricky situation, but if we're really going to expose ourselves to this risk by producing excess dollars demanded by foreign entities who very well may be diversifying out in the near future, we should be positioning ourselves to soften this effect. Right now, it's the private sector that is holding foreign-currency-denominated assets and it's simply not sufficient from a policy perspective.

              •  Wow, thanks. You're a VERY good writer. I've (0+ / 0-)

                read similar stuff, but this is very clearly put.

                Even I could follow it :)

                Glad to see you here, and hope you do 2 things:

                Join the Money and Public Purpose Group, so I can easily find you, and write as much as you can.

                •  I saw that group... (0+ / 0-)

                  ...but I can't really see how to join it. I've followed it though, if that counts :P

                  And thank you for the compliments.

                  I must say that I selfishly write these to confirm my own understanding of various topics and to open myself up to criticism so I can strengthen my knowledge base, but it's an added bonus that others benefit from understanding the system and various policies too :)

                  •  You just send a message requesting to join. You (0+ / 0-)

                    click on it, and a box opens, then you send a message.

                    I'd love  to see Wray's responses to you.

                    Do you participate on his blog, or NEP?  new economic perspectives?

                    •  NEP has enough voices (0+ / 0-)

                      I don't think they need my input, as there's plenty of talented economists part of that organization.

                      I'll send the request to join, thanks for the referral :)

                      •  I expect a diary a weak out of you. Also.... (0+ / 0-)

                        Sundays are weird.

                        This is a really important diary, I hope you republish it.

                        •  I've been going at roughly that pace (0+ / 0-)

                          So one a week fits my schedule pretty well :P

                          Actually, I have an incredibly long diary offline about how the economy needs stimulus right now, it was geared more towards Republicans/skeptics, so it was really "hand-holding" (you have to understand that as an ex Republican who worked in economic consulting, a big part of my network is Republicans, so I see a lot of the misconceptions they put out there and know what needs to be debunked or addressed in explanations to them).

                          So that anti-austerity pro-stimulus diary was meant to be a few pages ended up bloating into a monstrous 10-12 page discussion to address every possible retort that someone could have who is skeptical about the need, affordability, and sustainability of a large jobs-based stimulus plan right now. Anyway I haven't posted that becaus I thought it would just be too long, and it may be something that is better broken into multiple parts.

                          Regarding republishing -- I'm not sure where i'd be able to republish this particular diary, but the information tends to already be out there, just seems to be either overly technical for normal people to get or just sloppy. Glad you found it useful though! :)

                  •  Oh, I just looked up your profile. I see you're (0+ / 0-)

                    an ex Republican.  

                    Welcome to the less insane party ;)

      •  One of the points Fullwiler makes is that (1+ / 0-)
        Recommended by:

        we are presently in what he considers a normal interest rate environment. The heavy horizontal bars in the graph I provided above are the average 3mo and 10yr rates for the periods. There is a clear distinction between the 53-79 and the 79-00 periods, with reversion back to low (+/-current) rates beginning 2001 until present. Without presenting the data, he stated that periods predating the graph had similarly low rates.

        I have not thought deeply about fx for a number of reasons. First, the sheer size of the American economy dictates that, if the world is going to choose a single sovereign currency as a reserve, the USD is the only one that makes sense. And, since the world went for it when I was 2, it's the way I and much of the world think of the dollar. It seems in the first instance that removing the dollar from that status would be unduly painful to economies on both sides of the ledger. But the idea that it might be challenged or that the dollar could come under attack despite (or because of) that status is intriguing.

        Generally, my sense is that there are relatively few resources that are not abundant within the borders of the US, and no nation has greater manufacturing capacity than the US. And we have 23 million looking for full time work. So while we are fairly avid consumers on the world market, nothing forces us to be so. Indeed it appears there was a disproportionate decline in trade deficits with the recession.

        historical sector balances 1951-2010
        That was a move in a better direction. We will also become a net exporter of energy from domestic feed stocks in the not distant future. And with that we are going to have a huge amount of domestic work to do building new cities as the old ones are eaten by rising seas. But now I'm off on a tangent - I shall look up Beckworth.  
        •  Just because the dollar has been... (1+ / 0-)
          Recommended by:

          ...dominant and the reserve currency since you were a tot, doesn't mean it will be forever :)

          Heck, my grandma grew up under the gold standard, and that ended.

          You mention the 20+ million unemployed in the US, let me bring up two titans:

          India and China. Their growth rates dwarf ours and their capacity both in capital and labor will tower over ours. For me, it's hard to imagine a scenario where our economy will stay the dominant world economy, and the number of alternative currencies trading in levels at or higher than the volume of the dollar will only go up.

          That's why I'm concerned about long-run FX effects, the high-growth developing nations with much larger land mass and populations and capacity will take over, and we need to position ourselves for this, in my mind, because foreign entities won't hesitate to dump dollars for more attractive non-dollar opportunities later on.

          •  Could you lay out a scenario for that worries you? (1+ / 0-)
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            I guess I'm not feeling the insecurity that you are. In all of my thought experiments along these lines (where I am an EXTREME novice) I seem to be able to rationalize to daylight using what I have borrowed from MMT. Perhaps I am not posing the right questions. I need a narrative framework to work from. I have found Beckworth and I'm starting on his background material this morning. Keep writing, I'll be back!

            •  Well I guess the... (0+ / 0-)

              China story is one scenario.

              But it's not a "sudden shock" that i'm worried about necessarily, just that we don't care about the dollar's exchange rate as a matter of policy and it's something we need to care about because other economies are growing 10x faster than ours and have populations 3x the size of ours and we need to accept that their currencies will be in high demand so there will become less of an incentive to hold dollar denominated assets when there are safe equivalents in Asia.

              If we don't start stocking up on FX reserves to give us ammo against later potential threats of selloffs we just run a risk of being really vulnerable to their infleunce and not have a lot of options to fix it.

              •  But wouldn't that simply enhance our exports. (0+ / 0-)

                If I am a foreign holder of dollars either I or someone I trade with eventually has to buy some dollar denominated asset. Right now we offer treasuries, but there is no economic necessity for doing so. Ultimately a dollar's value is only realized when it is employed in a transaction. So they have to buy something. They tried to buy Unical(? Union Oil of Calif) and we said no, sorry, critical infrastructure, buy something else. So they can buy what we make, and we still make a lot of stuff, and they can buy real property and they can invest in US businesses. And they can buy now or later. But. if they wait to buy at some future time, they will likely get less bang for the buck. If they attack the buck, the bang goes down even more. To me that would be like a deranged individual threatening me with their own suicide.

                The other part about holding FX assets - we conduct more business than any other nation, and we do it all in dollars. About 1/3 of all nations align their currency with the dollar, or actually have adopted dollars (Ecuador, for example). I think it is important from the standpoint of currency sovereignty that we retain that "chauvinism" regarding the dollar and eschew any policy that would denominate any US debt in foreign currency. To me, the floating exchange rate IS the monetary relief valve. It is the required negative feedback loop. I honestly do not get the problem.

                •  No, it won't. (0+ / 0-)

                  I mean, it will, but that will also force Americans to slave away essentially for the rising powers (instead of us just stocking up on FX reserve so we can control our FX value). So it won't "simply" enhance our exports, it will have all sorts of other effects relating to the net marketable value of our dollar-assets (relative to non-dollar powers' goods/assets).

                  I'm not willing to adopt a worldview predicated on the idea that the dollar will forever be the world reserve currency and that the US will always be the biggest economy dominating everyone else, that's not a reasonable assumption going forward unless we find ways to continue pillaging other nations of their wealth for our own benefit.

                  There is with almost 100% certainty going to be competing systems rising, certainly in China, and they can easily in ADDITION to the American system. MMT focuses so much on "operational reality" and systemic facts, but it seems to completely ignore the trends in this respect and it really surprises me how short-sighted it is in that way (I mean no disrespect, I know you like MMT It's just a shortfall I've noticed in a lot of MMT literature).

                  The dollars accumulated by others through the seemingly perpetual outflow of dollars to foreign entities can easily be dumped in favor of the competing currencies later on in the system, they don't HAVE to spend it on dollar-assets.

                  I'm not saying that the US debt should be denominated outside of dollars, I'm saying that your 1/3 of nations (and this is only becasue of the IMF and other bullying tactics) who anchor to the dollar is nothing compared to the titans of China, Brazil, India, and others who are sovereigns who will just continue to rise. I fear you may be complacent in this respect.

                  What I am saying is that American hegemony is not going to go on forever. We can't "contain" powers like China, India/Pakistan, and Brazil. The chauvinism you refer to beyond just the debt being dollar-denominated but most world assets being dollar-denominated, will not be something that can go on forever.

                  I'm envisioning a world where there is competing systems and where the support of a failing world reserve policy would only weaken the US economy in the long run and force us to be producing into a market that has sold off dollars completely and leaving us at the mercy of other powers, much the way others are at the mercy of the almighty dollar right now.

                  Beyond this, I don't know how else I can explain my concern differently and we must simply agree to disagree and let time show what happens...

                  •  No, no, no (0+ / 0-)
                    The dollars accumulated by others through the seemingly perpetual outflow of dollars to foreign entities can easily be dumped in favor of the competing currencies later on in the system, they don't HAVE to spend it on dollar-assets.
                    Dumped to whom. I don't care if a Malasian buys dollars from China. That just means it's now the Malasian's problem to dispose of the dollars to someone who down the line either absorbs it into the mass of US dollars in circulation abroad or it comes home to buy domestic goods and services. How are we going to slave away for those dollar holders when you kind of reject the idea the Chinese industrial workers are employed to the advantage of the US consumers. Point is, whoever comes calling with the dollars, they're welcome to buy whatever is for sale. We are in business.
                    The chauvinism you refer to beyond just the debt being dollar-denominated but most world assets being dollar-denominated, will not be something that can go on forever.
                    Perhaps, but I still do not see the mechanism through which this harms our domestic economy. If you are asserting that these "titans" will rise in the new world while the US sits still, that we no longer have the required competitiveness, resources, whatever, to compete in the world, I would disagree. I am not thrilled with homo americanus but it is a capable enough member of the genus.

                    So when the rest of the world decides they don't want dollars, they will stimulate our economy for us, and if they don't want our exports and settle for real estate, they aren't so foreign anymore and they now have new incentives to keep America prosperous.

                    And, as I said earlier, I believe that the floating exchange rate is the proper mechanism for reconciliation of trade imbalances.

                    •  Yes yes yes! (0+ / 0-)

                      The dollars will be dumped on the highest bidder, which may be at a really low price, empowering other currencies at the cost of our own.

                      Yes, the dollars won't "disappear" and they have to be spent on dollar assets, but who is to say the dollar's power will be worth much on the world stage when they rise up and correct the dollar against our own policy goals?

                      Perhaps, but I still do not see the mechanism through which this harms our domestic economy
                      It will harm our economy in the sense that right now we are getting almost a free lunch as you imply, because the Chinese and Japanese and others are working for US and our dollars.

                      But how easily will American society and culture adjust to a reduced deficit in the longer run? A reduced dominance of the dollar as a reserve currency?

                      And, as I said earlier, I believe that the floating exchange rate is the proper mechanism for reconciliation of trade imbalances.
                      That's all fine and good, but there's no such thing as a floating exchange rate in reality.

                      China and Japan manipulate it for their advantage, Brazil manipulates it for their advantage, every nation out there manipulates exchange rates as an overt policy...

                      ...except the United States. So by adopting this idea domestically of a "free floating rate" we're essentially saying "okay, other countries can decide, and we'll just do our thing". And that's the main point i'm trying to drive home here is that we need to incorporate this into se coherent dollar policy given the developments due in the future.

                      Merely letting the markets decide where our economic policy will go is not something I'm willing to concede. I think we should do what every other country does: have a coherent FX policy and reduce the unsustainable currenct account deficits.

                      We have to agree to disagree. I'm not in agreement with all the MMT stuff outlined, because I think a lot of the institutional and future world balance effects aren't adequately addressed, it's very short-sighted. But hey, i'm with you guys on, say, 90% of what's going on...

                      •  Let me suggest a different perspective (0+ / 0-)

                        How did the dollar become the reserve currency? Was it by design or evolution? My understanding is that it was the latter and a result of the destruction of world economies brought about by WWII. That was a huge vacuum and we filled it because nobody else would or could. So now I'm trying to imagine a new process that displaces the dollar from that space. Either the vacuum has to be reapplied, or the substitute must replace it by flow and dilution. Another world war would do it, but in the nuclear age I think that's pretty unthinkable, and the dollar's place in the world becomes totally irrelevant.

                        The other mechanism would require a huge and rather acute and persistent allocation of the challengers sovereign currency to displace the dollars. And what happens? If I am a holder of dollars and say India wants to be BMOC, so they want me to hold rupees instead. Then it is they who are in the market for dollars, not I looking for rupees. That pressures the dollar up in that exchange. More rupees keep buying fewer bucks. It doesn't change what a dollar buys in Kansas City except for what we import from India - mangoes and such - and the price of American industrial equipment in New Delhi.  So who is getting hurt? Rupee holders. How do they weaken the dollar without first making it super strong against their own currency, and making themselves weak?

                        Are we so advantaged by the dollar's reserve status that India at 1/10th the size of US economy, or even China at currently 1/2 the US economy, would commit the immense financial resources necessary to replace us. I don't see the organism that I perceive as the world economy making such a transition - more than transition, a metamorphosis.  

                        Incidentally, I thought your last diary was terrific. I don't think I found a single point of disagreement. You are a highly intelligent and well educated young man, and you are passionate in your thinking, without disposing of the thinking part. I respect that, it is the quality I always looked for in my residents and fellows. Keep up the excellent work.  We need you!      

  •  Your equations are off (1+ / 0-)
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    if the original equation is

    Private Sector Balance (Income-Spending) = Trade Balance (Exports-Imports) - Fiscal Balance (Taxes-GovSpending)

    then rearranged, it should be:

    Trade Balance (Exports-Impports) = Private Sector Balance (Income-Spending) + Fiscal Balance (Taxes-GovSpending)

    You have it minus Fiscal Balance.

  •  Exactly! (1+ / 0-)
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    The Federal Budget can't be balanced now and the catfood pushers know it!

    The free market is not the solution, the free market is the problem.

    by Azazello on Sun Jan 27, 2013 at 08:40:19 AM PST

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