There have been a lot of thoughtful diaries recently on the probability of economic ruin in the United States. Simply put, as I understand the analysis, the twin evils of the budget deficit and the trade deficit could lead to a situation where the global economic markets lose confidence in the US economy and withdraw their capital, leading to a collapse of the dollar and hyperinflation from skyrocketing import prices.
I am not an economist, and am not qualified to analyze the probability of such a collapse in the near term. However, I do note that we had a similar budget deficit and trade deficit problem in the 1980's and survived. That precedent has been influential with this administration, as proven by
Cheney's statement to Paul O'Neill in support of drastic tax cuts:
"Cheney, at this moment, shows his hand," says Suskind. "He says, `You know, Paul, Reagan proved that deficits don't matter. We won the mid-term elections, this is our due.' ... O'Neill is speechless."
Which leads me to a question: how is the situation now different from the situation in the 1980's? Do deficits not matter, like Cheney said? Or is Cheney ignoring fundamental differences between the world as it existed in the 1980's and the world as it exists now.
I believe Cheney is wrong and the world is different in ways which make the twin deficits much more dangerous to our economic health. Here are a couple factors which support this conclusion.
- In the 1980's, there was no Euro, and therefore the Dollar stood unchallenged as the only currency with the political and economic track record to guarantee a stable investment. Today, the Euro is a plausible alternative to the dollar. Global capital invested in the Dollar has elsewhere to go.
- The United States' total share of the world's economy is less than it was in the 1980's. Although the United States' growth has been impressive since the 1980's (mostly as a result of the internet boom in the 1990's), the developing world's growth, led by China, has been impressive as well, and the total United States' share of the world economy has therefore slipped. (If there are professional economists who have more to add on this point, please do so). Moreover, most analysts believe that a good portion of the world's growth over the next several decades will take place in China and other parts of the developing world, leading to a further erosion of the United States' share of the global economy. Thus, again, the United States currency and economy is no longer "the only game in town," and the global markets could make a more plausible case for shifting capital from the United States to other countries/currencies than they could have during the 1980's.
- Finally, the United States' standing and position in the world has been harmed greatly by the Bush administration's conduct the last five years. As a result, if a crisis seems imminent, a political solution aided by other countries seems less likely than it did in the 1980's. In the 1980's, any collapse of the United States economy would have been devastating to Europe and Japan, which still had the Soviet Union's military threat to worry about. Today, much of Europe would probably be all to happy to see the United States economy taken down a few notches, and Japan, which is coming out of its own long term recession, would not be affected in the same manner in which they would have two decades ago.
Overall, then, it appears that based on these factors the probability of economic ruin in the United States seems much larger than it was in the 1980's, despite similar economic problems on the surface.
As I said, I am not an economist, and welcome any "peer review" on the issues discussed in this diary.
