Monday, December 1, 2008

Where I Was Wrong About The Current Economic Crisis

There seem to be lots of econoblogsters confessing their sins of bad forecasting out there. I will do so also, perhaps especially because I have been parading around the econoblogosphere bragging about having called the housing bubble, the derivatives mess, and that the whole thing would lead to a recession, without having called the latter too early as some who are now being widely praised did. My error was to think that the crash of the housing bubble would lead to a long-awaited crash of the dollar, given that perhaps the most extreme of deep imbalances in the world economy is the massive US current account deficit that has led to the US becoming by far the largest net foreign debtor in world history. I thought the housing and derivatives crashes would catastrophically crash the dollar. I was wrong.

Instead we had that old bizarre phenomenon of the dollar as the ultimate "safe haven," with US Treasury securities being the ultimate safe haven within the safe haven, even as measurable risk spreads on such securities have widened noticeably in this crisis (heck, nothing is safe). So, instead of the dollar crashing, it has risen noticeably in the last few months, from a low of around 1.6 to the euro to around 1.26 today, or thereabouts. And 90-day Treasury bills are yielding an astoundingly low one basis point, which is effectively negative in nominal terms, given purchase fees, and while looking like a nasty liquidity trap, does not at all indicate any problems for the US Treasury in borrowing money, despite our massive foreign indebtedness and dependence on the kindness of strange foreigners, especially the Chinese, to fund our forthcoming fiscal stimulus.


Peter Dorman said...

Barkley, I was going to post something similar, but you beat me to it. We erroneous prognosticators should commence self-flagellation forthwith, don't you think? I made exactly the same calls and missed the same two things, the extraordinary fragility of the credit markets and, above all, the extent to which risks emanating from US real estate had been distributed throughout the global system. In one sense, though, I remain unmoved: I think before this is over we are likely to see the long-prophecied run on the dollar. The Fed is sucking in the world's liquidity to play global lender of last resort, but this is on top of a continuing need for external financing for the CAD. At some point (and a world of hedging is built into that phrase) this has to be unsustainable. said...


It is very unclear when or how this international imbalance will be resolved. In a sense we saw a sort of run on the dollar already, except that it occurred gradually, from late 1980 to early 2008, when basically the dollar fell by about 50% against the euro. But it had little impact on the current account deficit, so what is a body to do? This sort of movement is consistent with the long swing theory of forex movements that Engel and Hamilton posited in 1990 in the AER, and that I think is in the data, but that Hamilton now defers to Menzie Chinn in saying does not beat a random walk.

In any case, I think that long swing thing is in there, and if you looked at PPP, the dollar was substantially undervalued earlier this year, even though those darned current account deficits were still there. So, on PPP reversion and long swing arguments, we were in for an upward movement of the dollar anyway, which just got given this extra push from this crazy "safe haven" stuff.

So, it is really unclear how we are going to make that adjustment, which could yet prove to be more painful than what we seem to be getting into now, although who knows when. For better or worse, I think that story is very much in the hands of the Chinese, who can pretty much singlehandedly keep it from happening for quite a long time, if they wish to, and I think that it is because they do not want it to happen that it has not happened so far already.

In the meantime, we can pass the whips back and forth... :-). said...

I meant from late 2000 to early 2008 in terms of the period that the dollar did its 50% decline against the euro.

Anonymous said...

...with US Treasury securities being the ultimate safe haven within the safe haven...

Is it possible that US Treasury securities are merely a safe haven, it's just that are a lot of them to be sold.

Suppose 10 month ago you wanted to invest your money by buying some European propery, some European stock and some US or European (doesn't matter) government bonds. The equilibrium rate was $1.6 for a Euro.

Now, suppose today you only want to invest into US or European (doesn't matter) government bonds. Well, the US has a lot of treasury bonds to sell, much more than Europe. So, the dollar goes up.

It doesn't necessarily mean that people believe that US Treasury securities have some magical qualities, it's just that the US has a lot of treasury securities to offer and treasury securities is what people want to buy now.

Does it make sense, what I'm saying?

Shag from Brookline said...

" We erroneous prognosticators should commence self-flagellation forthwith, don't you think?"

If Harry S. Truman were alive, he might enjoy watching such self-flagellation" by the two-handed economists he criticized.

Peter Dorman said...


Without getting into the related question of whether there are discernible patterns in xrates, I think I would characterize the long, slow slippage in the dollar as an adjustment rather than a run. It is true, as you say, that this was not remotely sufficient to rebalance, however. A real run will look different: an interest rate spike and a serious disruption of trade. I agree that the Chinese have a lot of discretion here, but they are not sitting on the god seat. If there were substantial private capital flight (we should remember that domestic holders of dollar assets are also potentially mobile), it would overwhelm Chinese stabilization resources. But since it is unlikely that policy will address these issues any time soon, we will see, won't we? said...


I would say that an increase in the supply of securities, as with most assets, would make people less interested in buying them and would reduce their price. In the case of bonds, this means a higher interest rate. As it is, at one basis point, 90 day Treasury bills have almost never been more highly priced, except for that short period on the afternoon of Sept.17 when the yields actually went negative.


Ouch, ouch, ouch!


Did I say that the decline of the dollar from Sept. 2000 to somewhere earlier this year was a "run." If so, that is not what I meant. As far as I am concerned, it fits with the "long swing" hypothesis, which at least one of its developers (Jim Hamilton) no longer defends. But it sure looks like it is there in the data. In any case, such a long decline should have provided plenty of time for an adjustment to occur. But it didn't. Deep doo doo land, still to be negotiated.

TheTrucker said...

The explanation of dollar hegemony is that the US military is big enough to overthrow any other government on this planet should that option be desired by the people that fund the US government. In the recent past this amounted to: "You will take these dollars for oil. If you don't take these dollars for oil then we will make up whatever sort of scary story we want to tell the American people. And then we will remove you from power and take control ourselves or appoint, anoint, or elect whatever ninny we want in your country who will take these dollars for the oil." That was the case with Iraq. It is the case with Iran and Venezuela. The financial control of the elections in the USA is pretty obvious. It is almost impossible to place someone in office that will not pursue policies that are conducive to control by the current controllers. Propaganda gooooooood!

While we may, on occasion, elect very good people to office they cannot expect to get anything done and they cannot stay in office unless they do as the "lobby" might like. Our government is both Orwellian and Machiavellian as controlled by the very wealthy. This is not a conspiracy. It is the nature of the beast as it is currently constructed. The only real answer to the problem is true education and representation of the enlightened common people right here in the USA that has all the guns. It is a frightening thing this democracy stuff.

We need to dramatically expand the House of Representatives such that the common people really do have control over their government. At present the lobby has control. If that scares you then you'd better make sure the people are reasonably educated especially regarding civics and REAL economics fundamentals ("Progress and Poverty"). The math and science can wait. The populous votes and they are the plumbers, electricians, and shop keepers and the like.

It is chicken and egg. Can we (the under-represented enlightened "left") force the K12 schools into doing a better job of education? Or do we try to force the issue by expanding the representation? It seems to me that we have no way to force the proper education because the schools are controlled by the people that want to remain in control. They want to teach creationism and obedience. Maybe we try to force the issue by forcing broader representation. The uneducated mob is a frightening thing. When education is your only escape from the guillotine then perhaps we will see some education.

If I was king of K12 you would have to pass a comprehension test of "1984" and "Progress and Poverty" or you would not get a high school diploma. Learning about frog guts, algebra, literature and chemistry is all well and good. But first you learn about government and what it can and will do to you every day of your life. Participation and activism is your only defense. Government is either about economics or it is about fascism.

"After Socialism, Fascism combats the whole complex system of democratic ideology, and repudiates it, whether in its theoretical premises or in its practical application. Fascism denies that the majority, by the simple fact that it is a majority, can direct human society; it denies that numbers alone can govern by means of a periodical consultation, and it affirms the immutable, beneficial, and fruitful inequality of mankind, which can never be permanently leveled through the mere operation of a mechanical process such as universal suffrage.... "