Asymmetrical Information

Good? You call that good? It's insipid. "The dollar is falling! The dollar is falling!"

Given the trade deficits we've run up the past decade, the dollar has to fall sooner or later. The sooner the better, probably.

We won't know the war's effect for a long time. Maybe we'll expand Nafta to include the entire "coalition of the willing." Who knows?

Right now, "good article about the economic costs of the war" is a relative metric. ;-)Besides, it's a nice primer on currency flows.

Kling - I've heard NAFTA expansion suggested before (as a possibly remedy to Turkey's exclusion to the EU). I'm curious, where do you see this going in the future? Is it an empty threat of the kind like, "We'll withdraw from the UN"? Is there something underway here -- and if so, what do you think will happen as a result?

I personally am not sure that expanding NAFTA is the right way to go only because even it has a high court that can trump US soveriengty. I do agree that reduced regulation and lower tarrifs are the right thing. If so, why aren't we doing this already in the WTO? Further wouldn't NAFTA expansion reduce free trade because it would provoke a protectionist response from the EU?

Like most commentators, he gets cause and effect wrong. The root cause of the current account deficit is not that the U.S. saves too little, its' that the rest of the world saves too much. A country that "net saves" (i.e., there is more demand for savings than for investment) can do one of two things: the government can run a deficit (providing net financial assets valued in the local currency) or run a trade surplus (accumulating assets denominated in another currency). There are no other options; since every debt is someone else's asset, all private financial assets must sum to 0. Additional savings must be parked either in foreign assets or in government debt, which is the only asset that has no corresponding debtor (I know, I know, you're gonna tell me that the government is the debtor - but since the government writes checks drawn on the central bank, the money doesn't "come from" anywhere except the mind of the central banker...)

For years now, many countries around the world (particularlly in Asia) have been running trade surpluses. Since the dollar is the world's preferred reserve currency, most of those excess savings have accumulated as dollar assets. It's not that Americans have been profligate overspenders or that the rest of the world doens't want to buy our crappy products; it's simply that foriegners would rather hold on to the dollars they get from selling us stuff than spend it on our stuff. Note that this could not happen in a fixed exchange rate regime, like we had under Bretton Woods until 1972, since the gold reserves backing the currencies would soon be used up (and it's because of simliar imbalances that Bretton Woods had to be abandoned) But under our current, floating rate system, the only thing stopping it is the willingness of foreigners to hold dollars. In effect, our position as the reserve currency-issuing nation subsidizes us to the tune of $500 billion a year. Nice work if you can get it. (Of course, the late 90's drive toward "surpluses" - i.e., destroying dollar-denominated assets - put a crimp in this, and had a lot to do with the Asian and Argentinian crises, but that's another story...)

So, if foreigners do have a reduced appetite for dollars, the dollar would go down, but that's not the end of the world - and would probably be a help overall, since it's not really healthy for countries to get too dependent on other's subsidies - a lot of the "hollowing out" of our manufacturing base is due to this situation. Since we are in a floating rate system, foreign debt doesn't really mean anything from a practical standpoint, and certainly doesn't affect the ability of the Federal governement to finaince anything it wishes...

"I do agree that reduced regulation and lower tarrifs are the right thing. If so, why aren't we doing this already in the WTO? Further wouldn't NAFTA expansion reduce free trade because it would provoke a protectionist response from the EU?"

Multilateral tariff reduction is almost an oxymoron. The most powerful form of tariff reduction is unilateral. Bilateral is next most powerful, etc. Multilateral just gets you caught up in "agreements" which put constraints on free trade.

I think we should cut tariffs whenever it's politically possible. I'm hoping that we'll feel good enough about Australia, Poland, and others to make us want to cut tariffs on their stuff.

Here's another commentary on the consequences to the dollar of the Iraqi war:

http://www.sierratimes.com/03/02/07/arpubwc020703.htm

In short, it argues that the reason for the war is to restore the dollar as Iraq's oil currency (it has been the Euro since 2000) thereby by strengthening the dollar against other currencies (esp. the Euro). The dollar is the world's reserve currency b/c it is the only currency you can buy oil with. All industrialized nations must maintain a reserve of dollars to buy oil from OPEC. In 2000, Iraq redenominated its oil sales to the Euro, and in 2001, OPEC hinted at doing the same thing. A sudden redenomination by OPEC would cause central banks around the world to "flush" their reserves of the dollar and replace it with the Euro. This would lead to massive devaluing of the dollar (20%-40%), the inability of the US Govt. to service its debt, massive inflation, etc. etc... general economic collapse. Therefore we go to war with Iraq to force them back onto the dollar standard and to pressure OPEC into maintaining the dollar as its oil currency.

The article is highly critical of this as a reason for war, however its basic premise is the exact opposite of Shapiro's claim that the war will cause the dollar to collapse. And personally, I have no problem with deposing a brutal dictator to keep the dollar the world's pre-imminent currency, when the alternative is that that the French are defending a brutal dictator to make the Euro the world's reserve currency. The less power in the world the French have, the better for the world, or freedom and rights-loving people, at least.

Good? Let’s think again. (Didn't realize I'd have so much company while writing this on the train.) One might get an easy hint that Shapiro is just repeating what he has read elsewhere from this:

“In 2001, private American holdings abroad were worth nearly $6.7 trillion—a third in direct foreign investments like factories and companies; another third in foreign stocks and bonds held by U.S. pension funds and others; and a third in various claims reported by U.S. banks and others. The dollar's decline in the last four months has reduced the dollar value of these holdings by $445 billion; its fall over the last year cost more than $950 billion.”

Unless my math instincts are failing me, a decline in the value of the dollar makes for a rise in the value of other currencies. That should mean a rise in the value of foreign assets. At worst, one could hold assets denominated in dollars, which would hold their value, but not appreciate.

But that’s not all. There is this:

“First, Middle Eastern investors converted a lot of their dollar holdings and took them home:”

I don’t have the Treasury data in front of me (tomorrow is another office day), but I don’t remember an avalanche of US asset selling by Mideast accounts in the Treasury holdings data. I do remember lots of hand-wringing in the press that it could or would or might happen. I’m vulnerable on this point till I get my hands on the data, but I’ll risk it. My bet is the data will see me through.

“Speculators such as hedge funds can sometimes make or lose a fortune overnight in currency bets, but the value of the dollar, the yen, and the euro are fundamentally driven by the normal transactions of the global economy.”

Now in the expression “Fundamentally driven”, is “fundamentally” meant to qualify, or to obfuscate? Shapiro wants to leave the impression that “normal transactions” determine foreign exchange rates without saying so absolutely. Ask Maggie Thatcher if that is true. Besides, what’s so abnormal about speculative transactions? They have been around for quite some time and represent the greater quantity of foreign exchange trade.

“The worst is probably yet to come,…” Come on, you know this one. If it is really “probable” that the worst is yet to come, then the worst would have come today. It is Shapiro’s opinion that the dollar will fall. He has even odds of being proven right, which won’t prove a thing.

“The rest of the world, with its big investment in a stable dollar, could help, too. One win-win solution would be for other countries to open their markets to more service imports—banking services, engineering, information services, and so on.”

This is the protectionist argument in reverse. It ain’t true in forward and it ain’t true in reverse. Shapiro makes the savings argument. He also wants to slip in the trade barrier argument. I can’t tell by reading whether he doesn’t realize that the savings argument nullifies the trade barrier argument or just hopes to slip it through.

The one argument Shapiro doesn’t make is the one that cuts through all the nonsense. If returns on US assets remain middling, no better than those elsewhere, then foreigners will reallocate their investments to reduce currency risk because currency risk doesn’t get them much. That currency risk is not inherent in Sharpiro’s view that the “worst is probably yet to come,” but rather in holding somebody else’s currency, which can fluctuate in value against one’s own.

A good primer on currency flows wouldn't be chock full of hooey.

Nuff said?

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