Does the US Need to Maintain the World’s Financial Confidence?

dollars

Not really, according to Dean Baker. Here’s his scenario in case everyone else loses confidence in US financial markets (haven’t they already?):

Suppose that foreign investors refuse to buy U.S. bonds. This would have two effects. First it would drive down bond prices (pushing up interest rates). Second it would drive down the value dollar.

Higher interest rates would be bad news right now, but we know how to counter this effect. The Fed just has to buy up long-term Treasury bonds. It can buy as many bonds as it needs to keep interest rates low. Would this cause inflation? That’s not likely given the severity of the downturn. We have 7.2 percent unemployment and it’s rising fast. That’s not an environment that is conducive to inflation.

The second issue, the fall in the dollar, is something that must happen in any case. Clinton gave us an over-valued dollar, which Bush largely maintained. The result was a huge trade deficit. The only remedy for our trade deficit is a lower dollar. (Remember, we have ostensibly been pressuring the Chinese to raise the value of their currency [i.e. lower the dollar]).

If large budget deficits are the mechanism that finally gets the dollar down to a sustainable level then it will be just one more benefit from the stimulus program. Rather than being a problem, as the NYT tells readers, this is an important part of the solution for getting the U.S. economy back on a sustainable growth path.

If I think back to Econ 101–and I’m not an economist–inflation looks like it will be an issue. If you print extra money, excess supply and devaluation beyond sustainable levels follow. But Baker brings up a valid point: Can the United States sustain itself with far less foreign financial intervention? Can it afford to be isolationist? Can we be clever enough with our resources at home to ride it out on a domestic level?

  • Alan McRae

    Inflation might not be the result of a dollar devaluation and more dollar money supply. In a globalized economy with severely underutilized industrial capacity, any successful attempt to raise prices might spur rapid increases in production (supply) that could force prices back downward. Countries like China & India have a lot of incentive to get workers & assembly lines working again, even if it means dumping production into the US. Plus, with mountains of credit debt being written off everywhere and gobs of US dollars sitting in foreign central banks, it is likely that our money supply is overly contracted right now. Since US dollars sitting abroad are wary of investing in the US again (thanks Wall Street!), there is little hope of increasing the velocity & supply of money here in the US other than printing (or borrowing) some more of it and placing it in the hands of those who will spend it (preferrably on US made goods, if there is such a thing). Hmm… if foreigners see that we will devalue & dilute our currency to re-start our economy, maybe some of them will feel the urgency to spend or invest it before it devalues significantly? Anyway, it seems that we are about to embark on a colossal experiment to re-start a first world economy during a severe deflationary/recession. (Since our current experiments with market globalization, global warming and post-industrial service economies are on such bad tracks at the moment, I see no particular reason to be optimistic on this one other than the vast improvement in administrations.)