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Wednesday, October 01, 2003

A Couple Rejoinders

Howie, thanks for your comments and the attached article. Some good points in the article, and I don't dispute that playing politics over exchange rate policy (or lack thereof) is not the way to go. It's just looking for a scapegoat. (Although, I do think that Bartley was being disingenuous in implying that the Chinese need to peg against something, so why not the dollar? Well, they certainly could peg against the dollar, but at a higher yuan rate. There's a lot of room between maintaining current rates and free-floating the yuan. I think Bartley implies a kind of choice there that isn't necessary.)

Whatever the arguments about political games, though, this doesn't necessarily mean that the dollar isn't likely to fall. At the macro level, we've got China and Japan (a) building up huge U.S. dollar reserves, and (b) buying up a huge amount of U.S. debt (at relatively low interest rates). Of course, dollars are not like celery, but at some point it seems possible that these countries' appetites for all those dollars (or promises thereof) may dampen, and, given the great heights to which we've climbed, even a little appetite dampening may cause a vicious downward spiral. The obvious counterbalancing effect is for U.S. interest rates to go up in order to attract more buying of our debt. Which, of course, could choke off growth and lead to a general weakening of our economy (and, perhaps, further weakening of the dollar -- although I realize that the r-squared value between GDP growth and currency strength is not terribly high, at least in the short term).

Of course, with current Chinese policies, the dollar may not weaken relative to the yuan, but it certainly could weaken substantially versus the Euro. Admittedly, this is very complex and political tinkering is likely to worsen impacts. But, because of the complexity (and the historically obvious dramatic nature of currency markets), it seems only prudent to at least be aware when we're getting way out on the end of the limb, i.e., highly leveraged, and to consider some self-regulating (not other-regulating) moves to inch back toward the middle. What are those moves? Tough question. But, it seems to me that some policies to encourage saving rather than rampant consumption would make sense. To me, it looks as if our economy is addicted to consumption - like cocaine to keep a body going. It just doesn't feel sustainable to me.

On another point, I want to dispel your contention that I implied "a free market system caused hardship for people and also did significant environmental damage." I'm a strong proponent of the free market system. In fact, I think that, in general, the system should be freer (e.g., without agricultural subsidies by the developed economies). The free market system is a wonderful force of innovation and efficiency. I do believe, though, that there is a substantial role for government in the free market system. In addition to maintaining reasonable balances with regard to fiscal and monetary policy, there are two key responsibilities: creating incentives and regulating. Personally, I think we overuse regulation (which is sometimes necessary, but always inefficient and usually corruptible), and that we underuse our opportunity to create incentives (which are efficient and quickly get integrated into the free market). Incentives can be created in various ways. Perhaps the most powerful is through tax policy (which will be the subject of my next "fomenting question"). Anyway, you don't need to convince me on that point. A fun book that I read many years ago, "Bionomics," by Michael Rothschild, lays out why the free market system is not only desirable, but inevitable. Any government attempting to suppress it, e.g., the Soviet Union, ends in disaster.

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