Mindorenyo

Tuesday, April 19, 2011

Fundamental Issues and Symptoms

Many people are worried about the federal budget deficit, and these worries have widely been conflated with worries about our trade deficit. The result is widespread confusion, amongst our political and economic elite as well as the unwashed masses.

(As I write this, a gold commercial (with an end times subtext) is playing on MSNBC. Both right and left have been bullish on gold in recent years. This is symptomatic of the issues I am discussing.)

My take is that the currencies of industrially developed nations, including especially the United States, are grossly overvalued. This basic fact is driving everything else.

I lived in the Philippines from 1977-1979, and was figuratively clubbed over the head with the enormous disparity in the relative values of the U.S. dollar and the Philippine peso. One could live like a king in the Philippines on the income of a poverty-stricken American. Middle class Filipinos, of comparable intelligence with middle class Americans, would earn 1/10 the salary. No doubt there are logical historical explanations for such disparity, but going forward it's not surprising that there is a narrowing of the income gap, as globalization facilitates international diversification, outsourcing, and migration of labor and capital.

In an ideal free market world, the global economy would quickly adapt to globalization by lowering the value of the U.S. dollar. But of course, in the real world, there is economic friction (resistance to change). The U.S. dollar remains overvalued, in spite of an enormous trade deficit, as developing nations undervalue their currencies in the mercantilist tradition. The U.S. government enables the mercantilist policies of developing nations by running large fiscal deficits, which keeps U.S. consumption strong in the face of reduced private sector income.

The statistical manifestations of the scenes described above are large trade and budget deficits. The trade deficit is rightly seen to be endogenous. That is, the trade deficit is not the result of a single government policy. Rather, it is the market determined product of numerous factors, including the imbalance inherent in currency valuation.

By contrast, the fiscal budget deficit is seen as something that is directly under the control of the federal government. For wont of a more convenient target, the budget deficit is fingered as the culprit for the problems stemming from the initial imbalance in currency values. In the sense that the budget deficit enables the trade deficit, there is a germ of truth in this. But the preponderance of the truth lies in the fact that the former wage disparities are not sustainable in a global economy.

With respect to the current hysteria in the U.S. political zeitgeist, the emphasis on the fiscal deficit is clearly misplaced. The fiscal deficit is keeping our heads above water as our international competitiveness diminishes. Without a huge fiscal deficit, the U.S. economy would be in deep depression. Many argue that we should let that happen, so that the necessary adjustments will begin at once. I am sympathetic to that position, but also sympathetic to the plight of Americans who would be devasted by a deep depression.

An informed analysis would recognize that the fundamental problem with the U.S. economy is our overvalued currency, and would recognize that the budget deficit is a symptom rather than a cause of our misfortunes. Addressing the budget deficit will not cure the problem; rather it will cause more misery and then force us to address the root cause...

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