Some Politics of U.S. "Hooliganism"

Paul Krugman sends us to Vlad "the Destroyer" Putin:

“Look at their trade balance, their debt, and budget. They turn on the printing press and flood the entire dollar zone — in other words, the whole world — with government bonds. There is no way we will act this way anytime soon. We don’t have the luxury of such hooliganism,” he said.

As Krugman notes, it takes two to tango. A big reason the U.S. has such a large trade deficit is because emerging markets have undervalued their currencies relative to the dollar*. And the big reason the U.S. has engaged in so much monetary stimulus is to boost employment, some of which would could have happened through the nominal exchange rate if so many other countries weren't actively managing their currencies. But adjustment still needs to happen, so now we're seeing pressures on the real exchange rate rather than the nominal exchange rate. In other words, inflation in emerging economies will rise until things become more into balance. And now Russia, and China, and Brazil, and others are complaining about the inflationary pressures that U.S. monetary policy is putting on their economies. But they can't have it both ways: while the U.S. economy is depressed, adjustment has to coming through the nominal exchange rate or the real exchange rate.

This isn't hooliganism. This is using monetary policy in textbook ways. As it happens, U.S. monetary policy has a great effect on external economies, which is why Putin calls the whole world the "dollar zone", but let's be clear: those countries want the U.S. to pursue less expansionary monetary policy so they can free-ride on it. It's fine for them to have that preference, and as I've argued before, I think the U.S. should allow some free-riding. But the U.S. government has citizens to satisfy as well, so those countries can't very well expect the U.S. to pursue a contractionary policies while the economy is so weak.

Krugman explains this as "capital wants to go South". I actually don't think that's right. I think capital "wants" to go North: witness the flight to safety, the historically low U.S. bond rates, the fact that the S&P downgrade warning had no effect on those rates, the rallying U.S. equity markets. Look at how developed countries increased their holdings in U.S. banks immediately following the banking crisis (clear in the animation here).

There's nothing preventing capital flight from the U.S., and yet that hasn't happened. Likely because while the U.S. has some problems, compared to many other large economies they are manageable. They aren't trying to stave off the collapse of a currency union, or a nuclear meltdown, or all the things China has to deal with. There's a high demand for safe, liquid assets, and the U.S. public and private sectors can provide more of those anyone else. The U.S. is at the center of the global financial network, which appears to behave in some ways according to a preferential attachment decision rule. Remember the Leontief paradox: factor-price equalization is not always the norm.

The U.S. government, on the other hand, wants some capital to go South. In other words, it doesn't want deflation, and it does want some dollar depreciation to boost employment via exports. The South, on the other hand, doesn't want capital inflows. Brazil has put currency controls in place, China has a closed capital account and fixed exchange rates, etc. The U.S. is trying to force adjustment through the real exchange rate, meaning higher inflation in exporting economies with managed exchange rates. These choices are political, not responsive to some economic natural laws.

*There's a lot of moving pieces here: budget deficits are a result of tax cuts + spending hikes (Medicare Part D plus wars), and then the recession. This also feeds into the national accounts. And while that is an accounting identity, not a behavioral relationship, I don't think it's a stretch to say that deficit spending is encouraged by low borrowing costs. Indeed this is what the Keynesians are arguing now, and it's one reason why Dick Cheney said that "deficits don't matter". During Bretton Woods II, there's been a huge rightward shift in the supply curve of funds available for the U.S. (either as sovereign, or as businesses and individuals) to borrow. When that happens, we'd expect the quantity demanded and thus equilibrium debt levels of the U.S. to also go up.