"There is always a philosophy for lack of courage."—Albert Camus

Monday, December 06, 2004

Hard Landing History

In December 1983, Stephen Marris of the Institute for International Economics wrote, "Crisis Ahead For The Dollar" for Fortune magazine. "When capital begins to flow out," Marris predicted, "U.S. interest rates will rise. And as the dollar goes down, inflation will accelerate." The dollar subsequently soared to astonishing heights for a couple of years and inflation fell by about ten percentage points.

In the Summer 1987 issue of Foreign Policy, Lester Thurow and Laura D'Andrea Tyson wrote the following warning about "The Economic Black Hole":

"The more Washington is forced to rely on a continuing fall of the dollar to restore the trade balance, the . . . more expensive imports will become with respect to exports. The drop in U.S. living standards will be consequently greater. A further drop in the dollar also threatens to touch off a worldwide recession and add instability to world financial markets . . . . As import prices continue to increase, the inflation rate will continue to accelerate."

In his 1988 book, America in The World Economy, C. Fred Bergsten wrote, “If foreign investors and central banks finally stop lending such quantities to the United States . . . the dollar will plunge and interest rates will soar."

Actually, the stock crash of October 1987 was as close as we ever got to a hard landing – not because the dollar had already fallen for more than two years (as a matter of deliberate G-7 and Fed policy), but because Treasury Secretary Baker then invited both U.S. and foreign investors to flee dollar-based investments by announcing in a TV interview that he wanted the dollar to drop even more. Significantly, the Fed had also raised the fed funds rate from 6.1 percent in January 1987 to 7.3 percent in October, which did not help. Even then, however, proponents of twin deficits and hard landings had it all wrong. The budget deficit in fiscal 1987 was sharply lower, not higher. And interest rates did not soar but fell in the wake of the October crash. The economy soon recovered and so did the dollar. We had recessions in 1990 and 2001, of course, but they too did not follow the hard landing script.

In short, the hard landing crowd has been very wrong for a very long time. Yet they keep peddling the same old story whenever (1) the U.S. economy is growing faster than others, and (2)there is a Republican in the White House.

So, the U.S. is once again said to be at grave risk if foreigners suddenly decide to sell their U.S. stocks and bonds. But if the current account deficit could not be financed then it could not exist. Hard landing zealots thus begin by fretting about the gap between imports and export and end by fretting that gap might disappear. They also claim trade deficits are bad because they will make the dollar fall; but the falling dollar is good because it will shrink the trade deficit.

If a falling dollar reduces the trade deficit and a shrinking trade deficit lifts the dollar, then it follows that a falling dollar must make the dollar rise. All of this makes as little sense as the related pretense that “restoring confidence” in a currency depends on higher taxes.


P.S., An apology is due to my old friend Bruce Bartlett, who’s earlier e-mail to me (mentioned in my previous blog) was, of course, a joke. I only meant to be teasing him about teasing me, nothing more.

1 comment:

Anonymous said...

Excellent analysis, on this post as well as the Investors Business Daily article. Helped me tremendously in understanding the justifications for igoniring the twin deficits hysteria that seems to have overcome the media worldwide.