Paul Krugman (NYT): Don't Look Down

[Dudley_DUright]

During the 1990's I spent much of my time focusing on economic crises around the world — in particular, on currency crises like those that struck Southeast Asia in 1997 and Argentina in 2001. The timing of such crises is hard to predict. But there are warning signs, like big trade and budget deficits and rising debt burdens.

And there's one thing I can't help noticing: a third world country with America's recent numbers — its huge budget and trade deficits, its growing reliance on short-term borrowing from the rest of the world — would definitely be on the watch list.

I'm not the only one thinking that. Lehman Brothers has a mathematical model known as Damocles that it calls "an early warning system to identify the likelihood of countries entering into financial crises." Developing nations are looking pretty safe these days. But applying the same model to some advanced countries "would set Damocles' alarm bells ringing." Lehman's press release adds, "Most conspicuous of these threats is the United States."

O.K., let's run through some reassuring counterarguments.

First, economists are very good at devising models that would have predicted past crises, but each new crisis tends to happen where and when they didn't expect it. So even though our budget deficit is bigger relative to the economy than Argentina's in 2000, and our trade deficit is bigger relative to the economy than Indonesia's in 1996, our experience needn't be the same.

more...

http://www.nytimes.com/2003/10/14/opinion/14KRUG.html

[realFedUp]

1. What does Paul advise us to do?

before we get to the cliff?

[chiburb]

2. Gots to make choices....

To answer your question:

There is now a huge structural gap — that is, a gap that won't go away even if the economy recovers — between U.S. spending and revenue. For the time being, borrowing can fill that gap. But eventually there must be either a large tax increase or major cuts in popular programs. If our political system can't bring itself to choose one alternative or the other — and so far the commander in chief refuses even to admit that we have a problem — we will eventually face a nasty financial crisis.

The crisis won't come immediately. For a few years, America will still be able to borrow freely, simply because lenders assume that things will somehow work out.

But at a certain point we'll have a Wile E. Coyote moment. For those not familiar with the Road Runner cartoons, Mr. Coyote had a habit of running off cliffs and taking several steps on thin air before noticing that there was nothing underneath his feet. Only then would he plunge.

[realFedUp]

3. I read what he said but what does the individual investor do?

Yank out our money? Where to put it?

[chiburb]

4. Krugman didn't say, but...

I'm gonna guess that "smart" money has been in Euros (and other foreign currency) for a while, and is likely to stay there.

See this post in the Economic forum, and click through to the article in Asia Times. V e r y interesting...

http://www.democraticunderground.com/discuss/duboard.php?az=show_topic&forum=114&topic_id=1839

[reachout]

5. Great article

I've read a lot of Krugman's work and really enjoyed it. I had only had a flirtation with economic theory in college, but in the last five years I've really dived headfirst into studying everything I can about the subject. I was amazed by two things: How ignorant most of us are about economics, and how thoroughly lied to we are by those we believe to be educated on the subject. The Chicago School of economic theory is really driving this country down the crapper...and aside from a couple of remaining institutions, it is about the only thing being taught in our universites.

Another author I would recommed is Michael Hudson.


It is a really bizzare system that has been set up in relation to the deficit. The Chicago School monetarists work under the assumption that all other economies in the world should adjust to provide the greatest possible benefit to the US economy.

Europe and Asia have financed most of the US Treasury's budget deficits in recent decades (it's up to something like 60% annually now). The theory being that America's federal budget deficits can go on without limit, because of what's known as the "balance of payment deficit." It started when Nixon took the dollar off the gold standard. By going off the gold standard ,the United States obliged the world's central banks to finance the U.S. balance of payments deficit by using their surplus dollars to buy US Treasury bonds, whose volume quickly exceeded America's ability or intention to pay. All the dollars that end up in European and Asian central banks as result of American's excessive import-imbalance, have no place to go but the U.S. Treasury. Because of the restrictions placed on the central banks these countries were forced to buy US treasuries or else accept the worthlessness of the dollars received through trade.

The US has said it can't pay back its dollar debts and doesn't intend to. As an alternative, it has proposed "funding the US dollar overhang". Other countries would get IMF credit equal to their dollar holdings, but these holdings no longer would be US Treasury obligations. The US would wipe its debt to foreign central banks off the hook. This would mean that it would have got all the balance of payments deficits for the past 32 years for free.

The fly in the ointment is that Europe and Asia are starting to stand up for themselves. They see the downward spiral of their own economies and are increasingly of a mind to let go of the Central Bank strategy, which places them in the thrall of America, and return to a more Keynesian model via their national treasuries. If that happens, this whole house of cards is going to come crashing down and we will see economic chaos.



From a personal financial standpoint, I don't know that I've read anyone who seems to have a good idea of what to do (other than avoiding high-risk investments). Some problems that may well arise include a sudden, sharp jump in interest rates. This will hit both individuals and businesses who have used low interest rates to float more debt. There are many who may actually see their home go into a negative equity situation. It is probably best to clear off as much debt as possible.

[realFedUp]

6. Good info

thanks for posting.

[tom_paine]

7. kick for the oft-unspoken truth

:kick: