Policy Options in a Dollar Crisis
The Bernanke/Paulson/Geithner/Bush/Obama response to the economic crisis has centered on a massive increase in the Fed balance sheet, large public investment in the financial sector (and select industrial sectors), and a large increase in debt-financed public spending generally. The goal is to avoid a repeat of the Great Depression, with massive deflation, a collapse in economic activity, the failure of much of the banking system, 20% unemployment, and so forth.
One risk this policy runs, as everybody involved understands, is that it won’t work – that nothing will be sufficient to keep the economy going. That wasn’t a strong argument against trying whatever had a chance of working and, moreover, there’s at least some evidence already for proponents to point to that the global economy is no longer falling off a cliff (whether because the policy worked or because some other response would have worked as well or better is something people will be debating for decades).
The more likely risk, again understood by everybody involved, is that it would work reasonably well – the economy would indeed stop falling off a cliff – but that it risked runaway inflation down the road, and, in the worst case, the potential for a collapse in international confidence in the dollar.
That hasn’t happened yet, of course. So far, the markets have reacted in a fairly orderly fashion to the problems being built in for the dollar. The US equity markets bottomed in early March; since then, their recovery has been highly correlated with the decline in the dollar against all major currencies (EUR most prominently, but also JPY, CAD, CHF, even – dramatically – GBP, in spite of the fact that sterling has the same kinds of problems that the dollar does, only worse), and with a rise in yields on the long bond. So long as this process remains orderly, the big trade our government is doing is likely to turn out well: we do know how to cure inflation, and even if we are slow to respond (as I expect we will be – nobody likes to take away the punchbowl) the results are still unlikely to be worse than a global depression. Moreover, if we use fiscal policy wisely in this period of fiscal expansion, we could take the opportunity to lay the foundation for more stable future growth, both by making smart public investments (e.g., in an upgraded electrical grid) and by reorganizing the tax system to encourage more productive investment (e.g., by eliminating the mortgage interest deduction, enacting 1986-style reform of the corporate income tax, replacing the payroll tax with a value-added tax). If we can raise our real growth rate through higher productivity, that gives us far greater flexibility to tackle inflation down the road while still being able to service our growing debt.
But if we get a true dollar crisis, that calculus no longer obtains. If the United States faces a situation at some point in the near future where we cannot finance our debts from abroad in our own currency, we would be forced into the kinds of austerity measures that created deep depressions in multiple emerging markets in the 1990s. To the extent that our current actions are retrospectively blamed for contributing to that crisis, we’ll regret them even more than we regret allowing the housing bubble to develop in the first place.
That housing bubble, remember, was principally a consequence of money being too easy for too long – i.e., Greenspan keeping interest rates too low for years after the economy began to recover in 2003. (I do want to stress: principally, not exclusively; there’s plenty of room for discussion of the other factors. But absent too much liquidity, those other factors couldn’t have caused the bubble; with too much liquidity, you were pretty much guaranteed to get a bubble somewhere.) There were many signs along the way that housing prices were getting crazy, but the Fed was very reluctant to set out to prick an asset bubble, and so its responses were consistently tamer than, in retrospect, we wish they had been.
Are we similarly going to see a dollar crisis developing slowly, and do nothing about it until it is upon us for fear of jeopardizing the gains we’ve already made through monetary and fiscal stimulus? How would we know whether, in fact, that was happening – now, for instance?
So here are my questions for Ben Bernanke as he looks at the possibility of a dollar crisis in the future:
- What signs are you looking for that such a crisis could be developing, if any? – If you don’t have any good forward-looking indicators, how is that shaping your policy response right now and your willingness to expand the Fed’s balance sheet seemingly without end? – If we find ourselves in the midst of a crisis of confidence in the dollar, what are the policy options open to you to respond and attempt to restore confidence? – Wouldn’t it make sense to give the market some indication of the seriousness with which you take the risk to confidence in the dollar by laying out these policy options in advance?
This is the thing I don’t get about liberals. Who is this “we” you keep talking about who is going to do things like upgrade the electrical grid and micromanage the money supply? It is inconceivable to me that Mr. Millman understands both electrical engineering and monetary policy, because either topic requires years of study in very divergent fields. (Though it is, alas, all too conceivable that the average Ivy League B.A. believes that he understands both fields, having taken a course in one and read an article on the other.) Issues of this nature are not suitable for decision by the political process because of their complexity. What Mr. Millman means is that People Like Him get to take my money and spend it on cool stuff like shale oil or the SST or any of the other government boondoggles that have impoverished ordinary working people over the decades. There’s no “we” about it.
— y81 · May 26, 07:05 PM · #
y81: is it really your view that complex issues for which expertise is required are as such inappropriate for the political process? How much do you know about policing and criminal justice? About foreign and defense policy? About monetary policy? Are these not areas that require years of study? Doesn’t that mean, by your logic, that the political process can’t handle them? Which means what, exactly – that we should abolish the departments of Justice, State, Defense and Treasury? Or that we should abolish “the political process” and let the “experts” make the decisions?
— Noah Millman · May 26, 07:27 PM · #
y81 has never even been to Target, what does he know?
— BrianF · May 26, 07:59 PM · #
BrianF, touche. I can see the west side of the Hudson from my office, but I would be lost if I tried to go there.
Noah Millman: I don’t consider the criminal justice system or American monetary policy as the product of a collective enterprise involving you and me. Military or other foreign action is by its nature a collective enterprise, which is one of several reasons why such enterprises are usually poorly executed. If your plan is to produce an electrical power grid that works as well as the Pentagon’s procurement system, count me out.
— y81 · May 26, 08:20 PM · #
y81: I’m at a loss to understand you. You said, apropos of a one-sentence aside about upgrading the electrical grid, and a general piece asking questions about monetary policy, that “Issues of this nature are not suitable for decision by the political process because of their complexity.” What does that mean? It either means: we shouldn’t have the government dealing with those issues; or, alternatively, that we shouldn’t have a “political” process dealing with them, but should somehow handle them (by the government) “outside” of politics.
The Fed is, indeed, insulated from short-term political pressures, but that in itself was a political decision; Congress could change the law and remove that layer of insulation, which means that, ultimately, the Fed is part of a “political process.” The criminal justice system is, similarly, somewhat insulated, inasmuch as big chunks of the judiciary are not directly elected, but again there is more than a little bit of “political process” involved in how the judiciary operates, not least because those judges and attorneys general who are not independently elected are appointed by elected officials.
When you say these are not “the product of a collective enterprise involving you and me” I have no idea what you mean. Their activities are funded by taxes from you and me, just like everything else the government does, and are undertaken by government employees, like most of what the government does. How are they less part of a “collective enterprise” than anything else the government does?
I’m really just very unclear what your point is. Is it just, “the government is bad at everything and hence should do less of everything, as little as can possibly be conceived, and posts that aren’t about how to shrink the government are about the wrong thing”?
— Noah Millman · May 26, 08:48 PM · #
I hesitate to jump into the midst of this battle of the titans, but let me approach this from an equally tangential model. My father is a very senior distribution engineer at a major utility and has been appointed point man for the smart grid recently. FWIW, he finds the whole thing a boondoggle run by DOE types who have very little practical experience in actually sending electricity to the public. But, since there’s money to be had, his company is lining up at the trough too.
By my reading (and I’ve said this elsewhere), the “smart grid” is three things: 1) the opposite of whatever we have (don’t forget that whatever we have is “third-world” or “primitive”) 2) something that has all sorts of Schneierian non-brittle networked cleverness (not that it’s a bad thing) and 3) an assurance to liberals that no, we won’t have to suck it up and build more real power plants (coal, nuclear, gas) and we can pretend that solar panels on your home and a Prius in the driveway will power your homes, your children’s home and the factory next door.
Apart from the specific technologies (superconducting cables being one, more investment into utility SCADA is another), the “smart grid” sounds and smells like B.S. to me.
==
P.S. “If we find ourselves in the midst of a crisis of confidence in the dollar”
What do you mean by “if”? If this (rapid rise in price of oil, difficulty with bond auctions) isn’t a crisis of confidence, what does a real one (a $CoC, that is) look like?
— Klug · May 26, 09:23 PM · #
So far, the response of prices to the rapid increase in the monetary base since last September has been next to nothing. Casey Mulligan and Kenneth Rogoff have offered that a shot of inflation would do the United States a good by reducing the real value of our uncollectible mortgage debt, but we got no inflation. What sort of reserve currency do you imagine emerging rapid to replace the dollar?
Both Yves Smith and Nouriel Roubini have had occasion to complain (the latter with regard to Mr. Paulson’s original TARP proposal, the former with regard to Mr. Geithner’s February non-plan), that the officials in charge have ignored the experience of foreign countries navagating banking crises (which are not an especially unusual phenomena worldwide). Should we entertain the idea that this crew will do something other than kick the can down the road and work to socialize yet another tranche of the cost of this?
— Art Deco · May 26, 09:27 PM · #
I don’t think that Noah Millman, or anyone like him, should be allowed to have any input about how the power grid in this country operates (except by investing his own money in utilities companies, if he so desires), because he doesn’t know anything about it. As a price for keeping Mr. Millman’s hands off the power grid, I’m willing to forswear any influence of my own over those decisions. In short, I’m kind of a libertarian. I don’t want to be involved in a collective enterprise whose purpose is to structure the electrical grid. I don’t want to be involved in a collective enterprise to set monetary policy. And there are a lot of other collective enterprises of this nature that I don’t want to be involved in, because I believe that the value of my input will be outweighed by the harm of Mr. Millman’s input.
One might say, as a one-sentence approximation, that the enterprises of a collective nature that I don’t want to be involved in are enterprises which involve complex activities which are not, by their nature, required to be supplied by the state (like military protection). But that one sentence is necessarily an oversimplification.
— y81 · May 26, 09:46 PM · #
I’m not sure—maybe Klug could tell me—but I bet the state had a pretty big hand in designing our current electrical grid, where the lines go, performance standards, equipment standards, safety standards. I know from re-wiring my house that the state pretty much tells me how I have to do that. I can’t imagine it would be much different for public utilities.
— cw · May 27, 02:50 PM · #
Due to my expertise, I should have final say on all policies concerning the ATF.
— Sargent · May 28, 02:28 AM · #