May 21, 2017
Yes, it’s yet another example of the skills shortage. In the middle of his review of a new book by Mervyn King, the former head of the Bank of England, Steven Pearlstein tells readers:
“If you are like me, just thinking about the constant interplay among trade flows, investment flows, savings rates, exchange rates, inflation, interest rates and asset prices makes your head hurt. Perhaps that’s because it’s never exactly clear what is cause and what is effect, or whether the effect is up or down.”
For people whose head doesn’t hurt, the chains of causation are actually fairly clear. While Pearlstein tells readers that the United States and the other Anglo-Saxon countries are “saving too little,” in a context where other countries are propping up the dollars (as King claims and Pearlstein apparently agrees), causing us to run large trade deficits, we are saving too much.
The trade deficits the United States and other countries run as a result of having over-valued currencies lead to unemployment unless they are offset by large budget deficits. The budget deficits run in the years after the 2001 recession and 2008–2009 recession were insufficient to restore the economy to full employment. (We did eventually reach something close to full employment in 2006–2007 due to the construction and consumption demand generated by the housing bubble.)
Larger budgets would mean less national savings, although the increased borrowing associated with the deficit would be partially offset by the additional output in the economy, which would lead to more savings. It is also possible to get back to full employment by reducing labor supply through measures such as work sharing, mandated paid vacations, and other measures designed to shorten the average work year. This is how Germany managed to reduce its unemployment in the Great Recession, even though it had a sharper fall in output than the United States.
Pearlstein’s confusion on cause and effect also leads him to claim some sort of crisis is imminent, since at some point other countries are likely to stop propping up the dollar. There is no basis for this assertion. We actually have a clear precedent for this story of adjustment.
In the late 1980s, following the 1985 Plaza Accord, Japan, Germany, and our other major trading partners helped to engineer a sharp reduction in the value of the dollar, which caused our trade deficit to decline from a peak of more than 3.0 percent of GDP in 1986 to roughly 1.0 percent of GDP by 1989. The economy grew at a respectable pace throughout this period and there was no major uptick in inflation.
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