It's Hard To Imagine....
Paul McCulley and Bill Gross both work for the same company
Please note those sections in bold. Then read the whole thing.
Fantastic read!
Mish
pimco.com
The argument as to the unsustainability of the current account deficit is really quite simple:
Americans spend beyond their means, consuming more than they produce, importing the difference from foreigners (a current account deficit), with foreigners financing the difference (a capital account surplus).
There must be a limit to foreigners’ willingness to grow their stock of claims on the United States. And when that limit is reached, there will be a day of reckoning for America: a lower dollar, which will generate higher inflation, push up interest rates and thereby retard American hedonism.
This limit has been reached with respect to foreign private investors, who are presently refusing to fund America’s current account deficit, requiring foreign official investors – central banks – to massively buy dollars to keep it from plunging.
Such massive (unsterilized) foreign-central bank dollar buying cannot be sustained indefinitely,because it will lead to excessively loose monetary policy in foreigners’ countries, generating asset price bubbles and/or inflation in goods and services prices.
Thus, America would be wise to preemptively take steps to shrink its current account deficit, notably tighter fiscal policy (reducing public sector dis-saving) and tighter monetary policy (reducing private sector borrowing).
It’s an old argument, one that I’ve heard in one form or another for my entire 20+ year career:
America is dependent upon the kindness of strangers, who might not always be kind, so Americans should get their collective financial houses in order. Preemptive Calvinism, if you will.
I‘m not a buyer of this line of reasoning, for a simple reason: the global economy has massively unused and underutilized resources, particularly human resources. Accordingly, the world faces no danger whatsoever of corrosive inflation – too much money chasing too few goods. On the contrary, the dominant risk scenario in the global economy is too many goods chasing too few buyers.
As long as this is the dominant risk case, there is no rational limit to foreign central banks’ ability to buy dollars, if and when private investors don’t want to fund America’s current account deficit at (1) the prevailing price for dollars and/or (2) prevailing dollar-denominated asset prices.
America is not hostage to the kindness of strangers, but rather, hostage to strangers acting in their own best interest: choosing to print their currencies to buy dollars, so as to prevent/temper appreciation of their currencies, which would impart a deflationary bias to their domestic price levels, while frustrating efforts to more fully employ their under-employed peoples. It really is that simple.
[Mish comment - WOW - Does this guy GET IT or what - Who the F is Bill Gross??]
When Ink is Free
But you ask: Don’t foreign central banks lose money on their dollar reserves when the dollar goes down? And isn’t their refusal to let their currencies appreciate robbing their consumers of the proper purchasing power fruits of their labor? The short answer on both scores is yes, but the fuller answer is that it doesn’t matter, at least in the short- to intermediate-term. Currency intervention is not a symmetric affair: protesting an appreciating currency is very different from defending a depreciating one!
A central bank resists appreciation by printing its own currency, whereas a central bank resists depreciation by selling appreciating currencies that it owns or has borrowed. Very different! In an economic sense, a central bank cannot lose money by printing its currency, even though it can from an accounting perspective (if it buys something that goes down in price, measured in its own currency). The beauty (or bane) of a fiat currency is the power to create nominal purchasing power for nothing! And when there is a shortage of global purchasing power, as manifest in unemployed and underemployed global labor resources, it is the duty of central banks to create nominal purchasing power by creating money out of thin air!
The problem is that the economist’s long-run dream is the politician’s short-term nightmare. Voters who benefit from free trade – employed consumers – do not reward politicians with yea votes, but those whose jobs are creatively destructed do punish politicians with nay votes. Thus, politicians are rationally less enthusiastic about free trade than economists.1 This is particularly the case in times of weak global aggregate demand growth, which begets “beggar thy neighbor” pathologies: political leaders rationally want to get re-elected!
In fact, I worry as much about America’s willingness to continue running a current account deficit as I do about the rest of the world’s continued willingness to fund America’s current account deficit. Indeed, I suspect that American citizens’ tolerance for exporting jobs is probably more shaky than other countries’ citizens appetite for sending their savings to America.
Bottom Line
What the world needs is a dollar so low that it has no place to go but up, which would reenergize foreign private sector appetite for dollar-denominated assets. Such a lower level for the dollar would, of course, be negative for U.S. consumers – hiking import prices while restoring some degree of pricing power to American producers in their home market. But such a further fall in the dollar need not be a crisis, so long as appreciating non-dollar currencies are more painful to the rest of the world than a falling dollar is for the United States.
With the world having won the war against inflation commenced in 1979 by General Paul Volcker, a falling dollar is not presently a global inflationary problem, but rather a threat to the peace of global price stability. A falling dollar is a deflationary problem for other countries, which begs for a reflationary response. In contrast, a falling dollar would be a problem for America if, and only if, (1) America had an inflationary problem and/or (2) the Fed thought America had an inflationary problem, regardless of whether it did or not. Neither of these conditions holds.
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