Modeling, Analytics and Business Intelligence

Willem Buiter on Future of US Economy

Posted in Economy by Sanjay Bapna on January 5, 2009

Interesting commentary by Willem Buiter dissected by Yves of NakedCapitalism. The original is available here and strongly recommended for those who have the time to read. This also gels with the other two Must-Read articles from Barron’s in this blog.

1) Stimulus will do nothing to stem the decline of the US economy and is money not well spent.

2) Dollar is going to implode in 2-5 years time. Very high inflation will be the norm then – all this will result in significant wage decreases.

There is no chance that a nation as reputationally scarred and maimed as the US is today, could extract any true ‘alpha’ from foreign investors for the next 25 years or so. So the US will have to start to pay a normal market price for the net resources it borrows from abroad. It will therefore have to start to generate primary surpluses, on average, for the indefinite future. A nation with credibility as regards its commitment to meeting its obligations could afford to delay the onset of the period of pain. It could borrow more from abroad today, because foreign creditors and investors are confident that, in due course, the country would be willing and able to generate the (correspondingly larger) future primary external surpluses required to service its external obligations. I don’t believe the US has either the external credibility or the goodwill capital any longer to ask, Oliver Twist-like, for a little more leeway, a little more latitude.I believe that markets – both the private players and the large public players managing the foreign exchange reserves of the PRC, Hong Kong, Taiwan, Singapore, the Gulf states, Japan and other nations – will make this clear.

There will, before long (my best guess is between 2 and 5 years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury Bills and Bonds are still viewed as a safe haven by many. But learning takes place. The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of ‘dark matter’ or ‘American alpha’ is not credible….

So two things will have to happen, on average and for the indefinite future, going forward. First, there will have to be some combination of higher taxes as a share of GDP or lower non-interest public spending as a share of GDP.  Second, there will have to be a large increase in national saving relative to domestic capital formation.

The only alternative is default on the Federal debt.  There is little doubt, in my view, that the Federal authorities will choose the inflation and currency depreciation route over the default route.

If I can figure this out, so can anyone in the US or abroad who follows recent economic developments.  The dawning of the realisation will lead to the dumping of the assets.

Beggars can’t be choosers. The US has been able to get away with decades of private sector improvidence because of two unique and time-limited factors. The first is a sequence of capital gains on household assets (stocks and real estate) that provided a lovely substitute for saving to provide for retirement, old age and a rainy day.  The second was the excess returns earned by the US on its net foreign investment (its ability to borrow at an unbelievably low rate of interest/rate of return) because of the unique position of the US as the ultimate source of liquidity and security.

Both rational drivers of a low US saving rate are gone.  … So the US has to shift aggregate demand from domestic demand to external demand.  And it has to shift production from non-tradables to tradables – exportable and import-competing goods and services.

 As regards shifting production towards tradables, this will not be easy.  And policy is pushing in the wrong direction. The Bushbama administrations have decided to bail out the US car industry.  That industry does not produce cars the rest of the world wants.

Other US industries are more competitive internationally.  But shifting resources towards tradables and away from non-tradables will require re-training and re-education as well as a significant depreciation of the US dollar’s real exchange rate – which amounts to a significant cut in real wages.   



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