>First, when the "cutoff" occurs the dollar falls by some large share
>of its value as demand for dollar-denominated assets tanks, we get
>to see exactly how good our central bank is at guiding expenditure
>shifting, but when the dust clears we find that (a) foreign
>portfolio investors in the U.S. have lost perhaps 1/3 of the real
>value of investments, (b) U.S. consumption has shrunk some (but U.S.
>savings has increased), (c) U.S. investment is down some, and (d)
>U.S. exports are up a lot.
(b) would be a major adjustment, given that the consumption share of GDP has risen from 67.7% to 69.3% during the Clinton years. As for (d), exports to whom?
>Second, when the "cutoff" occurs we suddenly discover that a lot of
>portfolio investment in the U.S. is either denominated in dollars or
>else that New York institutions have written a lot of derivatives
>insuring foreign investors against a dollar decline.
>
>In which case, all hell breaks loose...
>
>
>Brad DeLong, who is 90% on scenario 1, 10% on scenario 2...
Why do you ascribe 10% probability to #2? Just because it's too awful to contemplate? It's pretty much a dead certainty that there are lots of derivatives contracts that would be, um, stressed by a major decline in U.S. markets, especially one in which risk premia and other relationships were thrown out of whack.
Brad, you mentioned that during your brief tenure in the administration there was some worry about the continued inflow of foreign capital. You see any evidence that they still worry about this?
Doug