I would be a bit more cautious about dinging the twin deficits theory, if I were you. Certainly it looks pretty empty today with humongous budget surpluses and trade deficits coinciding. But in the early 80s it was not totally ridiculous to associate the increase in the trade deficit with the increase in the budget deficit under Reagan. The theory certainly was there for it: budget deficit to higher interest rates to higher value of dollar and higher trade deficit. And that seems to have been going on, especially prior to the end of 1982.
I would even remind you of the debate you and I had (I think on pkt) back the last time the Fed seriously tightened monetary policy and against standard theory the dollar declined. I argued then, following a rather large pile of literature, that there was no basis for the dollar to keep rising from late 1982 to early 1985, after the Fed eased monetary policy. In one of your truly delightful displays of data wonkery you showed a series of real interest rates showing that real interest rates in the US continued to be high through that period, thus justifying the continuing rise of the dollar (that worsened the trade deficit, with a continuing high budget deficit) through that period. Barkley Rosser -----Original Message----- From: Doug Henwood <dhenwood at panix.com> To: lbo-talk at lists.panix.com <lbo-talk at lists.panix.com> Date: Monday, September 27, 1999 7:03 PM Subject: U.S. prospects
>[Two Wall Street mavericks - so out of it that they're in New
>Hampshire - Marshall Auerback and Frank Veneroso of Veneroso
>Associates, caught wind of my U.S. foreign debt chart and sent me
>some of their stuff. I get uncomfortable amidst all this
>scaremongering, but here's an excerpt from one of their reports. The
>lead-in to this talked about how standard thinking in the 1980s was
>that the trade deficit was a function of the budget deficit, which it
>turned out not to be. The Long Beach data at the end refer to port
>shipping data, a proxy for Asia trade. As of July, outbound shipments
>were flat over the last year, while inbound shipments were strongly
>up.]
>
>The idea of the TWIN DEFICITS and its perils was a strange idea fixed
>in the minds of US investors in the past. Borrowing from abroad on
>the current account was somehow indissolubly associated with fiscal
>deficits even though economic theory and history suggested that
>external deficits and fiscal deficits were two completely different
>phenomena with no necessary linkage between them. There are ample
>cases to illustrate this point. Wartime USA was a period of massive
>fiscal deficits and huge current account surpluses. The emerging post
>war world was strewn with examples like Chile, where the current
>account deficit soared to 13% of GDP (1979) even though the Chicago
>boys ran a fiscal surplus. By 1993, Italy, a major G-7 economy, was
>running a giant fiscal deficit, but it enjoyed the largest current
>account surplus of the G-7 nations. And so forth.
>
>The question arises: does a current account deficit that occurs in a
>country with a fiscal surplus constitute a serious threat to that
>country's exchange rate and interest rate level? And the elementary
>answer is, of course it does. Chile in 1979 is a case in point. The
>massive current account surplus described above resulted in a massive
>depreciation of the exchange rate, sky high real interest rates, and
>ultimately a condition of both internal and external bankruptcy. The
>emerging world is full of other such examples. In the early 1990's,
>foreign investors poured into Mexico under the Salinas
>administration, because of the latter's widely admired fiscal
>policies. The resultant capital inflows created an overvalued
>exchange rate and a huge current account deficit, with the ultimate
>fall-out not unlike that of Chile. The same can be said for several
>of the emerging Asian countries in the recent crisis of 1997-98.
>
>Emerging Asia in this regard is most illustrative. Here we had
>countries with fiscal balances and low shares of government as a
>percentage of GDP. However, in some countries, there were large
>current account deficits which were matched by large private sector
>savings deficits. The combination proved to be especially combustible
>when the crisis came, since private borrowers, who are weaker debtors
>than governments and quasi-public institutions, proved to be
>especially vulnerable when foreign sources of finance withdrew en
>masse.
>
>Let us now look at the US from this perspective. The picture is not a
>pretty one. The US federal, state and local governments are
>generating a combined fiscal surplus of 1.5% of GDP or more. The US
>current account deficit is approaching 3.5% of GDP and likely rising.
>It is a national accounts identity that the savings deficits of the
>two combined private sectors - households and corporations---must
>equal the sum of these savings surpluses of the government and the
>rest of the world. It does not matter if the US household savings
>data understates household savings, as many Wall Street economists
>argue; that simply implies that the corporate savings data - retained
>profits -are overstated by a corresponding amount which, given the
>lofty valuation levels of current US stock prices, is probably for
>the worst (although these same Wall Street economists never
>acknowledge this latter point). Given the short falls in both US
>household and corporate savings, the large private sector deficit of
>the US must now be largely financed from borrowings from the rest of
>the world.
>
>How large is such a private sector deficit, comparatively speaking?
>Wynn Godley at the Levy Institute at Bard College tells us that at
>current levels, the US private sector is at a dangerous threshold; at
>these sorts of levels in other G-7 countries, a recession and, often,
>a financial crisis, has ensued. If the current account deficit in the
>US is in fact increasing, as the Long Beach export data suggests, and
>as Tim Congdon predicts, then, as by this simple national accounts
>identity, the US private sector deficit is entering new high ground.
>
>Now, if the US private sector financed its savings deficit with the
>issue of equity matters might not be so grave. Private borrowers
>cannot weather having the plug pulled on them by their lenders, but
>if they "borrow" with the issue of equity, not debts, the former
>being perpetual claims that require no fixed payments, such borrowers
>can weather a considerable storm. But in the US, in a manner with
>virtually no precedent in the history of capitalist economies, the
>corporate sector is not only financing its savings deficit with the
>issue of debt---it is also retiring equity with debt close to the
>tune of 2% of GDP a year. This implies that the debt issue of the US
>private sector equates to 7% of GDP and that this huge private debt
>issue is dependent upon foreign creditors. There are no parallels in
>the history of the industrialized world for such large and possibly
>very vulnerable private sector profligacy.
>