If something can’t go on forever . . . it will
Occasionally I do post inverting Ben Herbert Stein’s famous observation:
If something can’t go on forever, it won’t.
Some of my commenters say things that are clearly not true, such as the claim that NGDP cannot keep growing at 5% forever. Yet even economists can make those sorts of claims, as when they argue that Australia can’t keep running 4% of GDP current account deficits forever. (I heard that when I lived there in 1991, and yes it can.) Here’s an old FT article by Willem Buiter from January 2009, which is worth re-reading to get a sense of how even very smart people can misjudge which trends are unsustainable:
Some of the excess returns on US investment abroad relative to foreign investment in the US may have reflected true alpha, that is, true US alpha – excess risk-adjusted returns on investment in the US, permitting the US to offer lower financial pecuniary risk-adjusted rates of return, because, somehow, the US offered foreign investors unique liquidity, security and safety. Because of its unique position as the world’s largest economy, the world’s one remaining military and political superpower (since the demise of the Soviet Union in 1991) and the world’s joint-leading financial centre (with the City of London), the US could offer foreign investors lousy US returns on their investments in the US, without causing them to take their money and run. This is the “dark matter” explanation proposed by Hausmann and Sturzenegger for the “alpha” earned by the US on its (negative) net foreign investment position. If such was the case (a doubtful proposition at best, in my view), that time is definitely gone. The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally. Even the most hard-nosed, Guantanamo-bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed. Key wholesale markets are frozen; the internationally active part of its financial system has either been nationalised or underwritten and guaranteed by the Federal government in other ways. Most market-mediated financial intermediation has ground to a halt, and the Fed is desperately trying to replace private markets and financial institutions to intermediate between households and non-financial operations. The problem is not confined to commercial banks, investment banks and universal banks. It extends to insurance companies (AIG), Quangos (a British term meaning Quasi-Autonomous Government Organisations) like Fannie Mae and Freddie Mac, amorphous entities like GEC and GMac and many others.
The legal framework for the regulation of financial markets and institutions is a complete shambles. Even given the dismal state of the legal framework, the actual performance of key regulators like the Fed and the SEC has been appalling, with astonishing examples of incompetence and regulatory capture.
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 two and five years from now) be a global dumping of US dollar assets, including US government assets.
Maybe eventually, but don’t hold your breath.
Hmmm, I wonder if it’s time again for one of my “Apocalypse Later” posts on how another year went by without the expected collapse of the Chinese economy. I’ll take China’s 7% RGDP growth with all its “imbalances” over Brazil’s 0% growth.
PS. There are lessons in Buiter’s erroneous forecast. He lets emotion get in the way of cold hard logic. I can see how people believed that after all its economic/foreign policy screw-ups the US deserved to get its comeuppance. But life is not fair.
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1. May 2015 at 05:56
“Yet even economists can make those sorts of claims, as when they argue that Australia can’t keep running 4% of GDP current account deficits forever.”
It has and can:
https://thefaintofheart.wordpress.com/2014/07/25/a-useless-endeavor/
1. May 2015 at 06:00
Some more:
https://thefaintofheart.wordpress.com/2014/02/13/the-fragile-5-among-the-developed-economies/
1. May 2015 at 06:16
That would be Herbert Stein.
Ben Stein’s famous quote is “Bueller? Bueller?…”
https://www.youtube.com/watch?v=NP0mQeLWCCo
1. May 2015 at 07:45
Whew, I’m back to disagreeing with Sumner. Back to sanity. In this post Sumner confuses persistent current account deficits with prosperity and makes the logical error if ‘if not now, then never’ (best said in Latin). First, go here: http://en.wikipedia.org/wiki/Current_account#/media/File:Cumulative_Current_Account_Balance.png and notice India, Brazil, Spain, Italy, UK, Poland, Greece, Australia and especially the USA have persistent current account deficits since 1980, while Japan, Germany, China, USSR / Russia, Scandinavia, France, Saudi Arabia have surpluses. I rather be in surplus than deficit, but in any event from the disparate countries you can see there’s no cause and effect between prosperity and current account deficits.
Secondly, and more fundamentally, Sumner does not appreciate how quickly collapse can occur. Perhaps he should read Tainter’s classic book “The Collapse of Complex Societies” or simply observe how quickly Citigroup collapsed from it’s all-time highs in late 2006 to de facto bankruptcy less than two years later. Feet of clay is the USA and they crack quickly, like Humpty Dumpty on the wall.
1. May 2015 at 08:06
Yes. The US is operating a mutually beneficial trade in risk that is very lucrative. Key elements of this are US corporate foreign investment, trade deficit, low interest rates, and high home prices. Our benefits dont fit easily into national accounting processes. Because people have erroneous objections to every single leg on this beautiful stool, they wouldn’t be happy until they tanked it. So they tanked it. And now it’s “the market’s” fault that everything is out of whack. Being functional again can only mean higher home prices and a larger trade deficit. And that will happen until everyone craps themselves again in a big dumb freakout. It’s amazing how much damage we are willing to inflict on ourselves in the service of second guessing prices and transactions.
1. May 2015 at 10:04
Marcus, Thanks for the links.
Charlie, Thanks, I fixed it.
Ray. You said:
“In this post Sumner confuses persistent current account deficits with prosperity”
Whew, you are back to being always wrong. No, I did not equate CA surpluses with prosperity, I believe they are unrelated.
Kevin, Just keep NGDP growth steady and let markets sort out the rest.
1. May 2015 at 10:27
You mean you don’t agree that the Yuan is a huge risk to the dollar, Iran is taking over the Middle East, or Japan taking over the world. (Ok the last was from 25 years ago.)
I still find the basic contradiction of the 2008 Financial Crisis is the US was “Too Big To Fail.” And in 2015, the only thing that would stop this growth in the US is a stupid war. (It should be noted that Saudi Arabia is burning through currency reserves to make war.)
On China I don’t see how they are not following the Japanese model but they are still in the early 1980s Japan reality. (with a huge population)
1. May 2015 at 11:23
Scott, what are your thoughts on the dark matter hypothesis?
Funny enough, I tweeted about Buiter’s mistake yesterday:
https://twitter.com/jp_koning/status/593781919059410945
1. May 2015 at 11:40
Collin, If China follows Japan’s path they will be incredibly fortunate.
JP, Great minds think alike (I actually wrote the post a week ago.)
1. May 2015 at 13:37
What’s the theory behind current account deficits going on forever?
1. May 2015 at 16:09
“If China follows Japan’s path they will be incredibly fortunate.”
-The fear is not that China will become a New Japan, it’s that it’ll become a New famous manufacturing exporter with a thirty-five year history of stagnation at middle-income levels [hint: it’s just South of the border].
1. May 2015 at 16:29
The Internet is cruel. People fulminate, and then—bingo, years later rash predictions spring back to life.
Scaremongering we will always have—but perhaps we can hope for the occasional comeuppance.
Unless the Fed prints more money, I see catastrophic instability and deep declines in equity and property values in the US. And possibly foreign invasions by militaries hunting Benjamin Franklins.
1. May 2015 at 16:47
Buiter also defended the Trichet led ECB’s disastrous 2011 rate hikes / monetary tightenung. Really, one doesn’t need to know any more than that. Aiding and abetting an EPIC monetary FAILURE. And he never admitted that failure. And it was a failure.
1. May 2015 at 17:22
The internets can be so cruel. Especially when folks are dead wrong for a decade and its documented for all to see. At least haiHedge admitted a QE failed call before their fund imploded.
1. May 2015 at 19:59
“Some of my commenters say things that are clearly not true, such as the claim that NGDP cannot keep growing at 5% forever.”
But that is clearly true.
1. May 2015 at 20:00
“Yet even economists can make those sorts of claims, as when they argue that Australia can’t keep running 4% of GDP current account deficits forever. (I heard that when I lived there in 1991, and yes it can.)”
No they cannot.
1. May 2015 at 22:06
Would the person impersonating Major Freedom please refrain. These short snappy comments are so obviously faked.
2. May 2015 at 06:15
E. Harding, You said:
“What’s the theory behind current account deficits going on forever?”
No reason it can’t. Keep trading Gold Coast condos for cars.
China is nothing like Mexico, it’s hard to imagine two more different countries. I see little chance of China getting stuck in middle income levels.
Tommy, Sounds like he doesn’t have a good track record.
2. May 2015 at 09:54
Willem Buiter is absolutely 100% right. And anyone who knows where to look can see that the situation he is describing is already MUCH closer than one “ssumner” thinks. I see a number of things that makes me believe that situation is going to happen this year.
I expect long term US rates to explode higher.
The situation in Australia is actually very alike to the situation here in the US.
3. May 2015 at 01:50
I feel like the bias at work with these kinds of misforecasts might be related to the Gambelr’s Fallacy. You know, the one where you flip a ‘fair’ coin 99 times and get mostly heads, and then place a large bet that the next one coming up tails because tails is ‘due’ rather than just updating your priors on the fairness of the coin. Also possibly related to how Krugman complains of the moralism right-wingers inject into macro, where they support things like Austrianism because they feel like after a period of excess an economy becomes ‘due’ for a correction in the opposite direction due to the natural level. Which may be true for a level targeting central bank that overshoots in one period, but not otherwise.
3. May 2015 at 05:34
Willy2, The things that he said would happen in 2 to 5 years did not happen. Nor is there any sign they will happen. There’s nothing more to say.
Saturos, That might be part of it.
3. May 2015 at 11:46
@Saturos, @sumner
People tend to fall in love with their beliefs (especially smart people) and fail to see paradigm shifts … That happens all the time.
3. May 2015 at 14:58
Oh no, Buiter is absolutely right. But I would like to quote J.M. Keynes first:
“Markets can remain longer irrational than you can stay solvent”.
And the irrationality today is the notion that foreigners will keep buying USD denominated assets forever.
I would go even one step further than Buiter. I know there’s a situation where foreigners will be FORCED to sell US assets. To see that one has to look at the development of the dynamic(s) between the US budget balance & US Current Account deficit (CAD) since 1990.
See how the dynamic between the CAD & budget deficit changed over time:
Before 1995: US budget deficit > US CAD.
From 1995 up to say late 2008: budget deficit US CAD.
The REAL test will come WHEN (and NOT IF) the CAD turns into a CA Surplus. Then foreigners WILL be FORCED to sell their USD assets. Even if they don’t want to.
We already saw in the 2nd half of 2008 that foreingers ditched their Fannie Mae/Freddy Mac paper and swapped them for T-bonds. Foreigners actually bought in the 2nd half of 2008 MORE T-bonds than there were T-bonds issued. The balance came from the FED’s balance sheet. (Look it up !!!)
This ditching of Fannie Mae/Freddy Mac paper was ENABLED by the direction in which the CAD & US Budget deficit were moving.
Just look at Saudi Arabia today. For a long long time they were running Current Account Surpluses but NOW they are running a Deficit. In other words: Saudi Arabia is actually selling T-bonds. (Oil is priced in USD. Remember ?). If the US & Saudi Arabia were the only 2 countries on earth then the US would already be running Current Account Surplusses for months.
4. May 2015 at 06:26
Willy, I have another recent post (at Econlog) pointing out that Keynes was wrong on market irrationality.
4. May 2015 at 10:12
The reason why Australia kept running CA Deficits is that the money they earned with the commodities export weren’t “saved”. The Howard government (1996 – 2007) increased spending during that timeframe. By increasing spending consumption increased as well and pushed the CA into a deficit, and kept it in a deficit.
An australian analist called Gerard Minak did some excellent research on that topic.
5. May 2015 at 06:23
Willy2, This began long before 1991, and it’s not caused by some government policy.
7. May 2015 at 05:44
NO. If the australian government wants to then it can turn that CA Deficit into a Surplus. All it has to do is double the tax rates. But that’s something that wouldn’t go down too well.
No. Governments DO/CAN play an important role in creating Current Account Surplusses & Deficits.
Take e.g. Germany. In the 1990s Germany ran Current Account Deficits and that wasn’t to the liking of the german government. That’s why from 2000 onwards the german government changed its economic policy. It surpressed the rise in household income, thereby decreasing the rise in Household expenditures. The result was that Germany started to run LARGE CA Surplusses.
But since the total amount CA Deficits & Surplusses is Always ZERO, Germany running a CA Surplus of say $100 billion means that all other countries (e.g. Australia) combined are running a CA Deficit of also $ 100 billion.
I presume one SSumner doesn’t like this kind of thoughts because then he has to admit that the US CA Deficit could also disappear and also that the US currently is living beyond its means. Right ?