There were two posts yesterday. The first was “Twins No More:”
Back in the Reagan years two unprecedented things began happening to the US economy. For the first time ever, we began running large peacetime budget deficits; and for the first time ever we began running large trade deficits. In a famous analysis, Martin Feldstein pronounced them “twin deficits”, linking the external deficit to the budget deficit, a proposition that made sense at the time: the budget deficit was helping to drive up interest rates, and high rates led to an overvalued dollar.
It’s occurred to me recently that much discussion of deficits these days implicitly assumes that something similar applies in today’s world — that by running budget deficits we’re indebting ourselves, as a nation, to foreigners (especially China). So it’s worth pointing out that this isn’t remotely true.
It’s important to note, by the way, that the fraction of US government debt the Chinese own is basically irrelevant here; if the Chinese decide, say, to sell a bunch of stocks and buy government bonds instead, this raises the fraction of government debt they hold but doesn’t hurt the international investment position at all. What we should be looking at is simply the amount of external finance we’re relying on.
And what you actually see is this:
The budget balance here is for “general government” — federal, state, and local; the current account is the broad definition of trade, including investment income. What you see is that the surge in budget deficits after 2008 was accompanied by a significant decline in net foreign borrowing compared with the height of the housing bubble.
There’s no mystery here, of course: what happened in the slump was a collapse in private spending, which actually brought the trade deficit down even as it led to a sharp fall in revenue and rise in spending on safety-net programs. But it’s still very much at odds with the popular perception that our deficits are putting the nation deep into debt to foreigners.
And this in turn means that the notion that deficits are impoverishing the nation is all wrong. To the extent that our future wealth is being impaired, it’s overwhelmingly because we’re investing too little, not because we’re borrowing too much.
The second post of the day was “What’s the Greek for Corralito?”:
It’s now three years since I suggested a possible route to Greek exit from the euro: a banking crisis, followed by sharp limits on bank withdrawals similar to Argentina’s 2001 corralito, and then — with the panic argument against exit removed — reintroduction of a domestic currency.
Obviously, that hasn’t happened. Despite intense suffering, the Greek political elite’s commitment to the euro has proved incredibly strong. My analysis of the economics wasn’t wrong, but my political guesstimates were off.
Still, Cyprus is now following the first part of the script. And let me ask again: what, exactly, is the point of remaining on the euro? The convenience and efficiency of a single currency is gone; meanwhile, the future for Cyprus on the euro is one of years of grinding deflation and catastrophic austerity. Is the hope of someday, somehow restoring the status quo ante enough to justify all of this?