Buiter: Ultimate Disorderly Resolution of Global Imbalances?

I've been having difficulty identifying signs of hope; they've been too much like finding needles in a haystack. Take, for example, the much-anticipated fiscal stimulus that Obama's administration will bring: many see it as producing the light at the end of the tunnel. But what if, as Willem Buiter seems to argue, that the fiscal package does not signify light at the end of the tunnel, but instead the headbeam of an on-coming freight train?

In his blog post Can the US economy afford a Keynesian stimulus?, Buiter, in a long-form treatment, reminds us (A) that the U.S. debt-load is already unsupportable, which is why there was a credit crunch to begin with (who is going to be on the hook for repaying government debt? the same U.S. taxpayers that are currently already overly burdened by their own personal debt-loads, not to mention income-strained and under-water on their biggest assets positions -- houses and stocks); and (B) that the U.S. is dependent on foreign financing of its deficits.

Making (A) worse increases the likelihood that (B) unwinds; i.e. A + B = C: disorderly unwinding of global imbalances.

So, yes, there really IS a bubble in U.S. Treasuries, and interest rates will inevitably increase significantly, though it remains an open question as to when that is. Buiter's argument implies that huge fiscal stimulus, and the huge fiscal deficit that goes with it, brings forward the ultimate day of reckoning. And if you think the U.S. economy is having trouble with interest rates where they are right now, just wait to see what happens if they go back to double-digits!


His full post is worth reading, but a couple of excerpts give a sense of his argument:

First, the fiscal policy actions pursued thus far by the Bush administration, but even more so the policy proposals leaked by Obama’s proto-administration are afflicted by the Keynesian fallacy on steroids. They appear to exist outside time, with neither the long-run consequences of the actions like to be implemented over the next couple of years, nor the history that brought the US to its current predicament, the initial conditions, being given any serious attention

And:

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.

He concludes:

Given the bad fiscal position of the US Federal government and given the vulnerability of the external position of the US and its growing reliance on foreign funding, the scope for expansionary fiscal policy in the US is much more limited than president-elect Obama’s advisers appear to realise. Underneath the effective demand problem is a deep structural rot, especially in household sector and financial sector balance sheets. Keynesian cyclical policy options that would be open to more structurally sound economies should therefore not be tried on anything like the same scale by the US authorities.

Yves Smith's take on Buiter's post is worth reading as well (Willem Buiter calls for less US stimulus, expects collapse in price of dollar assets), for the background offered on how Buiter has been one of the few serious economists consistently willing to challenge orthodoxy, as well as for the brief discussion of the (differing) views of Paul Krugman and Tyler Cowen.