Lester Thurow: Oracle of Delphi or Cassandra?
I was doing some research for a paper the other day and came across this Boston Globe Op-Ed of November 28, 2000, written by Lester Thurow during the debate over the first round of Bush tax cuts. I don’t usually agree with Thurow on many things but his prescience is striking here.
"…the most likely cause of the next president's first economic crisis is easy to pinpoint. It is a foreign exchange crisis. If American consumption, investment, and government spending is aggregated, it exceeds American production by $450 billion - about 4.5 percent of gross domestic product. This is only viable as long as the rest of the world is willing to invest $450 billion more in the United States than Americans wish to invest in the rest of the world.
"Put simply, foreign money is needed to pay for the $450 billion excess of imports over exports - the imported goods and services that allow us to spend more than we produce. In his election campaign George W. Bush promised to give away most of the surplus in the federal budget in the form of a big tax cut. With fewer taxes to be paid, take-home income rises and Americans will want to consume and invest more than they are now consuming and investing. Since American spending already exceeds American production, this can only happen if foreigners are simultaneously willing to significantly increase the funds they are investing in America. The balance between payments deficit has to get bigger to give us the extra investment and consumption goods and services that lower taxes allow us to buy….The American economy is slowing, and, if anything, it will look like less of a good place to invest in the next eight years than it has in the past eight years. Also, economic growth is speeding up in much of the rest of the world. Foreigners will probably want to invest a smaller, not larger, portion of their funds in America over the next few years. In simple supply and demand terms, if Americans want to spend more and foreigners want to invest less, the value of the dollar has to fall. This makes foreign goods more expensive so that we buy less.
"As the dollar falls, however, foreigners with dollar assets in the United States will see the value of their American assets (measured in their own currencies) falling. To avoid big losses in their investment portfolios, they are likely to want to get out of some of their dollar investments. As they move their money back home, the fall in the value of the dollar accelerates. As they move out, they sell their stocks, and stock prices are apt to fall. Shrewd American investors, seeing that big short-run gains are possible if one holds the foreign currencies that are going up in value and noticing that stock prices are going down, also are apt to move their investments from dollar-denominated investments to foreign currency-denominated investments.
"At this point a Mexican-style run on the dollar becomes possible or even likely. The only remedy is a big increase in interest rates. Foreigners and Americans must be bribed to keep their money in America. But a big increase in rates leads to a recession. The demand for imports goes down because American incomes go down, but the demand for American-made goods also goes down.….One cannot ignore the rest of the world when designing American economic policies. What determines our ability to cut taxes or raise government spending is not the surplus in the federal government budget, but the balance between national spending and production."
You can read this and conclude either of two things. One, people on the Left are Chicken Littles who have been crowing about a foreign exchange crisis for years with no appreciable evidence of it happening. Two, that Thurow foresaw what many have been writing about lately (witness John Aloysius Farrell of the Denver Post, David Broder of the Washington Post, & Thomas Friedman of the New York Times all in the last week). Sooner or later the sky does fall when you pull out the joists which prop it up. If you are inclined to the former view (i.e. option one) allow me to remind you that Alan Greenspan gave his irrational exuberance speech in 1996.
"…the most likely cause of the next president's first economic crisis is easy to pinpoint. It is a foreign exchange crisis. If American consumption, investment, and government spending is aggregated, it exceeds American production by $450 billion - about 4.5 percent of gross domestic product. This is only viable as long as the rest of the world is willing to invest $450 billion more in the United States than Americans wish to invest in the rest of the world.
"Put simply, foreign money is needed to pay for the $450 billion excess of imports over exports - the imported goods and services that allow us to spend more than we produce. In his election campaign George W. Bush promised to give away most of the surplus in the federal budget in the form of a big tax cut. With fewer taxes to be paid, take-home income rises and Americans will want to consume and invest more than they are now consuming and investing. Since American spending already exceeds American production, this can only happen if foreigners are simultaneously willing to significantly increase the funds they are investing in America. The balance between payments deficit has to get bigger to give us the extra investment and consumption goods and services that lower taxes allow us to buy….The American economy is slowing, and, if anything, it will look like less of a good place to invest in the next eight years than it has in the past eight years. Also, economic growth is speeding up in much of the rest of the world. Foreigners will probably want to invest a smaller, not larger, portion of their funds in America over the next few years. In simple supply and demand terms, if Americans want to spend more and foreigners want to invest less, the value of the dollar has to fall. This makes foreign goods more expensive so that we buy less.
"As the dollar falls, however, foreigners with dollar assets in the United States will see the value of their American assets (measured in their own currencies) falling. To avoid big losses in their investment portfolios, they are likely to want to get out of some of their dollar investments. As they move their money back home, the fall in the value of the dollar accelerates. As they move out, they sell their stocks, and stock prices are apt to fall. Shrewd American investors, seeing that big short-run gains are possible if one holds the foreign currencies that are going up in value and noticing that stock prices are going down, also are apt to move their investments from dollar-denominated investments to foreign currency-denominated investments.
"At this point a Mexican-style run on the dollar becomes possible or even likely. The only remedy is a big increase in interest rates. Foreigners and Americans must be bribed to keep their money in America. But a big increase in rates leads to a recession. The demand for imports goes down because American incomes go down, but the demand for American-made goods also goes down.….One cannot ignore the rest of the world when designing American economic policies. What determines our ability to cut taxes or raise government spending is not the surplus in the federal government budget, but the balance between national spending and production."
You can read this and conclude either of two things. One, people on the Left are Chicken Littles who have been crowing about a foreign exchange crisis for years with no appreciable evidence of it happening. Two, that Thurow foresaw what many have been writing about lately (witness John Aloysius Farrell of the Denver Post, David Broder of the Washington Post, & Thomas Friedman of the New York Times all in the last week). Sooner or later the sky does fall when you pull out the joists which prop it up. If you are inclined to the former view (i.e. option one) allow me to remind you that Alan Greenspan gave his irrational exuberance speech in 1996.
posted by EPE | Link:3/02/2005 10:23:00 AM
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