Friday, August 12, 2011

Economic Ignorance

The tragedy is that people ignorant of economics hold the reins of power and drive the big political decisions. Heaven help us...

Here is a bit from a post by Dean Baker in his Beat the Press blog pointing out basic ignorance in the media:
The folks at Morning Edition may not know that this is what they said, but in fact, this is exactly what a Planet Money segment on the dollar's status as a reserve currency implied. The segment told listeners that it was a good thing that foreigners demanded large amounts of dollars to use and hold as a reserve currency.

If foreigners increase their holdings of dollars then this means that the United States has a trade deficit. This is a logical implication of foreigners efforts to acquire more dollars. In order to get more dollars, they have to sell more to the United States than they buy from the United States.There is no way around this.

If the United States has a trade deficit then it means that the country as a whole is a net borrower. That means that the combination of private and public savings must be negative. Again, this is an accounting identity, it must be true, just like 2+2 will always be equal to 4.

Generally private savings are roughly equal to private investment. The main exception is when asset bubbles like the stock market bubble or the housing bubble lead to a consumption boom and thereby depress private saving. (The housing bubble did also lead to a boom in construction, which as a component of investment allowed private investment to exceed savings, until the bubble burst.)

If the country has a trade deficit and private saving is equal to private investment, then the country must have a budget deficit. This means that in general circumstances, Morning Edition was telling us that budget deficits are good, since it told us that we should be happy that the dollar is the world's reserve currency.

There was another important aspect to this issue that the piece failed to mention. Even if the dollar is used as a reserve currency the amount that a country needs to support a given level of trade can vary enormously. The amount of reserves that developing countries hold soared in the wake of the East Asian financial crisis. This is usually attributed to the fact that the terms of the bailout imposed by the IMF on the countries of the region were viewed as being so harsh that developing countries wanted to make sure that they would never be put in the same situation. This meant accumulating massive amounts of reserves (i.e. U.S. dollars) as an insurance policy.

This was the origin of the massive trade deficits that the United States has been running in recent years. It would have been useful to make this point in this segment.
I find it funny. There are those who are pushy and self confident and those who are reserved and shy. There are those who are knowledgeable and those who are poorly informed. The ideal is to match up pushy/self confident/knowledgeable. But in reality, most leaders are pushy/self confident/poorly informed. The smart leaders are those who know how to surround themselves by the reserved/shy/knowledgeable and use them to secretly plan and guide their actions while getting up on the political stage and taking all the glory for "leading" the people. This happens from time to time, and these are the "golden age" eras of a civilization. Sadly, the US hasn't had a golden age in a long, long time.

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