Krugman, Hubbard, and Pete Peterson

I recommend this round table discussion between Paul Krugman, Glenn Hubbard, and Pete Peterson. I think I actually met Pete Peterson once, but that was a long time ago.

On the US trade deficit, Hubbard states

GLENN HUBBARD: Remember, though, that the mirror of the current account is what’s called the “capital account,” which tracks funds flowing in or out for investments and loans. Another way to look at the current account deficit is that there’s substantially more investment being done in the United States than there are savings.

Krugman agrees, but compares the current situation in the US to Argentina and Indonesia before their currency collapses

America is not Argentina. What turned the plunge of the peso into an economic collapse was the fact that Argentina’s debt was held in dollars. When the peso fell, banks and businesses found their debt in pesos exploding, and pretty much everyone went bankrupt. We hold our foreign debt in our own currency, so the immediate capital loss from a weakened dollar falls not on U.S. businesses but on foreign central banks—mainly the Bank of Japan and the People’s Bank of China, which finance almost all of our current account deficit.

This key difference, that US foreign debt is held in dollars is the critical difference that makes comparisons between Indonesian and Argentinian currency crises wholly inapplicable to the US position. I worked in a hedge fund during the rouble collapse, and subsequent broader emerging market collapse, and it was obvious to me that the vicious circle that lead to investors being forced to sell into declining markets was a direct result of the homogeneity of the investor class. The only people who held Indonesian debt were western money managers. By contrast, American debt is held by all kinds of different people -- Japanese central banks, Midwester grandmas, East Coast elite, the Chinese government, etc. If one class feels the need to hold a firesale the others will snap up the bargains. This diversification, I feel, insulates the US from the type of currency and interest rate volatility countries with thin capital markets have to deal with.

The key dynamic here seems to be that China, following mercantilist trade policy, is taking money from Chinese consumers and importers and giving it to Chinese exporters, who are in turn tying dollar bills to their exports. The rational thing to do in this circumstance would be to take the money and buy the Chinese exports -- anything else would be foolish! Thus the trade deficit. When the Chinese decide to stop taking from their local peasants and giving to American flat-screen TV buyers, then the trade deficit will go away, but until then American consumers should take the money and run.

Unfortunately, much of that money has run into real estate, and created a bubble there, but that too will correct as rates rise. I am not sure what the effect of a real estate bubble pop would be on the economy. I myself am short real estate but long broader business spending, so personally I am not as hedged as I would like.

Should the dollar fall? Probably. Do I care? Not really.

On the welfare state, Krugman seems somewhat schizophrenic. He wants more government spending and control, particularly in healthcare, and would prefer to ration healthcare by reducing research and reducing medical care to future generations. But he resists cutting social security benefits. This battle between the present and the future comes out pretty clearly here:

HUBBARD: That wouldn’t strike you as a large departure in fiscal policy? The best estimates from the research suggest that tax increases of that size would reduce the economy’s potential growth by as much as a percentage point. That is a huge hit to future standards of living.

KRUGMAN: I would dispute that. Look, Sweden is actually doing pretty decently these days—their economy grew at 3 percent last year, far more than Europe as a whole—despite a tax rate that nobody would consider having here. It does matter how the taxes are done: you can do a lot of damage to incentives with a poorly designed tax system, without even raising all that much money. But I don’t believe that the size of the tax increase needed to sustain the welfare state is a crippling objection.

Krugman would raise taxes on people and then give that money back in social security. He seems not have have heard of deadweight loss:

PETERSON: You can call it a tax if you wish, but I think there is a huge difference between writing a check to the government and letting it be spent on other people’s consumption, and taking money and putting it in your own account. I call that real savings, not taxes. But if you put a word like “taxes” on a plan, it immediately would lose support.

KRUGMAN: Someone will put that word on it.

PETERSON: This is one reason why I’m not opposed to personal retirement accounts as part of Social Security. What I can’t support is the idea to “fund”—I put that in big quotes—the accounts by borrowing trillions of dollars. If the administration would fund them, personal accounts would help to solve our savings problem. These really would be a genuine “lockbox,” in that they would keep the money out of the hands of Congress.

Any one who cannot see the difference between an individual saving money to give to themselves or their children in the future, and having the government taking your money to give to other people, really has no understanding of incentives or human behavior. Personal accounts are savings. Social Security is a tax.