Tuesday, March 29, 2005

Maybe the Best Econoblog Yet

Nouriel Roubini and David Altig spar today in what I think is the best WSJ Econoblog yet. The topic: Does Overseas Appetite for Bonds Put the U.S. Economy at Risk?

It's a funny question as a lead-in. Generally, when some other country has an "appetite" for something (like U.S. government bonds) that we make, we are not at risk but richer for it. There are some relative price shifts that have distributional consequences (like making U.S. exports relatively more expensive compared to foreign imports), but on the whole, the country is richer. For a variety of reasons, Asian central banks have been willing to not only hold U.S. debt but (via undervalued exchange rates) pay too much for it. At least initially, it's their problem, not ours.

So the real question, and the one that Nouriel and David seek to answer, is whether a potential loss in overseas appetites for U.S. government bonds will put the U.S. economy at risk. I think they both agree that the answer is affirmative, but they disagree on the magnitude and timing of the adjustments. Nouriel is arguing for big adjustments on a possibly sudden time scale (the hard landing), and David is arguing for more gradual adjustments (the soft landing). They come at the issue from every conceivable angle, and so I recommend it (as well as both of their blogs, linked at the right). The discussion is extensively documented.

Where am I on the issue? I've been a fan of Nouriel's for (ahem) 17 years, since he was a TA at Harvard in an undergraduate international macro class that I took, but I tend to agree with David that it is difficult to see the U.S. in a hard landing scenario. We're too big an economy, and our creditors' portfolio holdings are simply too large for them to behave rashly. Unfortunately, that perception that we may be immune from a hard landing has encouraged behavior--over a period of decades, in both the private and public sectors--that makes us a high-borrowing, high-consuming economy. In my view, it is our low national savings rate that puts us at risk, not the propensities of our creditors per se.

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Mark Thoma said...

This is a good discussion to have. I have also struggled to make a coherent statement regarding the level of interest rate risk faced by the U.S. (and may do so again in this comment…). The point estimates of this risk derived from reading various viewpoints in blogland, the two above prominent among them, seem to have a high variance.

My own sense is that we do face quite a bit of risk, but it will take a particular trigger to begin the snowball. Over the normal course of events a soft landing seems a reasonable proposition. I am not too worried about sudden changes in appetite without some underlying reason for the change.

What I am not sure of since I don’t delve too deeply into international finance, is what those triggers might be. Taiwan certainly comes to mind, but what other vulnerabilities are out there? Are foreign central bank inventories of foreign currencies nearly full? I’d appreciate any discussion of this that people would like to post. What might motivate large scale attempts to sell U.S. financial assets in the near future?

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