Writing in the Business Standard, Martin Feldstein makes his predictions for the United States economy. His key prediction is in his first sentence:
The combination of large future fiscal deficits and foreign lenders' reduced willingness to buy US securities will lead to both a lower dollar and higher US interest rates.
He is correct about long-term interest rates, but incorrect about short-term interest rates and also incorrect about a significantly lower dollar. Here is the passage in which he clearly states his delusion:
It is, of course, possible — I would say likely — that China and other foreign lenders will not be willing to continue to provide the current volume of lending to the US. Their reduced demand for dollars will cause the dollar to decline and the trade deficit to shrink.
In actuality, the People's Bank of China and other central banks will continue to bid up the dollar, compared to their currencies, so that they can increase their businesses' market share in their competition with American industry throughout this recession. If you want to know the Chinese government's intentions, you just have to read what they predict. The Chinese State Information Center (SIC) recently issued a report in which they made their predictions for 2009. They predicted that the Chinese economy would grow by 8% while Chinese imports would fall by 16%. The Chinese government is not about to let the Chinese people import more American goods and services.
As far as U.S. interest rates go, Feldstein is correct that the foreign central banks won't be buying US long-term bonds. Brad Setser has been closely following the foreign central bank switchover from long-term to short-term US Treasuries. As a result, the yields curve, shown below, on US Treasury Bonds has been fairly steep lately:
Feldstein is correct that the dollar will eventually fall. In fact it will eventually crash to half or quarter of its current value. But that crash will not happen within the next few years. China and the other mercantilist nations have a lot more US industry to steal before they let the dollar collapse. And the feckless Obama administration will let them steal it. Later in his commentary, Feldstein predicts a more likely outcome for the next few years:
Without a fall in the dollar and the resulting rise in net exports, a higher saving rate and reduced consumer spending could push the US economy into a deep recession.
Martin Feldstein is one of our country's greatest economists. But he has a blind spot. He still doesn't understand modern mercantilism. He lives in a dream world in which the Chinese government spontaneously decides to change its successful strategy. China has been maximizing exports and minimizing imports in order to steal our industry and replace us as the world's dominant economic and military power. We are letting them do so.
Disclosure: No positions.
