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Defunct economists, deficits and dollars

|Includes: PowerShares DB USD Bear ETF (UDN)

Craig Pirrong is dismissive of Keynesian thinking. He is equally dismissive of today's “slaves” to that “defunct economist”.


First Robert Reich:

1. Government spending needed to offset the continued reluctance of consumers and businesses to spend. You don’t have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging, the public sector has to borrow and spend in order to keep the economy moving forward.

No, you don’t have to be an orthodox Keynesian. That is a sufficient but not necessary condition for believing such silliness. Note the confident, imperative language: “As long as the private sector is deleveraging, the public sector HAS TO BORROW and spend.” In other words, people individually have decided to reduce their leverage, so the state has to borrow on their behalf, promising to use compulsory means to repay said borrowings. Yeah? Says who?


Dr Pirrong should not be so dismissive. If the private sector as a whole is deleveraging, then private net saving is increasing. If that is happening then either the trade deficit must reduce, or the government deficit increase, or both. If the trade deficit remains the same or worsens, then the government deficit MUST increase. That is the logic of sectoral balances.

Edward Harrison has talked about sectoral balances before here. He referred to some helpful graphs from Scott Fullwiler here. These give a picture of our sectoral balances over the last 60 years. The first shows the historical behavior of the private sector surplus and government sector deficit as a percent of GDP. Note how the private sector surplus matched the government deficit until about 1983.



After that, a big gap opened up. The reason is shown by adding the foreign sector i.e. the current account deficit.


If we had been a closed economy since the beginning of time, then we could only owe money to each other. Private sector savings would match government debt, or vice versa. Only a current account deficit can cause both domestic sectors to be in deficit.  Equally, if the current account is unchanged, changes in the private and government sectors must be equal and opposite. Consequently, unless the trade deficit improves, an increase in net private saving MUST lead to an increase in the government deficit and Dr Pirrong will be wrong.

This issue, along with so much else in our economy, leads back to the issue of the trade deficit. I hope that Dr Pirrong will be right, but for him to be right, we have to improve our trade position. Perhaps President Obama's export initiative will lead us in the right direction, but I have my doubts. The signs of strengthening that we see in the economy and the recent rise in the dollar, both suggest that the trade deficit may be widening again, not closing. That would lead to more debt in our economy, in the private sector, the government sector, or both. Ultimately only an improvement in trade will allow us to reduce our gross domestic debts, and that will probably have to be facilitated by a weakening dollar.

Disclosure: The author is long various foreign stocks and bonds, to hedge the long term decline of the dollar