doug noland: us deficit

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    September 30 – Bloomberg: “Former Treasury Secretary Robert Rubin said the U.S. faces a ‘day of reckoning’ because of a federal budget deficit that poses ‘a very serious threat to the future of our economy.’ Rubin also said a strong dollar is necessary to attract foreign capital to invest in U.S. financial assets such as government debt securities… Rubin said that the deficit in coming years could push up the yield on the 10-year bond by 2.5 percentage points from the current level to about 6.5 percent. He did not predict the timing of such an increase. ‘These effects are hugely consequential, but the effects could be far more severe if the markets decide that this fiscal imprudence is going to continue and that we are in a situation where the government may try to inflate its way out of these deficits rather than deal with them through fiscal discipline.’”

    President of the Dallas Fed Robert McTeer responding to a question after his speech Wednesday at the Kanaly Trust Company Distinguished Lecture reception:

    “What is my opinion of the current account deficit? Just to define the terms a little bit, the trade deficit is the excess of our imports of goods over our exports of goods. The current account deficit adds services and some other things in the balance of payments. It’s a better measure of our trading relationship with the rest of the world. In college in the 1960s when you studied things like that the answer was that a fairly large and sustained current account deficit – if you have a floating exchange rate – will cause the exchange rate to decline until it brings about equilibrium.

    The U.S. is a little bit of an exception to that, in that its dollar is used all over the world as a currency by a lot of people and it’s held by central banks all over the world as a reserve currency. To some extent, the world has long been willing to hold the excess dollars that we put out by buying more than we sell to the rest of the world. And we get sort of a free ride. Sort of like we’re in a poker game and we never have to cash in our chips. In the late nineties, when we were doing so, we had such a dynamic economy, particularly compared to the Eurosclerosis in Europe, there was a lot of funds floating to the United States from Europe that sort of artificially held up our dollar and made the current account deficit larger. In the 1960s you learned that trade was independent and capital flows were the financing mechanism – they were sort of passive.

    But these days capital flows are kind of independent too, and one could almost argue, not that our capital inflow is financing our current account deficit, one could almost argue that our current account deficit is financing our capital inflows. So long as that is happening, and as long as we are regarded as the dynamic economy and the best place in the world to invest, our large current account deficit is not going to cause us any problem. The problem will come when people change their mind about all that and they’ve decided, maybe suddenly, that the world has too many excess dollars and they’d like to sell a lot of them all at once in the foreign exchange market. If they did that all at once, we would experience an exchange rate crisis. We’d do no telling what to react to it. I don’t know exactly what would happen, but it wouldn’t be good. But we’ve had the potential for that to happen for several years now and it hasn’t. Most of the countries that own a lot of the dollar balances don’t have any real incentive to trigger a crisis like that. They would perhaps be hurt as much as anybody else by such a crisis. What is it they say: 'If you owe the bank a little money, you’ve got a problem. If you owe it a lot of money, the bank’s got a problem.' We might be in that situation.”

    Current account deficit reaching a Tipping Point? Are such thoughts even allowed at the Federal Reserve? Well, there is absolutely no doubt we are heading toward a major dollar crisis. The issue is only when. There is no doubt in my mind that the GSE Bubble will burst, and there are certainly enough issues unfolding to keep our analytical interest. These institutions and the marketplace are seemingly doing everything possible to ensure that this inevitable financial dislocation will be historic. I also have no doubt that the foreign central bank dollar Bubble will come to a most unpleasant end. That the interplay of these two ultra-powerful financing mechanisms has evolved to foster unprecedented Credit and speculative excess throughout the world is a deeply despairing worst-case-scenario unfolding right before our eyes.

    To wrap this up, it appears we have entered what will be a wildly unstable environment, as we meander towards some type of financial “resolution.” Yet there is today an atypically fine line between financial dislocation (likely related to the dollar) and abundant global liquidity unlike anything seen in our lifetimes. There is a fine line between a “Tipping Point” break in dollar confidence and desperate foreign central bank dollar purchases (unprecedented global liquidity injections). There is similarly a thin line between endless liquidity supporting our leveraged Credit system and consequences of incessant liquidity excess at some point terrorizing it. And it does today appear reasonable to presuppose that things may look absolutely wonderful to most right up until the proverbial “wheels come flying off.” Most financial crises develop as liquidity disappears over a period of time. But the nature of the runaway GSE/central bank financial Bubbles may dictate that enormous over-liquidity works its seductive magic until it abruptly doesn’t work anymore: a systemic crisis of confidence.
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