Paul Krugman is a preternaturally intelligent man, an incredibly talented economist, and a sporter of a handsomely-groomed beard (cf. Joey). Perhaps more important, from a societal point of view, Dr Krugman has a wonderful command of the pen. Ten years ago, he was kicking out some of the most lucid, easily-grokked economics writing ever, putting him in the same class as the great Milton Friedman.
Then he checked out and went off the reservation.
The last few years, via his New York Times column, have bared witness to articles about Katrina and FEMA, Iraq and WMDs, Republicans and lameness, Democrats and awesomeness, rich people and Satan, poor people and their salvation by Democrats, France and their superior Internet access (huh?), and then more on Iraq.
Which is all well and good—maybe this stuff needs to get out there, you know, to liberate the minds of the people—but any random journalist could write it. Krugman, an equally talented writer and economist, could be filling a real niche in public education.
Moreover, Krugman's world view is binary reductionist: Explanatory factors are one or both of an incompetent president or an evil upperclass. Think what you want about the leader of the free world or about the generators of wealth and innovation, but where does ill-designed software fit in? Or China?
This is all by way of saying that the New York Times column and the last seven years have not done Krugman any favors. He has gone from economic virtuoso to political hack. Even when he writes on economic topics (which, in these halcyon days of popular and behavioral economics, can be anything), he is too light on the economic theory and too heavy on the political defamation. With Krugman, we don't get an honest treatise on the economic merits of, say, single-payer healthcare, but in lieu drivel such as the GOP hates poor people. Yet honest, accurate economic analysis of these issues is exactly what this nation—particularly the left—needs right now. These are issues on which intelligent, reasonable people can disagree, and the goal should be to raise the level of national debate.
Who or what is to blame? Well, he certainly dislikes President Bush, which I can understand. And writing about economics is nontrivial, particularly when you have to do it twice a week. But he could always opine on more novel topics, introducing new thought, or at least repackage existing concepts into easier-to-comprehend prose. While Krugman understands trade better than most, he really does not know any more about Iraq than the rest of us. Ultimately, his discontent with the president pushed him off the deep end, and the Times has enough like-minded readers to reinforce that behavior. It is a tragedy, if not for Krugman, certainly for the nation.
Anyhow, that is all in introduction to this: Paul Krugman has a good piece up, Robert Rubin is wrong about the dollar, albeit in his blog and not his column.
The post is a rebuttal to a Secretary Rubin quote in the Financial Times:
Mr Rubin's mantra of the US believing in a "strong dollar" was taken on trust by investors. Now, he has a window seat at not only the troubles of Citigroup and Wall Street but what threatens to become a dollar rout. He says things could have been different if George W. Bush's administration had observed his devotion to a balanced budget and co-operating with other countries.
"You could have had surpluses that affected the savings rate and would have helped the trade balance. I think you would have had more confidence in the policy framework and you would have had a better dollar," he says regretfully. He pauses to reflect. "But we are where we are."
Arguing that the Bush tax cuts decreased the US savings rate, which in turn weakened the dollar, Bob Rubin echoes a Times OpEd back in August, A Weak Dollar and the Fed, that, to an even greater degree, tosses out economics for Bush-bashing:
How did the Fed lose room to maneuver? The answer is rooted in the Bush administration’s misguided economic policies.
Over the last several years, America's imbalances in trade and other global transactions have worsened dramatically, requiring the United States to borrow billions of dollars a day from abroad just to balance its books.
The only lasting way to fix the imbalances—and reduce that borrowing—is to increase America's savings. But the administration has steadfastly rejected that responsible approach since it would require rolling back excessive tax cuts and engaging in government-led health care reform to rein in looming crushing costs—both anathema to President Bush. It would also require revamping the nation's tax incentives so that they create new savings by typical families, instead of new shelters for the existing wealth of affluent families—another nonstarter for this White House.
Stymied by what it won't do, the administration has gone for a quicker fix—letting the dollar slide. A weaker dollar helps to ease the nation's imbalances by making American exports more affordable, thus narrowing the trade deficit.
The Times is saying that The Fed needs to continue interest rate reductions, except that it cannot, because lowering the interest rate will cause the dollar to fall further, and that this whole quagmire is the fault of President Bush's tax cuts. Krugman, surprisingly but not unwelcomely, rejoins:
There is a widespread view that world payments imbalances can be remedied through increased demand in surplus countries and reduced demand in deficit countries, without any need for real exchange rate changes. In fact shifts in demand and real exchange rate adjustment are necessary complements, not substitutes. The essential reason for this complementarity is that a much higher fraction of a marginal dollar of US than of foreign spending falls on US output. As a result, a redistribution of world spending away from the US leads to an excess supply of US goods unless accompanied by a decline in their relative price. Although some economists believe that the integration of world capital markets somehow eliminates this problem, this is a fallacy that confuses accounting identities with behavior.
(His post continues with a more readable, but much longer, lay explanation.)
I have long supported reforming government policy, such as moving from a tax on output to a consumption tax, to encourage savings over consumption. I also believe we need to reduce the budget deficit, preferably through entitlement reform and other reductions in government spending.
But I do not believe that increasing savings will strengthen the dollar. Indeed, both Secretary Rubin and the Times editorial board are wrong: Ceteris paribus, increased domestic savings will weaken the exchange value of a domestic currency.
One of the basic mechanisms by which lowering interest rates stimulates an economy is by lowering the exchange value of the currency and thus trending the trade balance in favor of exports. That is, a weaker domestic currency makes imports more expensive relative to domestic goods, thereby encouraging consumption of those domestic goods, ultimately increasing exports relative to imports. Moreover, a weaker currency makes goods denominated in that currency cheaper for those living in other countries, further encouraging exports.
You can look at the issue from another angle, too: Increased savings is equivalent to decreased consumption, decreasing consumption will result in a slowing of the economy, which in turn will cause The Fed to lower interest rates. Consequently, that reduction in interest rates will discourage the inflow of foreign capital, which will reduce the demand for the domestic currency, which finally will decrease that currency's exchange value. Given this, the Times and Rubin argument that the weak dollar is a resultant of a lack of savings is actually inverted. This relationship between savings and interests rates and the exchange value of the dollar is basic economics and wholly unrelated to President Bush's tax policies.
In fact, while it might not be what Rubin and Wall Street prefer, we should all want a cheaper dollar. Unless we want to keep the trade deficit at four or five percent of GDP, the exchange value of the dollar has to drop. Rubin and the Times, however, are right that an increase in savings can reduce the trade deficit. Increased savings is the same as decreased consumption, which means we buy less of everything, imports included. If we slow the economy enough, we can greatly reduce the amount of foreign goods we buy. But I don't think the Times is advocating forcing the economy into a brutal recession just to balance trade—people might buy less newspapers. So we have to couple the increased savings with a propensity for favoring domestic over foreign goods. How do you do that? With a cheaper dollar, of course.
As Krugman points it:
What it means is that something has to happen to induce people to switch to US goods. And it means that higher savings will normally reduce the trade deficit because they result in a weaker dollar.
It is naive to imagine that changes in the government's financial balance can translate directly into changes in physical trade flows, without working through a mechanism such as the exchange rate.
The Times is also wrong in their explanation of the reduction in US savings. The primary cause is the collapse of the housing bubble, which significantly propped up consumer consumption, not tax cuts and the resulting budget deficit. Again, increased consumption and decreased savings are two sides of the same coin.
There exist plenty of real problems with President Bush's economic policies; we do not need to make up nonexistent relationships between the weak dollar and lack of savings or blame the president for basic economic realities.