Rinse and repeat, until, well, exactly when it peters out is a good question.

Interesting Max, so China just forces a current account deficit onto Europe, Ausie and Brazil? Providing vendor financing for the US in addition to themselves? One would assume there would be policy responses in said countries as China moved from manipulating their currency to manipulating everyone else’s. Somehow I doubt that would end any better for China than the current situation, but it would be interesting to see them try.

You wrote a response to my comment but it was puzzling. I think it was meant for someone else? I never mentioned the US fiscal deficit. I was responding to your argument that

“It’s great that commentators are coming back, however temporarily, to a sense of reality and common sense. There never was likely to be a crisis in the ability of the US government to fund its deficits, and all the pleading to foreign governments to continue purchasing dollar assets was based on very fundamental misunderstandings of both the form of the global adjustment and the functioning of the global balance of payments”

Because the US government is the only one borrowing now, the current account deficit is funded by purchase of US treasuries (more or less) There IS a potential crisis in their ability to fund the deficit, the current account deficit that is. Of course, it WILL get funded, but the price might cause an economic crisis.

Just because China keeps the Yuan fixed to the USD doesn’t mean we can’t have a crisis in funding the USA. Suppose China says “every USD we buy from a Chinese exporter we sell to a European or a Brazilian or an Aussie for their local currency?” The Chinese would be forcing those markets to “price” the funding of US/China deficit, right? The Yuan would remain fixed and the USD would weaken substantially vs those currencies or maybe bond yields would rise or some combo? The Yuan would weaken too vs. those currencies and maybe produce even more exports for China? There is a lot of risk out there. I don’t think it is fair to say that people that think there is a possibility of a crisis in funding the US deficits fiscal or current, don’t understand the international balance of payments system. It will get funded but at what price. It may be a price that will cause a surplus to appear but it maybe a price that causes way too much pain way too fast?

Thanks for the reply. You say ‘excess savings means either that the desire for savings at current prices exceeds the desire for investment, or that production at current prices exceeds consumption, which is pretty much the same thing. The world must adjust by slowing growth.’

Cannot the adjustment take place through falling prices? If prices fall then won’t consumption and investment rise?

Stoneweapon, I share your concern about the rising US fiscal deficit. However I am also convinced that the global institutional framework that governs the next several decades will arise from the wreckage of the current crisis, and I think it is ion the best interest of the US and the world that the US slow down its adjustment so as to make it easier for China. If the US adjusts too quickly, China will be screwed, and we will be stuck with a world filled with hostility and mistrust. This can’t be a good thing. As for the Buy-China article in your next comment, I am worried that in retrospect this will be seen as China’s Smoot-Hawley.

David, you may be right, but for now I see rising global savings as a sticky problem that is not going to be easy to resolve and will only be made worse by declining global investment, especially as the massive fiscal stimulus programs around the world begin running into debt constraints.

Max, you misunderstand me. The point is not that we don’t need to worry about how the US fiscal deficit is funded. Rather it is that the surplus countries have little discretion in their financing decisions. It may be true that US obligations abroad pile up forever, but this will be because the US runs a trade deficit, not a fiscal deficit. I don’t want to get into the big debate about the relationship between the two, but for now the problem is not how difficult it will be to fund. As for weakness in the dollar, I think the dollar will and must weaken, but the reason it hasn’t is because many countries peg their currencies to the dollar at undervalued rates, so forcing excess strength in the dollar. Countries that do so cannot also complain about future potential weakness in the dollar versus, for example, the euro because their very policies only permit dollar weakness against un-pegged currencies. The dollar should weaken, but against Asian currencies.

As for your last point, I don’t consider myself as criticizing US or Chinese policies. I am trying to understand them and point out possible consequences. I don’t really discuss too often what I would do because it isn’t terribly relevant and anyway I have no big claims to knowing more than US and Chinese policymakers do. This is particularly true when policies are driven for political and not economic reasons. For example, I think current policies in China address short-term unemployment problems effectively but worsen the medium-term prospects for adjustment. Why choose one set of policies over the other? Politics. The choice may be perfectly reasonable, but I think it is nonetheless legitimate and necessary for guys like you and me to figure out the consequences.

Tel, as a former trader my guess is that if you are looking for “a completely reliable and unbiased opinion of the strength of the US dollar,” the last place you would find it is with someone who has an incentive to talk his book. More importantly, we must distinguish between politics and economics. While it makes political sense for a host of reasons for different people to say different things about the status of the dollar, it is much more useful to see what they are actually doing and what they actually can do. Check Brad Setser’s blog for the best estimate of what China is really doing with dollars.

As for your second point, I am not sure I understand. Fevered punditry notwithstanding, the US is easily the largest manufacturing nation in the world and manufacturing output has increased steadily over the past years. Since productivity has increased even faster (and this is a good thing), the employment share of manufacturing has decline. By the way when the same debate was taking place in the late 1970s and early 1980s, the answer as to what valuable goods the UIS should sell in the future turns out to have been high tech and information processing goods and services, but no one knew it at the time. Then, as now, it is almost impossible by definition to predict what the most technologically advanced country will produce in the future.

@ David Pearson -Very interesting comment. Thank you.