Nouriel Roubini on the Dollar
I recently discovered Nouriel Roubini's Global Macroeconomic and Financial Policy Site, an invaluable source of research on the dollar and the international financial system. Roubini is an economics professor at NYU who write s prolifically on monetary and financial topics.
The highlight of the site is his recent paper with Brad Setser, Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006. In this paper, they present an argument very similar to Richard Duncan in The Dollar Crisis: that the rest of the world will soon run out of the capability to absorb more dollar-denominated debt. Foreign central banks, especially China, cannot borrow enough domestically to purchase all of the bonds that they need to maintain their currency peg, so they print the rest. This is driving an inflationary boom in China that will run its course eventually and lead to a crash. The end game of this global inflationary boom will be a dollar crisis: a reduction in US consumption, higher interest rates, collapsing asset markets, and a recession.
In some parts of this paper, Roubini sounds very Austrian. Below, he describes exactly how lower interest rates cause mis-allocations of capital in the US that must be corrected.
As we discussed previously, the enormous accumulation of dollar reserves required to maintain the Bretton Woods 2 system has kept US Treasury interest rates lower than they otherwise would have been, and contributed to the broader rally in all dollar denominated bond markets. Low nominal and real US interest rates, in turn, certainly supported interest sensitive sectors of the US economy, and thus overall US employment. Given the current structure of the US economy, job gains in sectors favored by artificially low interest rates probably exceed job losses in sectors hurt by Asian competition – or in sectors that would be able to export more with more realistic exchange rates in Asia. But like any subsidy, an interest rate subsidy also distorts a range of decisions.
Stephen Roach has emphasized how low interest rates have discouraged personal savings rate, as low interest rates have pushed up in housing prices and allowed Americans to borrow against the rising values of their homes to support their current consumption.
The distortion though is much broader: low interest rates should encourage corporate investment (though recently firms have generally preferred to rebuild their balance sheets; corporate savings are high), but so long as low interest rates are the byproduct of central bank intervention to maintain undervalued currencies, they hardly encourage investment in the tradeable goods sector. Consequently, central bank intervention encourages over-investment in sectors like housing and under-investment in the production of tradable goods. Yet over time, the US will almost certainly need to increase the share of its capital stock devoted to the production of tradables to bring its trade deficit down and regain external debt sustainability. Eventually, many of the resources now flowing out of the tradeables sector will have to flow back into tradeables production.
Some other worthwhile reading on this site is:
- The US as a Net Debtor: The Sustainability of the US External Imbalances
- Roubini's BLOG
- Setser's BLOG
- Housing Market Bubbles and the Fed: The Higher They Blow, The Harder They Crash...or Why We May Need Houdini after Greenspan...
- The FT on BW2 free-riding and capital losses on holdings of dollar reserves: A "Hot Rotten Potatoes" Musical Chair Game...
- Liquidity/Rollover Risk on US Assets? A Nightmare Hard Landing Scenario for the US $ and the US Bond Market..
- US-China "Balance of Financial Terror" Game. A Prisoners Dilemma Game: hard landing MAD or Chinese pre-emption as the likely solution?