BAC asked these questions in another thread, but I thought this response should go in this one.
Bay Area Cat wrote:Link doesn't work. Can you just explain it to me, and let me know how much of our budget deficits over the last decade have been due to the "weak dollar"? Because we have had a weak dollar policy since the start of the Bush II years, at least in the eyes of experts in the Fx field (I used to spent a good portion of my job doing Fx hedging and spent a lot of time at wonky conferences about Fx as a result). So if that's a significant cause for the deficits we've experienced under Bush and Obama, that's a real game changer from the conventional wisdom we've been hearing.
Let me first thank you for asking these questions as they have forced me to take a deeper look. I think I understand this issue better, but I'm starting to realize that this is more of a fundamentals of philosophy argument. You are absolutely correct that Bush II had the same monetary policy as Obama. So lets start there. The first bubble to burst was the dotcoms on the stock market and rather than let those who invested in, well, nothing, suffer the consequences and take responsibility for the risk they took, Bush decided it would be better if the entire country absorb the responsibility with "quantitative easing." QE being stimulus, deficit spending, tax cuts, and lower interest rates. This QE plan seemed to work because our economy saw a dip, but as a by product, it started another boom in another sector, which gave us the illusion that our economy had recovered. With interest rates being held low and compound that with relaxed lending standards as a result of the CRA, we were on track for another bubble, this time in the housing market. Real estate prices began to soar. We all know what happened after that.
Government spending is funded through a couple ways. The government treasury must pay off government debt either with money it already holds or by financing it by issuing new bonds which are sold to either the public directly or the central bank, in order to raise the funds required to satisfy the debt. When the governments chooses to finance the deficit, bonds are placed with the Fed, the central bank will create the needed money by conducting an open market purchase, i.e. by increasing the monetary base through the money creation process. This process of financing government spending is called monetizing the debt. Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt, leaving the system with an increased supply of base money. This also devalues the dollar because it becomes less rare.
So now lets look at today, Obama and Bernanke haven't changed a thing. With more stimulus, and more deficit spending, its almost like Bush was here for another term. The illusion is that it is helping the economy, but clearly it is not. We are in a state of stagnation. The report of 700,000 jobs created sounds good, but if you look deeper, you will find that it has done nothing to improve our trade deficit. In fact, the trade deficit is higher than it was in 2008. A simple way to look at trade surplus vs. trade deficit is that it is our country's income statement. When we have a surplus, we are profitable and creating wealth, and when we have a deficit, we are losing wealth. So these jobs that were created are not the kind of jobs we need. They are in the service sector which is only compounding the next bubble.
As we constantly erode the value of the dollar, we also erode any demand for our bonds, which are funding our deficit spending. The point is that there is going to come a time when we can no longer sell our debt because no one will want to buy it. This will be the collapse of the dollar. We will no longer be able to put off dealing with our economic problem through QE. We will then have to face them. Currently the reason the dollar is trading well is because the Euro is not. Europe, is however, contrary to public opinion, going to recover faster than we are because they are using a different philosophy. They are choosing to deal with their problems head on instead of avoiding them. By avoiding our problems without any fiscal responsibility, we are on course for the train wreck that will be worse than the great depression.
The disappointing thing to me is that the only presidential candidate that understands this is only getting 8% of the Republican vote. If we were to change our economic and monetary policies from Keynesian to Austrian, sure that would cause a disruption. I'm saying that if we don't soon, we will be forced to do so when no one will buy our bonds and force the value of the dollar in the toilet. Keynesian economics only works if we can monetize the debt. I am very afraid for the future of our country. We might learn what hyper-inflation really is like. The marker that will burst the bubble will be the Euro. When it starts trading well again, you better hold on to your a$$ because its going to get ugly in a hurry. Consequently, the value of gold will sky-rocket so that is one way you can hedge against hyper-inflation.
All of this can be avoided though. The first step is to allow interest rates to rise naturally instead of artificially holding them low. This will stop/slow mal-investments or investments of capital that accomplish nothing or lose capital. Therefore purging the system. It will also slow down inflation, for which true inflation is being masked by the dollar value that is being propped up by the low value of the Euro. Some experts say that true inflation is approaching 5%. The next step is to cut spending on things we don't need and yes I do mean pork in the military. A comment was made this morning on Meet the Press about the pentagon not wanting to build tanks, but congress wanted them so we are building tanks. I'm also talking about all of the government spending that is intended to encourage consumer spending. That isn't accomplishing anything, but creating an illusion. The road to economic growth goes through austerity, not stimulus.
If we had just taken our lumps after the dotcoms, there is a good chance that the housing bubble doesn't happen because the free-flow of money wouldn't have happened due to the lower than normal interest rates. BAC, I get it now, CRA didn't create the boom, it compounded it. As they say, if ifs and buts were candy and nuts, it would Christmas all year long. Now, we should have learned that postponing the inevitable with QE only creates a boom and bust economy. Wouldn't slow and steady growth be better? What Bush did, was infect the system and Obama continues to feed us poison.
So I'll ask again..... What camp are you in? Keynesian or Austrian