This is the second installment of a critical review of Dean Baker's second reaction to the debate kicked off by the WaPo's piece on Modern Monetary Theory, written by Dylan Matthews. The first installment discussed Dean's views on using the monetary channel to boost aggregate demand, and began criticism on his views on devaluing the currency and increasing exports. This post continues that critique, and later takes up his views on work sharing.
Expanding US Exports at the Expense of Decreasing Real Wealth? (continued)
Dean goes on:
”To see this point, imagine a more extreme case. Suppose that we had a trade deficit equal to 50 percent of GDP. If the countries who were buying up dollar assets then decided that they had enough, so we could no longer rely on imports to meet half of our domestic demand, does anyone believe that the U.S. economy could quickly and painlessly replace our imports with domestic production?”
No, of course not! But, why do economists like Dean and Paul Krugman insist on relying on far-fetched scenarios to try to argue against simple truths that may apply today? The current account balance will probably be around 4-5% of GDP this year. As the economy recovers it will probably rise to 6% of GDP again, which represents a very real benefit to the United States. But there's no reason to expect that this growth would continue indefinitely or ever reach 50% of GDP. Why should it? What are the dynamics that would drive things this way, and make other nations value the dollar so much, that they will keep their own populations barefoot?
China, India, and Japan are all under pressure domestically to change their policies and make more of their production available to their own people. Europe may also abandon austerity soon, as they experience its ravages.
The long-term trend in the current account balance won't be up, It will be down, gradually down, for reasons I mentioned above. It just doesn't make sense for foreign nations to continue giving more than they're getting from the US. So, the 50% GDP scenario is just ridiculous. Why even bother suggesting it? What does the thought experiment prove, except that Dean Baker isn't thinking through a realistic model of the forces accounting for the international trade patterns we see?
In fact, Dean isn't even really serious about suggesting that this scenario somehow corresponds to a result of MMT economics. He says:
”I would not attribute this view to the MMTers, but then the question becomes one of a degree. Perhaps a trade deficit of 6 percent of GDP is okay, but presumably somewhere between 6 percent and 50 percent we get into a problem. It seems the question then has to be how quickly the U.S. economy could adjust to a much lower trade deficit and what is the risk that foreign countries will slow or stop their purchases of U.S. assets? We may differ on the answer to these questions, but they are the questions that must be asked.”
I think these are important questions. We should ask them. But, has Dean answered them? And do his answers indicate any serious problems for the United States economy? And if so, how does that relate to MMT? If these changes could possibly produce cost-push inflation in the United States, then MMT has some answers for that kind of problem. On the other hand, if other nations stop exporting so much to the US, then that may create less demand leakage for our economy. In which case, MMT predicts that we will get closer to full employment and also that we will have to moderate deficit spending as full employment is approached.
Dean continues with more scenarios about what would happen if foreign nations began to charge us more from imports. I won't reproduce each of these here or critique them. But, invariably, there is a general pattern to them. Read below the fold...