I got the conference volume from the Reserve Bank of Australia 2005 Conference quite a while ago, but I’ve only just read them. The main focus is on the decline in the volatility of the business cycle observed in the English-speaking countries since the mid-80s (or in Australia’s case since the end of the last recession).
There’s a lot of discussion of monetary policy, micro reform and so on, but no mention of what I would see as the single most important factor – the abandonment of the external balance objective. For most of the postwar period, economic policy makers juggled the desire to keep the domestic economy stable with the constraint imposed by the balance of payments. Not surprisingly, this was a difficult job and promising economic expansions were regularly choked off because of emerging current account deficits.
Now we have a deficit of 7 per cent of GDP (as do most other English-speaking countries) and no one worries. The assumption is that borrowers and lenders are consenting adults who can make their own decisions. Right or wrong, this assumption makes macroeconomic management an awful lot easier.
We may well be about to find out whether policymakers have been right to view trade deficits with benign neglect. The US dollar seems to be beginning its long-awaited depreciation against the euro and other trading partners (even against the $A) and long-term interest rates are rising. Some combination of the two should sooner or later bring the US back into trade balance. The question is whether this adjustment will be smooth or painful.
John Quiggin 
There is a most amusing anecdote about Mark Steyn in the latest Private Eye. It seems a Canadian freelance journo submitted an article to a British newspaper by email. The article made reference to the well-known play ‘The V****a Monologues’. The publication’s net nanny wouldn’t allow the email containing the naughty word through to its destination so the freelance substituted ‘Mark Steyn’, assuming the subs would understand the reference and make the appropriate correction. The article was published, complete however with reference to the hitherto unknown play ‘The Mark Steyn Monologues’.
The morals of the story appear to be that Mr S is not well regarded among his colleagues, and that one should assume knowledge on the part of newspaper subeditors at one’s peril.
That’s what I get for not proofreading. Keating quite clearly said “elephant under the carpet”
Savings: “Both definitions approximate the idea – what you don’t spend out of your income. The difference is that the second one includes changes to income from changes in asset prices, so it probably is a better measure of changes to wealth.”
No. Only if gains from asset price changes are realised does the change in wealth translate into income (+ or -). (Theoretically, all assets of all types would have to be traded simultaneously to calculate changes in wealth as part of income -see Radner, 1972. The transactions costs alone would reduce the potentially realisable value from one that is calculated from recorded asset prices).
James Farrell, I fully agree with you on this item.
Elephants and other elephants:
In the context of discussions of ‘asset price bubbles’ and CAD, I found the following advice on an earlier thread on a related topic:
�Current account deficits incorporate an investment income component. Apart from some nuance regarding valuation, the NIIP (net international investment position) is indeed simply a running sum of CADs.� [Term in brackets added].
Would anybody please explain to me how an ‘asset price bubble’ can grow out of a set of (linear algebra) accounting equations?
Whose elephant?
1. I agree with Chris C. that “external balance is only important inasmuch as it feeds through to credit creation.” (I’ve given my reasons on an earlier thread; using the same arguments but looking at it from the perspective of a relatively large economy, the USA may be considered a ‘close enough’ approximation for a ‘closed economy’; hence a credit growth bubble could burst there.).
2. Like Chris C., I also find it a bit hard to accept “that the USs unprecedented CAD will most likely lead to a ‘world crash’.
3. As for the US government paper. Suppose the prophesy of ‘financial meltdown’ in the USA turns out to become reality (for whatever reason). Those who don’t need the money and hence can hold these securities to maturity may sleep reasonable well no matter what happens in the secondary markets on the assumption that the US monetary authority will honour its obligations in US dollars. Now, suppose, ‘Country A’ bought US government paper with international trade surpluses. Upon redemption of the US government paper, in US dollars of course, ‘Country A’ can buy physical assets in the US. If the prophesy, advanced by some commentators, of a US credit crash turns out to become reality, some of the physical assets might become quite attractively priced, in US dollars. Of course this might not work as nicely for individual US paper holders or even for pension funds (since the managers are not the owners and can’t decide on whether to hold out or not).
What do you think?
While it may be technically correct to talk about the CAD as a “savings problem” in the sense that the savings of foreigners are required to balance Australia’s chronic goods and services trade deficit, I think the underlying issue is really a “compositional problem”.
This problem is that, in common with other high labour cost countries, Australian manufacturing has been destroyed by the emergence of a succession of low cost Asian competitors, starting with Japan and Hong Kong in the 1960s, followed by Korea and now China.
Have a look at the composition of the National Accounts to get a sense of the extent of this problem. The few commodities that provide us with a comparative advantage do not have sufficient value to offset our appetite for imported manufactures.
Given that the Australian minimum wage is about thirty times the going rate for factory labour in China, the prospects for any Australian manufacturing surviving is pretty well zero. In the end, the cost of labour determines everthing, as Locke and Smith and Ricardo amply demonstated two hundred years ago.
A single example of industrial decline will illustrate. Twenty years ago, the local auto industry held a quota-enforced 80% share of the domestic market. Now, following the removal of tariffs and quotas, local cars account for less than 20% of the domestic market. Automotive imports are now in excess of $20 billion per annum, or about 40% of the CAD, while Australian capacity is in decline. Exports have grown, but nothing like the growth in imports.
‘The few commodities that provide us with a comparative advantage do not have sufficient value to offset our appetite for imported manufactures.’
Strictly speaking, Craig, that statement doesn’t make sense. You can’t not have a comparative advantage in enough industries. Where precisely the advantages lie depends on relative productivitity, and has nothing to do with wages. But it remains true that real wages have to be commensurate with average productivity to make trade possible.
You haven’t spelt out your solution, but I take it you think a depreciation will solve the problem. As I’ve argued before, that’s a necessary but not a sufficient condition. To improve the current account balance, we’d still need to increase our saving rate.
Chris C,
The external balance is important because there is a limited amount of any one country’s assets that foreigners are interested in accumulating. In the case of the US, the inflows have supported massive credit creation, but that is circumstantial. The US happens to have had a well-developed and deep capital market, and a propensity for borrowing (although these two things are far from independent). This is to say, the low cost of internal and external capital in the US has encouraged credit creation, which has engendered asset bubbles, which have encouraged still more credit creation (with plenty of help along the way from Freddie, Fannie and Gennie). Of course, there are serious systemic risks that poses, but again, this is all circumstantial.
In any case, external imbalances in excess as currently abound always end in tears (hence, what cannot be sustained, won’t be). This is less the case when the imbalances are intranational, because debtors have no recourse to a printing press, and relatedly, because creditor delusion within a currency zone tends to be more narrowly bounded.
Majorajam,
What have been the historical precedents that have always “ended in tears”?
I suppose it also depends on how you define “tears” really – I mean, once the US CAD > RoW CAS, then global interest rates will rise (if not before), and economic activity will be lower.
But interest rates will still be lower (and activity higher) in most countries than if those countries were autarkic, so we will likely still be better off for globalisation.
on the subject of the US propensity for borrowing,
Washington Post
Another Possible Bump to the Debt Ceiling
By Jonathan Weisman and Shailagh Murray
Tuesday, May 9, 2006; Page A21
A $2.7 trillion budget plan pending before the House would raise the federal debt ceiling to nearly $10 trillion, less than two months after Congress last raised the federal government’s borrowing limit.
But the federal debt keeps climbing because of continued deficit spending and the government’s insatiable borrowing from the Social Security trust fund.
With passage of the budget, the House will have raised the federal borrowing limit by an additional $653 billion, to $9.62 trillion. It would be the fifth debt-ceiling increase in recent years, after boosts of $450 billion in 2002, a record $984 billion in 2003, $800 billion in 2004 and $653 billion in March. When Bush took office, the statutory borrowing limit stood at $5.95 trillion.
the people here that argue that this all fine and dandy and ‘the market’ will accomadate or self regulate are seriously kidding themselves
Craig,
Wages in Japan are actually higher than in Australia, yet they remain a successful manufacturing country able to profitably export to Australia and compete with the likes of China and Korea.
Many types of manufacturing are capital intensive, using large amounts of expensive manufacturing equipment and small amounts of labour to produce huge quantities of goods. As such the labour component of the final product is quite small which means that high labour costs don’t really matter. Japan has been successful by deliberately choosing capital intensive manufacturing. China is not a threat to them. No reason we can’t do the same.