The Poor House

Via John Quiggin, here's Matthew Turner in February 2004: "More pertinent for this site perhaps is the exchange rates at which European gdp per capitas overtake those in the Great Republic. For the Europeans it's around euro 1 = $1.46, i.e. they are unlikely to get there anytime soon given we're currently at $1.26." As it happens, the Euro was trading at a bit over $1.46 when I checked a bit earlier.

Now, of course, this isn't actually considered the correct way to do these comparisons -- you're supposed to use the Purchasing Power Parities method which still shows us as richer -- but surely these exchange rates have some significance.

Comments

Daily life is just better in Europe: so the Europeans are richer at any exchange rate.

Posted by Quentin | November 7, 2007 11:17 AM

but surely these exchange rates have some significance

Perhaps Matthew could explain what that significance might be, if absent changes in PPP?

Posted by Al | November 7, 2007 11:32 AM

Well PPP GDP estimates are somewhat artificial, since they are based on output prices and can't factor in how the composition of output would change if input prices were also to change.

Posted by Gene | November 7, 2007 11:39 AM

"but surely these exchange rates have some significance."

Well, they make american goods cheaper, meaning more growth for american companies, more jobs for american workers and a lower trade deficit.

Posted by Dave | November 7, 2007 12:01 PM

The falling dollar is bad in several respects:

a) It raises prices/cost of living for the average citizen: higher oil prices leads to higher gasoline prices plus higher food prices due to cost of transport

b) It keeps interest rates high -- because the FED can't cut interest rates for fear of capital leaving the USA. Plus, China is already mumbling about selling its holdings of US bonds because of the falling dollar. Bottom Line: Foreign creditors want higher interest rates on loans they make to the USA. Ask anyone on limited income what higher prices and higher interest charges on their adjustable rate mortages does to their savings and discretionary income.

c) If consumers' income is going to higher interest charges, then they have less to spend. Which hurts US stocks.

d) A possible offset is that low value of dollar makes US exports cheaper. Also makes our imports much more expensive. Which hurts in the case of imports we HAVE to buy --like oil. On the other hand, Ford and GM may get a boost from the higher prices of Toyotas and Hondas.

Posted by Don Williams | November 7, 2007 12:11 PM

http://www.xe.com/
quick and easy exchange rate website

McCain said during one of the debates "I wish interest rates were zero." Now that would help our embattled dollar!
http://www.nytimes.com/2007/10/09/us/politics/09debate-transcript.html?_r=1&pagewanted=26&oref=slogin

Posted by Dude, where's my dollar? | November 7, 2007 12:15 PM

"you're supposed to use the Purchasing Power Parities method which still shows us as richer"

Depends on what you're trying to measure. Usually these comparisons are made to show that the US is more "productive" than the EU. Exchange-weighted per-capita GDP shows that this isn't true when comparing tradeable-sectors. Which means that for some reason the US is *much* better at producing those goods aren't tradeable. (And the difference is unlikely to European workplace laws, since they apply to tradeable sectors as well).

Of course, another explanation is that the world market is ignoring around $1 trillion in arbitrage (last time I checked, there was around a 10% difference in PPP GDP and trade weighted GDP - this was before the big dollar crash). Seems unlikely...

It should be easy to determine what those sectors are - see which goods prices that make up PPP show the greatest variance. I'd be willing to bet big money that the difference is land, though. Anecdotally, my experience in Germany was that middle-class Germans seemed wealthier in everything except for house size (and workplace size, street width, etc). And clearly, they can't just import land.

Posted by bonecrusher | November 7, 2007 12:24 PM

Plus, China is already mumbling about selling its holdings of US bonds because of the falling dollar.

Does anybody with a lot more international economics expertise than I care to comment on Don Williams's point above? I keep hearing the Chinese might threaten to dump US holdings, but, why would they do so? Wouldn't that just put yet more, enormous downward pressure on the greenback, thereby making Chinese exports more costly? Last time I heard, they've got a lot of mouths to feed, and a very restive population; the last thing they need is massive layoffs.

Here's the point. The Chinese government is, um, a government. What does a government care if its holdings of a particular financial asset are worth less? It has these things called "printing presses," after all, and moreover the government of China is not saving for retirement or anticipating a costly wedding down the road.

I'm not saying people making such claims about the dumping of US bonds by the Chinese are wrong, mind you. I just don't understand the logic, and I was wondering if someone has an explanation.

Obviously private sector Chinese are dumping dollar-denominated assets just like folks around the world, or else the dollar wouldn't be dropping. I'm just wondering why they government in Beijing might want to do this. Seems to me a risky move for little (or no?) gain.

Posted by Jasper | November 7, 2007 12:24 PM

I would argue that the current exchange rate comparison is actually more meaningful. The PPP is supposed to capture some general notion of the subjective value of consumption, which really can't be quantified in a meaningful way. Keynes has a great line somewhere about how, outside of comparisons within the same counry over a short time period, saying that the price level was higher but real output was lower is like saying that Victoria was a better queen but not a happier woman than Elizabeth -- interesting, probably true, possibly important, but not something you can get at mathematically.

Whereas the current-exchange rate comparison has a very concrete meaning, namely the share of the world's tradable goods a country is able to claim.

Don Williams has the right idea but is wrong, I think, on the substance. On (b) and (c), the marginal and by far the largest investors financing the US current account deficit are Asian central banks. They are far more concerned with maintaining access to the US market for their exports (and in the case of some of the smaller countries, holding large dollar reserves to protect themselves against a repeat of the 1990s financial crisis) than with the return on their holdings. And of course the US is in the enviable position of having foreign liabilities denominated in its own currency. So, perhaps uniquely, the US can set interest rates based on domestic considerations without being constrained by exchange rate concerns.

On (a), it's a curious fact that most foreign exporters to the US market pass through exchange rate changes at considerably less than one to one -- something that's puzzled economists since the 1980s, when the big dollar devaluation following the Plaza Accord had a minimal impact on the prices of Japanese goods in the US. You can see this clearly with sites like Amazon, where the dollar price of the same product is now often much lower for US customers than for European ones. Of course the effect of exchange rates on prices isn't zero, but it's very small. In reality income changes do much more of the work of keeping trade balanced than price changes do.

The bottom line if that the US has succeeded in writing the rules of the international financial system in such a way that the pain of adjustments is borne almost entirely abroad. A declining dollar means lower profits for Asian investors rather than higher interest rates in the US; it means lower prices for US products abroad but not higher prices for foreign products here.

Posted by lemuel pitkin | November 7, 2007 12:30 PM

The Canadian dollar first closed above the US dollar on September 28.
http://www.cbc.ca/story/money/national/2007/09/28/loonie.html
In the last 40 days--40 days!--the US dollar has lost over 8% against it. Wow. As I write this xe.com says the US dollar is trading at 1US = 0.91694CAD.

Posted by Dude, where's my dollar? | November 7, 2007 12:31 PM

Wait a sec-- wasn't the Euro supposed to be some huge boondoggle and failed experiement cooked up by those sclerotic Europeans? I seem to remember some links from, I think it was the Drudge Report with associated flashing sirens, about how this was soon to be a worthless currency.

Posted by Tyro | November 7, 2007 12:33 PM

1) The Big Risk in a falling dollar is capital flight --similar to what devastated Argentina's economy in 2001.

As I've noted, our economy requires an injection of $1 Trillion in investment every year just to maintain the status quo.

If that investment fails to occur, people start starving in the streets -- as happened in Argentina. See
http://en.wikipedia.org/wiki/Argentine_economic_crisis_%281999-2002%29#The_crisis

2) The deep corruption of the Bush Administration has allowed our superrich to accumulate huge wealth. However, that was done by raiding the US Treasury to pass $2 Trillion to the superrich via tax cuts while stealing $Trillions from the Social Security/Medicare Trust Funds to pay for the tax cut and Big Oil's disasterous war in Iraq.
Plus printing US Treasuries. Our debt now is almost $4 TRILLION more than what it was projected to be when Bush entered office.

3) Now the government faces the problem of making good on its promises to a huge cohort of retiring baby boomers -- while being almost $10 Trillion in debt. Obviously, the Democrats will have to make the superrich give some of their ill-gotten gains back. Charlie Rangel's proposed surtax on income over $200,000 is just the opening salvo.

The superrich obviously don't want to pay for the disaster caused by their puppets -- Bush, Cheney, the Republican Congresses.

Hence, the need to move money abroad and hide it -- to buy Euros , gold,etc. To protect it from US taxes by investing it in foreign enterprises.

4) I'm trying to find out how much of the current rise in the Euro is the result of capital flowing out of the USA -- will report back when I get the data.

Posted by Don Williams | November 7, 2007 12:38 PM

The Big Risk in a falling dollar is capital flight --similar to what devastated Argentina's economy in 2001.

Now this is just silly. The US is not Argentina. First of all, our foreign liabilities are denominated in our own currency. For most debtor countries, if too many creditors try to withdraw at once, the government will run out of foreign exchange reserves. This can create a bank run dynamic -- investors rush for the door so that they're not the ones left holding the bag when the reserves run out. it is literally impossible for the US to run out of dollars, hence this kind of avalanche capital flight is not possible.

And as a matter of simple accounting, the US is experiencing net capital inflows, not outflows -- that's how we finance the deficit on the current account.

Second, capital flight to where? The US has the biggest, safest, most liquid financial markets in the world. It's also the place where third-world rentiers imagine heading if things go bad for them at home -- a non-trivial consideration when you think about the sociology of capital flight. Europe might be an alternative someday, but it sure isn't right now.

Third, as Jasper and others have noted, the key players financing the US current account deficit are central banks, not private investors. They care far more about keeping their export-producing factories humming than the notional value of their reserves.

if there is a crisis, the big losers will be in China and Japan, not here -- that's where workers will be out on the streets and investors will be wiped out. Which is why those countries are so willing to accommodate us.

Posted by lemuel pitkin | November 7, 2007 1:22 PM

Wow! Not a lot of econ majors blogging or commenting at this site. In Wolfgang Pauli's words, the comments here are "not even wrong."

Posted by y81 | November 7, 2007 1:24 PM

y81, I'm pretty sure I've taken quite a few more econ courses than you. Care to offer an argument?

Posted by lemuel pitkin | November 7, 2007 1:26 PM

Lemuel, do you have sources for comments at 12:30, about no constraints on U.S. interest rates due to foreign debt?

I understand this a respectable position and I have heard it before, but I haven't seen it sourced beyond hand-waving.

Posted by mq | November 7, 2007 1:57 PM

What the heck is that thing at the top of the Arc D'Triomphe?

Posted by Dilan Esper | November 7, 2007 2:23 PM

Sorry, mq, I'm at work now and my grad school years are far enough behind me that I don't remember names offhand. If you're still interested, check back tonight -- if I can dig up a cite from the files of articles I have at home I'll post it here.

Posted by lemuel pitkin | November 7, 2007 2:34 PM

That said, if you really want to get into these issues more deeply, the two absolute best places to start are Fred Block's Origins of International Economic Disorder and States and the Reemergence of Global Finance by Eric Helleiner. Both are a little dated now but they give by far the best overviews of the post-WW II evolution of the international financial system I know of, and they're accessible to an educated layperson.

Posted by lemuel pitkin | November 7, 2007 2:40 PM

but surely these exchange rates have some significance.

The exchange rates have a great deal of significance. One obvious area is tourism: Americans may be richer than Europeans in PPP terms, but now Europeans can afford nicer hotels in, say, South Africa than we can.

But more broadly it matters for all trade and financial flows. US GDP (in dollars) has risen faster than European GDP (in euros) over the last few years, but since their incomes measured in dollars, or yen or Thai baht have risen faster, they can afford to import more from the rest of the world. With money comes influence - US demand for Asian consumer electronics drives innovation there, but a stronger euro means Europeans will have more influence.

PPP is just a way to try and estimate how much a given amount of money purchases in its home country, and compare that across countries. But market exchange rates are the only way to compare how much a given amount of money can buy from the rest of the world. The average person in, say, Rwanda or Laos earns less than $2000 a year in PPP terms, but if he or she has to buy food from the rest of the world, they'd have to use market exchange rates, and that $2000 a year could become $500 a year or less.

Posted by JimVA | November 7, 2007 2:49 PM

> Second, capital flight to where? The US has the biggest, safest, most liquid financial markets in the world.

The danger to foreign capital isn't US default, it's dollar revaluation. So the answer is "flight to some market whose currency doesn't have to fall significantly to look even remotely rationally priced. Maybe some country not running -6% of GDP annual deficits."

Of course, as you point out, foreign capital isn't looking for return on investment - the BoC just wants exports to be cheap. But how long can they keep it up?

> It's also the place where third-world rentiers imagine heading if things go bad for them at home

$60 billion/month worth? I'd have to see some numbers to believe that this is a significant dollar prop.

Posted by bonecrusher | November 7, 2007 2:59 PM

Of course, as you point out, foreign capital isn't looking for return on investment - the BoC just wants exports to be cheap. But how long can they keep it up?

Until either:

(a)They run out of cheap labor at home and can no longer export competitively to the US. (With half a billion potential Chinese workers still in reserve in the countryside, this isn't happening anytime soon.)

(b) They reach technological parity with the US, make exports here less necessary from a development standpoint. Of course the Chinese authorities may still prefer exports to domestic consumption as a source of demand because the latter implies rising wages. And in any case, again, not happening any time soon.

(c) They run out of reasonably safe, liquid assets to buy in the US. This was a live issue under Clinton, when the federal budget surplus meant that foreign investors had to start branching out from Treasurys to GSE securities, which obviously don't look so good now. But a big government deficit means plenty of high-quality government paper for the Chinese central bank.

(d) The US government imposes restrictions on Chinese imports.

The first three of these barriers won't be reached for many years, if at all. The fourth is political rather than economic. So I can't see any reason why the current situation couldn't continue indefinitely, as long as the US and Chinese governments like it better than the alternatives. Can you?

(One way to think about it is the position of the US is something like the position of a gold-mining country under the gold standard. In effect we "export" the world's reserve currency, dollars.)

Posted by lemuel pitkin | November 7, 2007 3:35 PM

lemuel pitkin, my statement wasn't directed at your comment immediately above mine. You must have posted while I was writing. That comment I actually agree with. Your previous comment, that per capita GDP comparisons using current exchange rates are "more meaningful" than comparisons using PPP rates is probably meaningless (i.e., not even wrong), since there is no agreement as to what is meaningful, or else possibly it does rise to the level of being wrong, if we accept the basic, Keynes-flavored concept that the purpose of these comparisons is to measure people's overall material well-being, not their ability to buy the rather minor amount of globally-traded commodiities that the average person purchases.

I mean, let's not be silly here. Currencies can appreciate or appreciate 10 or 20 percent in a year. It's ludicrous to suggest that the people in the country with the rising currency are 20 percent better off. It isn't like comparing Victoria's and Elizabeth's moral worth, which would be hard, it's like comparing my income last year and this year.

Posted by y81 | November 7, 2007 3:47 PM

At current interest rates and deficits, in around 40 years 100% of US GDP will go to foreign debt service. Presumably, this will become economically infeasible before it becomes arithmetically impossible.

Posted by msw | November 7, 2007 4:49 PM

I should add a fifth constraint too the list above. Chinese financing of US deficits imparts a deflationary bias to Chinese monetary policy. At some point that might create strains on their financial system -- one would need a more detailed understanding of Chinese financial markets than I have to guess how much of a real problem that is. But in an economy growing at 10% a year, deflation is probably not much of a worry.

In the long run, I think the binding constraint on Chinese growth is going to be the willingness of Chinese workers to accept stagnant or declining real wages. But again, that's a political limit, not an economic one.

Posted by lemuel pitkin | November 7, 2007 4:50 PM

Lemuel Pitkin,

It's not possible until it happens.
And I think we are watching it break down right in front of our very eyes.
I mean if the sovereign funds (China, Japan, Russia, Arabs) were going to prop up the dollar wouldn't they have done so by now? The dollar deterioration is accelerating and the fed is going to face two bad choices: cut rates and unleash more inflation and dollar depretiation OR hold rates and grit their teeth through an increasingly likely hard landing.

I disagree about Europe in that they have sound money so wealth will park there but I would agree with you that if the American economy tanks that there will likely be no safe equity investments anywhere globally. Also a declining dollar may force China to favor domestic demand more aggressively.

http://bigpicture.typepad.com/comments/2007/11/crude-oil-98-go.html

Posted by Northern Observer | November 7, 2007 4:52 PM

msw-

But here we come to another puzzle, which is that the rates of return on US assets abroad are consistently higher than the rates of return on foreign assets in the US. (In fact there was one year in the early '90s when the total return on foreign assets in the US was actually negative.) The result is that the US has had a net inflow of capital income long after it became a net debtor.

Obviously a decline in the dollar unaccompanied by rising interest rates contributes to this pattern.

Bottom line: It's good to be the hegemon.

Posted by lemuel pitkin | November 7, 2007 4:54 PM

Northern-

Well, we'll see. My prediction is that the Fed will cut rates -- i.e. that monetary policy will continue to be driven by domestic rather than external concerns. The dollar will decline, but more slowly. US exports will increase, thanks to the declining dollar, and imports will decrease -- not so much because of the dollar, but because of the effect of the end of the housing bubble on consumption. The current account deficit will decline to a "manageable" level. And we'll keep going on as before. I could be wrong, of course.

As for Europe, the big problem there is political. They haven't been able to smash their working class the way the US has, so they're stuck with a slow-growth/high-unemployment model to keep wages nuder control.

Posted by lemuel pitkin | November 7, 2007 5:04 PM

lemuel -

is that still the case? Are capital flows still a net positive for the US?

And why deflationary for China? I would expect the opposite - isn't the BoC essentially buying dollars with "printed" yuan. I thought the big question was how China was sterilizing all that cash.

I don't see this holding. It's not just China - all the tigers, Japan and the oil states are playing along. Can China keep it up alone?

Posted by msw | November 7, 2007 5:06 PM

(And I've never bought that European argument. Aggregate growth is low, but hourly gdp growth is as high or higher there than in the US. The low aggregate numbers are because hours worked have fallen enough to offset the high productivity growth. The most obvious explanation to me is the introduction of the 35-hour work week. But that's a done deal now, so I would expect aggregate GDP growth to start to match hourly growth. I'm expecting a European boom.)

Posted by msw | November 7, 2007 5:19 PM

1) I'm amused when someone suggests that "economists" might disagree with me--
since ,in my opinion, the highest level of intellect shown by the economics
profession consists of having the low animal cunning to recognize that
"he whose bread I eat his song I should sing". Sing the agendas of wealthy
patrons via incoherent sophistry, that is.

2) In place of airy-fairy theology -- hilariously akin medieval argumentation re
how many angels fit on the head of a pin -- let's do what engineers do: look at
the data.

3) The US population grew from 281.4 million people in 2000 to an estimated 302.3 Mil
in third quarter 2007 -- an increase of 7.4 percent.

4) In that same time period, GDP grew from $9.817 Trillion to $11.630 Trillion --
an increase of 18.5 percent. At first this suggest prosperity --until you look at
the sources of GDP growth.

5) GDP = PCE + GPDI + NEXP + GOV, where PCE= Personal Consumption Expenditures,
GPDI = Gross Private Domestic Investment, NEXP = Net Exports ( value of US Exports - Value
of US imports ), and GOV = government expenditures (NOT the total US budget, as I will explain.)
GOV includes state and local expenditures as well as federal expenditures.

6) In REAL dollars, 2000 values for above were: PCE= $6.739Trillion , GDPI=1.735,
NEXP= -379 Billion
(neg because we run a trade DEficit), GOV = $1.721 Trillion. Values for 2007 (Q3) are
PCE=8.305, GPDI=1.841, NEXP=-.546, GOV=2.033.

7) Percentage increases of above in 2000-2007 are: PCE:23.2 percent ,
GDPI: 6.1 percent NEXP: 44 percent GOV: 18.2 percent

8) I don't see a very good trend: our CONSUMPTION (Government spending, Personal Consumption,
and our Trade DEFICIT ) has soared far above what our growth in population would
justify while our INVESTMENT has fallen WAY behind.

9) A look at the subcomponents of the above items doesn't provide encouragement.
GDPI consists of Residential investment (i.e, Homes) and corporate Nonresidential investment
in factories,etc.

Private homes make up a large chunk of US "investment" -- 447 Billion
in 2000, 464 Billion in 2007 (the latter low number reflects the steep fall in homebuying
since interest rates rose. Home buying had ran around 607 Billion in 2005 and early
2006.) Also, private McMansions are an "investment" only if the local economy continues
to provide enough jobs/high wages to support their price. In a declining economy, of course,
the values of homes can fall through the floor.

The Corporate NonResidential Investment increased from $1.232Trillion in 2000
to $1.382T in 2007 --an increase of 12 percent. However, corporate investment has
been depressed for much of the past 7 years -- the 2007 figure reflects some catching up.

10) Of the 2.003 Trillion GOV component in 2007, 763 billion consists of Federal spending
and 513 billion of that consists of Defense expenditures. Up from 370 Billion in
2000. Unless we have a nuclear war, that defense expenditure will be a form of
consumption. Actually, worse than consumption. Our military toys will rust away
if we don't continue to pour hundreds of Billions into their maintenance in the decade
to come.

(Note: I knoe -- the federal budget was $2.7 Trillion in 2007. However, the GDP
component does not count Social Security, Medicare, military pension transfers,Welfare,
etc as GOV -- neither consumption nor investment. I believe this is because such
payments show up in PCE when individuals cash and spend their government checks --
money which gets passed around several times and swells to the full GDP via the
multiplier effect.

11) So how do we consume so much without making investments that yield us profits?
Well, we borrow. Federal debt for 2007 is around $9 Trillion, up from roughly $5 Trillion
in 2000. An increase of 80 percent. We pay hundreds of billions on interest
for the federal debt alone -- not counting the huge Household debt.

12) The argument that the $1+ Trillion we owe to foreigners is not real debt because it
is in dollars is wrong. The price we pay for goods and oil have rose steeply in recent
years -- because the Chinese can us our dollars to buy oil from our suppliers. They
can use our dollars to educate their engineers here -- so they can defeat us in
economic competition in decades to come. Hundreds of billions that we should be
investing here in the US goes abroad as interest payments to foreigners.

Posted by Don Williams | November 7, 2007 5:20 PM

1) I should note that I did palm a card in the above post.

2) The $8.305 Trillion in PCE in 2007 has 3 subcomponents: Durable goods (1.242 T , up 44 percent from 2000), Nondurable goods (2.400T, up
23 percent ) and Services ($4.690 T, up 19 percent).

3) While expensive plasma TVs, BMW sports cars, and SUVs are a form of consumption, it can be argued that part of the Durable goods unit is a long term investment similar to homes.

4) Similarly, some part of the Services unit (small , in my opinion ) is an investment. E.g., K12 education and college education of productive workers like engineers, doctors, etc.

Education of lawyers and politicans, on the hand, should count as a big liability.

Posted by Don Williams | November 7, 2007 5:33 PM

msw, you might take a look at European unemployment rates! In fact, that's the cause of their relative poverty: the workers are adequately productive, but they have trouble finding jobs, especially for the young and the non-white/non-Christian.

Posted by y81 | November 7, 2007 5:56 PM

There's around a 2 point difference in Euro-area unemployment and US unemployment. I don't know anything about "non-christian" workers (are there working age "Christians" in Europe? I don't think I've ever seen anyone in a church under the age of 70 who wasn't a tourist).

Posted by msw | November 7, 2007 7:01 PM

msw, I only mean "Christian" in the sense of what religious institution you use for marriages and funerals.

Posted by y81 | November 7, 2007 8:21 PM

On a really important part of this topic, the thing at the top of the Arc de Triomphe was probably something to do with cleaning the stonework. It wasn't there this morning, though.

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Posted by Jan Huffman | November 21, 2007 1:50 AM