Is the International Status of the Dollar a Big Deal?
David R. Henderson has a thoughtful post that (among other things) endorses Paul Krugman’s recent thoughts on the significance (or lack thereof) of the dollar’s role as the world’s reserve currency. As David puts it, the role of seigniorage is relatively unimportant in its impact on Americans. In the comments I pushed back on David’s position, and I think it’s at the point where I should bring the discussion here.
Let me quote Krugman (which David does too) to get to the heart of our disagreement:
What is true is that the large holdings of US currency outside the United States — largely in the form of $100 bills, held for obvious reasons — represent, in effect, a roughly $500 billion zero-interest loan to America. That’s nice, but even in normal times it’s only worth around $20 billion a year, or roughly 0.15 percent of GDP.
In other words, what Americans basically get because of the dollar’s special status, is the ability to send abroad $500 billion worth of green pieces of paper, in exchange for $500 billion worth (in market value) goods and assets. So long as foreigners continue to hold those green pieces of paper, Americans never have to “make good” on the initial influx of goods (and assets) that the foreigners sent us. Viewed as an upfront loan of those goods–with a zero percent interest rate, since we don’t pay any interest on paper currency–that’s effectively a perpetual benefit to Americans of $20 billion per year, forever (so long as the situation lasts). That’s a big number in the abstract, but it’s small potatoes in the context of the huge U.S. economy.
I have two main objections to this demonstration:
First, I don’t see why we are converting it to an annualized, perpetual figure. Suppose a massive earthquake strikes California, causing $500 billion in damage. Putting aside the deaths, would David (or Krugman) say this was relatively unimportant, a mere blip for the US economy? (No broken window jokes, let’s stick to the monetary issue here.) After all, we could convert that seemingly huge $500 billion damage figure into a much more reasonable $20 billion per year, by saying the insurance companies and California residents will pay for the quake out of future income forever, rather than dealing with it upfront. Would that seem like an appropriate way to transform the number?
Second, I don’t think it’s right to count only foreign holdings of actual paper currency. Surely there are many foreigners who maintain checking account balances denominated in U.S. dollars, who would not do so if the dollar lost its status as reserve currency. Think of it this way: If we all agree that a Brazilian holding ten $100 bills under his mattress is conferring a benefit on U.S. citizens, then how does that change if–for reasons of convenience, security, etc.–he deposits those ten pieces of paper into a CitiBank checking account and never spends it, because its function is a hedge against the collapse of his own currency?
If you follow my logic, then surely the relevant number is much higher than $500 billion. We might even go further and include holdings of dollar-denominated assets, such as Treasuries and corporate bonds, held by foreigners. Presumably the demand for such assets would also plummet in the type of scenario in which the dollar loses its status as reserve currency.
In conclusion, I am still not convinced, but I’m willing to continue this discussion in case I’m missing something. But right now I still think a sudden loss in foreign confidence in the dollar would cause a substantial reduction in Americans’ standard of living.
Yglesias Psychoanalyzes Gold Bugs: Back at Ya, Matty
Matt Yglesias pokes fun at a Cato conference on the Fed (HT2 Scott Sumner). Here’s Yglesias:
[T]he affinity between free market economic thinking and hard money is an interesting and important phenomenon….I do think there’s a deep logic to it. Once you concede the fact that prosperity over both the long- and short-term depends in part on competent demand management from a powerful bureaucratic organization, then it’s difficult to resist the moral logic of redistribution regardless of the empirical merits of any particular government program. But there’s a deep yearning to give the case for free markets a profound moral reading rather than a pragmatic one, and that reading is hard to maintain in the face of a modern monetary system. Hence the hankering for gold.
Right, and by the same token, there’s a deep logic to the progressive support for graduated taxation and hatred of the gold standard. Someone who has no problem recommending that the government take people’s hard-earned money to spend on pet projects clearly has no respect for private property. It’s not at all surprising that such a person is fine with the US government reneging on its contractual obligations to redeem dollars for gold, and even lock people for up to 10 years in prison for the crime of holding on to a yellow piece of metal that they had acquired in legitimate commerce.
Oh, note that the URL for Yglesias’ post is “monetary derp at Cato.” Remember, “derp” is the extremely dorky term that our hipster Keynesian bloggers have adopted to be shorthand for “refusing to acknowledge that your views are totally falsified by the evidence.” On that note, click on this Yglesias post from mid-July. I don’t want to spoil the surprise; just check it out to see why Yglesias can justifiably mock others for their horrible derpitude.
Slate Admits Sarah Palin Was Right About Death Panels
Remember in 2009 when Sarah Palin warned that Obamacare would lead to “death panels”? People ridiculed her alleged right-wing paranoia; PolitiFact christened her accusation the “Lie of the Year.” In this context, it’s ironic that a recent Slate article admits that socialized medicine goes hand in hand with government death panels. What’s even more disturbing is that the author–Adam Goldenberg–applauds the practice.
Specifically, Goldenberg explains that “Canada Has Death Panels”; this is the very title of his piece. Here’s the news hook:
Last week Canada’s Supreme Court ruled that doctors could not unilaterally ignore a Toronto family’s decision to keep their near-dead husband and father on life support. In the same breath, however, the court also confirmed that, under the laws of Ontario, Canada’s most populous province, a group of government-appointed adjudicators could yet overrule the family’s choice. That tribunal, not the family or the doctors, has the ultimate power to pull the plug.
In other words: Canada has death panels.
And yet Goldenberg’s purpose is not to warn Americans to turn back now, lest we follow Canada down this horrifying path. On the contrary, Goldenberg thinks this outcome is just swell:
Perhaps it is easier for Canadians to trust government-appointed panels, rather than judges, with decisions like these. For reasons that arguably go back to our respective foundings, Canadians tend to have more faith in our government and our bureaucratic processes than Americans do in theirs…
[T]he question is no longer whether we can “play God,” but when, how, and who should do so. When humanity demands haste, and justice demands expert knowledge, Ontario’s death panels offer a solution—whatever Sarah Palin says.
And there you have it. Whether or not the Affordable Care Act (aka “Obamacare”) explicitly details the process, it is unavoidable that more government involvement in health care will lead to bureaucratic decisions concerning the proper use of “society’s” resources. Americans will eventually see that the problems with Obamacare go far beyond website glitches.
Gilligan Is Disabused of the Treasury View
I had nothing to do with the creation of this, and yes it is completely unfair. And hilarious.
Ross McKitrick Explains Why There Probably Is NOT a “Double Dividend” With Carbon Tax
I rarely get down and beg, but if you are a serious student of the economics of climate change debate, I implore you to watch Ross McKitrick’s presentation from IER’s carbon tax conference over the summer. I’m embedding the video and then adding my commentary, but for more context go read my post at IER.
The takeaway message here is that McKitrick–who is truly a world expert on the subject–shows that the peer-reviewed literature comes down on the conclusion that even a 100% dollar-for-dollar swap of income tax cuts for a new carbon tax would probably hurt conventional economic growth. So the people running around saying a carbon tax is a “win-win” because now we’re going to “tax bads, not goods” are Consensus Deniers.
- 1:00 – 2:00 McKitrick explains the “Pigovian” (named after the economist Pigou) analysis in which a tax on a “negative externality” is supposed to help, by reducing the behavior, such as emissions, toward the “socially optimal” level. But nobody really looked at how the tax revenue was used.
- Around the 3:00 mark, McKitrick explains that in the 1990s, economists began studying the effects of a completely revenue-neutral tax on a negative externality. This is where the “double dividend” idea comes into play, since—in theory—it should be good to (a) levy a tax on the behavior causing the negative externality and (b) raise revenue that will allow taxes on socially useful things (like labor and saving) to be reduced. Some economists became excited that “revenue recycling” (where the revenue from an emissions tax, say, is devoted to income tax or capital gains tax cuts) provided a painless way for the government to help both the economy and the environment.
- At 4:05 McKitrick raises the issue of the “tax interaction effect,” which caused researchers to pause in their tracks. The new tax—even if it’s levied on a negative externality—will still interact with the pre-existing tax code, exacerbating the original inefficiency in the code (or raising the “excess burden” of those original taxes). Thus the benefits of “revenue recycling” must be contrasted with the harms of the tax interaction effect. Is there a double dividend? Only if the former outweighs the latter.
- At 4:30 McKitrick says the “overly strong” claim was clearly false: We can’t say that any emissions tax that is coupled with 100 percent revenue recycling is always better than the status quo, even though that’s what some economists had originally thought. Thus, the people today who say matter-of-factly that the government should “tax bads not goods” are decades out of date, with respect to the actual published literature on the topic.
- At 4:45 McKitrick discusses a weaker version of the double dividend claim, which says that once we consider the possibility of revenue recycling, the government ought to set the emissions tax higher than the level that reflecting the negative externality. So for example, if the “social cost of carbon” is $35 per ton, then this weaker version of the double dividend hypothesis says that the government should set the actual carbon tax at higher than that, perhaps $40 per ton, since the carbon tax receipts not only help mitigate global warming, but also allow for pro-growth income tax cuts. Yet, McKitrick says that researchers in the field quickly concluded that even this weaker claim was probably false.
- Starting around 6:45 McKitrick explains that the first economists to develop models with enough detail to show the possibility of a revenue recycling effect, discovered that in fact the government should set a carbon tax much lower than the “social cost of carbon.” In fact, with plausible estimates of the actual “social cost of carbon,” the optimal carbon tax could be $0 per ton. This shows the tremendous importance of the tax interaction effect.
- Starting at 8:00 McKitrick tries to explain why the pre-existing tax code matters so much in these analyses. Part of the explanation is that the emissions tax has a smaller “base” than broader taxes such as income taxes. There is a general rule in the tax literature that a tax should be applied on as large a base as possible; this is one reason that a “revenue neutral carbon tax” can harm the economy.
- Around the 12:00 mark, McKitrick showed that actually Sandmo in 1975 had provided the general framework for thinking about these issues. These remarks will probably only help professional economists make sense of the seemingly counterintuitive result that the government should set an “optimal” carbon tax less than the “social cost of carbon.”
The Non-Falsifiable “Empirical” Frameworks of Paul Krugman and Scott Sumner
[UPDATE below.]
The defenders of both gentlemen will no doubt frame the matters differently, but my following summaries of four total blogs posts–two from Krugman and two from Sumner–are perfectly accurate.
KRUGMAN #1: In this post Krugman endorses (with a parenthetical caveat) Raj Chetty’s claim that empirical work shows that the extension of unemployment benefits has little effect on the unemployment rate. Krugman then comments, “But are such results actually being used to inform policy debate? Have conservative economists like Casey Mulligan said “OK, we were wrong to argue that extended unemployment benefits are the cause of high unemployment”? … You know the answer.” The overall point of the post is that yes, economics is an empirical science–which Krugman defines as being one where data are used to reject certain hypotheses–but certain economists are not themselves scientists, instead they “treat their field as a form of theology.”
KRUGMAN #2: The very next day, Krugman follows up this above post by writing:
[U]nless you at least try to think in terms of a broader model, all the empirical work in the world can’t answer some questions — and you can all too easily draw the wrong conclusions. Take Chetty’s very example, the effects of unemployment insurance. He reports evidence that extended benefits have only a small effect on the time people spend searching for work. But suppose the result went the other way; would that say that UI was hurting employment? Not necessarily, and I’d say not at all: right now the economy is constrained not by a lack of willing workers but by a lack of demand, so that making workers more choosy about accepting jobs would, to a first approximation, have no effect at all on overall employment. [Bold added.]
==> So, just to summarize, Casey Mulligan isn’t a scientist, but instead a theologian, for refusing to accept the empirical results about unemployment benefits. Yet Krugman elaborates that if the results of that experiment had turned out exactly opposite, Mulligan would still be wrong and Krugman would still be right.
SUMNER #1: In this post, Scott Sumner reports that John Taylor accused Alan Greenspan of fueling the housing bubble by holding interest rates too low. Greenspan totally denies it. Sumner concludes that Taylor is totally wrong in early phases but somewhere from 0% to 10% right in the year 2006.
SUMNER #2: The very next day, Sumner follows up on the above post by arguing that the Fed caused the housing bubble by keeping interest rates too low in 2006.
==> On this one more than with Krugman, Sumner’s defenders will object and say I’m misconstruing the argument. But I repeat: What I have written above is a perfectly correct description of what happened. That should be disturbing to Keynesians and Market Monetarists, but my falsifiable prediction is that it won’t be.
UPDATE: I should clarify that what Krugman did, in general, isn’t necessarily scandalous. For example, if Casey is arguing that OJ was guilty, while Paul claims that OJ is innocent, they would have to react to evidence about OJ’s alibi in different ways. If store surveillance camera has a video on the other side of town at the time the murders occurred, and OJ shows up on the video, then Paul could say, “Oh come on Casey, just admit you’re wrong.” In contrast, if OJ doesn’t show up on the video, then Paul can still reasonably say, “I still maintain that I’m right.” But (a) this particular example of unemployment isn’t quite like that, since Mulligan could conceivably embed his story in a macro GE effect like this guy says, and (b) Krugman pulls heads-I-win-tails-you-lose all the time, so I just thought this was hilarious when he deploys it in a post complaining that nobody follows the evidence.
Also, here’s Jim Manzi from the comments:
The UI “natural experiment” is not an experiment at all. The set of states that took the action were not randomly selected. It is plausible that those states that extended UI varied systematically form those that did not. For example, they may have had different prospective expectations of future unemployment, or may have had different balance of power between interest groups and on an on in ways that could be related to future employment. Inevitably, this results in the requirement for some kind of econometric adjustment (or more naively, no attempt to correct for bias) that means this is more econometric modeling, and not a controlled experiment or even a reasonable approximation to a controlled experiment. It’s especially bad, since N = 50, and generally n = somewhere between 5 and 20. I’ve gone into this in painful detail for the abortion-crime natural experiment, among others.
Potpourri
==> This report on how (some) schools deal with autistic kids and others with special learning needs is truly revolting. In the beginning I actually thought it was a hoax.
==> Tom Watson at Salon doesn’t want to oppose the NSA with those yucky libertarians.
==> This story reminds me of that Jack Handy bit: “I’ve always been afraid of clowns. I guess it goes back to the time I went to the circus, and a clown killed my dad.”
==> Joe Salerno relays J. Huston McCulloch’s argument that the US government has defaulted before on its debt.
==> I like Tyler Cowen best when he’s writing with plausible deniability.
==> Somebody asked me if Brad DeLong is making my point about Cochrane, by putting it into a private sector context. See Nick Rowe in the comments, whose views are closer to mine on this, but yeah I definitely see what DeLong is saying, and I think it’s basically right insofar as it goes.
==> Mario Rizzo has gotten even more pessimistic since I left NYU. I must have been a cheering influence.
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