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PeakTrader said...
Export-led economies are the manipulators, because they don't exchange their goods for enough U.S. goods, e.g. to maintain employment levels.

U.S. actual output has generally been below potential output since the late-'90s. There've been attempts to blame the Greenspan Fed for the housing bubble. However, it should be noted, in the mid-'90s, the Fed believed the economy could expand faster without fueling inflation and it was correct. In the early-'00s, the monetary easing was appropriate to spur domestic output. It worked and it wasn't the root cause of the housing bubble.

Ron H. said...
Peak Trader, If you don't think loose money policy by the Feds caused the stock market bubble of the late 90s and then the housing bubble of the 00s, what do you think did cause these bubbles?

You said:
"in the mid-'90s, the Fed believed the economy could expand faster without fueling inflation and it was correct."

Yes, but they overdid it. Inflation remained moderate, but the extra money created poured into the stock market. When the Feds finally put the brakes on, the higher interest rates caused the dotcom bubble to burst.

"In the early-'00s, the monetary easing was appropriate to spur domestic output. It worked and it wasn't the root cause of the housing bubble."

Once again, they overdid it. In their eagerness to provide a soft landing after the stock market bubble burst, they again poured too much money into the system, and this time it flowed into the housing market, assisted by government pressure on banks to loan to pretty much anybody who could walk in the door, and the secondary market for mortgages taking away the risk of making shaky loans.

As before, the eventual Fed tightening and the higher interest rates caused the bubble to burst.

PeakTrader said...
Ron, first off, the U.S. has never had a 10-year expansion without a recession, except from 1991-01, and then had one of the mildest recessions in 2001. So, to say the Greenspan Fed had a failure or overdid it is ridiculous.

Sustainable growth is optimal growth, because there's neither strain nor slack utilizing resources. In the 2000s, actual output was either below or roughly at potential output. So, there wasn't an aggregate production strain utilizing resources. The monetary easing was needed to take the slack out of the economy, and again the Fed didn't overdo it.

I believe, the root cause of the housing bubble was export-led economies sold their goods too cheaply and then lent their dollars too cheaply, causing a virtuous U.S. cycle of consumption and investment. The cycle turned into a boom, which was unsustainable. The U.S. current account deficit reached over $800 billion a year or over 6% of U.S. GDP. Without the housing bubble, and related goods, U.S. actual output would've remained below potential output throughout the 2000s.

The Fed uses crude tools to direct the economy rather than micromanage or fine-tune it, and it was increasingly successful smoothing-out business cycles, until Lehman failed in Sep '08. Also, I may add, the U.S. had a quick and massive creative-destruction process in a mild recession (mostly from 2000-02).

Ron H. said...
Peak, you said:

"I believe, the root cause of the housing bubble was export-led economies sold their goods too cheaply..."

If I understand correctly, you are saying that we as consumers had too much money to spend because we were able to buy cheap stuff from China, and we poured that extra money into real estate. Do you feel we should have spent more than we did for imported goods?

"...and then lent their dollars too cheaply..."

I don't understand that part.

Don't you think that holding Fed funds rates at 1% for a year caused any overheating? Could that have caused the boom you mentioned?

What do you think would happen if the Fed didn't exist, and the market set interest rates without interference?

PeakTrader said...
Ron, prices fell to maintain U.S. demand, because of diminishing marginal utility. Export-led economies had to make up in volume what they lost in value.

At some point when the dollar depreciated enough, when U.S. inflation was higher, and when interest rates were lower, export-led economies would exchange their goods for U.S. goods rather than for U.S. Treasury bonds. However, they took larger real losses instead, e.g. to maintain their employment levels.

Dollars were drained out of the private sector through export-led economies when U.S. consumers bought foreign goods and foreigners bought U.S. Treasury bonds. Americans borrowed to buy real estate.

The U.S. economy didn't overheat in the 2000s, because actual output didn't rise much above potential output, in part, because imports subtract from GDP. I think, without the Fed, the U.S. would have suboptimal growth, because of boom-bust cycles, and shocks to the system wouldn't be compensated. Also, fiscal policy should raise taxes in an expansion and cut taxes in a recession to help the Fed smooth-out business cycles.

Ron H. said...
Peak, are you making this stuff up? Do I need to read up on Post-Keynesian economics to understand what you're talking about?

You said:

"prices fell to maintain U.S. demand, because of diminishing marginal utility."

What does marginal utility have to do with it? You don't make much sense.

PeakTrader said...
Ron, I suggest you look up the meaning of diminishing marginal utility.

Also, I may add, most U.S. goods have rising prices, while most Chinese goods have declining prices. So, the U.S. exports inflation and imports deflation. The U.S. makes up in value what it loses in volume, while China makes up in volume, what it loses in value.

I suspect, when U.S. output picks up, inflation will accelerate, in part, because there will be fewer imports than before.

Craig said...
"Export-led economies are the manipulators, because they don't exchange their goods for enough U.S. goods, e.g. to maintain employment levels."

But economies don't trade -- people do. Germany, for example, is now being criticized in Europe for exactly the reason you state: they don't buy "enough" goods from the rest of the EU.

Should German citizens be required somehow to buy more goods from abroad? I suspect they're content with things the way they are and to call them "manipulators" seems harsh to me.

Craig said...
"I think, without the Fed, the U.S. would have suboptimal growth, because of boom-bust cycles, and shocks to the system wouldn't be compensated."

Well, that's where you're wrong. Without the Fed, growth would be optimal in the sense that it would be based on a more stable currency and interest rates that properly match available savings to loan demand. The Fed's manipulation of interest rates -- with its attendant money supply fluctuations -- causes businesses to make decisions based on false and temporary conditions.

"Also, fiscal policy should raise taxes in an expansion and cut taxes in a recession to help the Fed smooth-out business cycles."

How about we let tax rates remain constant so business (and consumers for that matter) can make decisions about the future that don't shift under their feet the minute some bureaucrat decides it's time to "optimize" the economy.

I find your obsession with governmental economic controls to be sub-optimum, economy-wise that is.

PeakTrader said...
Craig, if you don't want to use the term export-led economy, we can instead say people in a country who sell more goods than they buy, or perhaps call them export people.

Obviously, there's manipulation when people cannot exchange their goods for other people's goods, year after year.

When the U.S. was on the gold standard, there were many economic booms and busts. Of course, the U.S. economy was smaller back then. So, it expanded at a faster rate. Yet, it was suboptimal growth, because resources weren't utilized efficiently in both the boom and bust phases. Fiscal policy should also help smooth-out business cycles. Afterall, when times are good, it's wise to save for a rainy day.

Anyway, you really haven't explained why you believe economic booms and busts are optimal.

Ron H. said...
Peak,

I understand diminishing marginal utility just fine. Its the context you use it in that doesn't make sense. Are you saying simply that the laws of supply and demand are at work here? If so, why don't you just say it?

You seem convinced that booms and busts are inevitable without a benevolent Fed to ease the cycle, but you are ignoring the fact that historically most such booms have been CAUSED by misguided central bank policies that kept interest rates too low for too long, causing excess credit, and subsequent bubbles, which must eventually burst.

If Fed policies since 2000 created "optimal growth", where did the excess capital come from that flowed into the real estate market
to cause a bubble? Well, you answered that question already:

"Americans borrowed money to buy real estate."

Exactly. Artificially low interest rates caused excess credit which caused capital to flow into overpriced real estate, rather than into business growth. Optimal use of resources? Hardly.

As you said yourself,

"The Fed used crude tools to direct the economy."

I couldn't agree more. Maybe NO direction would be better. Without interference, interest rates would always be correct, and reflect the true demand for credit.

You are concerned with suboptimal growth, when resources aren't used most efficiently, but a less restricted market automatically directs resources to their most efficient use. Any business that doesn't use resources efficiently will lose out to competitors who do, and will soon go out of business.

That's what should have happened during this current recession, but it hasn't been allowed.

AIG? - taxpayer bailout.
GM? - taxpayer bailout
Chrysler? - taxpayer bailout.
Fannie May? - taxpayer bailout
Freddie Mac? - taxpayer bailout.

The list goes on.

Too big to fail? That's BS.

"Fiscal policy should also help smooth-out business cycles. Afterall, when times are good, it's wise to save for a rainy day."

That's just wrong. The government should never have more of my money than it needs for immediate expenditures. Why do you think government can somehow know better how to spend my money than I do?

PeakTrader said...
Ron, to induce demand, prices had to decline, because of diminishing marginal utility (also, falling interest rates induce demand). Consequently, the U.S. current account deficit reached over 6% of GDP.

The Fed has smoothed-out both short-term and long-wave business cycles. From 1982-07, there were two mild recessions in a period of disinflationary growth. Also, there were deep depressions in the 1870s and 1930s. However, the Fed prevented another deep depression in the 1970s.

Fiscal policy can also help smooth-out business cycles by raising or cutting taxes, which may be better than decreasing or increasing expenditures.

There are at least two ways to deal with the moral hazard of "too-big-to-fail."

1. Through regulation.

2. Through a deep depression.

It would seem regulation is the better choice.

However, there's a third way. Allow moral hazard to continue and bail-out the financial industry when necessary.

In the 2000s, the U.S. financial industry distributed trillions of dollars to the masses from the excess capital created and captured in the global economy, and the global saving glut, which helped raise U.S. actual output towards potential output. It seems, the excess capital was distributed efficiently, to the masses, and the risk was diversified or spread worldwide.

All the U.S. government had to do was bailout the financial industry, e.g. TARP, and a large tax cut would've allowed households to pay-off or pay-down debt to help strengthen the financial industry. Also, stronger household balance sheets would spur demand to increase production and help minimize the recession. The government would only be refunding money to the private sector.

The U.S. was on a path to a soft-landing or mild recession, until Lehman failed in Sep '08, and then the economy fell off a cliff. It would've been better if global imbalances corrected slowly rather than suddenly.

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