Dark Matter: Tamny v. Feldstein
While John Tamny does not explicitly have Dark Matter in mind, his criticism of Martin Feldstein largely rest on the thesis:
When he served under President Reagan as chairman of the Council of Economic Advisors, Martin Feldstein called for a weaker dollar to reduce the U.S. deficit in the current account … Nearly twenty years later, with the Dow Jones Industrial Average trading at levels nearly four-times higher than when Feldstein initially sounded the alarm, the U.S. economy is still somehow imperiled as a result of investor interest in our public and private assets. Although Adam Smith saw capital inflows as “the effect, not the cause, of public prosperity,” Feldstein apparently sees them in a reverse light. According to his January 10 op-ed in the Financial Times, they’re indicative of a looming dollar crash … The problem here is that there’s no discernible correlation between the current account deficit and the value of the dollar … Feldstein is of the belief that the present level of foreign investment in the U.S. is unsustainable. Leaving aside how long the “sky-is-falling” crowd has been incorrect, what’s unsustainable is not the deficit itself, but the causes of it.
Actually, we should be praising Martin Feldstein for his wisdom a generation ago – as well as his latest wisdom. While Tamny notes that the nominal value of stocks may be substantially higher now than twenty years ago, note that nominal GDP has also tripled over this time period (can you say price increases and population growth). It is true that household net wealth is about 4 times GDP versus 3.35 times GDP twenty years ago. Twenty years ago, the U.S. investments abroad roughly equaled foreign investments in the U.S. Today, foreign investments in the U.S. exceed U.S. investments abroad by roughly $3 trillion or 25% of GDP. Feldstein and many others are worried that this foreign indebtedness will continue to rise relative to our national income.
Tamny suggests correctly that we should examine the causes of the current account deficit. First of all, correlations between the exchange rate and the current account do not get at the cause and effect relationships. Feldstein was certainly not saying the exchange rate was the exogenous variable. Rather, the exchange rate is an endogenous variable that responds to factors such as the relationship between national savings and investment. We at the Angrybear have been arguing that it is this lack of national savings that has created the underlying conditions for why we have to rely on borrowing from abroad to finance the modest amount of investment that the U.S. is currently doing. If we ever get around to fiscal responsibility, then the consequence should be a weaker dollar and improved net exports.