Wednesday, March 11, 2009

"Financing" current account deficits...with bonus rant

The Economist (the only weekly publication that I read...Businessweek and others contain far too much noise, advertisement, and duplicity) for all of its strengths continually fails to understand just how strange a non-convertible fiat currency system can be. Its "Economics Focus" article from the 2/28 issue is no exception. So I will get to this misnomer...but first, a small rant today:

/start epistemological rant

I say "strange" above because The Economist is clearly grounded in the Liberal Economic school of thought, but suffers from the age old affliction of "Buk Nawledzhe". That is, too much reliance on elegant and enveloping theories than the nitty gritty of how things actually work. If ontogeny REcapitulates phylogeny in economists, this is likely due to "physics envy". In physics, simple, elegant theories are much more likely to be true than massively complex systems. (Murray Gell-Mann has written extensively on this phenomenon and to this day, I have a habit of audibly mumbling "epicycles" to any theory that becomes too complex). Physicists can and do simplify massively complex systems with a few equations. They do find laws that are applicable everywhere. Like Newton said:

Nature obeys laws, and it is the business of natural philosophy (i.e. "science") to find them out"

Since most economists now days have plenty of mathematical training, this "faith" in simplicity and the belief of Economist-as-Archimedes just waiting to scream "Eureka!" is pervasive. Economists want to believe "the answer" is out there, but in the messy world of human action...well, lets end this rant with a quote by Turgenev:

Would to god your horizon may broaden every day! The people who bind themselves to systems are those are those who are unable to encompass the whole truth and try to catch it by the tail: a system is like a tail of truth, but truth is like a lizard, it leaves its tail in your fingers and runs away knowing full well that it will grow a new one in a twinkling

/end epistemological rant

So, after that rant, let's get to work on this idea that "Current Account Imbalances need to be financed".

The argument is as follows: "Since a current account deficit means, by definition that a country imports more than it exports, said country must be importing capital to finance this deficit". In this case, the United States, by running a current account deficit, is at risk of losing its financing"

my response?

1. Markets aggregate desires. A Capital Account surplus reflects a desire for foreign nations to net-save U.S. financial assets as it does reflect a U.S. desire net import what it wishes to consume.

2. The term "financing" is misleading. If the desire to save in a currency is lessened, the exchange rate adjusts accordingly and the current account adjusts with the usual lags.

3. Countries (or currency areas) that own their currency are not operationally constrained by "borrowing" to "get" their currency. "Financing" a short-fall in the current account via depleting foreign exchange reserves is misleading. See Australia.

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