It is painful to read news article that relies on economists who could not see an $8 trillion housing bubble telling us how awful it will be if we don't get our deficit down. They don't have a coherent story, which reporters should be pointing out. This NYT article includes statements from economists who missed the $8 trillion bubble warning us of dire consequences if China and India get concerned about our deficits and stop buying U.S. bonds. Okay, let's try some arithmetic and basic economics. Suppose China and India stop buying dollar denominated assets (bonds and short-term money deposits) altogether. Then the dollar falls against their currencies and interest rates rise. Since both the Bush and Obama administrations have been pushing for China to raise the value of its currency against the dollar, why would we suddenly be upset if they finally do exactly what we have been asking? The other part of the story is that because they stop buying U.S. government bonds, long-term interest rates would rise. This is not good, but the Fed could offset the increase by buying long-term bonds itself. Will that lead to inflation? We should hope so. Modest inflation (3-4 percent a year) would be an extremely effective way to reduce the indebtedness of households. The economists who missed the $8 trillion housing bubble certainly have no better suggestions for boosting the economy. Of course the fall in the dollar would also boost exports, which could provide a substantial lift to the economy. So, what exactly are we supposed to be worried about in this story? We have lots of economists who missed the biggest threat to the world economy in 70 years telling us that if we don't listen to their whining all hell break loose. This would be funny if people didn't take it seriously.
--Dean Baker
