Is economic Armageddon coming?

The eminent Stephen Roach says yes.  The nub of the argument is that foreigners will abandon the dollar, thereby ceasing to fund our dual deficits.  This will force interest rates to skyrocket and lead to a rash of U.S. bankruptcies.  Brad DeLong is less alarmist, but wonders why long bonds are not plummeting in price.

Before you sign up for space tourism, keep the following in mind:

1. Doomsayers usually compare one financial flow to another; today they are focusing on trade deficits, budget deficits, and U.S. savings rates.  It is easy to make measured flows appear unsustainable, because indeed they probably are.  However it is less common for a flow-based problem to be compared to the total stock of wealth.  One very rough estimate pegs the U.S. as worth well over $100 trillion net.  And don’t forget the recent increase in the future expected value of China and India.  Problems with flows are real, but they won’t, in general, bring us to our knees.

2. The late 1970s were a terrible time by many measures.  The prime rate approached 20 percent, gold was above $800 an ounce, inflation and unemployment were high at the same time, and the U.S. was seen as having lost world leadership.  By 1983 — a mere few years later — matters were running well once again.  If a collapse did come today, we might expect a comparably quick recovery.

3. The doomsayers are not obviously richer than the rest of us.  Many of them (they know who they are!) do not invest on the basis of their gloomy prognoses.  And no, buying a house is not enough, I want to see at least five percent of your net worth in puts on T-Bond futures.

4. Richard Cooper offers the best case for sustainability of the status quo.

The most likely outcome: We will limp along with a government that refuses to accept fiscal responsibility.  A ruling political party will not raise taxes and/or cut spending until the last possible moment.  It will always look toward the problem falling in someone else’s lap.  In the meantime, the wealth of the world, and the benefits of investing in the U.S., will bail us out.  (Didn’t Winston Churchill once say "The Americans always do the right thing, once they have exhausted all other options", or something to that effect?) 

A few decades from now the crunch will come, as growing Medicare and Social Security liabilities are matched against low levels of accumulated savings.  We will have Western European levels of taxation and growth for a good twenty years or more, unless we get lucky with productivity growth in the meantime.  The costs will be very real, but economic Armageddon does not appear to lie around the corner.


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