Politics & Policy

Voodoo Volckernomics

The former Fed chair gets trade deficits all wrong.

In advance of Tuesday’s release of yet another large trade-deficit figure, former Federal Reserve chairman Paul Volcker weighed in with a Washington Post editorial that mixed myth and contradiction to bolster his contention that the trade and budget deficits have our economy “skating on increasingly thin ice.”

Volcker began his editorial by talking down the U.S. economy, noting the “disturbing trends, huge imbalances, disequilibria, [and] risks” that weigh it down. Remarkably, two paragraphs later he contradicted the ugly picture he painted by noting the “massive and growing flow of capital from abroad” at “attractive interest rates.”

Counter to Volcker’s less than sanguine outlook, the markets are most useful for discounting the future. Unless Volcker possesses more wisdom than the infinite collective insights that comprise the marketplace, he’s got things backward. That money flows into the U.S. so plentifully at such low rates is a pretty unambiguous sign that “disturbing trends” and “risks” exist everywhere but in the U.S. To quote his own sarcastic quip from the same editorial, “Where better to invest than the United States?”

Like seemingly all trade-deficit worriers, Volcker also bemoans the influx of foreign capital into the U.S., while at the same time acknowledging that things will be worse if/when the capital flees. In short, his argument is circular: Capital inflows give us trade deficits and have the economy on “thin ice,” but if those same inflows cease we’ll really be in trouble, only we won’t be burdened by the trade deficits that have him so worried in the first place.

Later in the editorial Volcker offered up his contention that “personal savings in the United States have practically disappeared.” Leaving aside the fact that the government statistic Volcker cited cannot reliably track the myriad ways Americans save, his assertion is belied by a recent Bear Stearns report on savings. In it David Malpass (NRO financial writer and Bear Stearns chief economist) shows per capita assets in the U.S. of $89,800 that make us the top saving country in the world. (Japan is second at $76,900 per head.)

The unreliable and contradictory nature of the savings rate should be very obvious to Volcker considering he presided over an extremely high rate during part of his tenure as Fed chairman. Indeed, government-calculated savings rose all the way to 12 percent (Volcker’s piece noted that it is 1.1 percent today) in 1982, a year in which both the unemployment and interest rates rose into the double digits. It should also be noted that the savings rate was very high during the Great Depression. High personal savings rates as calculated by the government tend to coincide with economic contractions.

Done with the savings rate, Volcker argued for a “combination of measures” from the government that would reduce the U.S.’s “import demand.” But as classical economists from Adam Smith to Robert Mundell have reminded us, “any decision to reduce imports involves a corresponding decision to reduce exports.” We could achieve Volcker’s desire for lower imports, but it would involve the economy falling into a recession.

Lastly, Volcker falls into the trap that many do in attempting to distinguish between foreign and domestic capital inflows. He argued, “at some point, both central banks and private institutions will have their fill of dollars,” as though foreign investors are somehow different from U.S. investors.

In truth, there is no difference. Capital knows no color or country; it only knows relative safety and returns. If foreign investors eventually lose interest in the U.S. economy, so too will American investors. What this tells us is that investment capital, regardless of its origin, is an unambiguous market signal that the United States is presently the best place to park one’s money.

Contrary to Paul Volcker’s assertions, the U.S. economy is not on thin ice. If anyone doubts this, they need only read the former Fed chairman’s editorial. It talks of capital inflows into the U.S. at very low interest rates. That’s not the stuff of an economy that’s about to fall off a cliff.

John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.


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