Beat the Press

Dean Baker's commentary on economic reporting


The Times Versus Bush on the Deficit and the Dollar

The lead editorial in Saturday’s New York Times noted the recent drop in the dollar. It then blamed President Bush’s deficits and warned of an impending recession unless the budget deficit is reduced. As best I can tell, the editorial was incoherent, like much of the discussion on the trade deficit and the budget deficit.

In the last quarter century, the conventional wisdom on the relationship between the dollar and the budget deficit has changed almost as frequently as the seasons. It may not be surprising that politicians would change their views on how the economy works whenever it is convenient. It is a bit more disappointing that the media would show similar flexibility.

In the old days, economists used to say that large budget deficits lead to higher interest rates in the United States. When interest rates in the United States rise, more people want to hold dollar denominated assets (e.g. government bonds or money market accounts in U.S. banks). This increases the demand for dollars, causing the dollar to rise. A higher dollar makes imports cheaper for people in the United States, leading us to buy more imports. It also makes U.S. exports more expensive for people living in other countries, thereby reducing demand for exports. With imports up and exports down, the trade deficit rises.

In this way, a budget deficit could be argued to cause a trade deficit. Note the importance of the dollar in this story -- the high dollar is the key mechanism. People shopping at Wal-Mart don’t buy the imported shirt rather than U.S. made shirt because the U.S. has a large budget deficit; they make the decision to buy the imported shirt because the high dollar has made the imported shirt cheaper.

This part of the story is important to emphasize, because in the Clinton-Rubin era the conventional wisdom was that a high dollar was somehow good, even though it led to an enormous trade deficit. Right thinking people everywhere (many of whom had decried the budget deficits of the Reagan-Bush 1 era in large part because of the trade deficits they caused) espoused the virtues of Robert Rubin’s high dollar policy. In other words, the demon of the over-valued dollar, and the resulting trade deficit, was somehow good when the over-valuation was driven by foreign investors who were anxious to lose their shirts in the U.S. stock bubble of the late nineties.

Now, the high dollar is again bad, although the current cause of the over-valuation is not quite clear in the conventional wisdom (at least as rendered on the Times editorial page). If we assume that the Times has returned to the world of standard economic theory, then the over-valuation of the dollar is attributable to the upward pressure on interest rates that is caused by budget deficits. In this world, a larger budget deficit leads to a higher dollar.

But wait, the Times seems to have a somewhat different story:

“The problem is this: unless a falling dollar is paired with reductions in the federal budget deficit, it could do more harm than good by driving up interest rates, perhaps sharply. That's because the foreign investors who finance the administration's "borrow as you go" budget are likely to demand higher returns to invest in a depreciating dollar.

But if budget deficits declined over the long run, the government's reduced need to borrow would help keep interest rates low as the dollar depreciated.”

Okay, foreign investors will demand higher returns to invest in a depreciating dollar (i.e. if the dollar is falling 5 percent a year against the euro, then investors want a return in dollars that is at least 5 percentage points higher than the return available in euros), that seems right. But, the dollar falls more in a world where the budget deficit is reduced than in a world where it stays high. (Remember – a higher budget deficit leads to a high dollar.)

This means that, at least through a period of transition to an era of a lower dollar, we might expect higher interest rates if the budget deficit were to be reduced rapidly and then the dollar fell enough to fill the gap in demand with more net exports.

I apologize if this discussion is unnecessarily complex, but tackling warped logic is not always easy. Putting a different twist on the basic issue could be helpful.

An over-valued dollar, regardless of the cause, creates imbalances (i.e. trade deficits) that inevitably imply a painful correction process. The current over-valuation was not caused by budget deficits (remember, we had a huge budget surplus in 2000, when the dollar was considerably higher than it is now). The correction from the over-valued dollar is going to hurt regardless of what we do with the budget deficit. The price of imports will rise between 10-20 percent, raising the rate of inflation and reducing living standards in the United States.

There are good arguments for reducing the budget deficit, but it’s just silly to pretend that the pain from a falling dollar is attributable to the budget deficit, or that a lower deficit will somehow prevent this pain.

The Fed and the Housing Bubble: Fool Me Once, …..

The financial press eagerly reported Federal Reserve Board Chairman Benjamin Bernanke’s comments this week saying that he expected a gradual softening of the housing market, not a serious collapse. Mr. Bernanke’s comments may reflect his true view of the housing market. However, it is also possible that these statements were made simply to soothe the financial markets.

One of the most fascinating stories in the stock bubble was Alan Greenspan’s view of the Fed’s proper role in dealing with the bubble. Following the bubble’s collapse, Greenspan has publicly stated that he recognized the stock bubble, but thought it was inappropriate for the Fed to take any steps to reign in the bubble. This included saying anything publicly about the bubble. Greenspan’s comments about the stock market as it was soaring to unprecedented price to earnings ratios were carefully crafted comments of noncommittal nonsense. He never said that a 5000 NASDAQ could be justified by fundamentals, but he was also very careful never to say that it could not.

Given that Mr. Greenspan thought that the Fed should not comment on a stock bubble, is it reasonable to think that he would have the same attitude toward a housing bubble. In other words, if Mr. Greenspan believed there is a housing bubble, would he tell us?

I don’t have the answer to that one, but it does seem a reasonable question. It also seems to be an important piece of information that should be included in any news story that focuses on Greenspan or his successor’s assessment of the housing market. In other words, if Greenspan, and now Bernanke, think the same way about the housing market as Greenspan thought about the stock market, they would not say that there was a housing bubble, even if they believed that there actually was one.


The Power of the Press: Congress Takes Back Tax Breaks for Big Oil

The New York Times had an article this morning about efforts in Congress to renegotiate federal oil and gas leases that gave the industry a windfall projected to be $20 billion over the next 25 years. The sums at stake are not huge for the country or the industry (the $800 million annual windfall is less than 1 percent of the industry’s current profits), but the story does show the impact that the media can have when they do their job.

The windfall was part of the energy bill approved by Congress last year. It included a provision that gave an incentive for the industry to drill in deep water off the U.S. coast, by not requiring royalty payments. The prior energy bill also included this incentive, except royalties would be required if the price of oil crossed $34 a barrel. The new energy bill dropped the $34 threshold provision, making all oil and gas from these wells royalty free.

Times reporter Ed Andrews wrote a series of pieces earlier this year exposing this little-known clause. The resulting outrage is forcing Congress to rewrite the legislation and require the government to renegotiate the leases. The press can do good.

Two small points:

1) To an outsider from another planet, this proposed renegotiation of offshore energy leases might look similar to the recent renegotiation of energy leases in Bolivia, Ecuador, and Venezuela that have prompted such outrage from the media.

2) The principle of having royalty payments kick in when oil prices cross a certain level works pretty much the same way as a properly designed windfall fall profit tax. The idea is that the industry will have incentives based on an expected future price of oil, but if the price soars, presumably due to events beyond the control of the industry, the government takes back part of this unearned and unexpected windfall.


Budget Reporting Without Context

The Times ran a piece this morning on a budget resolution passed by the House last night. According to the article, the resolution provides for a substantial increase in defense spending (not counting war expenditures) and some degree of cuts for everything else. However, it is not clear where (if anywhere) adjustments have been made for inflation (now between 3.0-4.0 percent) so I doubt that many readers have any clear sense of what spending changes would be implied by this resolution for a $2.7 trillion budget ($2.8 trillion on NPR).

In fairness, this bill was passed at 1:00 A.M. and the Senate will almost certainly not approve it, but if it was worth writing about, it was worth writing about in a way that provided information to readers.


The Conservative Nanny State in html

To increase sales, we now have my new book, The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer, available for free download in html format. It is still possible to get a free PDF download, or you can also order a paperback copy.

Also, for those interested in asking questions on the book, or just questioning my competence and integrity, I will be guest blogging at Maxspeak on Wednesday, May 24, from 1:00-2:30 (EDT).

European Union Enlargement and Mexico

Both the Clinton and Bush administrations were eager proponents of European union expansion, calling on the EU to quickly admit the former Soviet bloc countries, as well as Turkey. The media have typically presented resistance to rapid expansion as reflecting perverse European fears of globalization. The Post had another piece in this vein this morning.

In assessing this resistance to expansion, it would be helpful to point out that the EU is more than just a NAFTA type trading bloc. It is a quasi-state, that in principle allows free movement of people and workers across borders and provides for substantial subsidy flows from richer regions to poorer ones.

In this context, the people who oppose rapid ascension of the considerably poorer countries of east Europe and Turkey are showing the same sort of perverse fears as those people who oppose free entry of Mexican workers into the United States and a committment to use federal tax revenue to quickly bring Mexico up to U.S. living standards.


Immigration ID Logic

Perhaps I’m missing something, but it seems that there is an obvious flaw with President Bush’s proposal to have a tamper proof identification card for guest workers. As I understand it, under his program guest workers would be required to present this ID to employers when they get a job.

The flaw in the logic is that all workers are already required to present ID to employers showing that they are either a U.S. citizen or have legal authorization to work in the United States. The problem is that the necessary documents can be readily forged, which is why so many workers are employed illegally.

The question is, if the documents accepted for proof of U.S. citizenship can still be readily forged, what difference does it make that the ID for guest workers is relatively secure? If the flaw in the president’s plan has been reported, I have not seen it.


No Fun With Numbers: Another Cost of Intellectual Property

The Times had a piece this morning about how Major League Baseball is suing to prevent fantasy baseball games from using players' statistics without paying a licensing fee.

The article tried to be fair in presenting the views of both parties as well as independent legal scholars. What is missing from the discussion is any independent economic analysis. The lack of economic analysis in articles on efforts to extend intellectual property has been an ongoing problem in the media (read the discussions of the legal battles over Napster and related services). This would be comparable to reporting on the debates over agricultural protections without ever referring to their economic costs.

The economics profession has not been very good in its treatment of intellectual property (IP) issues, but that should not give the media an excuse to ignore the often sizable economic impact of IP controversies.


Two Points on Health Care

Since questions continually arise on my health care postings, I will make a couple of points here that do not directly relate to the news coverage.

First, health care costs have posed a problem everywhere, but nowhere do they pose as much of a problem as in the United States. If we look at the OECD data, in 2003 (the most recent year available) the United States spent 15.0 percent of its GDP on health care. The next three countries ranked by expenditure as a share of GDP are Switzerland, Germany, and Iceland at 11.5 percent, 11.1 percent and 10.5 percent, respectively. Canada clocks in at 9.9 percent of GDP, Sweden at 9.4 percent, and the United Kingdom at just 7.7 percent.

The comparison of GDP shares actually understates the gap in expenditures. Per capita GDP is more than 20 percent higher in the United States than in Europe, primarily because we work more hours.

The difference in current expenditure levels is attributable to much more rapidly growing costs in the U.S. than elsewhere. In 1970, the United States was tied with Sweden and the Netherlands for 3rd place in the rankings, behind Canada and Denmark. The story in other countries is that health care costs have somewhat outpaced the growth in per capita GDP (this is partially due to aging – most of these countries have a considerably older population than the U.S.), it is only the U.S. where health care spending is exploding relative to GDP.

The other point is that the projected cost explosion for our public sector health care programs (primarily Medicare and Medicaid) over the next two decades is grounded in projections of exploding private sector costs. I don’t make these projections – they come from the Centers for Medicare and Medicaid Services (CMS). The projections may well turn out to be too pessimistic (we should all hope that they are), but it is ludicrous to make plans to only deal with the public side of the problem and not address the problem of health care costs in the private sector.

The CMS projections imply that the average cost of health care for a person between the ages of 55 and 65 in the year 2025 will be almost $18,000 (in 2005 dollars). These are the 10 years before people reach the age of Medicare eligibility. How do we think that these people are going to pay for their health care in 2025? Anyone who is serious about tackling the projected explosion in Medicare and Medicaid costs better have a plan to deal with the explosion of private sector costs, otherwise, they are not being serious.