Brad DeLong's Semi-Daily Journal: Global Excess Liquidity?:
Brad DeLong has provided a simple, brief explanation of the economic problem looming over the country:
"Where I see the potential problem is that the dollar is overvalued and may--any moment--fall by 40% or more, should international currency speculators decide that the dollar's run is over and should central banks decide that keeping the value of the dollar high is now too expensive. The United States currently imports 16% of GDP. A 40% price rise in 16% of GDP is a one-shot 6 percentage point increase in the price level. The Federal Reserve is not going to let the inflation rate jump far above 3% per year: it will respond to a falling value of the dollar and the resulting accelerating inflation by raising interest rates far and fast. Thus should a sudden 40% (or more) fall in the dollar take place, a big recession follows.
"The way to try to head off this potential problem is to try to make sure that the decline in the dollar takes place slowly and gradually. Slowly shrink the federal government budget deficit--even move the government budget into surplus. Take other steps to shrink gross domestic purchases relative to gross domestic product. Allow other currencies to slowly appreciate relative to the dollar so that the supply shock delivered by dollar decline is spread out and small in any one time period.
"But raising interest rates is not a way to head off this potential problem. A balanced increase in interest rates would not affect the dollar, and leave the dollar overvaluation problem as serious as ever. An increase in U.S. interest rates would make dollar-denominated assets more attractive, and increase the magnitude of the dollar valuation problem. An increase in U.S. interest rates would raise U.S. unemployment. And to what gain?"
Like the War in Iraq, this economic situation presents a very real threat of "Hooverization." That is, the Bush administration may well succeed in pushing this problem off onto whoever is fool enough to get elected President in 2008. Putting off this economic disaster to 2009 or beyond is certainly feasible, and, for the conspiracy theorists among you, many of Bush's proposals on taxes, Social Security, etc., are loaded out there in 2009-2011, creating, in effect, timebombs, for whomever follows George "Apres Moi" Bush.
The kind of soft landing Brad describes was accomplished, more or less, by Clinton in the 1990's. Don't bet on Hillary doing such a great job. And, don't bet on a Republican at the Federal Reserve cooperating with a Democrat. The right-wing want deflation. The merely rich and very rich are not concerned about losing their jobs, and are more than willing to sacrifice the American middle classes to preserving the value of their claims on the U.S. treasury. Better 10% unemployment, blamed by the corporate right-wing media on a Democrat, than a bout of (wage) inflation. Rising wages are so icky!