The sky isn't falling...part II

Blogger Dale Franks at the QandO blog responds to yesterday's post in The National Piggy Bank II.

I think I sounded more inquisitorial than I intended. While we do share some common ground (e.g., fiscally relatively conservative) we do have some significant differences which can be summed as follows:

1. Franks believes that the Bush tax cuts aren't stimulative and are costing the government money. First, the middle class are likely spending the extra income nearly dollar for dollar and the higher brackets are spending some and saving/investing some. Second, the supply side effect of the cuts in government revenue may take time to manifest and I am not convinced that nominal rates are low enough that 'supply-side' effects are negligible. (Note, reside in a usuriously taxed municipality in a high tax state)

2. The twin deficits are important BUT the levels are more or less within historical ranges and the ability of the United States to withstand sizable deficits is greater than indicated.

3. The idea that foreign capital could suddenly 'leave the party'

In response to The National Piggy Bank II stating that the government has the right to print money that doesn't mean Weimar monetization, it means that the government can grow/allow to grow the money supply over time which reduces the value of the deficit/debt.

With regard to the potential currency fluctuations scaring international investors there is significant currency risk. Which is why there is a huge, liquid market where investors can HEDGE their currency risk. And many do. Some choose not to. If the People's Bank of China wants the to hold US Treasuries but is afraid that the dollar will plummet against, say the JPY, they can either sell dollars forward against the JPY or buy a put option on USD/JPY. (They don't need to worry about the USD/RMB rate because they've pegged it at 8.28)

So, foreign investors will adjust their US holdings over time but barring unforeseen cataclysmic events it is extremely unlikely that movements in and out of US markets will occur in an uncontrolled fashion. (Looking at holdings of US Treasuries (which ARE universally recognized as riskless in default terms) foreigners held 15%ish of outstanding in the early 90s which grew to low 20%s in the late 90s boom and are hovering around 20% today.)