Friday, October 12, 2007

Investment or Consumption? Consumption or Investment? What’s a Person to do?

The minutes of the September 2007 Federal Reserve Board Meeting indicated that fed governors were concerned that "if declines in house prices were to damp consumption, that would feed back on employment and income." They voted for a 50 basis-point interest rate cut to stem that prospect.

The U.S. suffers a savings/investment imbalance. We run an annual current account deficit in excess of $700 billion. This requires that the rest of the world lend us $2 billion a day to keep our international accounts in balance. Economists decry the lack of saving on the part of Americans. Although the gap can be filled by transfers of foreign savings, it puts the U.S. in a position of dependence on foreign capital, and also puts the dollar at further risk should foreigners decide to reduce their holdings of U.S. assets.

Whenever the economy looks weak or is threatened by a reduction in consumption, pressure is put on the fed to reduce interest rates lest the economy slow down. Yet almost every member of the fed and economics communities routinely assert the need for more domestic saving. It is obvious that the latter goal cannot be met if, as a first priority, consumption must be sustained. This amounts to an "iron law of consumption." Selling the family jewels, furniture, paintings, antiques, clothing, and ultimately the mansion to sustain consumption, however desirable in the short run, has very serious long-run consequences.

Kenneth Rogoff and Maurice Obstfeld, economics professors at Harvard and U.C. Berkeley respectively, believe that continued high current account deficits could lead to another 30 percent fall in the dollar against the euro and pound. That would take the euro up to $1.80 and the pound to $2.60. Imagine the bite that travelers will feel paying a thousand dollars a night for a premier hotel room and $80 for breakfast on their European vacations or business travel.

This prospect raises an important issue: Is globalization compatible with sovereignty? (More on this later.)

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