In my previous post on Peter Schiff and the Austrians a commenter pointed out that I might be misrepresenting Schiff’s position and that it could be salvaged if we allowed for some of Schiff’s own nonsense assumptions. The conversation got a little weedy and veered off course somewhat. Here I would like to take the commenter’s argument at face value, not debate the accounting and see if Schiff’s position remains consistent with very basic macroeconomics.
Okay, so let’s start with our sectoral balances framework,
(S – I) = (G – T) + (X – M)
Now, let’s substitute in some numbers that are fairly consistent with the current US numbers (all numbers are expressed as a percentage of GDP),
(8% – 4%) = (14% – 6%) + (4% – 8%)
These are approximations, of course. I did not look up the real numbers. But they are not far off and using them will not harm our argument in any way.
Now, recall that Peter Schiff argued that the US should do three things: first, it should increase savings; second, it should decrease the government deficit; third, it should increase the interest rate and strengthen the dollar.
In order to examine the first of these the commenter suggested that we reorganise the equation as such,
(S) = (I) + (G – T) + (X – M)
Again, we can give those expressions numerical values,
(8%) = (4%) + (8%) + (4% – 8%)
I’m not altogether comfortable with this approach for reasons I laid out in the comments section. But let us proceed to examine Schiff’s argument in this light anyway to see if it is possible.
Now, the interest rate should rise according to Schiff. This has the effect, according to him, of increasing private savings — which it would. But it would also have the effect of increasing the trade deficit as imports, M, became cheaper and exports, X, more expensive. Let’s plug some numbers into those parts of the equation then,
(10%) = (?%) + (?%) + (2% – 10%)
In order for this to balance, as I pointed out in the piece (while providing empirical evidence of just this) the government deficit, (G – T), would have to increase. The commenter said that this was not the case. Instead, private investment could increase.
There are two assumptions that need to be examined here. (1) That private investment would increase in a high interest rate environment and (2) That an increase in private investment in the face of a rise in the value of the dollar would not increase imports, M, and further worsen the trade balance.
Both assumptions are false. Private investment tends to fall, not rise, in the face of high interest rates — that is basic macroeconomics. Also, with a high value dollar imports would obviously rise if investment increased.
Let’s suppress the first assumption though. Let’s imagine that investment, for some bizarre reason, did rise in the face of increased interest rates. But let’s be realistic and assume that this also led to an increase in imports because of the increased investment together with the higher valued dollar. So,
(10%) = (8%) + (?%) + (2% – 11%)
Well, now we have to balance the equation by adding in a value for the government balance, (G – T), right? So, let’s do that,
(10%) = (8%) + (11%) + (2% – 11%)
What has happened? Even assuming that private investment increases in the face of high interest rates — a highly unlikely, if not impossible assumption — if we allow that such investment would further deteriorate the trade balance in the face of a high valued dollar, the government deficit still increases from 8% of GDP in our first equation to 11% of GDP when we try to implement Schiff-o-nomics.
This is, of course, perfectly consistent with the empirical example I laid out in the original post.
We could, of course, tell some different stories. We could have wages fall and this might offset the fall in exports from the higher valued dollar. Let’s try that then. Let’s say that the wage decreases totally offset the fall in exports,
(10%) = (8%) + (9%) + (4% – 11%)
Well, the government deficit still rises from 8% of GDP to 9% of GDP.
The lesson should be clear: Schiff’s story is totally inconsistent. It makes no sense. When examined in any detail it simply does not add up. Even if we give him the benefit of the doubt on certain issues — like the fact that investment will increase in the face of high interest rates — the argument doesn’t add up. Schiff and the Austrians are talking swill that is totally at odds with very basic macroeconomics. And that is the end of the story.