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Wednesday, April 20, 2005

Bruce Bartlett Whispers the "R" Word

by Calculated Risk on 4/20/2005 01:22:00 AM

Bartlett believes that talk of a recession is "premature", but he expresses his general concerns that "the financial sector of the economy is under growing strain that could burst and spill over into the real economy suddenly and without warning."

He concludes:

... there are the dreaded “twin deficits” looming over financial markets. Huge budget and current account deficits mean that vast amounts of capital flows are necessary to keep them funded. So far, this has gone well, but that is largely because the Chinese have been so accommodating about financing them—effectively financing their own exports by buying large quantities of U.S. Treasury securities with their export earnings.

But now the U.S. is strongly pressuring China to stop doing this in order to allow its currency to rise against the dollar. It is hoped that this will reduce China’s production advantage in dollar terms and bring down the bilateral trade deficit. However, the cost to the U.S. economy if this happens could be greater than the potential gain. At least in the short run, any scale-back in China’s buying of Treasury securities might cause interest rates to spike very quickly. This could prick the housing bubble and bring down home prices, eroding personal wealth and putting a squeeze on those with floating rate mortgages.

Hopefully, this can all be managed smoothly and without either a recession or a market break. But it will take great skill and a lot of luck to avoid both.
My question: Great skill? By whom? Is there anyone in the Administration even thinking about these issues?

UPDATE: pgl and William Polley add some comments. Make sure to read the comments in response to pgl's post.