Working Papers

The Doomsday Cult Comes to Reno

Warren Buffett is sounding more and more ridiculous:

“Right now, the rest of the world owns $3 trillion more of us than we own of them,” Buffett told business students and faculty Tuesday at the University of Nevada, Reno. “In my view, it will create political turmoil at some point. ... Pretty soon, I think there will be a big adjustment,” he said without elaborating.

One of the difficulties confronting the doomsday cult is that it requires a vivid imagination like Buffett’s to construct plausible scenarios that would give rise to serious concern about external imbalances, at least for countries with floating exchange rates.  Their worst case scenario - a ‘disorderly’ adjustment in foreign exchange markets - is something the doomsday cult should in fact welcome, since it is the shortest and most painless route to reducing imbalances.  It makes no sense to worry about the supposed disease as well as the cure.  One of the main advantages of having a floating exchange rate is that it insulates the domestic economy against external shocks.  It is far preferable to wear any adjustment to external imbalances on the exchange rate than on domestic growth.

posted on 25 January 2006 by skirchner in Economics

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“It is far perferable to wear any adjustment to external imbalances on the exchange rate than on domestic growth” —

I think you consider me somewhat to the shrill side of the sage of Omaha, yet I completely agree with your statement!  That’s why I have criticized central bank intervention in asia and in the oil exporters that has kept their currencies artificially weak, deferring the necessary (from my point of view) adjustment.  And obviously, i think the longer the adjustment process is delayed, the greater the risk that overall adjustment won’t be smooth.

I don’t see the cognitive dissonance, however.  I don’t worry about disorderly moves in the fx market; I do worry—as any sane person should—about disorderly moves in the US fixed income market.  Disorderly adjustment comes if fx market moves lead to moves in the fixed income market, and the corresponding real adjustment is not smooth.  Over time, resources have to shift from real estate/ domestic interest sensitive sectors to manufacturing/ service exports (or import-competiting sectors), and in the real world, that process won’t happen instantly or without big impacts on many lives.  Smooth adjustment implies smooth moves in key financial markets and smooth shifts in the composition of output in response to those signals.

Posted by .(JavaScript must be enabled to view this email address)  on  01/26  at  03:40 AM

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