It may be 10 or 20 years before debts get so cripplingly large that the president starts to pressure the Fed into abandoning its non-inflationary mandate. In all likelihood, the bank will never have to respond: when holders of U.S. dominated debt (read: China) get antsy about the future prospects of the dollar, they'll dump them at a loss, causing a devaluation the same as if the Fed printed money. We might get a devaluation much sooner than we'd planned just because our creditors lose faith. In the short term, at least, this is a more likely scenario, similar in spirit to Krugman's 1979 effort "A Model of Balance of Payments Crises".Today, in the NYTimes, the same Krugman writes of 'China's Dollar Trap':
China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets...And, just as I proposed, they're torn between dumping dollars at a big loss, or continuing to float down this river in hopes that something, somehow changes. Hence, Krugman writes, the vain idea of a global currency:
And just the other day, it seems, China’s leaders woke up and realized that they had a problem... [T]hey are, apparently, worried about the fact that around 70 percent of those assets are dollar-denominated, so any future fall in the dollar would mean a big capital loss for China.
So what Mr. Zhou’s proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. That’s not going to happen.Note: observant readers will note that this blog is not generally a fan of Paul Krugman, who abandoned a career as a good economist to become a lousy blogger. He remains generally sharp on his own fields of economics, like currency crises, though he gets pretty sloppy, as with the 'absence of mind' reference in today's piece.