Friday, July 02, 2004

John Quiggin has a -- shall we call it, "thought-provoking"? -- post today on "The Republican case for inflation". It's worth reading.

The Republican case for inflation is better than Quiggin admits, however. As interest rates rise, US debt obligations will rise as well. One important gravity-defying aspect of the US economy since the late 1980s has been its ability to be simultaneously a net debtor to the rest of the world (the US net investment position turned negative in 1988) while still receiving a positive net financial income. In 2003 the US net investment position was $2.4 trillion in the hole, some -25% of GDP, but net financial income was +33.3 billion. That is, we Americans make a tidy profit on our foreign investments while foreigners with capital in the US don't make squat.

With rates rising, and foreigners being most interested not in our stocks or FDI opportunities but in our government and corporate debt, this net flow of financial income could very well reverse. In fact, it's a minor miracle the flow hasn't reversed yet. With annual current account deficits, the size of the investment debt only grows and grows. When financial income reverses as well, the US starts falling into a serious debt trap. And the best way to get out of a debt trap? Inflate your debts away.

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