Wolf releases the hounds

Martin Wolf has another good column.  He keeps saying the same thing again and again of course, but as he refines it it's easier for us macro-economic novices to understand.  The punchline:

In last week's column ("Choices made in 2009 will shape the globe's destiny", January 6) I argued that the debt-encumbered US private sector would now be forced to save (see chart). The excess of income over expenditure in the private sector might be, say, 6 per cent of GDP for a lengthy period. If the structural current account deficit remained 4 per cent of GDP, the overall fiscal deficit would need to be 10 per cent of GDP. Moreover, this would be the structural – or full employment – deficit.

After that you can look at Naked Capitalism's typically anodyne comments on this logic.  She emphasizes a point which is slightly obscured by the way Wolf presented things, namely that his calculations of the deficits required to bring things back into balance are cumulative and structural.   That is, they are the best case scenario where the whole system stays at full employment the whole time.  The best way to do this is to take your lumps immediately, rather than letting things drag along and letting the gradually unfolding of the insolvency of the financial system, and the uncertainty this creates, lead to lost production.  This is why Wolf suggests proceeding directly to not just bank recapitalizations, but the forced mark downs of mortgages, asset-backed securities, and commercial real estate loans.  Or as Yves puts it:

Wolf is recommending cleaning out a badly infected wound full of shrapnel before it turns to gangrene. We'd rather take a penicillin shot and hope it clears up. Fat chance.

The end of her post also has an interesting quote from M. Pettis:

To get back to China and current issues, the problem with the US trade deficit now is sort of a "Keynesian" problem. US demand has the impact of generating both US production (and employment) as well as foreign production (and employment), and in a world of contracting demand, it is natural that countries that export demand – i.e. trade deficit countries – are going to be a lot less eager to do so. Anything that brings imports closer into balance with exports is likely to have a demand-enhancing impact similar to fiscal expansion, with the benefit that this isn't achieved by running up fiscal debt. On the other hand it will have a demand-reducing impact for trade surplus countries. That is why trade disputes are likely to be very attractive to trade deficit countries who have – I will continue to insist but it seems recently that this has become a much less "surprising" claim – the upper hand in any dispute with the "virtuous" countries with high savings rates and trade surpluses.

This actually adds another element to the debate, because it takes the 4% structural current account deficit that Wolf talks about as a given (the US as a whole currently "exports demand" to China because we have) and makes it a variable.  If the US needs to produce more than it consumes for a time, one way to do this would be to produce ourselves the part that we have China producing for us now.  This sudden repatriation, needless, to say, would not make the Chinese happy.