Gluck: In your book, you point out that China has not done all that much in this direction. Just about a week into the Obama administration, Tim Geithner criticized China for not allowing its currency to float more freely.
Wolf: China is, in my view, a currency manipulator. But I don't believe that is the heart of the crisis, and therefore focusing on it is a mistake. The crucial thing to focus on is the level of domestic spending in China. If domestic spending rises by enough-and it has to rise a lot relative to potential output-then the current account surplus will take care of itself.
Gluck: The stimulus plan being finalized in Congress right now-is that going to be enough to jolt the economy out of recession here in the U.S.?
Wolf: My reading of the numbers suggests very, very strongly that the answer to this question is no. But I never really thought it could. There still seems to be a lot of thinking in the U.S. that you can have a short-term stimulus that pump-primes the economy and then everything goes back to normal. I think this is nonsense. We are in a world in which, at least for the moment, private spending is collapsing. The government can and should fill the gap to sustain demand in the economy. Otherwise, we risk a cumulative collapse in demand. As private sector demand collapses, this leads to higher unemployment and more bankruptcy, which leads to more cutbacks in spending and so on, all the way down. That's how you get a real depression.
In 2005-2006, the U.S. household sector was outspending its income by about 5% or 6%. That has never happened in American history. This was partly on residential investment and partly on the purchase of consumer durables. This was, of course, all debt-fueled, and U.S. households were borrowing more than ever before, and its debt to disposable income ratio doubled. This can never happen again.
As I said, the fiscal package is just palliative. In the long run, you need higher investment in the economy-particularly from the private sector. The other thing that has to happen, as I've frequently said, is exports have to rise. There has to be more demand from abroad.
The fiscal stimulus likely is going to have to last for quite a while. It's not just a one-off. It's a holding operation until these bigger adjustments occur, but it is not about pump-priming so that American households can spend crazily again-because they are cashed out.
Gluck: You have written in your column in the Financial Times that economic "shock and awe" are needed to keep the U.S. from slipping into malaise or possibly worse. Explain what you mean, because a lot of Americans consider an $800 billion spending package to be shock and awe.
Wolf: Well, it's $800 billion over two years, so it's $400 billion a year, roughly. I think many people in America seem not to understand how big their own economy is, so they get a bit confused by all this. The U.S. economy is roughly $14 trillion a year. That's $14,000 billion a year. Eight hundred billion dollars, therefore, is about 6% of GDP. Over two years, that's 3% of GDP a year. In the context of a massive downshift in private spending, which is the main reason for the fiscal deficit today, a 3%-a-year stimulus is going to be an inadequate offset.
It is possible that the Fed's actions will be enough to prevent it, but I'm not convinced of that because the Fed ultimately-while offsetting the collapse of the financial system-is not itself creating final demand which the government spending plans can do.