Krugman talks down the dollar

The global economic free fall may be over, says the Nobel Prize winner, but that's no reason for cheer

Published May 21, 2009 5:47PM (EDT)

Even when Paul Krugman is saying relatively encouraging things about the economy, he still leaves some room for deep gloom. Speaking at a seminar in Ho Chi Minh City today, reports Bloomberg, Krugman said he thinks the "free fall" of the global economy may have come to an end.

The American economy may expand "slightly" in the second half, he said, citing a slowdown in the pace at which jobs are being lost.

Just about all of the economic indicators out there are suggesting that the free-fall has come to an end, that we've stabilized ... Probably the worst in terms of shocks to the system is over.

But ... there's a big but. Stabilization of the economy means that nervous investors worldwide will no longer be seeking the "safe haven" of U.S. dollars. Up until now, even though the U.S. is running huge deficits and the Fed is printing money like crazy, implying that inflation will eventually take hold, the value of the dollar has remained strong simply because it's the best of a bunch of bad options. But as tension eases, the appetite for the dollar will likely decline sharply, said Krugman.

This suggests a very nasty paradox. By going all out with both fiscal stimulus and expansive monetary policy, the U.S. may have stopped the bleeding. But to pay for these expensive treatments, the U.S. government depends on investors continuing to snap up U.S. Treasury bonds and bills -- which become progressively less attractive as global panic subsides.

So success breeds failure. But then again, a weakening dollar would presumably make U.S. exports more attractive globally, which could provide a much-needed stimulus to the American manufacturing sector. Which could cut down the trade deficit and increase domestic tax revenue that might help reduce the ongoing budget deficits. And around and around we go.

By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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How The World Works Paul Krugman U.s. Economy Wall Street