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[quote=Anonymous]From Nobel prize winning economist Paul Krugman's newsletter.  I can't include the graphs he shares, but it's a scary scenario he's describing.

[quote]
I wrote a month ago about the possibility of a sudden stop for the United States. Despite growing pressure on both U.S. interest rates and the dollar, we aren’t there yet. I was, however, a disciple of the late, great Rudiger Dornbusch, whose students often quote Dornbusch’s Law:

The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.

So a U.S. sudden stop still looks quite possible, indeed considerably more likely given the grotesquely cruel and irresponsible budget bill Republicans are trying to ram through. It doesn’t help that key players are being utterly dishonest about what they’re doing: House Republicans have been denying that the bill will increase the budget deficit, while Trump claims that “We’re not touching anything” on Medicaid, just eliminating waste, fraud and abuse (and somehow taking away health care for millions in the process.) Low-information voters may be fooled for a little while, but bond markets won’t.

But while I’ve already written about the possibility of a sudden stop, I haven’t said much about what such a stop, if it happens, would look like. So let’s game it out.

The starting point here is the fact that the United States runs persistent, large trade deficits:

We’ve been able to cover these deficits painlessly because the world has been eager to invest in America, with large inflows of capital matching our deficit in goods and services. One consequence of decades of capital inflows, however, is that America owes a lot of money to the rest of the world. Here’s our net international investment position, the difference between U.S. assets abroad and foreign assets here, shown as a percentage of GDP:

That’s a lot of U.S. debt held by foreigners! It hasn’t been a problem in the past because foreign investors have considered America a good place to put their money. But what happens if they change their minds?

A footnote: official numbers almost certainly understate how much America pays out each year to foreign investors, because of tax avoidance. Multinational corporations that earn profits in the United States use strategies like fictitious pricing and transfers of intellectual property to make those profits disappear here and reappear in low-tax countries like Ireland.

But the important point for now is that we have a big trade deficit covered by large inflows of capital, which in turn reflect the fact that foreign investors have considered America a good place to put their money.

And the question is what happens if investors change their minds — if they decide that we’re an unserious country in which the governing party believes in voodoo economics and the president is an authoritarian ruler who spends much of his time rage-tweeting about popular musicians.

A sudden stop to capital flows into America would mean that there would no longer be money to cover those big trade deficits — and this would mean a sharp drop in the foreign exchange value of the dollar. On the eve of its 2001 sudden-stop crisis Argentina had a trade deficit, as a share of GDP, similar to that of the United States now — and when the crisis hit the peso lost more than half its value. A U.S. sudden stop would probably be less severe because our foreign debts are overwhelmingly in dollars, which insulates us from some of the fallout Argentina faced. Still, this could be ugly.

The impact on interest rates could be especially ugly. The United States relies on inflows of capital from abroad to pay for a significant part of domestic investment spending.

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