I was listening to the radio the other night (NPR's Marketplace), which had a piece by sometime Labor Secretary and now pundit Robert Reich. The main upshot was poo-pooh'ing Obama's plans to cut the deficit as soon as is practical. The official plan is to reduce it by 50% by the end of his first term, which means starting to slice pretty aggressively as soon as the current free-fall is over.
Reich's main point was that the deficit doesn't *really* matter all that much in practice, at least not in the near term, because it's being funded by countries like China, and they don't have any choice. They have to keep buying Treasury bills because they've already bought so many. If they and other countries stop doing so, or worse yet, sell T-bills, the dollar will begin to sink, and all their existing holdings will be worth far less. They don't want that (for several reasons), so they need to keep buying.
We have a word for this, boys and girls: "bubble". When one asset class is providing excess returns, people pile into it because it is doing so. This causes the returns to continue to inflate, so others continue to pile in. In this particular case, it's not so much returns as security -- since everyone else is betting that T-bills are secure, everyone keeps making that bet. In this case, there are also additional reasons, particularly that everyone desperately needs the US economy to restart, so they can start selling us stuff again, and they need the dollar to remain strong relative to their own currencies so they can afford to do so.
Of course, the problem is that bubbles pop, and it doesn't take much to do so. Say it isn't China that starts pulling out, it's some smaller country -- pulling a name out of a hat, Thailand. In and of itself, that makes little difference. But it makes a somewhat larger country -- say, Indonesia -- notice, wonder what *they* know, and start to weaken its support. Before long, you have a full-scale panic, because nobody wants to be the last one left in a sinking market. And as it happens, the dollar crashes, quickly and ever-further. (Which, granted, suddenly gives us export power. But having export power in the resulting world depression is a mixed blessing at best.)
Everybody keeps talking about the "bubble" in credit card debt, which is at best a half-truth. There is probably a bubble in the securitized obligations built on credit card debt, and some of those will pop. But by and large, credit card debt isn't likely to cause bubbles, because you defaulting on your credit cards doesn't make me any more likely to do so, at least in any direct way. (Whereas you getting foreclosed *does* reduce the value of my house -- hence the mortgage bubble.) But it sounds to me like Treasury Bills *are* a bubble, and one that is several orders of magnitude bigger than... well, anything.
And *that* is why reducing the deficit matters. The US needs to get serious about its debt, precisely because it is the only way to bleed pressure out of that growing bubble. That, in turn, reduces the likelihood of a sudden day of reckoning that would make the current credit crisis look like a sideshow.
Today isn't the day for it -- despite being a member of the Concord Coalition from its founding days, I do think the stimulus package was necessary -- but starting to lay concrete groundwork to deal with it tomorrow is absolutely the right thing to do. Indeed, I worry that Obama's plan may not reduce it fast enough, but I think it's probably about as good a goal as is actually plausible in that time frame, and some of his other initiatives (in particular, evaluating the effectiveness of health care) have promise to reduce it further in the long run...