From Paul Krugman, via Brad DeLong:

[Stephen Roach} seems to have subscribed to the Underpants Gnomes theory of trade balances:

1. Increase savings
2. ?????
3. Exports!

To be honest, sometimes I feel that I’ve spent most of my adult life knocking down the same misunderstanding, over and over again. I wrote about more or less the same issue more than 20 years ago:

There is a widespread view that world payments imbalances can be remedied through increased demand in surplus countries and reduced demand in deficit countries, without any need for real exchange rate changes. In fact shifts in demand and real exchange rate adjustment are necessary complements, not substitutes.


This is what I was trying to drive at in Slash and Grow, though I was more of an ‘elasticity pessimist”, to borrow another phrase of Krugman’s; it did not look like a collapse in the £ would necessarily give us the external demand we needed, but has in the past often seen see increased margins instead. I intend another post on this one day, you lucky people.

I think if I had titled the paper something to do with Underpants and Gnomes, it might have got more attention. And the choice of graphic would have been much easier.


5 thoughts on “I wish I had heard of the Underpants Gnome theory before

  1. Although Paul Krugman has been pointing at the RMB/USD peg for some time. The article last week was particularly strongly worded. Maybe it was just in response to China ruling out an appreciation. Alternatively, because PK has a global audience he may have been encouraged by someone in the Obama administration to write it to stoke debate. A debate that sees others blaming the currency peg for depressing global demand opens the door for Geithner to label China a currency manipulator next month.

    1. Good post. Though one must admit that econ liberals are often guilty of the same, ahem, optimism. Like in the standard ‘solution’ to a problem:

      ‘there isn’t universal healthcare. Oh, and some of the regulations suck’

      ‘scrap all the regulations! All the markets will spring up to fill all the needs!

      See lib vision on healthcare for an example. One neat way of filling the ????? Bit is to assume absprcial magic to the words ‘civil society’ …

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