Paul Krugman:
Franc Thoughts on Bond Vigilantes: Suzy Khimm writes about the contrast between what financial industry honchos say worries them and what financial markets seem to be saying. The honchos declare that failure to reach a Grand Bargain would "spark a damaging loss of confidence in the U.S. government’s fiscal prospects, a run on Treasury bonds, and a spike in interest rates." But the bond markets are saying what me worry, with long-term rates at near-record lows….
[I]t’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionary effect? Yes, I know, Greece — but Greece doesn’t have its own currency…. The closest I can come to anything resembling the danger supposedly lurking for America is the tale of France in the 1920s, which emerged from World War I burdened by large debt, and which did in fact face an attack by speculators as a result…. It’s important to note, however, that France wasn’t a depressed economy in the 1920s, and therefore didn’t look much like America today…. [T]he really big effect was a sharp depreciation of the franc, which made France highly competitive and strengthened the economy:
But what about the brief but nasty slump in 1927? That wasn’t caused by spiking interest rates; it was, instead, caused by fiscal austerity, by the measures taken to stabilize the franc. So even when we look at the closest thing I can find to the scenario the deficit scolds want us to fear, it doesn’t play out at all as described.
