I'm not sure if anyone has done so, but it'd be neat if the ongoing US-Asian exporting countries situation can be defined in a game theory scenario, i.e., the "Prisoner's Dilemma". That is, what are the payoffs and losses on each side if:
(1) The US keeps borrowing at the current pace while Asian exporting countries pile on reserves well in excess of what's necessary;
(2) The US tries to keep borrowing at its current pace, but Asian exporting countries abruptly stop funding the CA gap;
(3)The US induces a slowdown in consumer spending at the expense of Asian exporting countries eager to keep the dollar artificially overvalued;
(4)The US induces a slowdown in consumer spending, while at the same time, Asian exporting countries stop funding the CA deficit.
The theoretical implications could certainly help us understand this situation better. Much is at stake here, and all means of analysis are welcome.
I haven't seen, much less done, a formal analysis of the outcomes, but surely a cooperative solution would dominate the noncooperative outcomes. A higher US saving rate, most easily achieved by an increase in public saving from its current abysmally low level, and a gradual tapering off of increases in Asian foreign exchange reserves, would be better for both sides than noncooperative and sudden solutions. But now that we're about to spend 1-2% of GDP to clean up after Katrina (per year or over several years?), what will happen to our budget deficit? It's hard to imagine Bush raising taxes, cutting spending in Iraq or other military spending, or even vetoing highway bills. With all the stimulus from spending on Katrina and Iraq, it seems unlikely that we'll have a slowdown [(3) and (4) above]. How long can (1) continue? If (2) occurs, at least we will no longer be embarrassed by our failure to explain the flat yield curve we now have.
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