Two cheers for the Washington Post’s coverage of the record trade deficit by Paul Blustein. It opens with mostly the facts:
The U.S. trade deficit soared to a record in 2005 for the fourth
year in a row, according to a government report released yesterday that
provided a reminder of the dangers hovering over a generally robust
economy.The United States imported $725.8 billion more in goods
and services than it exported last year, the Commerce Department said.
That is up 17.5 percent from last year, and it is an all-time high not
only in dollar terms but as a proportion of the economy; the figure is
equal to 5.8 percent of gross domestic product.For December alone, the trade gap increased to $65.7 billion from a
revised $64.7 billion in November. That is the third-highest monthly
deficit ever.
Pretty straightforward other than the "dangers hovering" remark. Now for the analysis. Here, the Post is quite cheerful:
In some respects, the trade deficit reflects the strength of the
U.S. economy, at least relative to other major trading partners.Because
U.S. economic growth has been rapid in recent years, American consumers
are snapping up foreign goods of all kinds — autos, electronics and
clothing being some of the biggest categories. At the same time,
relatively sluggish growth in economies such as the European Union and
Japan has dampened demand for goods made in the United States. Thus
even though U.S. exports rose 10.4 percent last year to $1.27 trillion,
imports surged 12.9 percent to nearly $2 trillion.
But enough cheer. Let’s let the worriers have their say, too:
But the gap worries many economists because it means the United States must borrow heavily from overseas.
As Don has pointed out many times, this simply isn’t true. A trade deficit doesn’t mean borrowing. It means that foreigners are buying American assets. Some of those assets are debt. And some are not. See if you can find the key word in what follows that allows Blustein to mislead the reader without being dishonest:
The dollars that Americans spend on imports are often invested by
foreigners in the bonds of the U.S. Treasury and mortgage agencies such
as Fannie Mae and Freddie Mac, so the more the trade deficit widens and
the longer it persists, the greater U.S. indebtedness becomes. That is
why some analysts fret about a scenario in which foreigners would sell
off U.S. securities en masse, causing interest rates to soar and the
global economy to fall into recession.
The key word is "often." That word contradicts the word "must" in the sentence just before it. Oh, well. This worrisome scenario gets invoked every month, the scenario where foreigners sell off U.S. securities. Now why would they do that? They bought those assets because they thought they were a useful place to park their money. They didn’t do it as a favor. So why would they suddenly decide to sell off those assets? And even if they did, wouldn’t it be hard to sell them off "en masse?" Wouldn’t that make it harder to get your money out at decent terms? Wouldn’t the price of those assets fall?
After describing the worriers’ scenario, Blustein admits that it hasn’t happened yet:
Nothing of the sort has materialized so far. On the contrary, overseas
demand for U.S. investments last year was powerful enough to drive up
the dollar against most major currencies.
Hmm. So not only has the scenario yet to materialize (30 years of trade deficits in a row and counting, but not one bad scenario so far), but in fact, the evidence seems to point in the other direction. So I give two cheers to Paul Blustein. He loses the third one for that "must" and "often" fudge.
Even better, Blustein gets Jeffery Frankel of Harvard to admit that the worriers might be wrong:
"It’s true that many of us have been concerned that foreigners will
grow tired of financing these ever larger trade deficits, and so far
there hasn’t been much sign of that," said Jeffrey A. Frankel, a
Harvard University economist who served on President Bill Clinton’s
Council of Economic Advisers.
But then Frankel goes on (and alas, Blustein quotes him):
"But there are plenty of reasons to be concerned," Frankel said. "We
know [the trade deficit] means we’re borrowing against the future, and
that our children will have lower standards of living than they would
otherwise. And just because a ‘hard landing’ hasn’t happened yet
doesn’t mean it won’t."
The brackets in the quote suggest some ambiguity. But if Frankel was really talking about the trade deficit he ought to be ashamed of himself. He knows that it doesn’t mean we’re borrowing against the future. And he knows that it doesn’t mean our children will have lower standards of living. Even the qualifying phrase "than they would otherwise" is wrong. I think what he really meant was the budget deficit. But even that is silly. The budget deficit isn’t what burdens our children. It’s the spending that is or isn’t worthwhile that’s important, not how it’s financed.
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Have you ever read Mises? I was wondering how you think your comments are consistent with his "The Theory of money and Credit"?
Paul Craig Roberts says:
At a time when America desperately needs the
voices of educated people as a counterweight to
the disinformation that emanates from the Bush
administration and its supporters, economists
have discredited themselves. This is especially
true for “free market economists” who foolishly
assumed that international labor arbitrage was an
example of free trade that was benefitting
Americans. Where is the benefit when employment
in US export industries and import-competitive
industries is shrinking? After decades of
struggle to regain credibility, free market
economics is on the verge of another wipeout.
Excerpted from here:
http://www.counterpunch.org/roberts02112006.html
Strange. Note free market econ in parentheses.
Needs your comment badly, Don.
This one makes me wretch or I'd do it myself.
Maybe later when I've cooled off.
Can anyone tell me the story of Paul Craig Roberts? His bio is really interesting. He looked like a card carrying member of the Kudlow free market republican club until a recent conversion to Left Liberalism. Is this correct?
Hmm, curious fact: I now have the job I've always wanted, but couldn't find until last year, when a UK firm that owns a subsidiary in Texas hired me.
This bit of evil foreign investment, which contibutes to the scary trade deficit, made possible a long-sought career change that has made me very happy; and I'm making twice as much money as I was previously making from my last U.S. employer.
Somehow, I'm pretty sure it makes my future children better off than they would be if I were still unemployed, or making half my salary.
Paul Craig Roberts is a paleocon. He always has been.
- Josh
Actually, there is a point about the lower standard of living of the future generations. Not because of the trade deficit itself, but because the trade deficit is to a great extent consumption-driven. Americans consume foreign goods and finance it through selling off domestic assets to foreigners. This means that the future returns to this capital stock will go to foreigners, and not to future generations. Of course, future Americans still get their labor share from these factories etc., but they will not enjoy the dividends on the assets which their fathers sold today in other to raise their own consumption.
Thus indeed future generations might be worse off. But not due to the trade deficit, but due to selfishness of today's Americans who prefer consumption to holding capital stock for their kids. This might be myopic in the very long term, but it is the optimal intertemporal decision from the point of view of today's decisionmakers.
Two additional points have to be made here. First, I abstract from immigration. Foreign holders of American assets can potentially immigrate, thus becoming Americans. Second, I haven't really looked deeply at the data to be able to say how significant this effect is. It might be that for the U.S., it may be negligible. But imagine a much smaller economy (say, the Czech Republic, where I'm from). In this case, it could easily happen that excessive consumption could lead to unnecessarily selling off _most_ of the country's capital stock to foreign hands. I am not talking about FDIs etc., where there is substantial value added through transfer of know-how, technologies etc.. I am talking about selling well-operating and rentable domestic capital just for the sake of today's consumption, which is nothing but sacrificing future well-being for today's well-being, and thus is nothing but intergenerational transfer.
>Americans consume foreign goods and finance it through selling off domestic assets to foreigners.
Isn't that simply an assumption? We buy foreign goods and foreigners invest in America by opening factories, buying bonds, etc. We invest overseas. Toyota opens a factory here, providing a higher wage which is then spent on American goods or American investment. Etc. How do you know that we have been "selling off domestic assets" at a higher rate than we are thus newly able to create them (because of the higher rate of free trade)?
Trade increases production and wealth through competitive advantage, then the wealth is reinvested – why would you think that there is less invested in America's future?
>> finance it through selling off domestic assets to foreigners. This means that the future returns to this capital stock will go to foreigners <<
I still insist this theory ignores endogenous wealth-creation, but leaving that aside to the next fallacy: the claim that selling assets deprives future generation of ownership.
That might be true if there were only a fixed set of assets to be divvied up, and no new ones were created; and if Americans were devoid of entrepreneurship.
Both those assumptions are clearly wrong.
New wealth and new assets are constantly created (labor + dirt = revenue generating office building). In reality, an American who sells an asset to a foreigner does not "consume" the proceeds, he re-invests it, most likely in a US asset.
And when Americans do work as "wage slaves" (remember that from the Scary Japan era?), they will often take the skills and networks they develop, and go off to launch their own company to create new wealth.
Actually, you look at history and you'll often see that when foreigners are flush with US Dollars, they'll often overpay for a US asset, buy at the top of a market, and wind up selling at a loss, back to an American, a few years later. That's actually pretty funny.
to Liberty:
>> Isn't that simply an assumption?
Let the numbers speak. The private consumption share on U.S. GDP went up from around 63% in the 1970s to around 70% in the 2000s. This is both statistically and economically significant increase. Gross capital formation went down from average 19.5% in 1970s to 18% in 2000s. This already includes the 4-5% trade deficit recorded every year in the 2000s. Government spending, although volatile, was about the same on average. [source: UN]
Foreign assets in the U.S. grew by average 780 bil. USD a year. U.S. assets abroad grew at 453 bil. USD a year. [source: BEA]
Thus it is a matter of fact (and national accounts) that consumption is crowding out domestic investment made by Americans. Otherwise the national account numbers don't add up.
As a second matter of fact, foreigners invest in the U.S. much more than Americans abroad.
I hope this confirms that my assertion is not just an assumption.
>> Trade increases production and wealth through competitive advantage
Well, this is correct – in a static setup, or in an infinitely lived dynamic model. In this case, trade is Pareto improving, no doubt about that. However, you have to think in terms of a dynamic model with limited participation. I come to this later.
to Kevin:
>> I still insist this theory ignores endogenous wealth-creation,
Well, I did not ignore it at all. I stressed that foreign investment can be a valuable source of technological transfer and other benefits, and thus contributing to domestic wealth creation. However, the U.S. should be a country that heavily exports technology rather than imports it (compare with the balance of payments of Switzerland). In other words, for a highly developed country like the U.S., these benefits are rather limited, and what is currently being done with foreign investment, could be easily done with domestic resources, if only the current generation wanted to sacrifice part of their consumption in favor of capital formation.
>> That might be true if there were only a fixed set of assets to be divvied up, and no new ones were created;
The data above indeed show that currently, there is a substantial crowding out effect. Of course, this could be because there are currently not enough good investment opportunities. But then foreigners would not invest in the U.S., and Americans would rather invest abroad. And this is not happening (see the balance of payments data).
>> foreigners are flush with US Dollars, they'll often overpay for a US asset, buy at the top of a market, and wind up selling at a loss
I don't have such data at hand which would confirm that. Of course, if you had data on stock trades according to the nationality of the seller/buyer, then you could verify or reject such a claim. But I guess such data are not available, or better do not exist at all (broker trades hide everything).
Finally, I would like to make a couple of things clear.
- The model I assume here is a limited participation model. Agents living today maximize their utility, which also depends on their bequest motives. I claim that the current U.S. population simply has a high discount factor and not exactly strong bequest motives, thus preferring current consumption to capital formation for future generations. The high preference for consumption is confirmed by the current national accounts data. Such a model can, even with perfect competition, utility maximization, and Pareto improving trade and foreign investment, lead to a situation when future generations will be worse off.
- Limited participation is tricky. If you were an unborn child, would you be happy that your parents or grandparents consume instead of invest? Well, definitely not. You would make your parents save so that they can cover your university fees, and you don't have to start your life with a substantial loan. Unfortunately, unborn children have little decision power.
- I stress, that the problem is not in the budget deficit itself, but in its composition, or in the composition of GDP as a whole. I again claim (and support it by the data above) that currently, Americans are selling off their assets, and they use the money to finance their current consumption at the expense of future generations. This, however, cannot be resolved by trying to somehow artificially level the budget deficit. The only way is to think less about current consumption and think more about the consumption of our grandchildren (but this is a much deeper structural problem, related to preferences, also to ability to technological innovation, and this leads us miles off the topic).
- My argument in no way denies free trade or capital mobility. On the contrary, I fully support it. But, as an economist, I look at the data, and look for explanations and possible consequences. I'm not presenting a catastrophic scenario. But I believe that the U.S. could be better off in the long-term if the composition of the GDP was different. Current situation is too myopic.
Jaroslav,
I'm not an economist, so please be patient if I missed something in your last post.
You state that "gross capital formation went down from average 19.5% in 1970s to 18% in 2000s". Does it really matter that the percentage went down? If capital in real dollars increased, why is the percentage important?
You then state that foreign assets in the U.S. increased by more than the increase in U.S. assets abroad. I'm not sure that supports your assertion that the U.S. is selling off its assets. Wouldn't that be true only if the increase in foreign assets in the U.S. exceeds the increase in all assets in the U.S.?
I don't understand why you think my generation – the boomers – should feel any guilt about what we pass on to our children and grandchildren. As I see it, the U.S. economy is larger and stronger than ever before. It is certainly larger and stronger than the economy I inherited from my parents and grandparents. Some of that growth must certainly be due to our generation becoming so productive and providing such a pro-business environment that we are now attracting record capital amounts from abroad.
Like I said, I'm not an economist so I may be overlooking an obvious point. But I'm pretty damned proud of what my generation accomplished in my 35 years as an adult. If I now want to spend some of that capital I grew over my lifetime, I'm not going to feel the least bit guilty about doing so.
Well said John Dewey.
I want to add a few more thoughts.
Your post is very interesting, Jaroslav. But I do think that models that try to get a snapshop of the macr-economy sometimes miss things like what John Dewey points out – and you recognize that trade and growth are key – that it is GDP per capita growth that indicates how well we are doing and what we will leave our children, not a measure of current savings as a percent of total GDP. Current savings as a percent is part of a question (how does savings affect standard of living?) but the final measure must be seen in the growth of standard of living.
Its true that it is possible that if we saved more the GDP/capita of future generations could be growing faster, but its possible that it would not. If there are limited good investments for Americans (and foreigners have different standards, risk aversion; any profit even with great difficulty is better than what is offerred in their home country), then the money spent on consumption will provide *more profit* for those fewer investments made. And again, if the total investment+consumption is greater than ever before per capita by some amount, the fact that a higher percentage consumption may not be bad.
The smaller number of investments are paying off, making bigger profits and paying higher wages to the workers. If investment was too low, unnaturally low, might that mean too few firms/jobs per capita and we should see unemployment? Unemployment is at an all-time low, standard of living at an all time high; maybe this is how it is supposed to be.
good post Jaroslav.
What I'm having problems understanding is our good hosts enthusiam for a situation that is being driven by one governemnt borrowing from another. Doesn't this have major conflict with his usual position reguarding government management of the economy.
What I'm seeing here are a lot of very good arguments explaining how free capital flows work in international capital markets. But none explaining why it is so great that the
Asian governments are buying dollar to artifically manipulate their exchange rates and loaning the dollars to Americans to subsidize their cheap exports.
Aren't you making the argument that this government distortion of the markets a good thing?
Spencer,
I think most of us, including the Libertarians, agree that the U.S. government should not spend hundreds of billions more than it takes in. Distortion of the markets is caused by government's reckless spending of taxpayers money – not by Chinese purchase of U.S. government debt. That government deficit spending is definitely not a good thing.
Where I think we disagree is whether it makes any difference who buys the U.S. government debt. We may also disagree about whether there is any harm in the increase in imports from Asia or in the investment in the U.S. by foreigners.
I have not seen any convincing arguments showing that U.S. government deficit spending and imports from Asia are strongly linked.
Suppose the U.S. government cut its spending by $300 billion and foreign governments stopped buying U.S. government debt. Would that impact trade flows very much at all? I doubt it. What I think would happen is this: foreign investors would provide more capital for expansion of U.S. industry; and U.S. consumers would buy just as much Asian goods.
John:
>> If capital in real dollars increased, why is the percentage important?
Just briefly. Most of the reasonable macroeconomic models show that our technology shows, on aggregate, approximately constant returns to scale. This means that along the balanced growth path of the economy (i.e optimal growth trajectory), the proportions of investment and consumptions should stay constant. If you decrease the percentage share of investment below the optimal level, the capital growth slows down, and the output (GDP) growth will have to slow down as well. This should explain why percentages, and not absolute levels are important.
I agree with you that what you do with your income (whether you invest or consume it) is pretty much your business. What I was trying to say is that if you had a hypothetical central planner who could decide about allocation of resources and would equally consider the welfare of current and future generations, then such a central planner would most probably make the current generation invest more, in order to create capital for future generations.
Liberty:
>> that it is GDP per capita growth that indicates how well we are doing and what we will leave our children
The first part of the statement is correct, the second part is doubtful. These are two different issues. You can have temporary growth even with underinvestment (the growth can be caused by the utilization of some previously unused resources), but with underinvestment, you can never achieve optimal long-term growth.
The same holds for unemployment. Reduced investment does not imply less job opportunities now, but less job opportunities (or lower wages) in the future, once the capital stock has depreciated due to insufficient investment. Currently, a substantial part of this investment decrease is offset by foreign investments in the U.S. If this continues it would keep the employment high, but the capital returns will flow abroad (as we have discussed earlier).
Your point about the rate of return influencing the investment/consumption decisions is completely valid and it makes sense to analyze the current situation. I would not say this is the case of the U.S. today. But I'd have to go deeper into the data to back this assertion by stronger evidence.
I agree with those who say that the U.S. has been doing amazingly well during the last 15 years, which have been marked by a substantial technological advantage (the IT/comm revolution of the 1990s), and excellent monetary policy of the Fed. This, as John points out, led to the current high welfare. However, over the last about five years, the data shows reduction in the share of investment (in particular made by domestic entities), combined with high current account deficits (not speaking about the government deficit, that's another story). We will only see the effects of this in not less than five years, rather a decade.
As I have already said, I am not drawing a catastrophic scenario. But in a situation when there are many high-growth emerging economies, rising energy prices (the steeply rising demand assures that we will never see low oil prices again, on the contrary), changes in global climate (and the U.S. will be severely hit by these changes), and other challenges, I simply do not see much space for enjoying the fruits of the success of the 1990s and resting on our laurels. As an example, energy-efficiency is an area where the U.S. is lagging behind and where vast investments will be necessary. Just think about the "golden age" of the 1960s and the following decades of various combinations of stagnations and stagflations.
Jaroslav,
Your points make sense to me, but I do have some reservations about some. When you write about an optimal level of investment, that seems to imply that someone knows what that level is. It seems possible to me, and in fact likely, that the U.S. overinvested in technology in the late 90's. I observed massive waste of funds thrown at dot.com ventures by my two employers. I know that both of them have since gained investment wisdom.
Is it also possible that the optimal level of investment for an economy is not constant? or even that it is cyclical?
I am not really understanding your criticism that my nation lags in energy efficiency. I pretty sure we are much more energy-efficient than we were 30 years ago. I expect us to be more energy-efficient in 30 years. Why should we care if we're not sacrificing growth by taxing energy consumption as the Europeans have done? I do not accept the assertion that we will soon face dwindling energy supplies. Is that the basis for your criticism?
Finally, I disagree with those who describe the 60's as golden years. Our standard of living today is much higher. Equality of opportunity has never been better. Our workforce is more educated. Our unemployment level is as low as ever. We are not in a race to doomsday with another superpower. As far as I'm concerned, the golden years in the U.S. are right now. I remain very proud of what my generation of boomers will pass on to our grandchildren.
>Most of the reasonable macroeconomic models show that our technology shows, on aggregate, approximately constant returns to scale. This means that along the balanced growth path of the economy (i.e optimal growth trajectory), the proportions of investment and consumptions should stay constant. If you decrease the percentage share of investment below the optimal level, the capital growth slows down, and the output (GDP) growth will have to slow down as well.
I tend to find most macro-economic models a little bit suspect due to their assumptions (they usually require static economy models and broad assumptions about long-term supply or the connection between variables or that government demand and consumer demand are the same etc).
I would rather look at evidence and econometric analysis. Has investment always remained the same and if not, lagging by how many ever years you think it takes, have we seen reduced growth following reduced investment? Causation would still be difficult to to prove and as you point out, investment can come from overseas, so can we be sure that a certain percent of GDP should be invested consistantly – what if there is a plataue (perhaps on a per capita basis) after which investment is no longer useful.
In other words, if we invest at 50% of GDP, consuming the other 50% both when GDP per capita is low and when GDP is very strong on a per capita basis, is it not possible that some of that latter period of investment is wasteful for the US and it would be better to let China do that investing and instead consume more? After all, the demand for investment dollars drives up the interest rate, maybe the returns are simply not good enough at that moment to increase investment. If it is wasted or an inefficient allocation of resources, it could be better for the long-term economy to consume instead and allow those dollars from consumption to go to already existing investments or those investments made by foreigners.
>You can have temporary growth even with underinvestment (the growth can be caused by the utilization of some previously unused resources), but with underinvestment, you can never achieve optimal long-term growth.
But what is underinvestment? If GDP/capita growth is very strong right now that means that we are producing a lot and either consuming or investing a lot, both of which feed the gains of productivity back in to the market. That bodes well for future generations.
>Reduced investment does not imply less job opportunities now, but less job opportunities (or lower wages) in the future, once the capital stock has depreciated due to insufficient investment.
This is true. It would be better to look at a longer-term picture of lower investment and GDP/capita growth to see whether our investment level is too low or just lower as a percentage than it was in the past.