Does It Matter that Other People Save? Yes. Does the Nationality of these Savers Matter? No

by Don Boudreaux on October 22, 2007

in Balance of Payments, Standard of Living, The Economy, Trade

Arnold Kling insightfully points out that among the distinguishing features of economics as it is taught and researched here at George Mason University is that we resist the temptation to treat abstract collectives as acting, relevant beings.  The typical GMU economist doesn’t believe that just because a group of people are conventionally called by a certain name – “Americans,” or “Ukrainians,” or “Taiwanese” – that such a designation carries much economic relevance.

Nowhere is the need to “lose the we” more important than in discussions and analyses of international trade – and in particular in discussions and analyses of the so-called “trade deficit.”

Nearly every American is part of the economy that can, without risking too much misunderstanding, be called the American economy — or, alternatively, the global economy.  But also part of this economy are foreigners who sell their goods and services to Americans – so too are foreigners who buy American-made goods and services – so too are foreigners who invest in dollar-denominated assets.

It’s easy to confuse Americans getting poorer with the American economy getting worse.  The latter does not necessarily follow from the former.

Suppose that 100 percent of Americans are irresponsible spendthrifts – something like the teenager who, upon receiving his first paycheck, spends it all on beer and rock concerts.  Clearly, unless this teenager changes his habits, prosperity beyond the norm will not come his way.  But if American institutions – work habits, trustworthiness, laws, structure of government, and so on – remain attractive to investors, then capital will continue to be invested in America.  New jobs will become available, jobs offering higher and higher pay.  New products and services will be produced, and their qualities will generally rise and prices generally fall over time – becoming more and more affordable even to spendthrift Americans.

Of course, in this scenario all investments will come from non-Americans – from foreigners who, being more prudent and patient than Americans, save and invest part of their current earnings in the economy of which Americans are part.  This economy thrives even if (in this unrealistically extreme example) no American enjoys the fruits that come from owning assets deployed in a vibrant economy.

Americans thrive more than they would thrive if foreigners didn’t invest in America (or if foreigners invested less in America).

Here’s good news for all of us who live in the United States: as long as lots of people are willing to invest in the U.S. economy, we will enjoy benefits over time even if each of us Americans is a spendthrift.  It should make no difference to me or to you if those people who do invest in the United States have passports issued by Uncle Sam or have passports issued by some other government.  If you are a spendthrift, you will not, of course, benefit from this thriving economy as much as you would if you became one of the savers and investors.  But whatever is your own personal rate of saving and success at investing, your material prosperity will be higher the greater is the willingness of other people – including foreigners – to invest in the American economy.

Put differently, if you become the only American willing to save and invest, and if foreigners (for whatever reason) stop investing in the American economy, you will likely be much worse off over time than you would be if you continue your spendthrift ways and foreigners continue their saving and investing-in-America ways.

Be Sociable, Share!

Comments

comments

Add a Comment    Share Share    Print    Email

{ 13 comments }

Marcus October 22, 2007 at 2:09 pm

With the recent credit crunch we can see foreign investment drying up. This should make the Lou Dobb's types quite happy as that should go a long way in 'correcting' the trade-deficit.

Tom Kelly October 22, 2007 at 3:14 pm

Likewise, the skin color or nationality of productive workers doesn't matter. What matters is what they produce relative to what they consume, even if they are living in a political region that considers them illegal aliens.

Production less consumption is savings and benefits us all.

Reach Upward October 22, 2007 at 3:30 pm

Much fearmongering has gone on lately about the idological bent of certain foreign investors (i.e. China). The implication is that the amount of U.S. bonds owned by the Chinese is simply a chit in a new type of economic warfare.

The fearmongers suggest that the Chinese buy U.S. government bonds (fund U.S. government debt) to put the U.S. over a barrel with the threat that the Chinese could simply dump these bonds at any time; thereby, crippling the economy. This threat, they suggest, will be sufficient to prevent the U.S. from defending itself or its allies from future Chinese aggression.

What would you say to these folks?

William Barratt October 22, 2007 at 4:47 pm

My concern with Americans not saving is unrelated to the above argument. What I'm afraid of is when all the American non-savers retire, only to discover that their Social Security check isn't nearly enough to maintain the standard of living they'd like. They'll ask the government to tax the savers (like me).

Marcus October 22, 2007 at 4:57 pm

William,

I think your concern is valid. I think what you might be missing is that the lack of savings by Americans is, at least to some degree, the market predicting the same thing.

John Dewey October 22, 2007 at 5:24 pm

Reach upward,

I'm not sure I understand. How would Chinese "dump" U.S. bonds in such a way that would cripple the U.S. economy?

According to Peter Morici, Professor of International Business at the university of Maryland:

"The Chinese Communist Party can make effective threats to disrupt the U.S. economy only if Americans are stupid enough to panic."

In the first place, according to Morici, if the Chinese were somehow successful in a massive sell-off of U.S. bonds that crippled the U.S. economy, China's economy would also be crippled. Chinese workers right now depend on the buying power of U.S. citizens.

If the Chinese government instead gradually sold off U.S. bonds, Morici provides two possible outcomes:

1. China could hold U.S. dollars, and the Federal Reserve would buy enough of the bonds that the Chinese sold to keep the amount of dollars in circulation unchanged;

2. China could buy other currencies with their newly-acquired dollars, raising the value of those currencies against the dollar, and reducing the U.S. trade deficit.

China’s Hollow Threat to Dump U.S. Bonds

lowcountryjoe October 22, 2007 at 8:57 pm

What would you say to these folks?

Bond issuers — those that are borrowing — have specfic terms regarding the loan in place (e.g. repayment schedule, interest rate, maturity, and other terms that affect the real rate of return) . It is very rare that you would see a borrower have terms on the bond's face that allowed the lender to reclaim their principal earlier than the maturity date — unless, of course, there are significant penalties attached.

For that reason (assuming there is no provision for the lender to ask for their principal back early), the only way a bond holder can get access to their principal is to sell the bond to another person willing to 'assume the loan' (technically, the conditions set forth on the face of the bond). In a market where, presumably, a large portion of Chinese bond holders wanted to dump their bonds on the open market, who would really be the loser? Yeah, sure, the selling pressure on these bonds would create higher interest rates for bonds that will be issued in the future (and result in larger repayments). But, in the meantime, the Chinese holders of bonds would take a significant loss as they continued to sell them. In each case, there would be a willing buyer — at the right price — to snap up such a bargain created. It seems like a hellofa way to teach us a lesson!

happyjuggler0 October 22, 2007 at 11:06 pm

I still don't understand why people are freaked out about China anyway. It's not like there is an upside to them for their military to attack the US.

Nor is there any upside for them to dump US bonds in an attempt to hurt the US economy (and hurt China's purchasing power in the process as lowcountryjoe pointed out).

Notwithstanding the fact that the Chinese still are run by a party called the Communist Party, the fact is they aren't communist. They are pretty much like us, they want to get rich, and they are astute enough to realize that the best way to get rich is to create riches, not get in a conflict which of course destroys wealth despite the misinformation that some people have that "wars are good for the economy".

Far from trying to shun the Chinese or trying to hinder their economic growth in a vain attempt to stop their military from having more buying power than the US military has (we can delay them perhaps, but not stop them, their population is too big), a much more sensible approach is to cultivate them as long term friends.

andy October 23, 2007 at 1:12 pm

John, I have heard this argument many times, but it still does not make sense to me. The question "were would Chinese factories sell their product" seems very disconnected to me. Actually, they don't sell it to the USA, they give it free (or at heavy discount), but the Chinese government by printing juans makes them believe that the USA has "buing power". In reality it does not have it, and the question is more – does it make sense for Chinese to hide this FACT from their businessmen?

If the China starts selling US dollar, it's exchange rate with China plummets…which will lower the US "buying power"…which is not a problem? When in the previous paragraph he said that that is the reason why china will not just sell the bonds?

China will most likely not sell everything within a fortnight as that would most likely exagerate the problem. But even if you exclude the panic, do you really think that when China sells the US bonds, that everything is going to be OK?

John Dewey October 23, 2007 at 5:20 pm

andy: "do you really think that when China sells the US bonds, that everything is going to be OK?"

Yes. Everything is going to be OK.

If China gradually sells its U.S. T-Bonds to other nations or to private investors, what is going to happen that is so terribly wrong? What difference will it make at all?

andy October 28, 2007 at 5:08 am

It will make it gradually impossible for US to sell any new bonds. If they gradually exchange the USD they get from the bonds to other currency, it will make it gradually impossible for other people to buy something for their USD.

The only difference between "gradually" and "immediately" selling the bonds is IMO only in the panic. However, that does not mean that only the panic is the problem.

John Dewey October 29, 2007 at 7:12 pm

Andy,

When has it ever been impossible for the U.S. to sell new bonds?

When has it ever been impossible for other people to buy something for their USD?

We may see some adjustment, but so what? We're not headed for doomsday. The U.S. economy is stronger than ever before in history, output is greater than ever, and that's really what matters.

Joe November 2, 2007 at 10:28 am

I would personally have no concern with the trade deficit if it were a market phenomenon, but I don't think a large part of it is. I think that that part is caused by the decision of the central banks of certain trading partners of the US to hold their currencies lower than they would otherwise be, with the necessary consequence that they must buy more dollars than they otherwise would. (Lower price, higher demand.) More specifically, they have chosen to leave some segment of their reserves in dollar-denominated bonds of various kinds, which in my view would tend to hold up bond prices (and hold bond yields down) and therefore support US consumption, private and governmental, in ways that might not otherwise occur. And if the current situation is a result of decisions by various central banks, they can easily change the situation by deciding something different. (Here I do not necessarily speak of "dumping" of US-dollar instruments, but, for example, a choice could be made to buy fewer or no dollar assets in the future, or fewer dollar bonds and more dollar equities.)

Previous post:

Next post: