- Blog Post
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Ronald McKinnon has an interesting argument in yesterday’s Financial Times (based on this policy brief), namely that manufacturing workers are paying for low US private savings and large US budget deficits. The counterpart to low savings is a large trade deficit, as the US depeneds on foreigners to save some of the money earn selling to the United States, and then to lend it back to the US. We have outsourced savings. McKinnon believes the solution is a smaller US budget deficit; Nouriel and I think you also need some exchange rate adjustment. But McKinnon’s basic argument is right -- manufacturing employment would be much higher if the US was not so dependent on foreign savings (McKinnon suggests manufacturing employment would rise from 10.5% of the labor force to 13.9%, a change worth 4.7m jobs).
Philip Coggan’s FT column incidentally notes that the financial sector generated 38% of all US corporate profits in the first quarter of the year. That too is linked to the United States’ ability to import foreign savings, which is keeping interest rates lower than they otherwise would be (particularly with a large budget deficit) and thus is fueling both a lending/ borrowing boom and appreciation in the price of many financial assets. A credit boom, plus low short-term rates (banks still borrow short and lend long, in various ways) = big financial sector profits.Why are the two linked? Consider two states, one that tends to specialize in the production of manufactures (Ohio) and another that tends to specialize in financial services (New Jersey or Connecticut). Without the capacity to borrow from abroad, large budget deficits would tend to drive up interest rates in a low savings economy, crowding out domestic private investment. High interest rates also tend to depress the value of financial assets -- and, of particular interest to residents of the East and West coasts, to depress the price of housing as well. All in all, that combination is not so good for New Jersey, or Connecticut.
Borrowing from abroad can change all that. So long as external financing is forthcoming, the low savings country can run large budget deficits without necessarily crowding out an expansion of private credit (This private credit recently has gone to households to finance consumption/ new construction more than to finance business investment) or driving up interest rates in a big way. That helps the financial sector, and it also helps regions either have lots of non-traded goods production (say, house construction)or that depend in part on the financial services industry. Say New Jersey.
However, foreigners cannot just print the dollars they are lending to the US. They have to earn their dollars by selling more to us than they buy from us. In other words, they must run a trade surplus (save) to finance their lending to us (our debt is their assset). That hurts regions -- like Ohio -- that still have large manufacturing industries.
At a minimum, a policy of budget deficits financed by external savings (particularly reserve accumulation) will have an impact on the composition of US output -- notably by lowering the output of tradeable goods. Since manufactured goods still are easier to trade than services, and since certain parts of the country produce more manufactured goods than others, that will have an important impact on the distribution of output across states. I suspect that the economy also does not adjust perfectly smoothly, so a policy that relies on growing trade deficits to provide the savings foreigners need to finance growing budget deficits also likely has some impact on the overall level of employment, at least in certain regions. In other words, unemployment in places like Ohio is part of the adjustment process as the economy reorients away from the production of tradeable goods.
This game is in my view ultimately not sustainable -- we are buidling up external debt way to fast, and cannot export 10% of GDP and import 16% of GDP for long (the US makes up the gap by exporting financial assets -- or fastest growing export is US treasury bills!). At some point, resources will have to flow back into the production of things that can be sold abroad, and that too will generate its own frictions.
If Bush loses Ohio, but does not win New Jersey or Connecticut, he has no one to blame but himself. States like New Jersey and Conneticut pay more in taxes to the federal government than they get back, and have relatively high incomes. They probably benefitted in aggregate from Bush’s tax cuts, and benefitted even more by the United States ability to borrow from abroad to limit the impact of budget deficts on interest rates and thus on home prices. But states like Ohio lost out, big time, in this trade.