from Follow the Money

Malpass on the US trade deficit …

December 23, 2006

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Tis the season to be compassionate.

And I guess that also applies to those who are allowed to grace the Wall Street Journal’s oped page –

The opinions there rarely come as much of a surprise.  One standard critique of the blogosphere is that it brings together people who already agree to reinforce their pre-existing convictions.  

That hardly seems to be feature unique to blogland: the Wall Street Journal oped page has long served a similar function.  But I was still surprised by the Malpass WSJ oped -- an oped that strongly suggests that the US trade deficit reflects surging business investment in the US, financed by aging, slow growing Europe and Japan. 

Malpass writes:

“the trade deficit and related capital inflow reflect U.S. growth, not weakness -- they link the younger, faster-growing U.S. with aging, slower-growing economies abroad …

The trade deficit is the mechanism allowing consumption and investment in the U.S.to grow faster than in Europe and Japan.  The issue for the U.S. is whether it's worth the interest costs. It's the same question facing a small business: Should it borrow money to expand the payroll, train employees, buy land and machines, conduct R&D, build inventory? Profit and credit-worthiness help make the decision.”  (Emphasis added)

Malpass is careful not to attribute the rise in the US current account deficit entirely to  a surge in business investment.  He talks of the increase in "consumption and investment" not of the increase in investment alone.  But the analogy between a small business looking for external financing and the US isn't an accident either.  Malpass very explicitly argues that the US external deficit doesn't reflect US profligacy.  In his view, it is a sign of the strength of the US economy.

Maybe.

But I am pretty sure that the US deficit doesn't stem from strong business investment -- and am quite sure that the recent rise in the the US deficit hasn't been financed by Europe and Japan.   

Rigt now, businesses are saving more than they invest, and so they are on net contributing to the United States national savings.  That is one of the unusual features of the current situation.   

The US savings shortfall comes from the fact that the US government still spends more than it takes in, even if the gap today is a bit smaller than it was in 2004.  Above all, though, the gap stems from households that don’t save any of their current income.  That means household sector that has to borrow to finance its investment in residential real estate.   

The Wall Street Journals oped page would never rely on a French bank for data analysis. But I still would recommend the charts showing the decomposition of the US savings gap that Philippe d’Arvisenet of BNP Paribas has pulled together (see p. 4).  The Paribas charts illustrate -- using data ultimately put out by the Fed, not by the French government -- the contribution of different sectors in the US to net national savings.

And then there is the little matter of who is financing the US.   Tis true that a decent chunk of the inflows financing the US must be coming from old, slow growing Japan.  But  Japan has run a current account surplus that has helped finance the US – at least when it wasn’t financing other Asian economies -- for quite some time now.  The rise in the US deficit since 2002 doesn’t primarily reflect a rise in Japan’s current account surplus.

Nor does it reflect a rise in Europe's surplus.  Last I checked both the UK and the Eurozone as a whole were running current account deficits – and thus not financing the US, at least not in aggregate.  For that matter, old Europe is now growing about as fast, if not faster, than the US.

So who is financing the US?

The IMF’s data shows (see Table 1.2, p. 12 of Chapter 1 of the WEO) a huge surge in the current account surplus of the emerging world -- a surge that has financed the surge in the US current account deficit.   Ben Bernanke, incidentally, tends to agree with the IMF

And whatever else you want to say about the world’s emerging economies, they aren’t growing slowly.

  • Some – Russia – are already urbanized, rapidly aging and growing rapidly.
  • Some – Saudi Arabia – are already urbanized, young and growing rapidly.
  • Some – China – are urbanzing, aging and growing rapidly.  To be totally fair, Malpass does mention the China (best I can tell, it is the only emerging market that Malpass mentions).  He links China’s aging to its demand for US bonds.  He just leaves out that it doesn’t quite fit the “slow-growing” part of his argument.
  • Some – India – are young, urbanizing and growing rapidly.

There are of course exceptions to the "rising surpluses in the emerging world financing the US deficit" story.  India, for example, doesn’t run a current account surplus, so technically its savings surplus doesn’t finance the US.  

But even India is attracting a lot more private capital than it needs to finance its own current account deficit.  As a result, India's central bank certainly does help finance the US deficit.  The RBI transforms foreign demand for Indian assets into Indian demand for US bonds.

I don't think there is much doubt -- at least among informed observors -- that fast growing emerging economies are a key source of financing for the US.  Nor is there much doubt that a large share of that financing comes not from private investors, but from central banks and oil investment funds.   It isn't clear that the US has been the most attractive place in the world for private investment over the past few years -- in dollar terms, returns on investment in the US have lagged returns on investment in Europe.  But few would doubt that the US has attracted more financing than anyone else from emerging market central banks over the past few years.

One of the stereotypes about blogs is that they live in the realm of opinion, a realm divorced from the facts. I am pretty sure that isn’t a vice limited to the blogosphere.

Update: Ben Stein's writes in the Sunday Times:

"Why is it [the cost of money] so low?  Because the Chinese people save about 40% of what they earn and use a lot of it to buy United States Treasury securities, keeping overall interest rates low.   The Japanese do the same, and so do the immensely wealthy petro-states ... savings in Guangdong China mean mansions in Greenwich, Conn."

This stuff isn't all that hard!

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