There seems to be no end in sight to the widening of America’s gaping external imbalance. A record $61 billion trade deficit for February is only the latest in a long string of warning signs for an unbalanced US and global economy. The rebalancing required to temper these deficits requires significant adjustments in macro policies. Yet with America’s fiscal and monetary authorities basically frozen at the switch, politicians are asserting greater control over the adjustment process — firing one protectionist salvo after another. The tradeoff between policy adjustments and political actions lies at the heart of the sustainability debate for ever-mounting global imbalances. A tipping point could be close at hand.
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And if there is anyone in the US guilty of living beyond his or her means, the American consumer certainly gets the prize. Since 1996, average growth in real consumption (3.9%) has exceeded gains in real disposable personal income (3.4%) by 0.5% per year. Over that period, the income-short consumer has been converted into an asset-dependent spending machine — first drawing sustenance from the equity bubble and more recently from the property bubble. As a result, the income-based personal saving rate has plunged toward zero and households have taken on record debt loads as they extract newfound purchasing power from increasingly over-valued homes. As a result, personal consumption has gone to excess — moving up to 71% of GDP in 2002–04 versus a 25-year norm of 67% over the 1975 to 2000 period. Little wonder that the import content of that consumption has also gone to excess.
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...the only way America will ever come to grips with its massive foreign trade deficit would be to bite the bullet and accept the pain of significantly higher real interest rates. Try telling that to the Fed or Asian central banks. It is simply unprecedented for the world’s leading economic power to be running chronic trade deficits that have now turned America into the largest foreign debtor in history.
When the correction comes to the US, there will be hell to pay. Already Friday, Wall Street had it's worst day in two years. Doublethink Dubya's advisors say:
The U.S. economy is on track for solid growth this year despite the "headwinds" it faces from lofty oil prices, two senior White House economic advisers said Thursday.
Complete Article
Global: Tough Love
Stephen Roach (New York)
There seems to be no end in sight to the widening of America’s gaping external imbalance. A record $61 billion trade deficit for February is only the latest in a long string of warning signs for an unbalanced US and global economy. The rebalancing required to temper these deficits requires significant adjustments in macro policies. Yet with America’s fiscal and monetary authorities basically frozen at the switch, politicians are asserting greater control over the adjustment process — firing one protectionist salvo after another. The tradeoff between policy adjustments and political actions lies at the heart of the sustainability debate for ever-mounting global imbalances. A tipping point could be close at hand.
There’s really no other way to put it — the latest trade numbers in the US were simply terrible. Annualizing the February shortfall puts the US trade deficit at a record 6.0% of GDP — up dramatically from the 4.8% gap only 12 months earlier. (Note: Our estimates would put the broader current-account deficit at yet another new record of around 6.6% of GDP in 1Q05 versus 5.1% a year earlier). For the first two months of 2005, the average annualized trade deficit was $33 billion wider than it was in the final period of 2004. Sure, surging oil prices were an important factor in February, but even after stripping out the trade flows associated with energy products, there was deterioration in the so-called non-petroleum deficit. In fact, over the 12 months ending February 2005, the real, or inflation-adjusted, non-petroleum trade balance widened from -$39.2 billion to -$49.4 billion (monthly rates) — accounting for virtually all the deterioration in the overall real trade balance over the same 12-month period (from -$51.0 billion in February 2004 to -$61.8 billion in February 2005).
In macro terms, trade and current-account deficits are emblematic of an economy that is living beyond its means — as those means are delineated by a nation’s domestic income-generating capacity. This shows up loud and clear in the United States: Over the past six years, growth in domestic demand (technically, gross domestic purchases) has exceeded overall GDP growth by about 0.6 percentage point per year. America’s ever-widening external deficit is the functional equivalent of an “income leakage†of roughly the same magnitude — that portion of internal demand that is sourced by foreign production. Yet even in the face of this income leakage, domestic demand has barely flinched; by our estimates, it expanded at a 4.5% rate (in real terms) over the four quarters ending in 1Q05 — considerably faster than the 20-year average of 3.3%.
Nor has the weakening of the dollar made even the slightest of dents in America’s external imbalance. On the contrary, since the dollar peaked in early 2002, the trade deficit has widened from 3.6% of GDP to 6.0% at present. In fact, over the most recent three-year period, when the broad trade-weighted dollar has fallen by about 15% in real terms, the external leakage averaged 0.6% per year — identical to that in the three years prior to the peaking of the dollar. In retrospect, it’s not all that surprising why the well-known lags of the “J-curve†are missing in action. In large part, that’s because America has an excess import problem that is largely insensitive to fluctuations in the currency. The latest trade report says it all — imports were fully 61% larger than exports. Dollar depreciation simply cannot address an excess import problem of this magnitude.
Which takes us to the heart of the problem — America’s consumption binge. Imports don’t come out of thin air. They are a very much a by-product of growth in domestic demand, especially private consumption. And if there is anyone in the US guilty of living beyond his or her means, the American consumer certainly gets the prize. Since 1996, average growth in real consumption (3.9%) has exceeded gains in real disposable personal income (3.4%) by 0.5% per year. Over that period, the income-short consumer has been converted into an asset-dependent spending machine — first drawing sustenance from the equity bubble and more recently from the property bubble. As a result, the income-based personal saving rate has plunged toward zero and households have taken on record debt loads as they extract newfound purchasing power from increasingly over-valued homes. As a result, personal consumption has gone to excess — moving up to 71% of GDP in 2002–04 versus a 25-year norm of 67% over the 1975 to 2000 period. Little wonder that the import content of that consumption has also gone to excess.
Central banks, in my view, are the real culprits behind the excesses on the import side of the trade equation. The Asset Economy has long been a levered play on unsustainably low real interest rates in the US. The Fed has anchored the short end of the yield curve with its post-bubble tactics — holding the real federal funds rate in negative territory or near the zero threshold for most of the past four years. And foreign central banks have capped US real rates at the long end of the curve — aggressively recycling rapidly rising foreign-exchange reserves into dollar-denominated assets in order to limit currency appreciation and maintain export competitiveness. In an income-short economy, asset-led consumption binges virtually guarantee ever-widening current-account and trade deficits. That means that the only way America will ever come to grips with its massive foreign trade deficit would be to bite the bullet and accept the pain of significantly higher real interest rates. Try telling that to the Fed or Asian central banks.
It is simply unprecedented for the world’s leading economic power to be running chronic trade deficits that have now turned America into the largest foreign debtor in history. This stands in sharp contrast with the experience in the first “golden era†of globalization in the years leading up to World War I. In that earlier period, trade was the engine of economic development as assets were shifted from colonial powers to their newly settled colonies. The developed world ran current-account surpluses, whereas the “settlement areas†were usually in deficit. Today, the tables have turned — surpluses in the developing world fund seemingly chronic deficits in the US. The world’s most powerful nation is, in effect, benefiting from a new form of foreign aid — capital inflows from poor countries. The developing world has seen its role change from users to providers of capital, whereas the opposite is the case in the developed world.
Nor is this reverse foreign aid program a sustainable outcome for the global economy either. The only way it can continue is if the capital providers of the world — especially Japan and China — continue to suppress domestic consumption and recycle surplus saving into dollar-denominated assets. Yet that outcome is a recipe for instability in saving-led economies like China — it leads to an investment overhang that can only end in tears. With China’s investment ratio likely to exceed 50% of its GDP this year — unheard of even in the annals of other Asian development miracles in places like Japan and Korea — the need to draw down surplus saving and boost private consumption is increasingly compelling. Yet any rejuvenation of domestic demand support in the current-account surplus economies of the world — China, Japan, and even in some parts of Europe — will absorb flows previously earmarked for America. That will make it exceedingly difficult for the US to keep attracting foreign capital without having to make concessions on the interest rate front. In other words, if the world puts its excess saving to work at home rather than in the United States, US real interest rates will finally adjust — as will the spending and import dynamic of the American consumer.
As the great powers gather for another G-7 meeting this weekend, one hopes there will be an active debate on these matters. Unfortunately, if past performance is any guide, that is unlikely to be the case. Policy makers grimace when you mention the words “imbalances†and “rebalancing†— knowing full well that they do not have the stomach to inflict painful remedies on their home countries. That requires a discipline to monetary and fiscal policy that is sorely lacking in the current environment. Yet there is no popular outcry for change. America’s latest disturbing news on its trade and current-account deficits was greeted with a yawn in financial markets and by threats of protectionist actions from politicians rather than calls for a restoration of sanity to fiscal and monetary policy.
There is one exception — Paul Volcker. The former Fed chairman has finally gone public with a plea for action in dealing with the perils of ever-rising US current-account and trade deficits (see his 10 April 2005 op-ed piece in the Washington Post “An Economy on Thin Iceâ€). The problem, in his view, is painfully simple — a lack of fiscal and monetary discipline. The solution he offers is hardly complex. In his words, “What is required is a willingness to act now — and next year, and the following year, and to act even when, on the surface, everything seems so placid and favorable.†Volcker was the personification of the tough, disciplined, independent central banker — unafraid to take on the body politic when he waged battle against double-digit inflation in the early 1980s. That approach worked 25 years ago and there is every reason to believe it would work again in going after a different problem today.
For a US economy that is living dangerously beyond its means, the tough love of fiscal and monetary discipline is the only way America will ever make lasting progress on the road to rebalancing. A further decline in the dollar is needed, as is a meaningful increase in real US interest rates. The longer we wait, the more treacherous the endgame. As Paul Volcker also reminds us, “what can be left to later usually is — and then, alas, it’s too late.â€
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