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August 08, 2006

Roubini on the "Twin Deficits"

Don Boudreaux

In the latest issue of the Cato Journal, NYU’s Nouriel Roubini offers again his case on “The Unsustainability of the U.S. Twin Deficits.”

I agree with much of what Roubini says. Clearly, Uncle Sam’s deficit spending is harmful, not least because it is the product of persons A, B, and C going on spending sprees with the expectation that the bill, when it comes due, will be paid by persons X, Y, and Z – whose identities today are unknown even to X, Y, and Z. The current indistinctness – the current absence of the specific identities of the persons who will become X, Y, and Z – ensures that X, Y, and Z issue no complaints about being stuck with a future obligation to pay for Senator A’s, and Rep. B’s, and President C’s handouts to electorally important interest groups. Spending under such conditions of brilliant irresponsibility is almost certainly both excessive in size and inefficient in how it’s directed.

But “harmful” doesn’t necessarily mean “unsustainable.” I have no firm opinion about whether or not Uncle Sam’s budget deficits are unsustainable over any reasonably relevant number of years.

But I disagree with Roubini’s take on the trade deficit.

He’s right that the current-account deficit is unsustainable, but only

• if it is largely the result of foreigners buying debt issued by Uncle Sam, and

•  if Uncle Sam’s budget deficit is unsustainable, and

• if the foreigners who today are buying Uncle Sam’s debt will choose, when Uncle Sam is forced to stop running budget deficits and to begin reducing the value of his outstanding debt, to spend their dollars on American exports rather than on dollar-denominated assets other than U.S. Treasuries.

But recent evidence suggests that these are big ifs. Most significantly, as I blogged on here, foreign purchasers of dollar-denominated assets recently began buying much less of Uncle Sam’s debt and buying more corporate securities and other privately created assets.

More fundamentally, I have a real problem with the allegation of “excess savings” – as in this passage from Roubini’s article:

It is true that in 2005 the U.S current account deficit worsened at a time when the fiscal balance was improving. Indeed, excess savings by China and oil exporters in 2005 and on may have contributed to keep U.S. long-term interest rates lower than otherwise [p. 347].

What are “excess savings?” Surely the fact that the number of attractive investment opportunities within a given country falls short of the amount of savings by that country’s citizens does not mean that the difference is “excess savings”? (Ironically enough, the most coherent notion of excess savings would be supplied, I think, by Austrian economists who worry that government intervention might prompt certain investments to be undertaken that prove eventually to be unsustainable. I get no sense that what Roubini means by the term “excess savings” is anything remotely close to what, say, Mises or Hayek might have meant.)

Even more troubling are passages such as this one:

And since one can expect, at current trends, U.S. current account deficits of at least $1 trillion a year from 2007 on, one can forecast that, if an increasing fraction of the new desired inflow of capital into the United States will go into equities rather than debt, an increasing fraction of the entire U.S. capital stock will, in a matter of a decade, be owned by nonresidents [p. 350].

First, this claim isn’t necessarily correct.  The size of the capital stock isn’t fixed; in healthy economies it grows.  So the U.S. current-account deficit can grow significantly over the next several years, through foreigners purchasing equities, without an increasing fraction of the entire U.S. capital stock being owned by nonresidents. Indeed, the current-account deficit can grow through such purchases of equities and, simultaneously, the fraction of the U.S. capital stock owned by nonresidents can fall.

Second and more fundamentally, so what if an increasing fraction of the U.S. capital stock is owned by nonresidents? Roubini mentions this outcome and presumes that it speaks for itself.  But it doesn’t.

As I’ve asked before, if savings and investment are desirable (and they are), what difference does it – or should it – make to me if the factory in Alabama or the R&D lab in Utah is owned by someone holding an American passport or someone holding a Swiss or a Sri Lankan passport?  The important thing is that the factory and the R&D are funded.

I suppose that the concern is that foreigners, not being Americans, are less… less… less what? loyal to? interested in? America.  Foreigners who invest here are entrusting large chunks of their wealth to the American economy.  Doesn’t that fact itself create a presumption that these foreign investors are peaceful, productive people interested in the stability of the political system and economy in the United States?  Doesn’t that fact make these foreign investors more interested in the well-being of America?

Indeed, doesn’t that fact make these foreign investors, in an economic sense, at least partly American?  Or, better yet, don't such cross-border investments tend to break down purely political and nationalistic notions of citizenship by creating as the relevant society the global economy?  A hermit living in the Blue Ridge mountains of my home state of Virginia surely is less of a citizen of the same society to which I belong than is, say, a Parisian who owns a restaurant in Fairfax, VA, or a Chinese entrepreneur who, although perhaps never having set foot on American soil, owns a large stake in a factory located in Kentucky, some equity shares traded on the New York Stock Exchange, and a factory in Shanghai that makes electrical components for my laptop and my car.

Other problems plague Roubini’s article, including his seeming acceptance of the cost-push theory of inflation.  But his implicit xenophobia is what is most bothersome and unjustified.

Posted by Don Boudreaux in Trade | Permalink

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Cafe Hayek posts on a article in the new issue of Cato Journal by Nouriel Roubini on the nature of the US twin deficit problem. The twin deficit problem is cited by many as a critical problem facing the US.  However, ther... [Read More]

Tracked on Aug 9, 2006 11:30:36 AM

Comments

It comes down to an even more elemental point, there is no reason for the state to be the salient economic unit. Exports, imports, and foreign investment are all meaningless terms.

If tommorow the borders were erased, exports would become sales, imports purchases and foreign investments investments. And if tommorow a global currency were instituted, talk of the trade deficit would disappear.

Posted by: Mickey Klein | Aug 8, 2006 1:36:12 PM

Also, if the government issues ten bonds and sells them all to the Chinese, the US incures exactly the same state debt as if they sold them to people in Kansas. Trade deficit scaremongers would like us to believe that we are adding a second realm of debt by selling the bonds to the foreigners. Bush spending to much is not some scary new twin deficit but rather one gaping whole in the federal pocket.

Posted by: Mickey Klein | Aug 8, 2006 1:44:15 PM

I think Robert Reich made some of the same points in 'Who Is Us?'.
In my opinion one of the main benefits of all this cross-national investment is that it creates powerful incentives against war between the powers involved (mainly China and the USA in this case).

Posted by: bbartlog | Aug 8, 2006 2:26:24 PM

On the xenophobia point, I am in complete agreement. Even if we take the extreme example where "foreigners" invest in America and we then got to war we these foreigners. What would the result be? NOTHING! At worst the US governemnt would seize the asset. Its not like the Swiss investors could magically move their factory to Switzerland once hostilities break out. Moreover the Swiss investors would presumably put pressure on their own governemnt not to allow this to happen. Inother words foreign ivnestors would provide a natrul pro-american consituency in the foreign country.

Posted by: Michael | Aug 8, 2006 6:11:24 PM

Why do people persist in defining inflation as generally rising prices rather than a generally declining value of money? Are they trying to hide something?

Posted by: Russell Nelson | Aug 9, 2006 3:11:30 AM

Can you explain the distinction between the two definitions? Because, frankly, I don't see it. The value of money is in what you can buy with it; prices go up, you can buy less with the same amount of money, that's inflation. Do you have an issue with the basket of goods being used in some particular entity's calculation of inflation? Because that would be a whole different problem...

Posted by: bbartlog | Aug 9, 2006 7:23:31 AM

bbartlog: "In my opinion one of the main benefits of all this cross-national investment is that it creates powerful incentives against war between the powers involved"

About 40 years ago I first read how commerce leads to mutual dependency so strong that war can be avoided. I think it was Asimov's Foundation trilogy that introduced me to the idea. I can remember thinking that the Indochina War might have been avoided if we had somehow opened a few McDonald's and K-Mart's in Hanoi and Peking (Beijing). Of course, I never considered that those Asian communists might someday want to own Unocal or Maytag.

Posted by: John Dewey | Aug 9, 2006 11:12:03 AM

"Can you explain the distinction between the two definitions? Because, frankly, I don't see it. The value of money is in what you can buy with it; prices go up, you can buy less with the same amount of money, that's inflation."

If money devalues by half, but productivity increases due to technology and what-have-you cut the price of a good in half at the same time, the market price ends up the same as before. The "rising prices" definition says no inflation took place.

The rising prices definition arose as a measurement convenience. Sadly it has totally obscured our understanding of the subject. Prices simply reflect economic reality, which has many dimensions. Inflation is a monetary phenomenon and does not strictly have anything to do with observed prices.

Posted by: Noah Yetter | Aug 9, 2006 1:30:49 PM

Well, OK. I see what you're getting at. Still... if productivity gains cut the price of *one* good in half (or several goods), then it can be considered as an individual phenomenon, and whether it affects 'inflation' will depend on how the measure is defined (whether the good(s) are in the basket of goods being used). If on the other hand productivity cuts the price of a majority of goods, or all of them in varying measures, then there would seem to be a strong presumption that more money will be chasing goods (and services, what have you) less affected by productivity gains. The prices of these would go up, and once again the basket composition becomes relevant...
Thinking about it still more, I see I'm assuming that demand for these goods is not very elastic as they become cheaper. For some goods, the total spent on them will increase as they become more affordable. So to actually try to model something like this you would need a vector of all the demand elasticities. I can see why an empirical approach was used.

Posted by: bbartlog | Aug 9, 2006 2:31:04 PM

Klein:

"It comes down to an even more elemental point, there is no reason for the state to be the salient economic unit. Exports, imports, and foreign investment are all meaningless terms."

Don't you think that it matters whether and to what extent trade and labor and investment cross currency zone boundaries, and whether the state manages its money base responsibly?

Indeed, this principle extends to other arenas as well. Any time you concede there is some condition the state is supposed to manage, it may "matter" when influencing factors (e.g. labor) cross national boundaries.

Perhaps in a completely private, competitive economy (including banking) and with a minimal or nonexistant state, your point would be true. But even then, other states might have influence asymmetrically (e.g. China pegging its currency) in a way that it might be handy to react to in a concerted, public fashion.

Posted by: Aaron Krowne | Aug 10, 2006 8:49:19 AM

By the way, as long as we're inflating the capital stock like mad, its a good thing for it to be owned by foreigners. It means we're taxing the suckers like there's no tomorrow, and there ain't nothing they can do about it.

Except, uh, dump it. But its not like there are any political or economic reasons to do that...

Posted by: Aaron Krowne | Aug 10, 2006 9:06:32 AM

The fact that the effect is different across goods even further gives the lie to the idea of inflation-as-general-price-increase. The price increase is never even nor simultaneous.

Posted by: Noah Yetter | Aug 10, 2006 12:14:25 PM

"I get no sense that what Roubini means by the term “excess savings” "

As regards China, I think Roubini is simply referring to a trade surplus that remains unused by domestic investment. Or, he could mean the lack of dollar import purchases.

Whichever, the surplus money is simply reinvested in reserve currency debt instruments (T-notes), precious metals and (why not) foreign equity purchases. The Arab oil companies do exactly the same with thier surpluses.

The trade deficit is supposedly "unsustainable" because trade surplus nations will not hold our debt (by continuing forever to purchanse T-notes). This is not evident. The US has been in a chronic trade deficit imbalance for more than half a century and there has been no visibly sustained crisis yet.

What can happen is that instead of keeping dollars (in debt instruments), trade surplus nations adopt another reserve currency ... say, the Euro. Not purchasing the dollar forces dollar interest rates up in order to attract buyers. A rise in long-term interest rates affects domestic economic activity negatively.

All of this, however, has yet to be proven. For the moment, China is quite content to lend money to Americans (by means of holding T-notes) so that Americans continue to buy thier products. This also gives the Chinese a certain leverage in financial circles that they are very pleased to enjoy.

For instance, the US has every reason to crow about the artificial weakness of the Chinese yen. But, why should China appreciate the yen (by letting it rise) when it is holding so many dollars in reserve? That would be stupid.

This sort of financial influence can be used as bargaining chips in geopolitical situations. The US has done so in the past, and China could certainly employ the same tactic in the future.

Posted by: A. PERLA | Aug 10, 2006 6:06:19 PM

I have some charts on the change in foreign preference for stocks over US treasuries that began back in June-04.

http://vitalaccuratethinking.blogspot.com/2006/07/fewer-treasuries-more-stocks.html

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Posted by: CountingAutumn | Sep 3, 2006 5:20:35 AM

Don,

You exhibit the typical Cato Inc. blindness relative to immigration and globalization.

There is more to homo sapiens than homo economicus. If Arcelor Mittal buys a steel foundry in Penssylvania and shuts it down in order to increase the demand for the products of its cheaper foundry in country X,Y or Z, does it not matter to citizens of the US? The stock-owners will have come out whole, but will we?

And if Lenovo now supplies the computers for the Pentagon, does it not make a difference from when IBM did it?

Forget the "New World Order." Putin has shown you exactly where it belongs. This is the real world, Don, not a theory to be maximized.

BTW, I am a far-from-nativist immigrant, and am equally at ease in five languages.

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