The US recorded a trade deficit of $725.8 billion or 5.8 per cent of GDP in 2006. That’s roughly equal to Australia’s entire GDP. With short-run interest rates having risen, the income component of the current account deficit is bound to start growing rapidly soon. If the trade deficit doesn’t turn around this will generate an unsustainable explosion in debt and deficits.
What can’t be sustained won’t be, so it’s safe to predict that the trend shown will be reversed sometime soon. What’s harder to predict is the mechanism by which this will happen.
The optimistic theory was that strong US productivity growth, aided by the moderate depreciation of the early 2000s would lead to a revival of the US export sector. This seems to have worked for Boeing, but nowhere much else, and both the depreciation and the productivity boom have now run their course. And the loss of traded-sector jobs (mostly manufacturing) that took place in the recession hasn’t been reversed, suggesting that US businesses don’t anticipate any big growth in this area.
A really big depreciation would be another possibility, but nothing like this is priced into US interest rates at present. It seems likely that the US dollar is being held up by foreign central banks. This process must unwind some time, and its impossible to tell whether the process will be orderly or chaotic. Even so, it’s hard to imagine a depreciation large enough to restore balance in time.
The third possibility is a reduction in US demand. It doesn’t seem likely that this will come from the public sector: there’s no hint in the latest Bush budget that chronic deficits are a problem. So a big decline in household consumption is needed to restore balance, and also to repair household balance sheets, which look bad now and will look worse if housing prices fall.
Such an increase could result from a general recognition by households of the need to save more, but it seems more likely to result from an increase in long-term interest rates. Again, we come back to the observation that no such increase is being priced in by the market.
Australia is, of course, in a very similar position. Suggestions that our deficit problems would right themselves when the drought ended or when coal exports started moving have proved false. Our adjustment process will almost certainly be tied up with that of the US.
John Quiggin 
As a percent of GDP, 5.8% isn’t a historically devastating number. I think in 1997, it was more than double that percentage of GDP. Unless demand starts reducing drastically in the US, which I don’t personally think is likely, I think we’ll continue to maintain a fairly high trade deficit. It seems to be our pattern, growth fueled by ever-rising demand, fueling ever-higher growth. I don’t know that the US is comparable to Australia or any other nation. Comparing trade deficits would require both nations being compared to have similar growth levels.
Avaroo, this is way off the mark.
The trade deficit is a record per cent of GDP for the US (at least since 1900 or so when these statistics are available), and at the level where most economists traditionally assumed crisis becomes inevitable.
And as I point out, a large trade deficit can’t be sustained indefinitely.
If you want to comment on this kind of topic, you should learn some economics.
Prof Q, there’s one weird anomaly (at least to a non-economist) in the discussion of the US’s trade deficit, saying that the US, despite its enormous apparent deficit, makes more income from its foriegn debts than the rest of the world gets from it’s US debt. The Economist mentioned this recently. The argument therefore goes that there must be something screwy with the US’s foriegn debt figure.
What’s your take on this?
Do you have the statistics for each years since 1990, showing the trade deficit as a % of GDP?
Historically, the US has had a large trade deficit in comparison to other countries for decades, so it looks like what some consider a large trade deficit may be sustained indefinitely. It depends what the growth level is. That’s why the US isn’t like other countries.
Any predicted probabilities for any of these scenarios ? Or perhaps combination of them ?
The US economy appears to perform better in years when the trade deficit is rising than in years when it shrinks. Unemployment seems to have a similar relationship with rising trade deficits. In years when the deficit rises, unemployment (and poverty) has historically fallen and vice versa. The US has a constantly rising level of investment in technology and equipment, which requires importing capital to finance.
The Rosy Scenario “deficits don’t matter” is articulated in the following Cato Institute extract:
http://www.freetrade.org/pubs/pas/tpa-012.pdf
“America’s annual trade deficits are sustainable as long as the United States remains a safe and profitable destination for the world’s savings. The accumulating net foreign ownership of U.S. assets, America’s so-called foreign debt, does not threaten our sovereignty, our ability to finance that investment, or continued economic expansion.
“The best policy response for the [Bush] administration and Congress would be to ignore the U.S. trade deficit as a target of policy and concentrate instead on maintaining a strong and open domestic economy that welcomes foreign investment.”
But the Cato Institute’s construction of the position any country experiencing large and sustained trade deficits, while arguing against alarmism, seems in fact to confirm JQ’s concerns.
The Rosy Scenario argument asserts that there is a limit to the sustainability of trade deficits: only as long as there are US assets to sell to foreign investors. By definition, that stops when foreign ownership reaches 100%.
However, in reality any nation, especially one as prone to nationalism as the United States may become an uncongenial host for foreign ownership long before the maximum 100% is reached.
It may be an entertaining parlour game to estimate the acceptable limits of foreign ownership, in percentage terms.
Avaroo: Do you have the statistics for each years since 1990, showing the trade deficit as a % of GDP?
Do you?
The information is probably available on the internet and iIm sure you had some basis for your claim that the US trade deficit exceeded 11% of GDP in 1997.
Avaroo: I don’t know that the US is comparable to Australia or any other nation.
As for growth rates – I’m through doing your research for you but US and Australian growth rates are quite similar.
There is also no necessary connection between growth and a trade deficit – China, for example, manages to combine high growth with a trade surplus.
That’s a great link. I don’t resd it as saying “deficits don’t matter” though. The article does explain the reasons the US (and Australia btw) have such high deficits.
Nationalism, as it is commonly understood, doesn’t really exist in the US. It’s hard for people in the US, from all over the world to be nationalistic about where they happen to live today. We have such a high % of Americans whose parents are/were foreign born. If by nationalistic, you mean that we have a very high % of people who have CHOSEN to be Americans, rather than simply being born and living here for generations then I think that’s not nationalistic.
Even the concept of foreign ownership, I think would be different in the US than it might be anywhere else.
“Do you?”
My question on statistics concerned this claim:
“The trade deficit is a record per cent of GDP for the US (at least since 1900 or so when these statistics are available), and at the level where most economists traditionally assumed crisis becomes inevitable.”
Australian growth rates may be similar to the US’ but I don’t know that Australia attracts the level of foreign investtment the US does.
You can read Katz’ link for information on China, and why you’re wrong about it.
I think perhaps “patriotism” is a better term for what you’d find on a large scale in the US, rather than “nationalism”. Honestly, in order to be nationalistic, you’d have to spend some time thinking about nations other than your own. And I can’t honestly say that I think many Americans do.
If interest rates rise in the US, to dampen consumer demand and overall economic activity because of fears of over the CAD, then won’t more FDI money pour into the US to soak up all that interest!
Actually Katz’ link (at a quick browse) says nothign at all abotu China’s current account balance – it deals with the impact of Chinese imports on US growth and employment – a totally different topic.
China has maintained a trade surplus almost continuously for the past twenty years: http://www.chinability.com/CurrentAccount.htm.
China’s GDP growth is available here: http://www.chinability.com/GDP.htm
By the way, Katz link DOES show that you claim of a 11% of GDP trade defict is nonsense.
Don’t you ever get tired of making a fool of yourself?
Ian, if you believe that China represents the model for the US, then we’re so far apart, there’s little point in talking.
I don’t think I ever claimed an 11% of GDP US trade deficit.
Avaroo, unless you’re willing to admit to yourself that you’re totally ignorant about economics and economic statistics, you’re unlikely to benefit much from reading this blog. There are so many errors in your comments on this thread alone, that it would take me an hour or more to correct them all. Since you give no indication of being willing to learn, I don’t intend to bother.
Katz, one point in the link you posted, that I don’t know that anyone has covered is the desirability of “encouraging faster growth abroad through the liberalization of trade and investment flows and the spread of technology”.
Rather than trying to curtail demand in the US, increasing demand elsewhere seems a reasonable tactic. A domestic recession to reduce the trade deficit would cost American families too much as your link says.
Donald Boudreaux, Chairman, Department of Economics, George Mason University, is not worried.
http://www.tcsdaily.com/article.aspx?id=021006G
Avaroo: Ian, if you believe that China represents the model for the US, then we’re so far apart, there’s little point in talking.
I don’t believe China “representa model for the US” – I think it is proof that there is no necessary link between the trade balance and the rate of economic growth.
Avaroo: I don’t think I ever claimed an 11% of GDP US trade deficit.
Yes you did, when you wrote: “As a percent of GDP, 5.8% isn’t a historically devastating number. I think in 1997, it was more than double that percentage of GDP.”
Double 5.8% is 11.6%.
If you read through to the end, you’ll see he is kinda worried.
These are the words of Donald Boudreaux, Chairman, Department of Economics, George Mason University, cited above:
“Isn’t it better, though, if Americans do the investing and foreigners the consuming? No. What’s important is to have lots of investment to increase worker productivity, which ultimately is the only way to raise our living standards. The nationality of investors is insignificant.”
These are the words of a thoroughly logically consistent economic liberal who cares only about the quality of the product he buys. He cases not at all about the location or nationality of the owners of the businesses that made the product.
And in the United States, the identity of owners of assets never matters, until it matters.
In fact, the US has exhibited a long history of confiscation of assets from identifiable groups in the national interest.
Thus, slavery stole the rights of the person and gave them to her master. This idea existed for almost three-quarters of the existence of English-speaking North America.
The Federal Indian Removal Act of 1830 enabled coerced dispossession of the property of all Indians East of the Mississippi.
California Alien Land Law of 1913 prohibited “aliens ineligible for citizenship” (i.e. all Asian immigrants) from owning land or property, but permitted three year leases. This law allowed speculators to buy Japanese-owned land for a song as more than 100,000 Japanese, many of who were actually US citizens, were interned in the aftermath of Pearl Harbor.
(The U.S. government officially apologized for the internment in 1988, saying it was based on “race prejudice, war hysteria, and a failure of political leadership”. Fine sentiments, but too late for many whose lives had been ruined.)
Post 9/11 US could well be described as a nation flirting with “race prejudice [and] war hysteria”. And if the administration of FDR can be said to have suffered ” a failure of political leadership”, what might be said of the administration of GWB?
Thus the good sense of the thoroughly decent and tolerant Donald Boudreaux, Chairman, Department of Economics, George Mason University is by no means guaranteed to be the ruling spirit of American economic policy.
During periods of stress in the past, Americans had turned vengeful against out groups.
Why should foreign economic interests resident in America feel immune from another upsurge of American nationalism and another major episode of confiscation?
‘The Donald’ said this (pubished yesterday): Then there’s the argument put forward by Donald Boudreaux, a George Mason University economist. He opines that the deficit is really a blessing, not a curse. “America’s trade deficit is evidence, not of any imbalance, but of the happy fact that our economy is so strong and stable that foreigners invest here eagerly,â€? Boudreaux writes. http://www.stltoday.com/blogs/business-mound-city-money/2006/02/trade-deficit-should-we-worry-yet/
In fact, sovereign risk was a huge issue for outside investors in the US during the 19th century. Contrary to all the tosh from Americans about how the USA has “never” welched on its debts, this has actually been routine procedure since its inception although often in a disguised form. Soevereign risk destroyed practically all the European long term holdings there by the end of the century (read Billy the Kid’s back story and why he turned to crime when his employer went broke). It has been estimated that European wealth lost to Americans in this way exceeded Marshall Aid later (sorry, I can’t give a reference – I think it once got mentioned in the Spectator).
For a mid-19th century viewpoint, read Trollope’s remarks in his finance chapter of “North America”. Other chapters show that European landowners were much less ecologically destructive than locals, too – more true investment and less destructive exploitation.
My guess is that peaceful penetration will lead to US wealth transfers of this sort from other countries that will be leaned on to make a free trade a cover for cheap “investment” by outsiders who really pay for it via inflated currency. The game will be rigged, as usual.
The big current account deficit can mean that the rest of the world is not investing enough. Indeed some recent commentaries on China identify abundant capital due to high rates of savings as being more influential in creating growth than a large population.
Mathematically you are right, the US cannot maintain high rates of capital inflow foreover – though Australia has for most of the last 150 years. But the high rates of capital inflow may eventually peter out rather than collapse and the US dollar, accordingly, take a gradual decline.
Avaroo is hilarious. I especially liked “The US economy appears to perform better in years when the trade deficit is rising than in years when it shrinks.” Umm, avaroo, have you given a moments thought to which way the causality runs here?
We see no reccomendation as to a solution to this problem on this thread. But all good economic policy solutions begin with ruthless financial triage in non-defense spending.
“I don’t believe China “representa model for the USâ€? – I think it is proof that there is no necessary link between the trade balance and the rate of economic growth.”
I don’t know that there’s a link either. What I actually said was that the US has been able to sustain a high trade deficit because growth is also relatively high.
derider, I don’t think there is necessarily a causality. Re-read what I actually said.
“Mathematically you are right, the US cannot maintain high rates of capital inflow foreover”
Probably true, but that’s why we need to encourage a faster rate of growth outside of the US, so that the capital the US needs can be imported. We can’t fuel our own level of growth all by ourselves. But if demand outside the US can be stimulated, that will help both the US and those outside the US.
Tho’ not an economist, I venture the observation that it is the combination of negative balance of trade and balance of payments which is crucial here. In his excellent book “The First Industrial Nation”, Peter Mathias notes that the UK ran a negative balance of trade for the whole nineteenth century, but the positive balance on invisibles plus earnings on foreign investments kept the balance of payments in the black – until two world wars wrecked these compensating income flows.
The same website Prof. Quiggin links to has an Excel table showing “US international transactions 1960-present” http://www.bea.gov/bea/di/home/bop.htm
If I have interpreted this table rightly, the US has been running a negative balance of payments AS WELL AS a negative balance of trade for the entire period reported except for one year (1991) which looks like an anomaly in a steadily widening BOP deficit.
By further comparison, our total debt as ratio to GDP is not to flash either. The US Budget Progam shows no indication of any attempt to reduce the Federal deficit or the American terms of trade but may hold the line. Bush has run out of political capital to introduce sane taxation policies and has placed the Federal Government into reduced income position by fiscal largesse to American capital owners. The US and Australian discretionary expenditure based on debt from inflated assets must also begin to wane so that slowdown in spending will slow imports. It would not be unreasonable to presume that any US consumer slowdown would have effects in Asia and in particular China and slow their increasing surpluses. The balances and the currency outlook will be speculation dependent, given the significant stake in the US currency in Asia and the lack of alternative except their own the funding of the US deficit and maturing debt will continue. It will be interesting therefore to see if the US opts for a currency devaluation, Gates and Buffet have not been able to short the currency despite their efforts, suits the Japanese and Chinese fine.
My futher look at the dark matter hypothesis suggests the income alluded to is perhaps merely a reincarnationof of the dodgy intellectual property values of the dot.com boom, these are not necessarily invalid arguments but few translate R&D or intellectual wealth into a cash stream say like MS or Google do. This may provide accounting solice but cannot see it generating cash flows externally sufficient to halt the US deficit.
The danger here is evident already, with the state sectoral economic performance showing our reliance once again on a commodities boom in WA and QLD.
I think we are about to enter an destabilising deflatory subsidence ala the Japanses through the eighties and nineties.
What is clearly unsustainable in the short to medium term is the US running both a current account AND a fiscal deficit.
US fiscal policies will have to change. Tax cuts, defense spending, and the war against terrorism will all have to be scaled back. This will work through to impacts on the current account.
Other changes to the American way of life flowing from the probably unsustainable current account deficits are already evident in the downscaling of featherbedding in the form of uncompetitive pension schemes in places like the motor industry, under the pressure of international credit ratings.
The big question is can these adjustments be made without inducing world wide recession?
Originally, I thought tax cuts during wartime were a bad idea. But they’ve proven to be very helpful in keeping the US economic engine fed. It will be tough politically to cut defense spending right now. And candidate suggesting it will be marginalized pretty quickly. I’m not sure how one goes about scaling back the war on terror. Unless, of course, terror itself becomes less frequent, which would be a very good thing.
Avaroo, just one more reminder that you ought to learn some economics before continuing to comment on topics you clearly don’t understand, or care to inform yourself about.
I’d like to give some of the real economists participating in this forum some room to discuss the issues, without having the thread derailed by your uninformed pontification. There are plenty of political posts where you can comment as much as you like.
Another thread makes mention of cuckoos in the nest:
Looks like Avaroo is something of a cuckoo:
Google Search: Results 1 – 10 of about 82 for troll avaroo. (0.39 seconds)
“Posted by tennessee claflin at January 30, 2006 10:27 AM
“You guys know, don’t you, that avaroo for several years posted on Guardian International – she stopped about four months ago, and indulged in what we call clown dancing – trying to send people mad by reversals and spins in argument. It was a continual wind-up – never replying specifically to points but bending and tilting. She could go on all night.
“She is very strong on anti-terrorism until it comes to the IRA – which she is very much in favour of.
“The impression was she had a very unhappy marriage.”
I guess even troll cuckoos have gotta lay their eggs somewhere.
One country’s trade deficit is, by definition, another countries trade surplus.
The Rest of the Wrold is currently running a US$700 billion a year+ surplus with the US and is lending it the money to fudn that surplus.
When we talk about the sustainabiltiy of the US’ trade deficit we are also talking about the sustainability of the RoW’s trade surplus and associated lending.
The Economsit suggested a couple of months back that if the US deficit continues to grow at recent rates, it will soon exceed the total savings of the rest of the world.
Leaving aside the impact of this on investment and interest rates in the ROW, at that point the US will presumably either have to import less or fund those imports in some other way – presumably by selling assets.
Umm, that last post is wrong – if the RoW can no longer finance the US borrowing demand from current savings it will need to do so by some other mechanism.
Since the ROW considered as a whole obviously can’t borrow from the US if the US is a net borrower, that would probably involve some form of dissaving such as not replacing fixed assets as they depreciated.
Limits to sustainable current account deficits?
There is an unarguable Malthusian proposition that a run of current account deficits is ultimately bound by selling off 100% of the farm.
As with Malthusian propositions about the limited carrying capacity of the land, the path to ultimate doom is difficult to predict because increasing productivity staves off the evil day.
The Australian case is illustrative. We have run current account deficits averaging 4.5% of GDP since the mid 1980s. Yet the most boring graph of any economic stats around is the % foreign ownership of Australian companies. Over the same period it is almost dead flat. How is this so?
One of the reasons for this is that the current account deficit, when expressed as a % of national net worth is a lot less alarming than its % to GDP. In other words we have sold off parts of the farm and used the proceeds to increase the value of the patch we have left such that it is worth more than the total before we sold. To continue the farming analogy, we have sold off the sheep country and we now farm high value crops.
So whilst productivity increases, the 100% ownership limit is ephemeral. The real issue is what are the limits of productivity growth in Australia (and USA)? Which brings us to innovation, education, infrastructure….
Derick, a current account deficit is sustainable indefinitely if i
CAD/GDP=g*(Debt/GDP) where
g is the growth rate of nominal GDP, and debt is foreign obligations (including equity).
What is not sustainable is a large positive trade deficit, since this implies explosive growth in the CAD. I’ll post on this again some time.
Derick: The real issue is what are the limits of productivity growth in Australia (and USA)?
No, the real question is what happens if the growth rate of the deficit is persistently greater than the productivity gowth rate.
Derick, I agree. Also, what is sold to foreign interests doesn’t necessarily remain under foreign ownership. For example, Pebble Beach was sold in the 1990’s to some Japanese investors but then sold 10 years later back to a group of Americans, including Peter Uberroth and Arnold Palmer and Clint Eastwood (for considerably less than the Japanese paid for it). At one point, Mitsubishi owned Rockefeller Plaza but now I believe it’s US held again.
QUOTE: What can’t be sustained won’t be, so it’s safe to predict that the trend shown will be reversed sometime soon.
RESPONSE: Actually the logic of that attempted tautology does not follow. If the word “soon” had been omitted then it would.
I still believe that regulating interest rates (through open market operations) distorts the credit markets. If central banks targeted the price of commodities instead of the price of credit then these things would sort themselves out a lot more smoothly.
PrQ: > a current account deficit is sustainable indefinitely if i
> CAD/GDP=g*(Debt/GDP) where
> g is the growth rate of nominal GDP, and debt is foreign obligations > (including equity).
> What is not sustainable is a large positive trade deficit, since this implies > explosive growth in the CAD. I’ll post on this again some time.
I’m going to have to think about this. My first reaction is that all the equation is saying is that we can sustain a CAD so long as we can service the financing of it, and evidence for that is CAD growth less than GDP growth.
If that’s the general thrust then I think its saying that productivity of use of incoming foreign investment must be greater than the servicing charge, otherwise there will have to be a correction, and we are in agreement.
On the other hand (its an economics forum, after all) I don’t understand components of the equation, like ratios of flows (CAD, GDP) mixed in with point in time stock concept like debt (and I assume you mean net debt, not gross). Its a lazy hot Sunday here and I can’t wrap my mind around the detail.
Also, “large positive trade deficit” = large current account surplus?
Ian Gould: > No, the real question is what happens if the growth rate of the > deficit is persistently greater than the productivity gowth rate.
See above. There has to be a correction.
Avaroo: > Derick, I agree.
A bit of a worry!!!
Terje, reread the post and you’ll see an earlier “soon” that makes the argument work just fine.
PrQ,
In my experience of markets, the turn comes only when everyone has stopped looking for it. Look for the last bear to be driven out of the market and that will be where the bear market starts.
Following this logic, once you and everyone else starts saying that you do not understand the current trends but believe they will continue, that is when the turn will happen. I will wait for you to say this before putting together a structured play to profit from it.
Also, “large positive trade deficit� = large current account surplus?
No,
trade deficit+income deficit=current account deficit=capital account surplus
My yerterday’s comment is still “awaiting moderation” after 24 hrs. I thought I was a pretty moderate guy anyway – how moderate do you want?
If the deficits are so bad then why aren’t the markets reacting to them? Why doesn’t the USD get sold off heavily and why do non-US investors keep wanting to invest in the US. Either, they are irrational (which I strongly doubt) or they have faith in the US economy to continue to perform well.
The yield curve in the US is currently inverted, with recent 30 year T-note auctions being very well patronised. Why is this so, if they are going to hell in a hand-basket?
The same questions arise for the Australian economy.
No explanation from the academics of the dismal science that is rational and reflects the current occurrence. And if you really believe that you have all identified a major problem then why aren’t you moving your assets out of USD and AUD assets into other currencies?
I believe that well managed economies in a floating FOREX market can maintain CADs in the long-run (time for a Keynesian pun). I personally carry a lot more debt than my parents ever did because the financial markets are much more flexible and will lend more than back in the day when you had to be male and wear a suit to meet the bank manager. There might be a a Nobel prize in this for someone one day. My opinion is that Central Banks should just concentrate on managing the money supply and keeping inflation down and governments should be fiscally responsible, the media and academics should also be responsible and not scare people and if all these things happen then currencies and CADs will sort themselves out.
Enough of the Chicken Little stuff (I have not seen the recent movie.)
The responses to the The Onion’s Vox Pops on the Bush tax cuts says it all: see http://www.theonion.com/content/node/45352
>If the deficits are so bad then why aren’t the markets reacting to them?
Because markets are only rational on average and in the long term.
Similar arguments were being made about US share prices right up to the 2001 crash (and the 87 crash before that).
Ian Gould says: “2001 crash”
I’m not sure there was such a thing. It was more like a slow-motion trainwreck that started in 2000 and finished in 2003. The sudden drop in 2001 was more a panic response to 9/11, that largely reversed itself after a couple of months.