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 
Ian,
Yes, I have seen that argument posted on this site before. I am yet to be convinced that the comparison is valid because the stock markets are investment markets that are buffeted by the winds of fear and greed where as FOREX markets are much more aligned to demand and supply – Currencies are basically a commodity.
In both ’87 and the ’00 crash (which continued through ’01 to Mar ’03) rational investors sold out. There is an excellent book titled ‘Irrational Exuberance’ (the quote made famous by Greenspan) that looks at the valuation issues.
It appears that what the CAD Chicken Littlers are forecasting is a massive drop in consumer demand across the developed world that will lead to fall in demand from China for Australian commodities which will lead to a major slowdown in the Australian Economy (or should I say Western Australian Economy?). I just don’t see that happening. Europe and Asia all don’t move in lockstep with the US. The growth in the new-Europe is improving and if German voters can be convinced to get off the nanny state teat that will drive growth there also.
Hopefully the Chinese will move to a free float in the next decade and that will assist greatly with smoothing out adjustments.
The old saw is that “markets go up by the stairs, down by the elevator”.
Look at virtually any time series of actively traded assets to perceive how often this observation is true.
In other words fear works much quick than greed.
Market crashes almost never happen without warning.
1. Generally, pessimists point out the high p/e ratios. They talk about weak fundamentals.
2. Market loyalists then respond that this time is different from the last time the market crashed. Market operators have learned their lesson the last time, ther has been a permanent productivity revolution, beg debts don’t matter, etc., etc.
3. Bulls test the market. It dips. Then it rallies. Market loyalists exclaim “We told you so!”
4. A large player turns from bull to bear and liquidates his position.
5. There is a general rush for the door. Many get trampled.
6. Amidst all the hubbub a market loyalist is heard to expostulate. “The market is fundamentally sound.”
7. These words signal the arrival of the crash.
I read somewhere that the 1987 crash was signalled by Scottish insurance companies cashing out of equity markets.
>It appears that what the CAD Chicken Littlers are forecasting is a massive drop in consumer demand across the developed world that will lead to fall in demand from China for Australian commodities which will lead to a major slowdown in the Australian Economy
No what I’m forecasting is an increase of at least 1-2% in Us interest rates over the next couple of years, a rise in Us inflation and unemployment and a run on the US dollar which will probably take 10% or mroe off its value against the TWI.
I don’t think thei mapct on china will be that great and I don;t think Australia will be all that severely affected either.
Razor says:
It’s easy when you fabricate the opponent’s argument, isn’t it?
You’ll note that John actually proposed three different possible corrections, one of which was your consumer demand drop, which you don’t think will ever happen.
Razor says:
Um, that would actually be one of the other corrections, wouldn’t it? And if they moved to a free float tomorrow, there’d be a dollar crash. The only thing holding up the dollar in the futures market is a belief that the Chinese will not free float.
That’s kinda John’s point, doncha think? That there’s some irrational belief that things will continue as they are forever.
Pr Q is saying that the US is approaching a Debt Trap, that is where the growth in the cost of servicing debt starts to greatly exceed the revenue earned by that debt.
The US has incurred a huge amount of debt over the past half-decade (several trillions), mainly to finance the acquisition of bogus technology companies, an orgy of luxury consumption and a domestic housing bubble. None of these investments are likely to return large revenue flows. OTOH, the US economy is also continuing to record very strong productivity growth, largely owing to the takeup of info-tech by non-tech companies (eg Walmart).
So far the US debts have been serviceable owing to the frugal habits of the earners in North East Asian industrial economies. As soon as these savers start demanding a higher price (interest rate) for the privilege of investing in US securities the US economy will plunge into the Debt Trap.
For some reason, US financial markets do not appear to be factoring in the impending doom of its financial system. The price of US security, equity, property and currency have remained high or risen higher in the past few years.
So Pr Q is really arguing that there is a massive market failure in the ability of US financial markets to properly calculate and propagate the real relationship between risk and reward over longer time periods.
SJ – fair cop – I need to do the fabricating because the CAD doomsayers don’t clearly layout in plain English and straight forward causations what is going to cause the Crash of the Noughties.
I’ve been reading this line of reasoning on this site for ages now and it is starting to remind me of Dr Ravi Batra and his continual doomsaying (hasn’t been right yet but sells lots of books).
I am interested in why you think a Chinese free float would cause a dollar crash. I may be wrong but I feel sure the US among others have been pushing for a devaluation for at least the past two years.
Ian – the US Yield curve doesn’t support your view. If you believe what you are saying then you should go short on T-Bond futures – you’ll make a killing!!
Razor Says:
Yeah, yeah. Just like the US has been pushing for democritisation in the Middle East whilst promoting the overthrow of elected governments in Central and South America, the rhetoric doesn’t quite match what’s going on in the reality-based community.
I’m sure it wouldn’t be all that hard for you to understand. The useless Bush government doesn’t want to accept any blame for running a huge deficit. So they claim that it’s the fault of the Chinese, that the US is acting as the “spender of last resort”. But, as you say:
So tell me, what do you think happens when China stops buying up US dollars to maintain the currency peg? What happens to the US dollar?
Duh.
SJ – is China actually buying USD in order to maintain the peg? With a massive trade surplus, there shouldn’t be a need to be buying USD on market.
Got any other good conspiracy theories about the US being ‘for but against’ supporting democratisation or currency floats?
Razor Says:
Um, isn’t what you’ve said, um, a bit silly? What other mechanism is there for maintaining the peg?
No, they only need to buy dollars to defend the peg when there is a shortage of incoming USD.
China does not have a peg with the US dollar any more. But if they did they would not need to buy any US dollars to defend it. They could target the US dollar exchange rate but actualise it by buying and selling gold (or euros). The target of monetary policy does not need to be the instrument.
You could have a gold peg without buying or selling gold. You could have a Euro peg without buying or selling Euros. You could have a Dollar peg without buying or selling Dollars.
In Australia with have a crawling “interest rate” peg.
Not being any sort of an economist, I hesitate to enter, but…
can you tell me, does the Australian government’s virtual elimination of public debt help much in any of these gloomy scenarios?
Presumably if it all started looking like a poo sandwich we’d have the flexibility of either getting into a bit of Keynsian pump-priming, or be able to maintain service levels through borrowing to cover the reduced taxation?
To find a gloomy scenario in Australia current economic situation requires a little bit of digging.
Keynesian pump-priming is another word for wasting money. If you want to stimulate the economy then you should lower the domestic trade barriers. ie cut taxes and red tape. ie Fiscal and Microeconomic reform.
But the answer to my main question? is Australia substantially different to the US, because our public debt is so low?
wilful – the answer is Yes – the successful elimination of federal government debt has put the Australian economy in a very sound position. If we had a large government debt, such as when Paul Keating was talking about Banana Republics, then we would be in a much worse position. There have been some really good articles about this in both the AFR and The Australian in the last couple of years. That said the US has both large CAD and large Federal Deficit but is able to sustain it successfully because they have a strong well managed economy, much to the chagrin of the Bush haters.
It is a gloomy scenario isn’t it with virtually Zero net government debt, a floating exchange rate, interest rates – inflation – and unemployment being sustained at historically low levels, rising business investment, federal government surpluses, a GST pouring funds into State treasuries, likelihood of lower taxes, workplace reform allowing more productivity gains, “. . .but. . . but . . .BUT. . .HoWARitlerbushyAWBOverboard is going to roooon us because the CAD is big – QUICK RUN!!! (Why is everybody ignoring us????)
Razor, good post
🙂
Oh I dunno, how about infrastructure, education, private debt, unaffordable housing? They’re not so hot, are they? And where’s the economic evidence/analysis that says workplace ‘reform’ will do anything for productivity?
Wern’t the reforms of the 80s and early 90s crucial in setting Australia up for the sunshine anyway?
Also, to suggest that the only role of government is to manage the economy is just flat out wrong.
Sorry, still a Howard hater (with a nod to his Government maintaining a reasonably well managed economy in the short term).
Government debt is not bad so long as it is invested in assets (income producing investments). The governments biggest source of income is the nations tax base. It should invest in enlarging this asset. A decent tax cut would help do the trick. Even if it meant no more surplus.
How about, instead of making a very low tax country even lower taxed, reforming the tax system to remove disincentives for people to pay a fair share of tax, and to get back into work?
What matters to either a government or a firm is net worth, not net debt.
Australia is in a better position than the US because the government is in modest surplus, adding to net worth, but not because of actions like the sale of Telstra, which reduced net worth.
JQ,
I have heard it asserted that the anomaly in US demand growth, (anomalous in its incessant rise), over the last 25 years is a function of financial sphere excess, i.e. explosive credit and capital markets growth. In this scenario, the trade deficit is a creature of monetary excess- not vis versa, and market misperception of macroeconomic risks is not so much a curiosity as it is a necessary condition.
If there is credence to this hypothesis, as I would argue, then the unwinding of this unsustainable trade and current account situation can only be precipitated by a reversal in the growth of credit. Given the current paradigm of our malevolent financial system, the most essential component of which being the Fed’s policy of easing at any sign of financial fragility, I would furthermore argue that a reversal of credit growth is only possible as precipitated by a full blown systemic crisis. The most likely catalyst for such an event, as in 1998 or 1994, would be the slowing of credit growth leading to default in one or a few large issuers (EM or corporate). This would inevitably trigger a meltdown in the sea of asset backed structures and derivatives that sit atop that paper- with notional amounts far in excess of those existing in previous crises- massive deleveraging of the leveraged speculative, i.e. hedge fund, community (with a share of the credit system far exceeding that in previous crises), concomitant collateral damage on the broker/dealers, and concomitant collateral damage so on down the line.
What I am intrigued about is whether such a pandemonium, which would surely have the Fed pumping liquidity into the banking system hand over fist, could trigger a run on the dollar, (the ultimate backstop for the trade deficit). If it is reasonable to suspect so, we may have our high probability scenario for the terminus of the unsustainable.
On the bright side, imploding global demand and “cascading defaults” (ironic Greenspanism) are a surefire way to reduce carbon emissions…
Majorajam
ma·lev·o·lent ( P ) Pronunciation Key (m-lv-lnt)
adj.
Having or exhibiting ill will; wishing harm to others; malicious.
Having an evil or harmful influence: malevolent stars.
That might be your paradigm but fortunately you are a insignificant minority.
Do you have any proof that the financial system is deliberately malevolent?
wilful – infrastructure is generally a State issue and funnily enough is generally slowed down by NIMBYs Greenies and land rights issues.
Education – the State governmemnts are responsible for the vast majority of Education.
Private Debt – what is wrong with private debt? It is an individuals choice to borrow or not borrow – personally I’m up to my eyeballs in it and loving it.
Unaffordable Housing – the first issue is what is unaffordable – the places I want to live are currently unaffordable to me (if my wife bumps me off and collects on the super, insurance and the business she might be able tomove there but she’d have to work or marry well, again). The second issue is – since when has housing been a federal issu? It is the State and Local governments who aren’t releasing land quickly enough. For christ sake we’ve got the most sparsley populated continanet outside Antartica and there we can’t provide cheap land to those who want!! Once again NIMBYs Greenies and land rights. Not Federal not federal not federal – and don’t even try it on with the bunkem about CGT concessions.
Fair cop on the work place reform – hasn’t exactly ended the world as we know it for working men and women as advertised by the unions either, has it!
The reforms by the Hawke-Keating Governments do under-pin our current situation, but that isn’t a reason to sit on our arses. Continual improvement is required to remain internationally competitive.
Government should only play a role in regulating the economy, provision of public goods such as Defence, and welfare safety nets. Every effort must be made to minimise government. The less tax taken the more a Citizen has to spend, save or invest as they see fit, not the government at all levels.
The analogy between a firm and a government is accurate. However a liberal democratic government should not be interested merely in maximising the net worth of the public sector. It should be interested in maximising the net worth of both the private sector and the public sector combined. It should care about the combined value of public goods and private goods.
In practice governments are often more narrow than that. They tend to operate like a profit maximising corporation rather than a benevolent ruler.
The Laffer curve argument (ie a lower tax rate will lead to a bigger public sector) is based on an appeal to the corporate nature of government. However there is a good argument to cut taxes lower than the laffer curve would suggest to expand the output of private goods. The ideal tax rate to operate at is the point at which ‘private goods plus public goods’ is maximised rather than the point at which ‘public goods’ are maximised.
Canberra is currently gripped by a form of fiscal conservatism.
Fiscal Conservatism – I almost spat my coffee on the keyboard on that one.
Howard is the biggest taxing and spending government in history. It is not fiscally conservative…not
NOT
not
. . . not.
I can’t believe the amount of tax I pay – personal income tax, GST, company tax, superannuation taxes, state taxes and local taxes – I f****g bleed taxes. And then they go and spend it on middle class welfare, dole bludgers and the yaaarts – and they can’t spend enough money to keep our ADF helicopters in the air, hire and train a full compliment of pilots or possess heavy airlift capability, nor do we have our own military satelites or cruise missiles and our Air-superiority fighters are only on par with the best in the region, not the best in the region. I wouldn’t mind paying it if the money was well spent, but it ain’t. (Good to see the Australian kicking up a stink about the crap issued to the diggers – I spent thousands on personal gear when I was in.)
razor, I know you will contest this, but Australia is a low taxing nation compared to all other OECD members.
Infrastructure is often State based, but there is a massive role for the commonwealth. And the NIMBY greenie myth is exactly that.
Education – federal contributions to secondary education have gone nowhere to improving the vast majority of Australians, while tertiary education (a federal issue) is going backwards.
Private debt is fine for individuals much of the time but the feds have a clear role in managing the economy in taking it into account. Private debt is in large part housing. And the main cause of the housing boom as far as I can fathom is investor demand, which is due to negative gearing and CGT concessions. It’s basically a bit of a rort and a wealth transfer from young families trying to get a modest house near enough to their workpalce to a small class of investors manipulating the tax system.
It’s got sweet FA to do with land releases and availability. Melbourne has at least 15 years of land available right at this moment, so that’s a nonsense.
Waste my tax dollars on big impressive toys? Are you kidding me? Australia needs Air Warfare Destroyers like it needs a war in the Taiwan Sea. $6 BILLION on a totally unnecessary capacity, what’s the point of fleet air defence when you don’t have a fleet?
“what’s the point of fleet air defence when you don’t have a fleet?”
1. Two small things we are acquiring called Amphibiuos Assualt Ships, apart from the existing surface fleet, or are they not real like the $600 family payment defined as not real by the ALP in the last election campaign.
2. To be able to actively and positively fulfill our role as a good global citizen by being able to effectively operate within and contribute to a combined task force with the same guys we’ve been fighting alongside for the last ninety or so years.
Negative Gearing is a tax-dodge? What is wrong with the principle that if you make a loss you don’t pay tax? What about the fact that while income tax isn’t collected up front – the investor pays CGT when they sell. I’m not a big fan of the 50% CGT discount for holding more than 12 months because it distorts the investment decision (bias towards CGT after 12 months over dividends). But the fact is that tax is paid. Now if you are an investor who is negative geared and doesn’t make a gain, hence paying no CGT, then you’ve blown your money, haven’t you.
Real Estate prices are a factor of supply and demand – limited land releases keeps the price up. If the people want cheaper housing then vote in State and Local governments that will release more land – it is straight forward supply and demand. Then all that needs to happen is to push the cost of building down. Of course, in Perth where a new brick plant is being proposed near the airport the NIMBYs and Greenies are up in arms to stop the project. The Wagyl has yet to slither into the picture but is no doubt very near by.
Razor: It is a gloomy scenario isn’t it with virtually Zero net government debt, a floating exchange rate, interest rates – inflation – and unemployment being sustained at historically low levels, rising business investment, federal government surpluses, a GST pouring funds into State treasuries, likelihood of lower taxes, workplace reform allowing more productivity gains, “. . .but. . . but . . .BUT. . .HoWARitlerbushyAWBOverboard is going to roooon us because the CAD is big – QUICK RUN!!!
Once again you insist on fabricating the alleged positions of the people who disagree with you.
I have said repeatedly on this site that the Australian economy is in very good shape but then we all know that you really only support Howard and Bush because of your pathological hatred of muslims.
(Hey if you can do it, I can do it.)
Razor and Ian- We also have a chronic balance of payments deficit, grossly inflated property prices and a huge national debt. Unemployment stats are only low because the stats do not take into account the underemployed and discouraged job seekers.
There is no sign that any of these problems are being adequately addressed by the Howard government.
The economic silver cloud has at least a few grey linings.
Razor,
You have an interesting way of formulating a question. Be that as it may, my post largely describes the ma·lev·o·lent influence that I allude to. I’ll leave it to Herbert Hoover to put a finer point on it:
“Whatever the remote causes may be, a large and immediate cause of most hard times is inflationary booms. These strike some segment of economic life somewhere in the world, and their re-echoing destructive results bring depression and hard times. These inflations in currency or credit, in land or securities, or overexpansion in some sort of commodity production beyond possible demand—even in good times—may take place at home or abroad; but they all bring retribution”
Negative Gearing is a tax-dodge? What is wrong with the principle…
The figures aren’t at hand, but I read recently that an absurd figure was written off in supposed losses on real estate last year. Tens of billions. Showing that virtually the only driver for real estate investment was to minimise taxes. There’s a lot of fraud in there, but more importantly, the tax rules are driving investment, which is a stupid stupid distortion to the economy.
Negative gearing on investment properties cannot be completely abolished since it would probably lead to a shortage in rental properties.
However the rate of negative should be lessened in some way as this would cut the cost of housing. For instance, investors could be allowed to claim 75% rather than 100% of there so-called losses.
I should disclose that I am a beneficiary of negative gearing. Nevertheless I don’t think our grossly inflated housing prices are fair on first home buyers. Accordingly I would gladly forgo some of my current tax benefits in the interests of equity.
Majorajam,
If that is meant to be proof of the malevolence of the world financial system I suggest you look at both the quote and the source. Hoover may have been a fine mining engineer, but he was no economist and the quote was (at a guess) an attempt to excuse his (lack of) reaction to the onset of the great depression.
.
wilful – I suggest you impose a reasonableness test on the figure you give for write offs due to negative gearing. The real figure is less than $2 billion – the bulk of which is tax deferred, not lost.
.
Ian, Razor – as usual, the correct answer (IMHO) is somewhere between the two extremes. This government has done much to continue and solidify the gains made in productivity improvements through flexibility under Hawke and Keating. This has tailed off in the past few years as they have increasingly listened to the regulators and increased regulation. Hopefully, the workplace reforms will have their desired effect to further improve productivity. On the macro front they have partially got it right, but are spending and taxing too much, even if we still are below the OECD average.
The mindless pursuit of being an ‘average’ country should not be a game we play.
I agree that the Howard government is the highest taxing in our history. In both relative and absolute terms the amount of tax we pay has never been this high before. The comparably low levels of government involvement in our lives (and wallets) that was enjoyed in the 1960s and early is but a distant memory.
However the term “fiscal conservative” does make sence. The Howard government runs a surplus. They are conservative in the sence that in each budget they seek to obtain more revenue than they actually require for the current round of spending. The Howard government seems intrinsically opposed to government debt and so would rather risk higher taxes than a budget that was not in surplus.
Personally I think that the “fiscal conservatism” is seriously misplaced. The states have of late tried to emulate the mentality. In NSW the government sees a deficit budget as bad news. So does the media.
Governments should borrow when it comes to spending on state and national infastructure. If a road will provide utility for the next 50-100 years there is no reason at all to put the entire capital cost on this years tax bill. Future taxpayers should share a portion of the burden as they will share in the utility of the road.
Politically it makes a small amount of sense to bring forward capital costs if it creates an excuse to reduce other non essential expenditure. It gives you some political scope to ensure spending discipline in other areas.
Howard is both a “fiscal conservative” and a high taxer. There is no inconsistency in that claim.
mmm, I’m not so sure.
Howard is definitely NOT a conservative. He and his minions are showing quite a radical bent nowadays: huge taxes, attacks on state rights, usurping the Gov. General’s role, a WAR without HONOUR, etc
1. Howard has abolished the Menzian consensus on a range of socio-political issues, ranging from state-funded nation-building to industrial relations. That makes him a radical in the service of export business interests long irritated by the uncompetitiveness of Australian industry, and small business irritated by the political, legal and industrial power of the Australian workforce.
2. Howard pays lip service to traditionalist cultural and moral positions. That makes him a seem like a conservative to gullible nostalgics who have accepted Howard’s description of their lives as an accurate reflection of their lives.
3. Howard lies and prevaricates with the skill of a sideshow barker. He is prepared to sacrifice everything to achieve 1. above.
Howard is therefore a radical.
Terje says: “However the term “fiscal conservativeâ€? does make sence.”
No, Terje, it doesn’t make “sence”. You can’t arbitrarily redefine terms and expect other people to either agree with you, or even understand what you’re saying.
P.S. It’s not generally a good idea to invent your own spelling, either.
Razor says:
I can see that you don’t understand this very well. Nevertheless, I’ll persist. I can even answer both questions with a single cite. So, is the Bush Administration for bashing China or against it?:
sj – followed your link but didn’t follow the reasoning in the article.
Anyway – thank you to you all for the argie bargie – keeps the grey matter ticking over.
A little advice to a few.
sj – maintain the rage.
Ian Gould – your heart is in the right place – keep fighting the good fight.
avaroo – take JQs advice and get a more solid grounding in economics before you start trying to smack the lefties around the head with their policy stances.
Carlos – give up on the War without Honour stuff. I doubt you would know what the word means let alone concepts of duty, courage and loyalty that service men and women live and die by.
Thanks JQ – I will now withdraw from the field until I again feel the need to give you guys a tweak.
Andrew Reynolds,
Never let ignorance of a subject diminish the stridence in which you argue it. First of all, if you would like to take issue with my assessment of the global financial system, you should read my original post. I cited it in the post you respond to as “proof”, or rather, as the appropriate response to a non sequitur request for proof.
Secondly, regarding the Herbert Hoover bon mot, it would appear you know as little about the man as you do about monetary processes and speculative finance. Hoover understood the role of credit in the securities and land speculation whose bubbling created the boom & bust dynamics of the Roaring 20s and Great Depression, (although, along with the rest of the world, in hindsight). He furthermore understood the importance of reconstituting the credit system and stoking demand in the Great Depression, but was unable to overcome its profound psychological fallout. In short, the behavioral response to the collapsing real economy of the 1930’s frustrated all subsequent attempts at stimulating the economy. This ‘wealth effect’ of exploding asset bubbles and bankrupted banks compelled people to exceptional levels of thrift, (the “hoarding” of savings), which, in some sense paradoxically, magnified the malaise. Hoover understood these economic relationships and tried unsuccessfully to counter them but would be frustrated in his efforts, as would be his successor.
As an aside, I am intrigued by this idea that I should need to “prove” that the financial system is malevolent, (a statement more ambiguous in this context than in that originally stated). Does that mean the null hypothesis is that it is benevolent- why would that be? I suppose that given the right wing’s full commitment to the cause of cognitive dissonance, such ploys come in handy. Evolution? Global warming? Prove it.
SJ,
I am not arbitrarily redefining terms. I am not being original in my usage of the term “fiscal conservative”. It is used in the manner I have just used it many times and many places. There are no easy references that I can point you to but here are a few links with extracts:-
http://en.wikipedia.org/wiki/Conservative
EXTRACT: “Fiscal conservatism is not a political philosophy, and more a tradition of prudence in government spending and debt.”
http://www.centristpolicynetwork.org/archives/000056.html
EXTRACT: “Real fiscal conservatives are supposed to support balanced budgets, not deep deficits.”
Regards,
Terje.
P.S. I will now kick off a Wikipedia article devoted to the term and see where it evolves to.
Since everyone else seems to be repeating the things they always say when this topic come up, I see no reason to desist.
There is a big difference between the US and Australia. Australia already has net foreign liabilities of around 70 percent of GDP, so the net income part of the current account is basically predetermined for the foreseeable future, hovering around the 3 percent (of GDP) mark, and swamping the (average) contribution of trade balance. So nothing that happens in an electoral cycle will make much difference. We will just drift further into the debt trap. In the US, by contrast, net freign liabilities are still negligable and the net income from them miraculaosuly positive. They have time to fix the problem, but it’s make or break time, and I think they know it.
Jack is, as usual, about half right when it come to macroeconomics. Interest rates will have to go up in the US. But it has nothing to do with foreign savers ‘demanding’ higher interest. The US will need to accept a big real devaluation to increase net exports. Given that they are close to full employment and that, as John said, they are not likely to tighten fiscal policy in the near future, they can only achieve this by dampening consumption and investment. Otherwise domestic excess demand will eventually trigger inflation. The Federal Reserve will have to raise the interest rate to avoid that.
James,
US net foreign liabilities are not so negligible when you consider, a) that net investment income has been positive historically due to its currency’s reserve status, (“exorbitant privilege”), but more recently due to the coincidence of exorbitant privilege and a massively unstable asset-liability mismatch (our liabilities in currency and T-bonds, assets in private and traded equity) and b) total debt to GDP in the US is higher than at any point in the 20th century, inclusive of the credit bubble before and collapse in GDP after the Great Depression.
As far as a) goes, two things should be pointed out. First, net liabilities courtesy of 6% of GDP current account deficits are starting to negate both of the return advantages as stated. This despite the 20 some odd percent trade weighted depreciation of the dollar in the last five years. Second, the asset liability mismatch that has been so fortuitous in the past three years will be decidedly unfortunate when equity and private equity returns go negative. As far as b) goes, it should be interesting to see whether the Fed can slow domestic demand without triggering defaults on scale especially given that we’ve turned over so much of the credit creation responsibilities to institutions that operate on paper thin capital margins (hedge funds) and in the presense of untold trillions in derivative notional value.
I think it’s fair to say, time is no longer on our side. The time to fix this problem was 10 years ago.
I have no background in economics, so it’s quite likely I’m getting things all wrong, but why is a large net foreign debt anything to worry about, so long as the debt servicing is manageable? For example, an individual thinks nothing of a debt that is 70% (and more) of current earnings, as he can service this debt. Why doesnt the logic extend to the country as a whole?
I take the point that continued growth in the trade deficit would mean a fast increase in the CAD, but what makes a higher CAD (and higher foreign debt) so worrying? Couldnt we sustain a much higher foreign debt — up to the point where repayments on debt become prohibitive? And isn’t that a long way off?
Apologies in advance if there are obvious answers to these questions — as I said, I have no background in economics.
Peter2,
The problem is (IMHO) two-fold. What is sustainable and at what cost? A person can sustain walking for years with a big rock on their back, but the cost may be a shorter life, bowed legs and an inability to run a marathon or win a sprint. The US may be able to sustain a large amount of debt, but it may substantially impede performance. Also, a large rock may be able to be carried for a short time, giving the appearance of sustainability, but may actually be doing long-lasting damage while it is there.
OTOH, if the debt (lets get out of the metaphor now) is being carried to build or buy productive assets or otherwise improve things it may be sustainable indefinately and may actually improve things. How it is used, its efficiency, is a critical consideration.
In the case of many corrupt countries the debt may simply go to conspicuous consumption on the part of the leader (of his or her Swiss bank account – think Sani Abacha of Nigeria) in which case even a small debt could be unsustainable. In the case of the US there is a better (but not perfect) chance that it is being used productively, so a larger one may be sustainable.
Andrew.
Thanks for the explanation, but I have more questions 🙂
Even if much of the money has been spent on non-productive assets, a foreign debt of 70% of GDP is still pretty servicable, no? A household can sustain a debt to earning ratio of 70% and higher pretty easily, so why cant a country? Even if most of the debt is on unproductive housing related finance (the worst case scenario, it seems, to most economists), our debt servicing requirements are not too onerous. So, to return to your metaphor, I guess what I’m saying is that the rock doesnt seem so big. So what am I missing?
Is there any evidence that US investors have put these borrowings to productive economic use? On the face of it there seems to be a coincidence between a rising US CAD and falling US international economic competitiveness.
Trade statistics since the late 1960s indicate that on a wide range of products and services US producers have declined in international competitiveness.
Thus US producers often cannot compete in international markets.
Moreover, US producers are finding it difficult to replace imports in their domestic market.
The late 1960s marks the beginning of post WWII current account deficits.
What, if anything, does this coincidence signify?
“The comparably low levels of government involvement in our lives (and wallets) that was enjoyed in the 1960s and early is but a distant memory.”
Terje can I urge you to go and do some reading on the 1960’s and earlier?
“Government involvement in our lives” was rife in areas such as censorship; criminalisation of contraception and homosexuality; regulation of the exchange rate and interest rates and protectionism to name just a few examples.
SJ,
Your’s and the Bush Administration’s description of China’s exchange rate regime as ‘currency manipulation’ is interesting, given that the similar Bretton-Woods arrangement (underpinned by the US) was a cornerstone of international trade for over 3 decades post-WWII.
Running a fixed exchange rate, or ‘targetted basket’, or crawling peg, (heck, even a gold standard – cheers Terje) indeed any of the many other non-free-floating currency regimes is a perfectly valid alternative lifestyle.
If the Chinese Government issues the yuan, it has the perfect sovereign right to set its value (assuming it has deep enough pockets to do this).
This does not come without its costs of course – in essence the Chinese Govt has handed over its ability to set domestic interest rates to the US Fed.
But if the US still believes this is dirty tricks manipulation, then it too has the perfectly sovereign right to fix ITS own currency at a lower level. Whether the US Government has the resources to do this is a completely different story, of course.