Macroblog

June 9, 2007

Like Ben Said

Calculated Risk makes an interesting observation:

The trade deficit, ex-petroleum, appears to have peaked at about the same time as Mortgage Equity Withdrawal in the U.S.

"Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit. To be sure, correlation is not causation, and there have been many influences on both mortgage debt and the current account."
Alan Greenspan, Feb, 2005

... Declining MEW is one of the reasons I forecast the trade deficit to decline in '07. And a declining trade deficit also has possible implications for U.S. interest rates; as the trade deficit declines, rates may rise in the U.S. because foreign CBs will have less to invest in the U.S.. This is why I forecast rates to rise in '07.

I think that CR has the causation running from the housing market to the trade deficit, but as always there is another interpretation.  I take you back to one of my favorite Fed speeches of all time, from the current Fed chairman:

What then accounts for the rapid increase in the U.S. current account deficit? My own preferred explanation focuses on what I see as the emergence of a global saving glut in the past eight to ten years...

The current account positions of the industrial countries adjusted endogenously to these changes in financial market conditions. I will focus here on the case of the United States, which bore the bulk of the adjustment...

After the stock-market decline that began in March 2000, new capital investment and thus the demand for financing waned around the world. Yet desired global saving remained strong. The textbook analysis suggests that, with desired saving outstripping desired investment, the real rate of interest should fall to equilibrate the market for global saving. Indeed, real interest rates have been relatively low in recent years, not only in the United States but also abroad. From a narrow U.S. perspective, these low long-term rates are puzzling; from a global perspective, they may be less so.

The weakening of new capital investment after the drop in equity prices did not much change the net effect of the global saving glut on the U.S. current account. The transmission mechanism changed, however, as low real interest rates rather than high stock prices became a principal cause of lower U.S. saving. In particular, during the past few years, the key asset-price effects of the global saving glut appear to have occurred in the market for residential investment, as low mortgage rates have supported record levels of home construction and strong gains in housing prices. Indeed, increases in home values, together with a stock-market recovery that began in 2003, have recently returned the wealth-to-income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 and above its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, much of it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low--and indeed, together with the significant worsening of the federal budget outlook, helped to drive it lower...

The direct implication, of course, was that the reversal of U.S. current account deficits would likely be associated with higher real interest rates, a weakening of foreign-capital financed investment, and higher saving in the U.S. (of which a slowdown in mortgage equity withdrawals could be a part). It is worht noting that Chairman Bernanke was decidedly less than sanguine about the consequences of such adjustments:

... in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.

Whether or not Mr. Bernanke believes that we find ourselves in the process of meeting those burdens I cannot say.  But those who buy the global saving glut story -- as I do -- have acknowledged all along that the day of adjustment would look pretty much like it does at the moment.

• June 9, 2007 in
  • Federal Reserve and Monetary Policy
  • Housing
  • Saving Capital and Investment
  • Trade Deficit
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February 14, 2007

The Twins Part Ways

From the AP (via abcNews.com):

The deficit for the first four months of the current budget year is down sharply from the same period a year ago as the government continues to benefit from record levels of tax collections.

The Treasury Department reported Monday that the deficit for the budget year that began Oct. 1 totals $42.2 billion, down 57.2 percent from the same period a year ago.

From the New York Times:

The United States ran a record trade deficit in 2006 for the fifth consecutive year, the Census Bureau reported Tuesday in an announcement that quickly reignited the dispute between the Bush administration and Democrats over the value of past and future deals lowering trade barriers.

The bureau said that the trade deficit, or gap between what the United States sells abroad and what it imports, reached a new high of $763.3 billion last year, a 6.5 percent increase over the year before. The deficit was fueled by the continuing American need for foreign oil and imports of consumer goods from China and other countries.

The fact that the two deficits are moving in opposite directions is not really anything new:

Twin deficits?  Not so much.

• February 14, 2007 in
  • Federal Debt and Deficits
  • Trade Deficit
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September 26, 2006

Of Course Trade Deficits Aren't Necessarily Bad (Wherein In My Readers Set Me Straight)

Yesterday I nodded approvingly to the following remarks on the consequences of trade and current account deficits from Nouriel Roubini, as recounted by the Wall Street Journal:

"Your standard of living is going to be reduced unless you work much harder," says Nouriel Roubini, chairman of Roubini Global Economics. "The longer we wait to adjust our consumption and reduce our debt, the bigger will be the impact on our consumption in the future."

Reader Jim K responded...

"Your standard of living is going to be reduced unless you work much harder...."

Doesn't that depend on what we do with the proceeds of all this borrowing? If it is invested productively, then we won't have to reduce our consumption.

... and reader Gerald MacDonnell seconded the objection:

I agree with Jim. If anything he understates the point. The question boils down to what returns we earn on capital investment here. The tendency for capital deepening to raise labor returns is independent of who owns the capital. And even the net financial return seems likely to rise, despite the rising net tribute paid to foreigners.

Well, those are mighty fine points, and I was mighty remiss in not making them.  So then, is it likely true that the sharp increase in the U.S. current account deficit that commenced in about 1997 has deepened the capital stock beyond what it otherwise would have been?  knzn responds to Jim and Gerald's comments: 

Although the other commentators make theoretically correct points, I think they are wrong empirically. Over the past few years, the US capital surplus (i.e., “borrowing”) has mostly been invested in residential real estate, which is not nearly as productive a use as one might hope for. Residential investment won’t do a whole lot to raise labor returns in the future.

Ben Bernanke raised the same issue a few years back in what, by pure virtue of the number of times I have cited it, is one of my all-time favorite Fed speeches:

Because investment by businesses in equipment and structures has been relatively low in recent years (for cyclical and other reasons) and because the tax and financial systems in the United States and many other countries are designed to promote homeownership, much of the recent capital inflow into the developed world has shown up in higher rates of home construction and in higher home prices. Higher home prices in turn have encouraged households to increase their consumption. Of course, increased rates of homeownership and household consumption are both good things. However, in the long run, productivity gains are more likely to be driven by nonresidential investment, such as business purchases of new machines. The greater the extent to which capital inflows act to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt is likely to be.

This is a really intriguing question:  Should we care if investment takes the form of physical capital that will ultimately be devoted to producing goods and services sold in markets, as opposed to physical capital that will ultimately be devoted to "home production" (that is, the manufacture of all those things that make us happy that households create for themselves)?

I'm not so sure.  It would be true that increased quantity and quality in residential housing would do little to raise productivity in market activities, but surely it must raise productivity in home production.  It would also be true that devoting more resources to home production means fewer resources for market production.  In other words, if we decide to enjoy the "output" a larger yard, a more inviting family room, a gourmet kitchen,or whatever, we may have to cut down on our consumption of other things.  But so what?  That's a choice that individuals make all the time, and the truth is that economists don't have much to say about whether it is a good thing or a bad thing: De gustibus non est disputandum.

I can think of at least a couple of reasons to not be indifferent about the market/home investment distinction.  For one thing, as mentioned by Mr. Bernanke, the deck is already stacked in favor of housing via tax incentives, institutions like Fannie Mae, and so on.  A boom in a distorted market may not be such a great thing.   

Perhaps more important from the financial stability point of view, home production is, by definition, non-tradable, so investment in housing has a limited capacity to directly generate the means to pay back foreigners who lend to us.  That's the sense in which I was agreeing with Roubini and knzn -- the payback would have to come in the form of reducing our own consumption of market goods (again, below what it would otherwise be).  Again, that is not a bad thing per se, but there is some possibility that this makes the whole set of transactions riskier from the point of view of the lenders, raising borrowing costs and inducing market volatility.  There is yet scant evidence that this is the case, but I suppose it is a possibility.

Others may have additional reasons for worrying about a shift from market to home production.  I'd like to hear them.  But for now, I take the point that conclusions about the "problem" of the current account deficit are not clear cut.  Consider me duly chastened.

UPDATE:  Be sure to read the very thoughtful contributions to the comment section.

MORE WORTHY THOUGHTS:  From Claus Vistesen, who you should be checking out regularly if you aren't already.   Claus ruminates on this post, and Brad Setser's more extensive version of his comments below.

• September 26, 2006 in
  • Saving Capital and Investment
  • Trade Deficit
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September 25, 2006

The End Of Dark Matter?

From this morning's Wall Street Journal (page A1 in the print edition), a return to one of last year's hot debates:

Exactly how the U.S. has managed to load on so much debt without seeing its net payments rise remains something of a mystery. Even in the second quarter, the U.S., in effect, was paying only a 0.4% annualized interest rate on its net debt. "It's still quite a good deal," says Pierre-Olivier Gourinchas, an economics professor at the University of California, Berkeley.

In a recent paper, Harvard economists Ricardo Hausmann and Federico Sturzenegger went so far as to suggest that the U.S. might not be a net debtor at all. Instead, they surmised, the U.S. might actually have income-producing assets abroad, such as know-how transferred to foreign subsidiaries, that have evaded measurement -- assets they call "dark matter," after a similarly elusive quarry in physics. Mr. Sturzenegger says the latest data haven't changed his view.

Most economists, however, see a more prosaic explanation: Foreigners have been willing to accept a much lower return on relatively safe U.S. investments than U.S. investors have earned on their assets abroad. Take, for example, China, which since 2001 has invested some $250 billion in U.S. Treasury bonds yielding around 5% or less -- part of a strategy to boost its exports by keeping its currency cheap in relation to the dollar.

Well, to be fair to Hausmann and Sturzenegger, that interest rate differential was part of their story.  Much of the debate was actually about the meaning of that differential: Is it some inherently superior aspect of the US economy that drives foreigners to pay a premium for our financial assets?  Or is it the agenda of, for example, the People's Bank of China, pursuing policies that are more about internal political objectives than market fundamentals? 

In any event, the Journal article suggests that, just maybe, we are seeing the beginning of the end:

As interest rates rise, America's debt payments are starting to climb -- so much so that for the first time in at least 90 years, the U.S. is paying noticeably more to its foreign creditors than it receives from its investments abroad. The gap reached $2.5 billion in the second quarter of 2006. In effect, the U.S. made a quarterly debt payment of about $22 for each American household, a turnaround from the $31 in net investment income per household it received a year earlier...

The gap is still small within the context of the $13 trillion American economy. And the trend could reverse if U.S. interest rates decline. But economists say America's emergence as a net payer illustrates an important point: In years to come, a growing share of whatever prosperity the nation achieves probably will be sent abroad in the form of debt-service payments. That means Americans will have to work harder to maintain the same living standards -- or cut back sharply to pay down the debt.

The article contains a lot of comments hinting at a deep instability that seem, to me, a bit over the top:

If the trend persists, it could also raise concerns about the nation's creditworthiness, putting pressure on the U.S. currency. "It's an additional challenge for the dollar," says Jim O'Neill, chief economist at Goldman Sachs in London...

Among economists' biggest concerns, though, is the fast pace at which the U.S. is accumulating new debt. As that leads to larger interest payments, it will make the current-account deficit harder to control -- a vicious cycle that could accelerate if worried foreign investors demand higher interest rates to compensate for the added risk...

"You end up having to pay more and borrow more," says the University of California's Prof. Gourinchas. "Things could get out of hand very quickly."

And this statement just seems wrong:

The size of the nation's debt payments matters because it represents a share of income that American consumers, companies and government won't be able to spend or save. The higher the debt payments, the harder it will be for the U.S. to prosper.

Any rapid change in capital flows could, of course, be disruptive in the short run, but a lot of borrowing by the country means the same thing as it does for you:  Accumulated debt doesn't stop you from earning income, it just limits your ability to spend it.  Nouriel Roubini puts his finger on what it all really means:

"Your standard of living is going to be reduced unless you work much harder," says Nouriel Roubini, chairman of Roubini Global Economics. "The longer we wait to adjust our consumption and reduce our debt, the bigger will be the impact on our consumption in the future."

No argument here.

UPDATE: You can find quite a few links to comments on dark matter at Alpha.Sources blog.

• September 25, 2006 in
  • Exchange Rates and the Dollar
  • Saving Capital and Investment
  • Trade Deficit
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