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Thursday, August 21, 2003

WHAT CAUSES THE LARGE AND PERSISTENT US TRADE DEFICIT, AND SHOULD WE WORRY ABOUT IT. PART TWO

This is part two of a three-part mini-series on the US Trade Deficit --- its causes, and whether it's really a problem worth worrying about. Part one was published two days ago, and needless to add, it will help if you've read it before plunging into part two. It starts off with some thoughtful comments left by a visitor, Tom Dechaene in Belgium, and some lengthy replies by the buggy prof that help clarify and illustrate many of the main points that the argument in part one unfurled.

Note that part one dealt mainly with the causes of the large and persistent US current account deficit over the last two decades or so, with some ups and downs. Part two continues the analysis of these matters. Part three, which will be forthcoming soon --- probably tomorrow --- will dealt much more directly with the question whether these current account deficits of ours are something worth worrying seriously about . . . or at all.


Comments on the US Trade Deficit by Tom Dechaene

I agree with your refutations of the 3 "exorbitant" privileges. Furthermore, central banks are small players in the international currency markets.

I believe the reason the US has been able to sustain a trade deficit for so long without depreciation is that Japan and the EU have much higher savings rates and their financial institutions channel a large proportion of these to the US because (i) they want to geographically diversify, (ii) they believe(d) in better prospects for US companies than for their counterparts in Japan or Europe.

It was interesting to see how these capital inflows fell as soon as the US markets fell. I guess these inflows have picked up again somewhat lately, given the positive earnings forecasts from US companies, hence the $ has done better lately than in quite some time.

All it means is that more and more of the US is owned by Japanese and Europeans (although they tend to be investors when markets are high...).This is not much different from myself borrowing from my bank because I spend more than I earn. This is OK as long as my earnings increase fast enough. If Japan and Europe stopped investing in the US, I guess there is only one way for the $ : down, which should solve the trade balance somewhat, but not totally.

Does this make sense ?



THE BUGGY REPLIES


Tom: These are stimulating comments, mainly sound too, and I thank you for them. Some brief remarks follow, largely to clarify and expand on your comments and many of my own set out earlier in part one.



I. The politically charged exorbitant privileges that Brad DeLong singles out on his site aren't so much wrong as overdone, with exorbitant a highly provocative term. That foreigners --- private individuals, firms, financial institutions, and central banks --- want to invest so heavily in the US reflects in large part, it seems, nothing less than mutually beneficial market exchange: essentially, they find the US a safe haven and simultaneously appreciate price stability here as well as unrivaled investment opportunities in vast stock and bond markets, US real estate, US companies, and the like . . . all at a time when the US is a more dynamic, fast-growing country compared to the EU and Japan, the only other possible rivals for attracting investment capital. (Like US investors, however, many have probably been scared off since 2001 and the revelations of financial hanky-panky played by US corporations and accounting firms.) That's one thing they get: good investment opportunities and promised returns.

Another thing they get? The governments of Germany and much of the EU, of Japan and almost all of Pacific Asia, and some others all have come to rely on export-led growth as the major engine of GDP growth in their economies . . . a tradition that goes back to the resurgence of Germany and Japan and then the rest of West Europe in the 1950s, followed by the big breakthroughs in GDP growth by other Asian dynamos after the mid-1960s, right down to China currently. And they normally get such export-led growth by relying on the US economy, which is remarkably open (save in certain agricultural goods and textiles, despite the recent protection around steel in the Bush-Jr. era), and by ensuring that the dollar rises sufficiently through their purchases of US financial assets, short- and long-term, to facilitate their export-drives while limiting US imports into their own countries.

What does the US get in return? One thing is a general indifference by US fiscal and monetary authorities to the size of the US trade deficit --- which is financed by the huge inflows of foreign capital. (The exception seems to be when the influx of imported goods from abroad surges so much that it produces a big political backlash: the case in the early and mid-1980s, and more recently in this decade.) Another thing: the huge inflow of foreign capital adds to US savings and helps keep interest rates lower here than would otherwise be the case.

 

II. You're right too --- as the last section of the article here will show (not completed as yet) --- that countries with excess savings over their investment needs will then export the capital abroad and tend to run, simultaneously in consequence, a current account surplus.

That follows, as we'll show, from national income analysis. Oppositely, a country like the US where the level of investments --- by households, business firms, and the government in education and infrastructure etc --- chronically outpaces our level of national savings will tend to import the necessary savings. In the process, that raises the price of the US$ in exchange markets against the Yen and euro, and hence causes a corresponding current account deficit: the trade in goods and services.

 

III. You've also successfully identified two of the specific reasons for investing the excess savings in the US:

1) geographical diversification (which really means financial diversification)

2) and beliefs by foreign and US investors that the financial return in US stock and corporate bond markets is a better deal than similar returns in the EU or Japan.

Add in to this

3) the unrivaled range and depth of US financial assets --- the EU hasn't integrated stock and bond markets (and won't likely have them soon), while Japan's financial future is just uncertain despite some still outstanding giant firms with home bases there like Sony and Toyota.

4) Then, too, there's the traditional hospitality of the US to foreign investment, with little jingoist reaction . . . even, generally, in the regions where certain manufacturing industries have lost employment owing to the rapid growth of US imports since the early 1980s. One reason for this, of course, is that even if textile firmss --- to single it out --- have shed lots of jobs in the last two or three decades, the South where they're concentrated has been a region of choice for EU and Japanese multinational investments in autos and to an extent in consumer electronics. Scarcely any local government in the US isn't scrambling to attract such foreign investment these days.

You yourself hint at this in talking about foreign ownership of US assets. These amount to trillions of dollars, and even close to a trillion $ in foreign multinational investment here, something highly desirable. Does anyone save a xenophobe really care if he or she is holding a good job whether the utlimate unseen bosses back in Tokyo or Frankfurt or Seoul speak a different language? Do the politicians and citizens of the communities where the foreign multinationals invest mind having the jobs and the tax benefits?

It's only fair to add that such indifference to nationalist concerns does not exist widely abroad --- certainly not in Japan (despite changes in the last decade) or much of Asia. Even in China which absorbs over half of the multinational investment going to developing countries, the Chinese government and bureaucracy carefully negotiate to control the investments of Taiwanese, Korean, Japanese, US, and German multinationals: where they can locate, with what kinds of technological transfer, and so on. In the EU, where European and American multinationals can locate pretty freely now, there are still resistances to Japanese multinational investment in some countries (and Japanese imports), to say nothing of other Asian business firms taking over existing European ones. When Daewoo, the South Korean giant, tried to buy the French electronics firm Thompson in 1996 and 1997, there was a tremendous xenophobic outburst in France that you could easily follow by watching (as Nancy and I do every day) French television news that reaches the US by means of satellite and cable TV.

5) And the political motives of foreign investors that DeLong singles out --- but with a key one ignored by him and already identified by us: the singleminded desire of political leaders in Japan, the rest of Pacific Asia, and most of the EU to rely on export-led growth.

In the last two to three years alone, US GDP growth has accounted for over 50% of world GDP growth --- directly and also indirectly: the latter by sucking in relentlessly their exports, which in turn then add to their own GDP growth through local multiiplier effects. And as long as Japan, China, South Korea, Germany, and much of the EU could rely on export-drives into the US economy --- and through multiplier effects in their own countries in trade with one another (especially in the EU) --- their governments have been under less pressure to undertake structural changes and reforms of their economies . . . all of which would be politically tension-laden, to say the least.

 

IV. All this does, however, create a big problem of imbalance in the global economy. The US economy hasn't grown as much since the end of the recession as we had hoped for --- though this could be changing. As a result, even the EU --- stagnant last year and likely to remain that way this year and even next (scarcely averaging 0.5% GDP growth in 2002 and 2003 so far) --- has found governments beginning to take more seriously politically charged reforms in social security taxes and labor market laws

In the meantime, the failure of our economy to create new jobs since the end of the recession in the fall of 2001 has increased the political backlashes here to bursting imports, especially from China, concentrated in certain US industries. The buggy prof has dealt with this problem earlier --- see Is China's Economy A Threat? --- and will return to it again.

Again, Tom, thank you for your stimulating comments. --- Michael, The Buggy Prof

Replies: 1 Comment

I sent you and E-Mail on/03 about a number of Muslin students putting down their prayer rugs and making their obeisance to Allah at the end of a corridor at school. They are openly Anti-American and would-be graduate students or medical interns. I did not receive a response back from you,so perhaps you never received the E-Mail. I do not see Catholic students saying their rosary or Jewish students reciting their prayer. There is a larger question of whether appropriating a public space for private religious reasons should be allowed. I would appreciate your comments on this matter. Thanks and have a good weekend .

Suzanne:

Thanks for the comment. No, I didn't get the email you refer to. Looking over your comment here, I'm not sure to which of the buggy articles you're referring: there were several on Islam and the Middle East and Islamist fundamentalism and terrorism, but they all go back to the spring. All the same, you raise a valid point: our public schools forbid the practice of religion or religious education, and so you may be right: what you saw the students doing, assuming this is a public university and not a private one, could be illegal. I suggest you talk to any accessible official there and find out what's what as far as school's policy goes. If that doesn't bring satisfaction, you might try the local chapter of the American Civil Liberties Union.

You might find some of the articles by Dr. Theodore Dalrymple, a British psychiatrist who writes frequently for City Journal, useful here. For instance, an article about a year old that deals precisely with the topic you refer to, only at a British Medical School: "Behind the Veil," http://www.city-journal.org/html/eon_7_30_02td.html

His observations on the growing problem of fundamentalist Islam and the French school system --- the latter militantly secular, created in the Church-State, clerical and anti-clerical struggles that shook that country between 1870 and 1903 (the year, I believe, when the Catholic Church there was dis-established as a State-Church) --- are worth looking at too: "France's Headscarf Problem," http://www.city-journal.org/html/eon_4_23_03td.html

That said, keep in mind that Islamist fundamentalism isn't the problem in the US that it is in West Europe. (See gordon-newspost, May 2002: https://mail.lsit.ucsb.edu/pipermail/gordon-newspost/2002-May/002424.html .) For one thing, our Muslim population is far smaller: roughly 2 - 3 million according to two academics studies published in 2001, compared to 15-20 million in the EU. For another thing, the Muslim population here is better educated than the average American (most came here as college grads), and earns more than average income. For yet a third thing, despite militancy and posturing and huffing-and-puffling among Muslim Student Associations in the US over the Middle East and US foreign policy --- especially in the spring of 2002 --- the agitation was in no small measure a result of foreign students studying here, and I imagine most of those associations may have more FBI and local police infiltrators at their meetings than members these days. For what it's worth, too, keep in mind that most Americans of Arab descent are Christians, their immigration going back to the start of the 20th century.

In the EU, by contrast, education levels in the Muslim communities are far worse than the average; joblessness is a major problem; so too is growing violent crime; and fundamentalism has been making huge inroads, especially among the younger generations.

For more gordon-newspost commentaries and links to articles by others, see this one on France: https://mail.lsit.ucsb.edu/pipermail/gordon-newspost/2002-February/002162.html (Feb 2002). And on anti-semitism and attacks on Jews --- which were rife in France, especially in the months before and during the French Presidential elections in the late spring of 2002 --- see this gordon-newspost commentary and links: https://mail.lsit.ucsb.edu/pipermail/gordon-newspost/2002-February/002170.html

There are lots more. If you want, run a google search with terms like "gordon-newspost" AND "EU" AND "Muslims" AND "Fundamentalism" You'll find pages of the stuff. Gordon-newspost itself ran daily for several years, from 1997 until January 2003, and there were thousands of articles that the buggy prof posted there. When the buggy prof site started its life in late January this year, gordon-newspost went into a well-earned and very silent retirement.

Posted by Suzanne @ 08/22/2003 07:02 PM PST