Posted on 02/14/2006 6:18:22 PM PST by A. Pole
Most believe that the dollar holds the key to global rebalancing. Academics are especially adamant on this point, with many maintaining that it will take at least a 20-30% drop in the greenback to “fix” the US external imbalance. Yet that remedy doesn’t square with the raison d’être of America’s trade deficit. The problem is concentrated on the import side of the equation, driven largely by the excesses of asset-dependent consumption. That means higher real interest rates are likely to be far more important than a weaker dollar in resolving America’s external imbalances.
The latest US trade report says it all. In December 2005, imports of foreign goods and services ($177.2 billion) were fully 59% larger than exports ($111.5 billion). Moreover, it turns out that a -$70.6 billion deficit on goods was cushioned by a $4.9 billion surplus on services. Within the goods component of the December trade gap, the disparity between imports ($149.6 billion) and exports ($79.0 billion) was even larger. This underscores the daunting arithmetic of a turnaround to America’s external imbalance. With goods imports fully 89% larger than goods exports, even if exports grow at twice the rate of imports, the deficit on goods will remain essentially unchanged. In other words, just from an arithmetic point of view, it will be exceedingly difficult for the United States to export its way out of its trade deficit.
The export solution also suffers from an even more glaring deficiency -- the hollowing of Smokestack America. With manufacturing capacity and jobs moving steadily offshore over the past 20-plus years, the US simply lacks the wherewithal to spark an export-led turnaround in foreign trade. In all too many cases, the loss of US manufacturing prowess has been a permanent, or structural, erosion. The list of “lost industries” -- from steel and autos to textiles and even computers -- speaks of a competitive dynamic that makes it all but impossible for the US to recapture its once leading market share as an industrial powerhouse. As I noted recently, that leaves the US on the outside looking in when one of its formerly large trading partners like Japan springs back to life (see my 10 February dispatch, “Rebalancing Made in Japan?”).
I am certain there is a level of the dollar that might reverse this process. But I think it is well in excess of the 20-30% decline that many believe is the answer to America’s massive trade imbalance. Given the structural tilt to the global playing field, my guess is that in order to make a meaningful difference to America’s trade dynamics on both the export and import sides of the equation, the US currency would have to be sustained at an exchange rate on the order of 30-50% below present levels on a broad trade-weighted basis. And the key word here is “sustained.” A trading blip will not give US exporters the confidence -- or the economics -- they need to go back into business. Needless to say, the odds are quite low that either the US or other global authorities would accept such a dollar-collapse scenario as a palliative for America’s trade deficit. Largely for those reasons, I think it is safe to conclude that a weaker dollar is not the answer for the US external imbalance.
And that takes us to the essence of the problem -- America’s massive import overhang. Import fluctuations in any economy are, of course, a derivative of the cyclical ups and downs of domestic demand. But there is also an important secular overlay that is traceable to the same structural pressures noted above. On both counts, the United States qualifies as “importer extraordinaire.” The shift in the global competitive playing field leaves an increasingly hollow US economy with little choice but to rely more and more on foreign production to source internal demand. And the extraordinary burst of domestic consumer demand in recent years -- with personal consumption expenditures holding at a record 71% of GDP since early 2002 -- pushes the internal-demand underpinnings of US imports into an entirely different realm. Little wonder the US continues to lead the global import sweepstakes, with some $1.7 trillion in imports in 2005 --well in excess of dollar-based import bills of the Euro zone (US$1.5 trillion), UK ($0.5 trillion), Japan ($0.5 trillion), and China ($0.7 trillion).
In terms of fixing America’s external imbalance, for reasons also noted above, I am not optimistic that the answer can be found in the structural, or competitive, angle. Instead, my sense is that the answer lies mainly in the cyclical piece of the equation -- specifically, in the asset-driven excesses of US consumption. With consumption growth running well ahead of labor income growth over the entire four years of the current economic expansion, there can be no mistaking the importance of property-driven wealth effects in closing the gap. Estimates conducted by none other than former Fed Chairman Alan Greenspan put the equity extraction from residential property in excess of $600 billion in 2005 alone -- enough, by his reckoning, to have accounted for all of the decline in household saving since 1995 (see the September 2005 Federal Reserve working paper by Alan Greenspan and James Kennedy, “Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences”). In short, look no further than the asset-dependent consumption binge as a major cyclical culprit behind America’s import overhang.
This takes us to the most controversial piece of the debate -- the so-called real interest conundrum. In my view, led by the world’s major central banks at the short end of the curve, and augmented by the conundrum at the longer end of the curve, the super-liquidity cycle has played the decisive role in taking asset markets to excess over the past decade. First with equities, then bonds, and now property, American consumers, in particular, have come to take excessive rates of asset appreciation as an entitlement. As I see it, the Federal Reserve played a critical role in fostering this outcome -- first by condoning the equity bubble in the late 1990s and then by setting up the now infamous serial-bubble syndrome by slashing its nominal policy rate to the rock-bottom 1% level once the equity bubble burst. The overall level of real interest rates was artificially depressed throughout this period -- sustaining the rise of asset-dependent consumption and a concomitant overhang of excess imports.
The Fed, of course, has attempted to normalize real interest rates over the past 18 months, but its 350 basis points of tightening at the short end of the curve has had next to no impact at the long end. Policy-related buying of dollar-denominated assets by Asian central banks has been an important, but by no means exclusive explanation of this conundrum. So has the globalization of disinflation. But for me, the bottom line is clear: If the US wants to come to grips with this imbalance, or if the world wants to address this increasingly worrisome source of instability, the answer can probably be found more in the real interest rate than in the dollar.
Whatever the reason, there can be little doubt that the excesses of asset-dependent consumption lie at the heart of America’s import problem -- and therefore at the heart of the world’s biggest imbalance, the US trade deficit. And, of course, the saving problem is the mirror image of this statement. Lacking in domestic saving -- America’s net national saving rate fell into negative territory for the first time in modern history in late 2005 -- the US has turned heavily to foreign saving in order to fill the void. And it has had to run massive current account and trade deficits to attract the foreign capital. Yet there is no free lunch. The imported saving comes at a real cost -- overly-indebted and asset-stretched American consumers, on the one hand, and a collection of US creditors that are under-consuming at home and massively overweight dollars in their rapidly growing stashes of official foreign exchange reserves. I don’t buy the idea that these tensions are manifestations of a glorious new era for a dollar-centric world economy. I worry, instead, that as the liquidity cycle turns, asset-driven global imbalances are reaching the breaking point
Bump
That second sentence shows the shortsightedness of supporters of outsourcing & unfettered free trade.
I am not strong in economy enough to speculate, but I wonder if the outsourcing, lack of tariffs and keeping wages low has something to do with it:
If the US wages were higher and more production were done here then the domestic market would be larger and based more on real income than on spending the equity. Downside would be that prices on products would be higher but it could be a small price to pay for long term stability and better bargaining position of US labor.
Am I right about that?
I can't believe somebody gets paid (probably very well) to write this stuff. Why not just lift it for free from some of the screeds on FR?
I agree with your position. What's in practice now is not something that can continue indefinitely.
First with equities, then bonds, and now property, American consumers, in particular, have come to take excessive rates of asset appreciation as an entitlement.
Most investors saw huge losses in equity values in 2000-2002. This comment is crazy, even taking into account home asset appreciation. Nobody who lost $100,000 to $1,000,000 or more in the stock market crash would ever tell you that asset appreciation is an "entitlement".
2] Whatever the reason, there can be little doubt that the excesses of asset-dependent consumption lie at the heart of America’s import problem.
Bull.
Major factors re the "important problem" are:
a) Oil. A great portion of our trade imbalance is oil imports. Our failure to develop nuclear energy and other sources is our own fault. We have spent over $400 BILLION on the Energy Department since its creation and we are worse off today than when that department was created.
b) Leftists schools. Lousy teachers that do not get fired. Unions. Degradation of standards. Kids who don't know math or science because it is not taught. No homework. Political correctness. Ad infinitum . . .
c) Unions. Over regulation. Tort insanity and failure to control tort extortion. Ad infinitum.
The USA digs its own hole with the blunt end of the stupidity shovel.
You paint the situation it in a very dark colors. What would be your solution for the next few years? Deregulation and marginalizing unions?
In a nutshell, indirectly, you have hit on the problem. Wealth is earned, rather than legislated, but the American public has been sufficiently mis-educated by the liberal establishment for so long that economics is fast becoming an arcane science.
A person headed for security in his life earns as much as his talents and efforts can command. But that is only half of the equation. He must also understand what income that he has, and after paying his living expenses, apportion the remainder between buying life's rewards (as he can afford them)... and saving for those later periods in life where health and age will cut down his income.
Until recently, a large part of that was accomplished by his mortgage payments, and equity built for future use.
Then came the advent of the Pepsi generation, of "live for the moment", "unlock that hidden equity in your house", "be all that you can be... billed for".
Before the advent of the social safety nets, Americans understood that those persons irresponsible enough to provide reserves, in the form of savings, for their families, were no more than ne'er do well delinquents. Now, they are "interest groups".
The point the author made well was that such irresponsibility will continue only so long as someone else is willing to pay for breakfast. Once overseas investors begin to doubt that the usual business of lending money to enable Americans to spend themselves into oblivion, will pay the same safe net returns as in the past... then, the excesses will no longer be financed by those did save.
When this happens, and the risk of placing investments into American debt clearly is overshadowed by the impending inability to pay, a rather shattering set of circumstances will occur. The most shattering of which will be psychological, with a clear pattern.
Picture the starting family, which understood that they could have everything they wanted using credit cards and "rent-to-buy". Put aside whose fault it is that they were convinced of such insanity. It takes them years just to dig themselves out of the swamp of debt brought about by past overspending. This is done by eating week-old, marked down bologna and wearing shoes to the point of falling apart. This is nothing new. Young people make mistakes. It is something you grow out of, once you get burned enough to get your rapt attention.
Now, contrast that with an awesome number of folks to whom the "Great Depression" was "uhhh, some sinkhole or something that the teachers mentioned briefly- I dunno- none of us paid attention because the homecoming game was coming up".
These folks are entering their fifties, now, are good Democrats, and think they are "entitled" to a good income because the media has always assured them that if things get bad, they only have to get angry at their congressmen.
Those congressmen, as in the Katrina pecuni-orgy, will immediately shovel more trillions into their lifestyles, enabling them to ride out any little re-adjustments to reality.
They have no idea what bus is about to hit them, as the ability to continue to overspend is brutally stripped away from the United States, and so suddenly educates a voting public that everyone cannot declare bankruptcy simultaneously.
It will not be the only time in history that a people has been unwilling to listen to reason, and require that reality rolls over them like a tidal wave.
Pay your debts, save until it hurts a little bit, teach your children what responsibiliy means...
and then get ready to see irresponsible people in tears.
It's all you can do.
In post # 7, "important problem" is supposed to be "import problem".
American stupidity and politicians placing their interests ahead of the nation has caused the import problem. I touched on many of the most crucial factors in post #7.
You ask what my solution would be............just reverse the points I made in #7, e.g., fire the lousy teachers, outlaw the radical/socialist control of the Education Department, fire all the Energy Department workers except those who work for the nuclear arms departmetns, mandate construction of nuclear power plants until at least 50% of our power is from nuke energy, have Marine Coprs Drill Sergeants installed as heads of the Education Department and principals of all schools, end all eastern civ and western culture classes and double the math and science classes, . . .
You get the picture. We must get radical if this is to reverse.
[T]he super-liquidity cycle has played the decisive role in taking asset markets to excess over the past decade. First with equities, then bonds, and now property, American consumers, in particular, have come to take excessive rates of asset appreciation as an entitlement. . . [T]he Federal Reserve played a critical role in fostering this outcome -- . . . by slashing its nominal . . . rate to the rock-bottom 1% level once the equity bubble burst. The overall level of real interest rates was artificially depressed throughout this period -- sustaining the rise of asset-dependent consumption and a concomitant overhang of excess imports."
Thus, we were all shafted by the Gub'met. Ergo, either we are all fools or all stupid victims?
One thing to think about is what would the U.S. manufacturing workforce have to be to suddenly exit from the free trade trap, and restore U.S. production balance?
It would likely be far beyond the jobs lost from outsourcing. Because we would not just have to restore the 7 or 8 million jobs disruptively relocated...i.e., "lost" for those who still don't get it... over the last 15 years to the Pacific rim countries...we would have to also replace the jobs that were never here...because they went automatically to the Pacific Rim without passing "Go". But all to export to the U.S.A. Hence, jobs that should have been considered for here.
How is it exactly that you propose that wages be higher?
His track record is something less than stellar, but he does have some of that cocktail party circuit, cult of personality this going.
By limiting illegal immigration and restoring tariffs which would compensate for the differences in cost of living.
I wonder the same thing about Paul Krugman.
How then do you make up for the loss of economic activity which result from the reduction in trade caused by increased tarrifs?
I am glad you asked this question. The rise in US wages would lead the opening of the HUGE domestic market followed by increase in economic activity and domestic production. This would jump start US economy and shift it from the present speculative rentier mode into mass production again.
In other words, I am for trickle UP economy.
Have I got this right?
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