commissioner.org
| Source | Michael Perelman |
| Date | 05/12/17/21:27 |
| The U.S. Trade Deficit and Net Foreign Income: No Escaping the Problem
Copyright Thomas I. Palley Economists have long had an obsession with physics, evidenced by the metaphors of utility indifference curves and production iso-quants that derive from 19th century force field physics. Recently (Financial Times, Friday 8 December – not The Onion, April 1), Harvard University economists Ricardo Hausmann and Federico Sturzenegger claim to have discovered financial “dark matter“ that shows that neither the U.S. nor the global economy suffer from international financial imbalances. Consequently, the U.S. trade deficit is no longer an issue of concern. The dark matter story runs as follows. Over the past twenty-five years the U.S. has spent approximately 4.5 trillion dollars more than it has earned via its cumulative current account deficit. Given this accumulation of debt and the fact that foreign lenders must be paid, the U.S. should have experienced a massive decrease in its net foreign income. Yet, surprisingly, U.S. net foreign income in 2004 was $30 billion, roughly what it was in 1980. Hausman and Sturzenegger claim this is because U.S. foreign investments have been ultra-productive, generating enough income to cover the debts incurred through cumulative trade deficits. They call these investments “dark matter” because they supposedly offset the black hole of foreign debt, thereby preventing financial crisis. Unfortunately, there are problems with the “dark matter” thesis. First, throughout the 1990s U.S. net foreign receipts actually trended down. Though net foreign receipts rose in the last four years, they were approximately zero in the first six months of 2005. Second, net foreign payments to the U.S. include repatriated profits of multinational corporations that are partly owned by foreigners who have increasingly purchased shares in them. If these undistributed company profits were attributed to foreign shareholders, the U.S. net position would look worse. Third, U.S. foreign investments tend to be illiquid and hard to cash out, whereas much foreign investment in the U.S. is liquid and easy to cash out. That is partly why foreigners earn a lower return, but it also makes for U.S. financial vulnerability. Fourth, and most importantly, there remains a fundamental problem with the trade deficit regardless of the U.S. net foreign investment position. The deficit is draining spending out of the economy and costing jobs and real investment; it is remaking the economy by eroding manufacturing, which in turn entrenches America’s reliance on imports and erodes capacity to export; lastly, it is being financed by an unsustainable household borrowing bubble, which promises to tank the global economy when it bursts. Hausmann and Sturzenegger claim that financial dark matter has prevented a financial crisis, and that none looms because the U.S. is far wealthier than the records show. But there is another less exotic explanation for the absence of crisis -- supply and demand for credit. On the supply side, countries like China have been willing to provide unlimited foreign finance to purchase their products. They do so because their economies depend on exports and would tumble into recession if they raised the price of their exports. On the demand side, U.S. consumers have been on a spending binge financed by successive stock market and housing price bubbles. These bubbles have backed borrowing that has funded both domestic consumption and imports, and China and others have willingly accepted the borrowed dollars as payment. There are two ways the spending merry-go-round can stop. One is if foreign countries stop accepting dollars as payment. This is unlikely because these countries need the U.S. market. The second is if either American consumers stop borrowing or local American banks stop lending because of fears that households are over-extended and housing prices are inflated so that the collateral is unsound. This seems the more likely channel. If the merry-go round does stop, the U.S. economy will surely be hit and the dollar will likely fall owing to diminished U.S. economic prospects. However, other economies that depend on the U.S. market will also be hit, so that the dollar may fall less than many predict. Recognition of the source of unsustainability and the implications of interdependence are the missing elements in discussions of both global policy and the dollar’s future course. Financial dark matter is an unhelpful distraction, a case of more heat than light. |
Copyright (c) 1998, Joongpil Cho