The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

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July 20, 2005

Are American Consumers Responsible For The Large Trade Deficits?

Professor Hamilton, continuing to bat 1.000 with his posts, thinks that, yeah, they are:

I agree very strongly... that net foreign borrowing is not in and of itself a bad thing. In my mind, it really all depends on why we're doing the borrowing. If businesses were using the borrowed funds to do additional investing in plant and equipment, then even though we'd be owing more to foreigners, we'd also be creating the additional productive resources with which to pay them back and provide for our own future as well. Or if there was some good reason why we temporarily have a great need to borrow and would be in a better position to pay for what we now want at some point in the future, it might be a good idea to sell off some of our assets or go more deeply into debt to those in other countries.

But I see neither of these as a good description of our current situation. Investment has actually declined as a fraction of GDP over this period, and I don't see why it's going to be that much easier for either the government or private households to pay off that debt in the future. Instead to me it has more the appearance of a consumption binge.

I certainly agree that our large current account deficits -- the flip side of a lot of net foreign borrowing -- cannot be attributed to an extraordinary investment boom.  And I am, for the sake of argument, willing to accept the proposition that there is not a "good reason why we temporarily have a great need to borrow."  I think that this is at least arguable, but as I hope will become clear I believe it to be beside the point anyway -- to me, our current situation does not feel like a consumption binge.

Here's why.  What would I expect the world to look like if borrowing from foreigners was indeed being driven by an autonomous decision by consumers to save less and spend more?  To answer that, let's start by assuming that there is no rest of the world -- that is, assume that in any given year U.S. consumption, investment, and government purchases must sum to the amount of goods and services produced during the course of that year.

Now suppose everyone arises one fine morning and decides it's a good day for a consumption binge.  Assuming that we hold the government's behavior fixed, the eventual effect will be that consumption spending "crowds out" investment spending by firms.  By what mechanism does some investment spending drop out of the picture?  Rising interest rates.

Things don't really change if we allow some amount of the consumption binge to be financed by borrowing from foreigners.  The pressure on domestic investment and interest rates will certainly be mitigated by the "safety valve" of imported goods and services -- which, at the end of the day, are paid for by borrowing -- but the basic qualitative effects are the same.

To put it short: I find it hard to reconcile the "conundrum" of low market interest rates with an explanation of large current account deficits and net borrowing from foreigners that hinges primarily on an exogenous increase in desired consumption spending by U.S. households (which is how I am, perhaps incorrectly, interpreting the phrase "consumption binge").

What I don't find hard to reconcile is a story that is fundamentally about low saving rates being driven in large part by low interest rates, which themselves are a result of some third (or fourth or fifth) source.

What are my candidates for this source?  I'll start with the global saving glut.  Or if that term turns you pale because it does not sufficiently distinguish between private and public (read central bank) sources of foreign funds, call it the global dollar demand glut.  In either case, a willingness by foreigners to absorb U.S. debt ultimately corresponds to a willingness to export goods and services to the United States.  Absent a desire by U.S. consumers to automatically absorb those exports, prices adjust to stoke those desires -- lower interest rates, for example, that do the work of stimulating consumption spending.

I'll add to the list the oddly muted desire on the part of firms to invest in plants and equipment.  Although investment demand over the past four quarters has been reasonably good, I would still characterize it as restrained.   Here's an update of a picture I posted many months back:    


Although the ratio of cash-flows to investment has fallen off of its peak, by historical standards the ratio is still quite high.  This is not a picture that suggests a full-throttle investment environment to me.  All the more reason to suspect that low interest rates, and the resulting stimulus to consumption spending, would be the order of the day.

Does this mean that our current account deficits are completely benign?  No, not at all.  But if my interpretation of things is the right one, it does suggest that we would be better off asking -- and formulating answers to -- questions like "Why aren't firms investing?", or "What is the appropriate policy response to a global dollar demand glut?", rather than "Why won't households save?"   

July 20, 2005 in Trade Deficit | Permalink


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» Chinese Re-valuation effects from Unpaid Punditry Corps
Due to the massive number of marginal mortgages that have been made as short term adjustable rate mortgages, the stressed out American consumer with little real wage growth in the past four years is shouldering significant interest rate risk. Since... [Read More]

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» Chinese Revaluation Effects from Fester's Place
Due to the massive number of marginal mortgages that have been made as short term adjustable rate mortgages, the stressed out American consumer with little real wage growth in the past four years is shouldering significant interest rate risk. Sin... [Read More]

Tracked on Jul 21, 2005 9:03:21 PM


I think part of the problem is whether housing purchases and higher education spending are considered "investment" or "consuming".

Without a place to live or an education, I certainly would not be generating the same income.

Posted by: Mr. Econotarian | July 20, 2005 at 04:59 PM

appropriate response -- dunno, maybe policies that would create a bit demand more consumption in China (more demand for goods, less for dollar and dollar denominated assets) -- the very low levels of consumption to GDP strike me as tightly linked to all this.

of course, that would require some shifts in the composition in US output -- toward sectors that produce things that can be sold to countries that sell things to china, if not directly into sectors that export to china, and away from sectors that hinge on the export of debt to china.

the anolomity that has not been explained well is why large private inflows of capital into china (part of the savings glut outside of china) don't bid up the price of chinese assets, or fund more consumer finance, or whatever. obvious answer is that the government of china doesn't let em (and financial system is poorly developed) ...

Posted by: brad | July 20, 2005 at 07:19 PM


we should remember that right now, the market wants to finance a large Chinese current account deficit. Private capital inflows are 8,9, 10% of GDP ...

Posted by: brad | July 20, 2005 at 07:21 PM

Very interesting and important point, Dave. But the decline in the U.S. saving rate has been a continuous process for the last 20 years. It seems to me we've seen enough ups and downs in real interest rates over that span to make it hard for me to see as clear a connection as the one you're describing.

Posted by: James Hamilton | July 20, 2005 at 08:03 PM

They are investing overseas. It all started with Nike.

I wouldn't invest in the US either. Why support a SUV culture? Ultimately a business has to pay for a workers lifestyle. The American lifestyle is too expensive. Another way of saying this is that the American lifestyle isn't competitive with other countries.

Posted by: vorpal | July 21, 2005 at 12:05 AM

The free cash flow yield of the S&P500 was nearly 5.5% as of last
Friday--historically very high.

Clearly under "normal" investment
conditions it would be a lot lower.

This is a post 9/11 phenomenon.

Is geopolitical uncertainty a big factor here?

Posted by: Bruce Weiss | July 21, 2005 at 06:16 AM

BRAVO! FANTASTIC! GREAT OBSERVATION! You hit this one out of the Ball Park. Keep this post up there for a month, maybe SOMEONE will catch on.

Posted by: bailey | July 21, 2005 at 09:06 AM

David Wessel has a piece in the WSJ today about dearth of corporate investment. He mostly describes the phenomena and guesses at the end that it has something to do with recovery from the 1990's investment boom.

Posted by: Mark Sullivan | July 21, 2005 at 09:36 AM

re: the global dollar demand glut

Or a dollar supply glut. Couldn't this sort of thing be a sign that foreigners are holding more than the usual number of dollars and can't figure out what to do with them? One would expect that several years of low real interest rates would eventually push up american CPI inflation. If the created dollars mostly went overseas, foreigners would use their extra dollars to bid up things other than groceries, rent, and whatever else goes into the american CPI. Dollar-denominated fixed income instruments seem like poor assets to buy with excess dollars, but doing so would certainly bid up the prices.

Posted by: Mark Sullivan | July 21, 2005 at 09:56 AM

I think that a key to understanding the current situation is to view what the Asian governments -- especially the Chinese and Japanese -- are doing by buying US securities (and by indirect means encouraging their private financial institutions to do so too) is essentially the same as the "vendor financing" of the '90s telecom bubble era.

In the telecom bubble years, Nortel, Lucent et al made it appear they were doing great business, but in fact were only creating artificial and unsustainable demand by loaning their customers the money to buy their products. Since they were not sovereign governments, and were subject to auditing by outsiders, they couldn't continue that forever, but Asian governments can (if not forever, for a very long time).

Posted by: jm | July 21, 2005 at 11:07 AM

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