The Wall Street Journal isn't worried about the US current account deficit,
which was 805 billion last year and is expected to reach one trillion USD's
this year. The standard argument of conservative hopefuls is that the
overhang doesn't represent any danger so long as the dollar is the reserve
currency and foreign confidence in the US economy remains high.
A new wrinkle, referred to by the Journal below, was added last year when
two Harvard economists, Ricardo Hausmann and Federico Sturzenegger, argued
that the current account deficit doesn't exist except as an accounting
fiction after what they describe as "dark matter" - notably the accumulated
capital gains from America's net assets abroad - is factored into the
balance. It seems to me to be essentially the same argument applied
internationally which is used domestically to justify high levels of US
consumer debt by measuring it against the corresponding appreciation of
household real estate and stock values. In each case the pollyannish
assumption is that the good economic times will continue to roll. Also, no
accounting appears to have been taken of the offsetting appreciation of FDI
in the US.
A Financial Times piece in December by Hausmann and Sturzenegger which
offers a condensed version of their views is copied below the WSJ editorial.
MG
=====================================
Trade Deficit Disorder
Wall Street Journal editorial
March 16, 2006; Page A12
The economy is growing smartly, more Americans are working, wages are
rising, capital spending is robust and federal tax revenues are rising at a
double-digit year-over-year pace. This must mean it's time for everyone to
worry about the trade deficit as the latest sign that all this prosperity is
an illusion.
On Tuesday, the Commerce Department reported that the U.S. current-account
deficit (the amount of net American borrowing from foreigners) grew by 20%
to $804.8 billion in 2005. Last week's related headliner was that the U.S.
merchandise trade deficit hit $726 billion in 2005. And all of this has
caused the trade protection caucus on Capitol Hill to start
hyperventilating.
One protectionist group in Washington is claiming that three million
manufacturing jobs have been lost to low-cost imports. Warren Buffett moans
that Americans who aren't as rich as he is "have been selling off the farm"
to live beyond their means. He even lost a bundle for his shareholders
betting that the dollar was headed for a dive. Senators Lindsey Graham of
South Carolina and Chuck Schumer of New York are proposing a 27.5% tariff
against imported goods from China.
Here we go again. For at least the past 30 years protectionists have warned
that the trade deficit will lead to ruin, but it's closer to the truth to
say this has it exactly backward: Since the mid-1980s the trade deficit has
risen when the economy has grown and receded when the economy has faltered.
The lowest annual U.S. trade deficit in recent times was recorded in 1991, a
recession year. Dan Griswold of the Cato Institute recently ran the numbers
and discovered that "there is a strong correlation between rising trade
deficits and falling unemployment."
Part of the problem here is simply one of accounting definition. In the
national income accounts, the mirror image of a merchandise trade deficit is
a capital-import surplus. When the U.S. investment climate improves --
through such policies as reducing the tax rate on capital gains -- global
investment dollars flow into the U.S. Foreigners in turn earn the dollars to
pay for those investments by selling Americans more goods and services than
they buy from us.
This global exchange process has been a formula for U.S. success: American
workers get the auto, technology and financial services jobs that come with
foreign investment here; American consumers get the benefit of low-priced
products from China and elsewhere, which raises workers' standard of living.
We would all be better served by simply throwing overboard the term "trade
deficit" -- which inaccurately connotes a disadvantage or inferiority. To
refresh some memories, that was precisely the conclusion of the U.S.
Advisory Committee on the Presentation of Balance of Payment Statistics
during a previous trade-deficit scare in 1976.
That group of eminent economists advised that "the words 'surplus' and
'deficit' should be avoided insofar as possible" because "these words are
frequently taken to mean that the developments are 'good' or 'bad'
respectively. Since that interpretation is often incorrect, the terms may be
widely misunderstood and used in lieu of analysis." (Our emphasis.)
Senators might also consult a new study by Ricardo Hausmann and Federico
Sturzenegger, of Harvard's Kennedy School, who argue that these
current-account deficits are in reality a statistical illusion. They found
that the net return on the U.S. financial position in 2004 was roughly a
positive $30 billion and not much different than it had been in 1982,
despite 22 years of deficits.
How can that be? "A correct descriptive explanation of this puzzle is that
the rates of return of U.S. liabilities is significantly smaller than the
return on its assets," Mr. Hausmann writes. Foreigners are willing to accept
a lower rate of return on their U.S. investments, such as Treasury bills,
because they are partly buying dollar currency stability, liquidity, and a
safe haven against political and economic risk. Foreigners, for example,
hold hundreds of billions of dollars of U.S. currency, which is the
equivalent of a zero interest loan to Americans.
By contrast, American assets abroad earn higher than normal rates of return
because of noncounted factors such as insurance, know-how, and the value of
universally recognized brand names like McDonald's and Disney. When taking
these into account, the authors conclude that America is a net creditor, not
a net debtor, nation. Even more surprising, correctly measured, China is a
net debtor to the U.S.
Ironically, those who are most alarmist about a fire-sale on U.S. assets are
promoting policies that would encourage that capital flight. Raising the
U.S. capital gains tax rate back to 20% from 15%, or the dividend rate to
35% from 15%, would reduce the after-tax return on capital invested here and
contribute to the very investment sell-off that the critics fret about.
Capital also flees nations with protectionist trade policies, so the
Graham-Schumer tariff bill would be economically self-defeating.
There are things Congress could do to raise net national U.S. saving --
notably, spend less money. This means we wouldn't borrow so much from
abroad. But in a global capital market, the key to growth is providing the
opportunities to invest, not whether your national accounts balance. The
time to worry about the trade deficit is when Congress tries to do something
about it.
-30-
Dark Matter' Makes the U.S. Deficit Disappear
Ricardo Hausmann and Federico Sturzenegger
Financial Times
December 8, 2005
In 2005 the US current account deficit is expected to top $700bn (£404bn).
It comes after 27 years of unbroken deficits that have totalled more than
$5,000bn, leading to concerns of an impending global crisis. Once the
massive financing required to keep on paying for such a widening gap dries
up, there will be an ugly adjustment in the world economy. The dollar will
collapse, triggering a stampede away from US debt, interest rates will shoot
up and a sharp global recession will ensue.
Ricardo Hausmann is director of the Center for International Development at
Harvard University's Kennedy School of Government; Federico Sturzenegger is
visiting professor of public affairs.
But wait a minute. If this is such an open and shut case, why have markets
not precipitated the crisis already?
Maybe it is because there is something wrong with the diagnosis. Let us look
at some facts. The Bureau of Economic Analysis indicates that in 1980 the US
had about $365bn of net foreign assets that rendered a net return of about
$30bn. Between 1980 and 2004, the US accumulated a current account deficit
of $4,500bn. You would expect the net foreign assets of the US to have
fallen by that amount to, say, minus $4,100bn. If it paid 5 per cent on that
debt, the net return on its financial position should have moved from an
income of $30bn in 1982 to an expenditure of $210bn a year in 2004. Right?
After all, debtors need to service their debt. But the 2004 number was,
still, an income of $30bn, as in 1980. The US has spent $4,500bn more than
it has earned (which is what the cumulative current account deficit implies)
for free.
How could this be? Here the official story becomes murky. Part of the answer
is that the US benefited from about $1,600bn of net capital gains (which, at
best, cuts the puzzle in half). The other part of the official answer is
that the US earns a higher return on its holdings of foreign assets than it
pays to foreigners on its liabilities. But where did those large capital
gains come from? Or, why are US investors abroad so much smarter than
foreign investors in the US?
We propose a different way of describing the facts.* We measure the assets
according to how much they earn and the current account by how much these
assets change over time. This is just like valuing a company by calculating
its earnings and multiplying by a price-earnings ratio. Of course this opens
up methodological questions, but the discrepancies with official numbers are
so big that the details do not matter. To keep things simple in what follows
we just take an arbitrary 5 per cent rate of return, which implies a
price-earnings ratio of 20.
Let's get to work. We know that the US net income on its financial portfolio
is $30bn. This is a 5 per cent return on an asset of $600bn. So the US is a
$600bn net creditor, not a $4,100bn net debtor. Since the assets have
remained stable then on average the US has not had a current account deficit
at all over the past 25 years. That is why it is still a net creditor.
We call the $4,700bn difference between our measure of US net assets and the
standard numbers "dark matter", because it corresponds to assets that
generate revenue but cannot be seen. The name is taken from a term used in
physics to account for the fact that the world is more stable than you would
think if it were held together only by gravity emanating from visible
matter.
There are several reasons why dark matter exists. The most obvious is
superior returns on US foreign direct investment. Why do US assets earn such
returns? Because that investment comes with a substantial amount of know-how
that increases its earning potential. It explains why the US can earn more
on its assets than it pays on its liabilities and why foreigners cannot do
the same. In measuring FDI, the value of the know-how is poorly accounted
for. There are other sources of dark matter, but FDI is where the big bucks
are. Once dark matter is considered, the world is surprisingly balanced. The
US and European Union essentially cover their apparent imbalance with the
export of dark matter, emerging markets use their surplus to import dark
matter and Japan finances the rest of the world. Net asset positions of all
big regions are fairly small.
Is US dark matter a stable asset? We find that it is. It now stands at more
than 40 per cent of gross domestic product and has fallen in only six of the
last 25 years, never by more than 1.9 per cent of GDP.
In a nutshell our story is simple. Once assets are valued according to the
income they generate, there has not been a big US external imbalance and
there are no serious global imbalances.
*US and Global Imbalances: Can Dark Matter Prevent a Big Bang?
