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Wednesday, August 11, 2004

Exploding Budget Deficit, Exploding Trade Deficit

An issue that hasn't gotten enough attention is the exploding U.S. trade deficit, which rose to a record-breaking 4.8 percent of GDP last year, and currently on pace to break another record this year. The CBO has a new report laying out the situation:

The current-account balance summarizes a country's current transactions with the rest of the world, which include trade, income from international investments, and transfers. After rising briefly to be roughly in balance in 1991, the U.S. current account returned to a deficit soon afterwards. After 1997, the balance began to fall markedly, reaching a record deficit of 4.8 percent of gross domestic product (GDP) in 2003, considerably larger than the pre-1990s record deficit of 3.4 percent of GDP in 1987.
The CBO says the "primary causes" of the sinking U.S. trade balance are:
So a big trade deficit can be either a good sign or a bad sign. More rapid growth is nice, and a "surge in demand" for U.S. assets means that foreigners see the U.S. as a good place to invest. But a trade deficit can also be driven by falling savings, which isn't so great.

If you're wondering why "declining competitiveness" or some such isn't one of the factors, and why savings and investment are emphasized, you might take a look at the CBO report, which is a helpful introduction to the economics of trade. One answer is that a trade deficit means that we're consuming more than we produce, and to do that, we have to borrow from abroad. Similarly, if we decide to borrow more from abroad, say in order for the government to finance tax cuts for the rich, that means that we're getting stuff from foreigners and paying for it not in goods and services, but in stocks and bonds: and that's a trade deficit.

The important point is that under Clinton, the trade deficit increased mainly for positive reasons: the U.S. was growing more rapidly than our trading partners, and the foreigners were eager to invest in the U.S. tech boom and to find a safe haven from the financial crises in much of the developing world (Southeast Asia, Russia, Brazil). That is, it's a plus for the U.S. to be viewed as a "safe haven" for investment; the crises weren' t so great for the developing world.

Under Bush, trade deficit has continued to balloon, but now mainly for unfortunate reasons. True, the U.S. has continued to grow faster than other wealthy countries, though less so than under Clinton. But the factor that's really taken a turn for the worse under Bush is the national savings rate. And that's because the government budget deficit is part of national savings, and, as everybody knows, it's been exploding.

The graph below shows what's been happening. Under Clinton, foreign purchases of Treasury securities fell to zero. After all, we were running a surplus, not issuing debt. But foreign investment in U.S. firms boomed. Under Bush, both trends have reversed. Foreigners are now lending the U.S. government over 3 percent of GDP a year, which means they're financing the majority of the budget deficit.

Foreigners are also investing a lot less in U.S. companies, presumably because they're not so confident about these firms' future prospects (at least compared to investment opportunities in other countries). I also suspect that increased border security and decreased civil liberties are driving out foreign investment. After all, you'd hardly want to build a factory in Cleveland if you're worried about your executives being detained at the border, expelled for technical violations, or arrested as a "material witnesss" because of a confusion over names.

Remember, these investment numbers are just the flip side of the trade deficit. Along with some financial flows that aren't in the graph, mainly U.S. investment overseas, they add up to exactly the trade deficit.

One could argue that these figures aren't that alarming. After all, we've just gone back to the situation of 1996, which was a pretty good year. But in 1996, the trend was positive. What's worrisome is that now the trend is in the wrong direction.

Posted by Hello

Source: Capital flows data: BEA. GDP data: BEA.

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