In Monday’s Financial Times, there is an Op-Ed piece by George Shultz and John Taylor on the US trade deficit (“The silver lining in America’s subprime cloud”).They say:
The good news is the recent reversal of the steady upward climb in the current account deficit. During the past three quarters for which we have data the deficit has been cut by $119bn, falling from about 6 per cent of gross domestic product to 5 per cent, and the adjustment appears to be continuing.
Why the reversal? One explanation is the implementation of policies that these same international policymakers agreed to at recent past meetings. The basic economic principle that led to these policies is that the US current account deficit is caused by the gap between saving and investment. Accordingly, a three-pronged strategy was called for – reducing the US budget deficit to decrease government dissaving, raising economic growth abroad relative to the US in order to stimulate US exports and increasing the flexibility of exchange rates, especially in China, to facilitate the adjustment.
You can see the strategy being implemented now. The budget deficit has come down sharply to 1.2 per cent of GDP, well below historical averages and less than in most other countries. World economic growth – especially in emerging markets – has been strong, even as US growth has slowed. And China’s exchange rate has become more flexible – appreciating by 10 per cent since the peg was abandoned. Forward markets project further appreciation. All these policies are expected to reduce the current account deficit, but they take time – too much time to explain the sharp reduction in the current account in the past year.
So there must be other forces at work too. Because the current account deficit equals saving minus investment, these are logical places to look. Herein lies the silver lining. The housing turmoil has indeed cut a chunk out of investment – residential investment has fallen by $81bn in the three quarters during which the current account deficit declined, and even more compared with the peak of the housing boom earlier last year.
Hence a good part of the current account reduction can be directly attributed to the decline in residential investment. Moreover, the decline in housing prices is starting to increase the personal saving rate, as home equity loans are drying up and people are recognising that their housing wealth is not as large as they had expected. When asset prices were rising, households could spend what they earned and still see an increase in their net worth. Sometimes spending even exceeded income. Now, consumption is falling relative to income, so there is more household saving.
I worry that if the current global trade imbalance is caused not so much by US over-consumption but rather by excess Asian savings, the second prong, “raising economic growth abroad relative to the US in order to stimulate US exports” is far more important than the first, “reducing the US budget deficit to decrease government dissaving”.
If there is a sharp US slowdown (something about which, by the way, I am not wholly convinced) accompanied by a rise in US savings, I think the world’s balance of payments will indeed adjust, but how?I am not optimistic that faster growth abroad is likely in the face of a sharp US slowdown – I am not a believer in the “decoupling” theory given that the US trade deficit in the past decade has risen, not dropped, as a share of global GDP.The world still depends on US demand, and I suspect that if there is a US slowdown and a declining trade deficit, they will bring with them a global slowdown.If the US raises its savings rate, that global slowdown could be even sharper.
Past globalization cycles have all been underpinned by some event that caused a significant expansion in global liquidity, and for a long time I have been arguing that the combination of asset securitization (especially mortgage securitization) and the recycling of the US trade deficit has been the source of the liquidity expansion that has underpinned the latest globalization cycle.If over the next two or three years we begin to see the unwinding or slowing of both, my theory will certainly be tested.
It's impossible for China or some other "emerging country" to take up US's role as the global locomotive. A downturn in the US market will be much more likely be accompanied by a sharp decline rather than steady growth in the global economy. Considering China's case, the export sector compose the most vigorous part in the economy and creats tens of million of job. A negative and direct shock will be unavoidable when US market goes weak. Thinking of the haunting pressure of unemployment, the already tense relations between the rich and poor social classes, and the still very weak banking system, I always doubt the bold opptimism of those who make assertive predictions that China can go smoothly through a sever negative shock in the export sector.
By Smallfish - 11/8/2007 5:53 AM
Hopefully we are wrong and the rest of the world can chug along in the face of the US. Global imbalances were talked about a lot in 2004, but died away the last three years. I suspect they are going to become a much greater issue going forward. Im not so sure the Chinese or the rest of the world understand how important is to try and balance trade.
By Shrek - 11/8/2007 8:01 AM
There are two arguments which suggest that China can withstand a US recession.
1) Export/GDP figures vastly overstate the importance of exports to China. You put together two widgets worth 50 cents to one spocket that is worth $1.10 which is then exported. This gets count in export revenue as $1.10 but just contributes to 10 cents to GDP. If you then calculate export/GDP you get a figure that overstates the importance of the export.
2) The second is historical. Since 1978, the Chinese economy has been unaffected by US recessions, including most recently the 2001 recession which hit a lot of other East Asian countries hard.
As far as jobs, I don't see it to be particularly difficult to redirect export production inward if this is necessary. Most of the exports to the US are consumer goods, which Chinese would want if the US doesn't take them. Also, most of the new jobs in China produced in the last 25 years aren't in manufacturing. They are in services. What happens is that as productivity increases and as people have fatter paychecks, they want to get their hair done, remodel the apartment, eat in nicer restaurants etc. etc.
Unemployment can be dealt with through public works projects. Tension between rich and poor may be less destablizing then one imagines. The really, really poor are too busy trying to survive to fight the system. The less poor are able to fight the system, but they are more interested in using it to get rich. IMHO, banks are in much less bad shape than some people think, and certainly in much better shape than the last US recession in 2001.
The reason global imbalances aren't talked about much any more is that the reason they were talked about in 2004 was that certain interest groups in the US wanted certain specific things, and talking about RMB revaluation and global imbalances was a way of uniting the groups. No one cares about it much any more because those groups basically got what they really wanted. Textiles manufacturers got an extension to the multi-fiber agreement, and Wall Street has gotten a lot of financial service liberalization.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (3) for "The declining US trade deficit"
- 11/10/2007 12:17 AM
January, 2008