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« on: December 21, 2006, 09:48:00 AM »
THE WALL STREET JOURNAL
Embrace the Deficit
By DAVID MALPASS
December 21, 2006; Page A16
For decades, the trade deficit has been a political and journalistic
lightning rod, inspiring countless predictions of America's imminent
economic collapse. The reality is different. Our imports grow with
our economy and population while our exports grow with foreign
economies, especially those of industrialized countries. Though
widely criticized as an imbalance, the trade deficit and related
capital inflow reflect U.S. growth, not weakness -- they link the
younger, faster-growing U.S. with aging, slower-growing economies
abroad.
Since the 2001 recession, the U.S. economy has created 9.3 million
new jobs, compared with 360,000 in Japan and 1.1 million in the euro
zone excluding Spain. This despite our trade deficit and their trade
surpluses. Like the U.S., Spain (3.6 million new jobs) and the U.K.
(1.3 million new jobs) ran trade deficits and created jobs rapidly
in this five-year period. Wages are rising solidly in these three.
The economics is clear (for once) that a liberal trading environment
allows more jobs with higher wages as people specialize.
The latest data on growth in jobs, retail sales and housing starts,
and the record level of household savings, underscores the solid
economy described by Fed Chairman Ben Bernanke last month.
Supporting the "solid-growth" view are rising global stock markets,
strong growth of corporate profits, the narrow credit spread between
Treasurys and riskier bonds, and low interest rates relative to
inflation and to growth -- nominal growth in the 12 months through
September was 6%, yet the Fed funds rate, usually in line with
nominal growth, only averaged 4.6%.
The trade deficit and a low "personal savings rate" are key parts of
the bond market's multi-year pessimism about the U.S. growth
outlook. But just as the high level of U.S. savings is likely to add
to future growth -- the savings rate is only low if you arbitrarily
exclude gains -- the trade deficit and heavy capital inflows are
also positive parts of the growth outlook. Rather than signaling a
slowdown, the inversion of the yield curve -- "Greenspan's
conundrum," in which bond yields are low despite solid growth and
rising inflation -- is probably the result of this deep
underestimate of the U.S. growth outlook, plentiful liquidity, and a
backward-looking deflation premium for bonds, the reverse of the
backward-looking inflation premium that kept bond yields unusually
high in the 1980s.
The common perception is that Americans drive the trade deficit in
an unhealthy way by spending more than we produce. To make up the
difference, foreigners ship us things on credit. This sounds bad,
but should be evaluated in terms of our demographics, low
unemployment rate, attractiveness to foreign investment and rising
household savings.
The recent surge in the U.S. trade deficit reflects, in part, the
unprecedented shift in the demographics of the world's large
economies. The under-60 U.S. population is expected to grow for at
least 50 years while the under-60 populations in Japan and Europe
are already declining and in China will turn down within a decade.
They need bonds while Americans need capital. They want to save more
than they invest in their own economies, and are eager to help us
invest more heavily (through their purchase of bonds.) This makes
good demographic sense. Older investors (concentrated abroad) need
steady returns, lending to younger generations through bank
deposits, bond purchases and life insurance premiums (which are
reinvested in growth). Younger people (concentrated in the U.S.)
need cash and debt for college degrees, houses and business
startups. This creates a healthy synergy across generations and
across borders.
Like young households, many companies also spend more than they
produce, using bonds and bank loans, some from foreigners, to make
up the difference. They add employees, machines, supplies and
advertising before they produce. Growing corporations are expected
to be cash hungry. This leverage is treated as a positive for
companies but a negative for countries, a key inconsistency in
popular economics. Rather than paying the debt back, the growing
company rolls the debt over and adds more, just as the U.S. has been
doing throughout most of its prosperous economic history. Part of
each additional bond offering puts the company and the U.S. in the
position of investing more than we save, drawing in foreign
investment and contributing to the trade deficit.
With all the negativism about the U.S. economy, it's easy to forget
its attractiveness. Foreigners are as eager to invest in the U.S. as
we are to buy goods and services from them -- it's a two-way street.
Our 10-year government bonds yield 4.6% per year versus 1.6% in
Japan, while our government debt is 38% of GDP versus 86% in Japan.
The comparisons with Europe are not as extreme as Japan's, but still
heavily favor the U.S.
While the net foreign debt of the U.S. is growing (the result of
capital inflows), household net worth is growing faster, meaning
foreigners are investing in the U.S. too slowly and conservatively
to keep up with our growth. Their capital mingles with domestic
savings, providing $2.7 trillion of net international capital to
combine with $27 trillion in net U.S. household financial savings as
of Sept. 30.
The already-large foreign demand for investments in the U.S. is
likely to grow from here, putting upward pressure on the trade
deficit even if foreign growth continues to accelerate. The U.S.
offers a relatively high and steady return on investment -- high
because of the innovation and growth taking place here, steady
because the commodity and manufacturing parts of many businesses are
increasingly done abroad, reducing the volatility in U.S. growth.
Equally important, the demographics of the world's large economies
are shifting rapidly in favor of the U.S.
The trade deficit is the mechanism allowing consumption and
investment in the U.S. to grow faster than in Europe and Japan. The
issue for the U.S. is whether it's worth the interest costs. It's
the same question facing a small business: Should it borrow money to
expand the payroll, train employees, buy land and machines, conduct
R&D, build inventory? Profit and credit-worthiness help make the
decision.
The post-election dollar weakness pleased those who still think the
U.S. is heading in the wrong economic direction. They advocate a
weaker dollar as medicine for the trade deficit, often blaming it
for more economic problems than we actually have.
But the trade deficit, around for hundreds of years of solid
American growth, doesn't justify the inflation risk from dollar
weakness or the growth risk from protectionism. And the trade
deficit probably wouldn't respond to a weaker dollar anyway -- yen
strength hasn't dented Japan's trade surplus, and it took a
recession to create our last trade surplus in 1990-1991.
The swing vote on the dollar, and probably the controlling vote, is
Fed policy. For now, this leaves unresolved the market debate over
whether the U.S. will encourage dollar weakness and inflation in an
effort to fight the trade deficit. More likely the Fed will fight
inflation, strengthening the dollar, and leaving the trade deficit
dependent on U.S. growth and demographics -- right where it should
be.
Mr. Malpass is Bear Stearns's chief economist.
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