Alan Reynolds writes:
“The Economist (11 September) repeats the editors' habitual lecturing about a "reckless" U.S. budget deficit, which amounts to 3.6 percent of GDP. In a related essay, C. Fred Bergsten recycles his ill-fated "hard landing" scares of the 1980s, based on a metaphysical assertion that "larger budget deficits will produce larger American trade deficits . . .. [and] higher interest rates."The statistical tables at the back of The Economist, by contrast, tell a different tale. Budget deficits in France and Germany are just as large as in the U.S., and the budget gap in Japan is twice as large. Yet all three countries have a current account surplus, not "twin deficits." And the interest rate on 10-year government bonds is only 1.6 percent in Japan.
Australia, by contrast, has maintained budget surpluses since 1998. Yet Australia's current account deficit is larger than that of the United States, as it was in all but one of the past six years. Australia's 10-year interest rate is 5.6 percent -- substantially higher than the U.S. rate of 4.2 percent. Canada, with a budget surplus since 1997, also has a higher interest rate than the U.S, 4.7 percent. These are regular patterns, not anomalies.
From 1994 through 2003, annual budget deficits averaged 5.8 percent of GDP in Japan, compared with 1.6 percent in the U.S. If budget deficits really increased interest rates and current account deficits, then Japan should be experiencing high interest rates and a large current account deficit by now. Countries with budget surpluses, like Australia, should be experiencing much lower interest rates and current account surpluses. The facts obviously don't fit the conventional theory.”
This view also contrast with the points made in the recent paper on the “twin deficits” by Roubini and Setser The US as a Net Debtor:The Sustainability of the US External Imbalances”:
““The rapid deterioration of US net external debt position implied by large trade andcurrent account deficits cannot continue indefinitely. At some point, the interest rate that the U.S. needs to pay to attract the external financing it needs to run ongoing deficits will rise, slowing the U.S. economy and improving the trade balance even as higher interest rates increase the amount the U.S. must pay to its existing creditors. The U.S. will increasingly have to learn to live with the vulnerabilities associated with being a major net debtor -- vulnerabilities that are attenuated by the dollar’s continued position as a reserve currency, but not entirely eliminated.”
In my view both are probably right; None of the US current account deficit, budget deficit and the relevant stocks of external debt and domestic debt are large (relative to GDP) by either historical standards or international standards. Nor indeed are they large by absolute standards – the gross external debt of the US is only about 20% higher than that of the United Kingdom alone while its stock of government debt is comparable to that of Japans. Thus attatching the reckless epithets is hardly justified.
On the other hand mean reversion implies that the deficits are more likely to get smaller than larger and interest rates on that debt are more likely to rise than fall. So the views expreseed in Roubini’s paper are farily safe bets even if the tone is alarmist.
The point however that is lost by the repeated accusation “recklessness” is the rationality of the deficits; as long as China, Japan and the rest of the world capital markets are prepared to lend at around 1%, it perfectly rational for the US to take advantage of these rates to borrow as much as it can (provided of course that the expected return is larger).
What is perhaps less easily explained is why so many other countries are not prepared or able to take advantage of these generous lending terms.
Posted by wardx107 at September 23, 2004 11:02 AM