Another major issue that the early twenty-first century is struggling with is the profligacy of the United States, both its citizens and its government. This has evolved into a major area of concern for several very bright thinkers.
Living within one’s means is always a more stable way to conduct one’s financial affairs. The same can be said for governments, which, ac- cording to Keynesian economics, do have to run deficits from time to time to offset economic weakness. The problem develops when deficits become too large in both absolute and relative terms and lead to rising interest rates and inflationary pressures. Rising deficits of the fiscal kind are a fact today, and by themselves are manageable—if the economy in question is a closed economy. However, we don’t live in a closed econ- omy anymore. In fact, several economists and other notables (including
the previously quoted Pete Peterson) are deeply concerned over the grow- ing global imbalances of savings, debt, and deficits. To them, the world is upside down. They believe, and I fully agree with them, that the present situation of big deficits as far as the eye can see and the world’s largest economy being the world’s largest net debtor is unsustainable and a pre- scription for disaster if left unchecked.
The world economy cannot sustain the imbalances of deficits and debts, nor can the world’s largest economy continue to be the world’s largest debtor indefinitely. In fact, the issue of an upside-down economic world was expressed quite clearly by Financial Timescontributing econo- mist Martin Wolf, when he wrote in April 2005:
. . . current trends are unsustainable and undesirable. If the trends in imports and exports of the past 15 years were to con- tinue, US net liabilities could jump from roughly a quarter of gross domestic product at the end of 2003 to 120 per cent of GDP by 2014. Even if the current account deficit were to stabi- lize as a share of GDP, the ratio would reach 80 per cent of GDP.
It is hard to believe that the foreign private sector would will- ingly hold such huge claims, denominated in the dollar, at cur- rent US asset prices.
Yet it is also hard to imagine that the foreign official sector would, or should, provide resources to the US on so vast a scale.
Between 2002 and 2004, inclusive, the foreign official sector’s di- rect financing of the US current account deficit amounted to
$718 billion. Between December 2001 and December 2004, global foreign exchange reserves increased by $1,680 billion, to reach $3,730 billion. . . . Goldman Sachs has recently argued that foreign exchange bank reserves exceed the optimal level by
$1,400 billion. The precise calculations are questionable. But the point is not.
China, for example, had accumulated $600 billion by the end of last year. A 30 per cent appreciation of the renminbi would in- flict a loss of 10 per cent of GDP. As Morris Goldstein and Nicholas Lardy of the Washington-based Institute for Interna- tional Economics argue, this policy cannot make sense. Growing by giving resources away cannot be a sensible strategy.12
In the aforementioned book, Running on Empty, Peter Peterson, for- mer Commerce Secretary and lifelong Republican, addressed the issue of deficits in this way: “Deficits have become like aspirin, a sort of fiscal won-
der drug. We should take them regularly just to stay healthy and take lots of them whenever we’re feeling out of sorts.” The former chairman of the Federal Reserve Bank of New York goes on to write:
Most economists who study this issue conclude, in general, that the strongest connection is between long-term real interest rates and long-term deficit expectations. A single deficit year doesn’t matter much; indeed, a deficit during a recession is usually good policy. What matters is what markets believe about the deficit trend over the next decade or more.
So does that mean large long-term deficits always translate into a predictably high real interest rate? Not always—economists always have their provisos. In the near term, interest rates can be hugely influenced by temporary swings in the demand for invest- ment and in the supply of savings. Such swings explain why the in- terest rates have remained very low over the last few years despite the dramatic shift in deficit projections.13
And Stephen Roach, chief economist with Morgan Stanley, adds the following on September 16, 2005:
The disparity between current account deficits and surpluses is now closing in on a record 5 percent of world GDP. Behind this imbalance lurks an important and potentially dangerous asymme- try: Deficits are heavily concentrated in one economy whereas sur- pluses are spread out widely over a large number of nations. This mismatch could well exert a very destabilizing influence on the coming rebalancing of the global economy.
There are no guarantees that there will be a synchronous re- balancing in the mix of global saving—that a US saving increase will be accompanied by declining saving rates elsewhere in the world. To the contrary, there is good reason to fear a further widening of the disparity in global saving and current account po- sitions over the next couple of years. While there is a growing and welcome possibility of some saving reduction in the major surplus economies, that constructive trend could well be more than offset by a sharp deterioration on the US saving front.
America’s national saving outlook is in the process of going from bad to worse.
Today’s unbalanced world is in an extremely delicate state of equilibrium. The asymmetrical distribution of current account
deficits and surpluses around the world means global rebalancing will involve an equally asymmetrical realignment in the mix of global saving. This is potentially a “hair-trigger” result for an already un- balanced world. America is having a highly disproportionate impact on the state of imbalance in today’s global economy. As such, there is much greater urgency for the US to raise its record low domestic sav- ing rate than there is for any one country—or group of countries—to draw down surplus saving. Yet a US-centric rebalancing is very much a double-edged sword for a lopsided world: An increase in US saving would also crimp the major engine on the demand side of the global economy. Depending on the path of the saving adjustment—gradual or abrupt—the outcomes could range from a sustained shortfall in global growth to a sharp worldwide recession.
This is where the asymmetries in the mix of global saving have the clear potential to become a serious problem. If the world’s dom- inant deficit economy—the United States—goes even deeper into deficit at the same time the world’s surplus economies start to ab- sorb their domestic saving, America’s ever-mounting external fi- nancing pressures are likely to be vented in world financial markets.
This, of course, is the stuff of a classic current-account adjustment—
the case for a weaker dollar and higher US interest rates. As long as the non-US world was in an excess saving position, a major re- pricing of dollar-denominated assets could be avoided. But now, with an asymmetrical shift in the mix of global saving increasingly likely, it could well become all the tougher for the United States to avoid this treacherous endgame.
Here is the question that I have: What happens when (not if) the world economy goes into a slump? With deficits already at record levels, how does the world economy recover when only one lever, monetary policy, is at the disposal of the world’s leaders? If this sounds familiar, it is. This is the “pushing-on-a-string” environment of the pre-Depression era. If the world economy must hope that monetary policy alone can help the global economy to recover from a recession, then it is pinning its future on some- thing akin to pushing on a string.
The consequences of such a scenario are mind-boggling. The short and very tragic list includes a massive diminution of America’s standing in the world, for the blame will most certainly fall on the leading proponent of the most aggressive form of free market capitalism. Perhaps you can under- stand why the likes of Paul Volcker, Robert Rubin, the three gentlemen quoted earlier, and a raft of others have such concerns. I do. Do you?