Economics

For those of you who want a divertion from the grim reality of American politics: here’s the equally grim reality of the American economy. The January trade deficit was the worst ever. You can find the official report here: Department of Commerce Home Page

There’s nothing much to add is there? America continues to have an appetite for foreign products that is way, way beyond the appetite foreigners have for American products. The trade deficit is now larger in absolute dollars and as a percentage of the economy than ever before.

Here’s my take: the deficit is bad. The American economy is gamboling along at a solid rate. As a result it is sucking in stuff from around the world. This is particularly true for oil and some types of manufactured goods. The problem is that American demand is inflated by very low interest rates, low taxes, and a complete lack of savings [as I have commented before Americans now save less than zero: the last time that happened was in the Depression].

Those infamous tax cuts did not stimulate production in the U.S., instead the money was spent on foreign goods: think of all those Chinese workers who are living off the tax cut money. Bush is correct when he says that tax cuts stimulated the economy, the problem is that they stimulated only one side of the equation. Investment in the American economy was not stimulated. Those new jobs etc were added abroad.

Interest rates have been held low for far too long with the result that there has been a distortion in investment: investment money has been channelled into assets like housing [hence the bubble] rather than factories etc that help boost the future economy. So even though recent productivity numbers have looked good, they probably will tail away over the medium term. And low interest rates have created a disincentive to save: why save when the return is so low? On the contrary low interest rates are an incentive to borrow. Americans have been following the low interest rate script perfectly. They are borrowing and then spending like no tomorrow.

And these trade deficit figures are the end result, and will have to be corrected sometime. They are unsustainable because the corresponding inflow of capital needed to pay for the trade deficit [don’t forget that a trade deficit automatically implies a capital inflow surplus] is being used for consumption rather than infrastructure and investment. In laymen’s terms this is like borrowing money to go out to dinner rather than to build a new home: the dinner is gone in a twinkling while the house is an asset for years to come. More prosaically foreigners are lending to Americans so that Americans can turn around and buy goods from those same foreigners. Its a classic addiction. So rather than building for the future Americans are consuming in the present. Sooner or later they will have to pay for the binge.

The question becomes one of how damaging the “adjustment” will be. I doubt whether there will be a dramatic collapse. Most likely the dollar will fall considerably over a few years and American demand will have to be curtailed below its historic average for a few years also. After that slow period trade will be back closer to balance. So look for slower growth, higher taxes, and higher interest rates. Nothing too calamitous, but just insidious enough to remind us all that the mistakes of the Bush era will resonate long into the future, not just in foreign policy, but here at home as well.