Jan. 2. 2004 — Q: In a recent issue of the Economist magazine an article stated that our huge trade imbalance with countries like China and Japan are due to America's extremely low savings rate. I fail to see this connection and hope you can explain to me why the Economist magazine editors think this is true. — Dave M., Bay City, Mich.
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A: There are lots of economists out there who fail to see the connection, too. But then, as the old joke goes, if you lined up all the economists in the world end-to-end, they still couldn't reach a conclusion.
For the dismal science of economics, explaining the causes and impacts of the U.S. trade deficit is definitely a work in progress. The last time the subject reached the current level of hang-wringing was the mid-80s, when the value of the dollar was cut in half relative to the then-dominant currencies, the Japanese yen and the German mark. The U.S. trade deficit from 1980 to 1987 shot up nearly ten-fold. (For more on that period, check out this essay by Martin Feldstein, chief economist during the Reagan administration.)
Despite dire predictions then that the sky was falling, the global economy defied the gloomiest computer models. The U.S. economy is still standing, and the reasons why are still subject to some spirited debate.
But the textbook explanation goes something like this: The U.S. trade deficit has two components, how much we import from other countries and how much we export back to them. When we pay more for imports than we get back from selling exports, there’s a deficit.
One way the low savings rate could expand that deficit is that people who don’t save money will then spend more on goods and services that they wouldn’t otherwise. And these days, those goods are more likely to be made in China than in Michigan. So those purchases worsen the deficit on the import side of the ledger.
The other side of the ledger is a little fuzzier, but the basic idea is that a low savings rate produces less capital for American businesses to borrow, so they wind up borrowing more from foreign investors. Among other negative impacts, that tends to depress the amount of money used to support U.S. exports, which further worsens the deficit. (The flow of capital is measured by the “current account” deficit – another number that some economists watch for worrisome trends.)
But there are a few problems with blaming the U.S. trade deficit on our low savings rate. For one thing, the statistic itself is the subject of some debate. For example, the number doesn’t include capital gains from investments like stocks or homes – which form a big part of many Americans' savings. Worse, there are lots of other forces moving the trade deficit that likely have a much greater influence than the size of your bank account. The rise in energy prices, for example, has had a big impact on the cost of U.S. oil imports. On the export side, lower foreign wages have pushed much U.S. manufacturing offshore, which has hurt U.S. export volumes. But the profits from many of the goods made offshore still flow to American companies and investors. (Discussion question: Is that good or bad for the U.S. economy?)
Still, it’s entirely possible that the expanding trade deficit -- which ran $418 billion last year, up from $38 billion in 1992 -- will “catch up with us.” If a long, slow slide in the dollar convinces foreign investors that U.S. stocks and bonds are a bad deal, it will be harder and harder for American companies (and consumers) to find money to borrow. That means interest rates go up – no matter what the Fed decides. And that makes it that much harder for the U.S. economy to grow. In the past 20 years, we’ve become accustomed to U.S. economic growth as a cyclical thing – if the economy weakens, we all just wait it out. But there have been periods in U.S. history, and there are economies abroad (think Japan), where the pain is deep and protracted.
But while a long-running, and growing, trade deficit could produce such a result, it’s pretty unlikely that economists will ever be able to agree on exactly why.
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