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Setser and Roubini respond to Levey and Brown: deficits do matter

by Brad Setser
June 20, 2005

The current issue of Foreign Affairs contains the rebuttal that Nouriel and I wrote to the David Levey and Stuart Brown’s “Current account deficits do not matter” article that appeared in the March/April issue (Real title of the Levey/ Brown article is “The Overstretch Myth”).

Levey and Brown have a short rebuttal to our rebuttal as well. Their rebuttal puts forward a variant of Bernanke’s argument. Levey and Brown emphasize excess savings in Europe and Japan. Bernanke, correctly, identifies the world’s emerging economies, not Europe, as the home of the “savings glut.”

Regular readers of this blog will not find much new in the Foreign Affairs . Most of themes covered in the article have been discussed here in greater length.

But some of you may still find it interesting. Nouriel and I did try to be somewhat provocative.

I suspect the following sentence will catch a bit of flak:

“These banks [foreign central banks] are not buying dollar-denominated bonds because they are attracted to US economic strength, the high returns offered in the United States, or the liquidity of US markets; they are buying them because they fear US weakness.”

And so will this:

“Asian policy makers, in particular, view US economic policy not as a model but as a problem: the United States’ “exorbitant privilege” — Charles de Gaulle’s term for Washington’s ability to finance deficits by printing dollars — comes at their expense.”

In the article, Nouriel and I put forward the thesis that economic power usually flows to creditors not debtors. It is hard to run an (informal) empire “on the cheap” for long. That too, no doubt, is a controversial statement. I would certainly be interested in hearing dissenting views. Certainly one can argue that a debtor of the United States size poses such a problem for its creditors that it has a bit of leverage in a pinch — though I personally would not want to test that proposition.

The core argument of this blog was expressed in the riff that ended the Foreign Affairs piece:

“Arguing that deficits — external as well as domestic– do not matter does not make them go away. Celebrating the United States’ real economic strengths while the real — and growing — economic vulnerabilities associated with unprecedented current account deficits is dangerous.”

Update: For more on the comparison between the “American” and “British” (informal) empire check out Nouriel’s blog. Remember, the US was a major creditor country through the early stages of the cold war, and at the height of its empire, the Great Britain was a major net creditor to the world.

32 Comments

  • Posted by Stormy

    I read the article earlier this morning, but now I can’t get to it. I should have printed it while I had the chance.

    But I had a question about one of the numbers that Levy and Brown used–actually the number plus the construction of the sentence. As best as I can remember, they seemed to add FDI inflows and FDI outflows as a way of making the defict look smaller.

    Maybe I will have to wait till I can read it again.

  • Posted by Jim M

    Brad, I thought you guys did a great piece, and Levey and Brown were pretty tendentious in their response. They go on about “foreign investment” in the US but fail to mention that it’s mostly corporate bonds and agencies, not equity and FDI, which are what most of us think about when we use the term. They talk about inflows without mentioning balances, which allows them to ignore the fact that lots of “investments” are driven by foreigners having to do something with the cash dollars they accumulate. They respond to your obviously reasonable point about the sustainability of US power by turning it into “power presupposes creditor status” and referring disingenously and illogically to Germany and Japan (this takes “Y presupposes X” to mean “X is a sufficient condition for Y” rather than a necessary one). And so on.
    What I think ought to be explored more is their easy dismissal, in the original article, of concerns about the proportion of Treasury debt that will, on current trends, be held by foreigners. They say that such projections wrongly omit the beneficial effects of “future dollar depreciation and market adjustments in interest rates and asset prices.” That is, we’ll be OK once the dollar, Wall Street, and property prices go down enough, and US interest rates go up, because Americans’ foreign holdings will gain value compared to foreigners’ American assets. This is ridiculous. You can’t argue against the likelihood of a major adjustment and then turn around and appeal to its likelihood in order to solve a different problem. Valuation gains will go less and less far as the NII stock balance shifts further against us. These guys are not serious.

    So what happens to a great power if 80 percent of its public debt is held abroad? (Niall Ferguson just addressed part of this in Daedalus.) Do you think people would start talking about repudiation? Or reinstating the old 30 percent withholding tax on nonresident UST debt interest income (abolished by Reagan in 1984)?

  • Posted by Dorothy

    The post turned out to be great. Keep the good work up.

  • Posted by Stormy

    “This accounting is incomplete, because it ignores most of the funds flowing into and out of the United States — especially private foreign investment, which totaled over $800 billion in 2004. $500 billion provided by central banks, therefore, represents only one-third, not three-fourths, of total capital inflows.”

    I really do not understand this statement. What exactly comprises the $800 billion?

    Current account deficit – $665
    Central banks. . . . . . . . . .$500 Central banks 75% of $665
    Funds into and out of. . . $800
    Total capital inflows. . . . $1465 Central banks approx now 33%

    Foreign assets purchased $821
    Net. . . . . . . . . . . . . . . . . . $644

    Somebody help me here. Is this the way Brown and Levy do the numbers?

  • Posted by brad

    stormy –

    suspect levey and brown used line 55 of this release — gross inflows into the us.

    http://www.bea.gov/bea/newsrelarchive/2005/trans105.xls

    the bea data has a slightly lower number for central bank inflows as well — $400 v $500 for the reasons that i have discussed. it also includes roughly $450 b in claims on us reported by banks and non-banks. that inflow is almost perfectly offset by an equivalent outflow from claims on foreigners reported by us banks and non-banks. i suspect that is not an accident.

    the number i like is gross sales of debt securities to foreigners — reported by the TIC. that is about $900b. known sales to central banks were a bit over $300 b (probably 1/2 to the BOJ). i suspect real sales to FCBs were a bit higher, more like $400b.

    that $900 b in debt exports financed: a) the current account deficit; b) net FDI outflows and c) net outflows of portfolio equity.

    But that assumes you believe, as i do, that it makes sense to net out the symmetrical rise in bank and non-bank claims. in the past, i have argued that there is a reason why these claims go up (and fall) together — they reflect the tranactional activities of the big banks, and those banks are not in the business of providing large amounts of net financing to the us. European banks don’t take in euro deposits and lend in $ to the US — they want to be hedged, which requires someone else to take the $ risk and another transaction. Maybe that’s right, maybe it is not. what is clearly true is that this line item has not been a major source of net financing for the US current account deficit, or for net equity outflows

  • Posted by MC3

    what happens if the US says tomorrow to their creditors: “sorry, i cannot pay you”?
    Who can force the US to honour their obligations?
    Will China (really) start a war against the US in order to get paid?
    What kind of sanction the US will receive from the World Bank? or the IMF?
    ??
    I dont know “official” empires, just know about empires…

  • Posted by steve kyle

    “Certainly one can argue that a debtor of the United States size poses such a problem for its creditors that it has a bit of leverage in a pinch”

    You got that right. There were several countries which were “too big to default” in the 80′s and after because their debt outstanding would have wreaked havoc with our banking system. But they sure didnt have a happy time with their leverage.

    And the US even hinting at such a thing? Blowback is a tame term for what could happen. Time to cash in all my assets and buy a deer rifle. Hunting from my front porch will start looking mighty attractive as a means of support if the US decides to play chicken with the world financial system. Yes, we can have another meltdown. That would do it.

  • Posted by kr

    The article is a nice summary of the extended discussion here. I’ll extend some credit to L&B in regards to your discussion of the solution… I could have been more convinced by what you put forth. If we increase taxes and reduce federal spending, there should be a definite negative short-term economic impact, no? Aren’t foreign investors going to be even less attracted to US assets if we don’t maintain them (from the side-effects of government spending redirected to reduce the debt load)?

    I don’t doubt that we’ve created a mess here, but I can’t see how much deeper we’ll have to dig before things start to improve. From a policy standpoint, this is the toughest thing – if one can’t show immediate results from a repair policy of any kind, are we doomed to stagger from one approach to another, never really knowing whether the roots are growing or not? (i.e. Japan)

  • Posted by Stormy

    Thanks, Brad.

    On the European Union…and the struggle in the states concerning the excesses of capitalism…an intersting article in The Guardian, which frames some of the larger issues:

    http://www.guardian.co.uk/comment/story/0,3604,1511718,00.html

  • Posted by Movie Guy

    Brad,

    I read your article this morning. Good effort.

    By the way, you didn’t post a follow up on the oil thread regarding crude oil from Iraq.

    Your last remarks: “re: Iraq’s production (exports are less by about 0.5 mbd if memory serves), the latest i saw is 1.9 mbd — below the 2.4 average of 01.

    http://www.eia.doe.gov/emeu/ipsr/t11a.xls

    unfortunately, this computer crashed when i tried to open brookings’ iraq index — the best source for these things.”

    The Brookings Institute information on Iraq oil is taken from U.S. Department of State Iraq Weekly Status Reports. Here’s the Brooking info:

    Page 23, Brookings Institute Iraq Index (Brookings information available prior to 20 June 2005):

    * MBPD – million barrels per day

    June crude oil production: 2.15 MBPD

    June crude oil exports: 1.333 MBPD

    2005 crude oil production average: 2.11 Million barrels per day (MBPD)
    ** my calculation

    2005 crude oil exports average: 1.367 MBPD
    ** my calculation

    2005 crude oil exports to production ratio: 64.78%
    ** my calculation

    Page 23, Brookings Institute Iraq Index (Brookings information available on 21 June 2005):

    June crude oil production: 2.2 MBPD

    June crude oil exports: 1.362 MBPD

    * This latest data is misstated by Brookings based on rolling up and averaging the weekly reports from State which Brookings cites as its data source. Production is still misstated without the averaging.

    Here is the Iraq crude oil information from the latest Iraq Weekly Status Report, U.S. Dept of State:

    Production Pre-War Peak: 2.5 MBPD in Mar 2003

    Production Post-War Peak: 2.67 MBPD

    Production Monthly Output Target: 2.5 MBPD

    Production weekly average (6-12 June): 2.16 MBPD

    Crude Oil Exports (6-12 June): 1.362 MBPD

    As you can see, there is a considerable difference between crude oil production and export volume in Iraq. Moreover, Iraq is importing refined product to offset its refining shortfalls against demand and reserve targets.

    The previous link, EIA.DOE.GOV – Iraq, that I posted is a good source for understanding why there is such a difference between Iraq’s crude oil production and its actual crude oil exports. Moreover, some of the sublinks offer further detail.

    Similarly, the differences between crude oil production and export volume should be analyzed for other nations as well. Production isn’t the only issue. Export volume and refined product imports (to the crude oil exporting nation) have to be calculated into the picture to appreciate net growth in world crude oil supply.

    Hope you discuss in another post.

  • Posted by dsquared

    The Levey & Brown article looks to me like a version of what we in the UK call “The Lawson Doctrine” after the Chancellor of the Exchequer in the Thatcher years (those years being dividend into “the Lawson boom” and “the Lawson slump”). I’m surprised that they didn’t pick up his felicitous phrase “benign and self-correcting”.

  • Posted by FT

    This explanation becomes less alarming, however, when you consider that both savings and investment are seriously undervalued in U.S. economic accounts. Capital gains on equities, 401(k) plans, and home values are excluded from measurements of personal saving; when they are added, total U.S. domestic saving is around 20 percent of GDP–about the same rate as in other developed economies.

    Make sure you nail the above L&B quote to your office wall, Brad.

  • Posted by Alex

    These guys have definitely been drinking Kool Aide.

    “Despite the persistence and pervasiveness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in the innovation and application of new technology”

    I wonder why Microsoft and Intel and other American multinationals plan to expand their R&D centers in India? The last next I checked, India wasn’t a state in the union or a territory of the United States.

    Or what about Ford and GM aggresively expanding operations in China, while cutting back in the continental United States? Obviously the American hegemon operates in a ways that defy the reason and logic of mortal men.

    In fact I’d love to continue on this point but its quite obvious that the authors are making wild and indefensible claims.

    In fact if anything is true the US is actually losing its technological edge as multinationals begin moving more production,design and manufacturing overseas.

    Here is a a quote from CNET

    Intel Chief Executive Craig Barrett and educators on Wednesday warned that the United States is in danger of losing its premier position as the world’s science and technology leader.”

    Here is another interesting quote:
    “Capital gains on equities, 401(k) plans, and home values are excluded from measurements of personal saving.”

    Wow that theory makes perfect sense doesn’t itJust because your home in New York or California has gone up 40% the capital stock of the economy has increased by the same amount? That’s ridiculous and its why capital gains are not counted towards savings. Yes you can borrow against capital gains in your home but guess what someone (probably from Asia) had to lend you money to begin with!

    I only have a Bachelor’s gree in Economics and I can’t believe these guys can come up with more interesting or creative points.

    Personally I would have mounted a colorful and creative defense of my position. “The San Fernanado valley produces 70% of the adult movies made in the world. We have a huge a trade advantage in this sector.”

    Or “Smith and Wesson is one the largest revolver manufacturers in the world and few foreign firms have the depth of expertise or manufacturing knowledge to compete with Smith and Wesson.”

    These guys are clearly out their league and not up to the task of explaining why Roubini and Setser are wrong.

    Personally Foreign Affairs should have hired me to write that article. I could have mounted a much more interesting and colorful attack.

  • Posted by kr

    Regarding technology, one US import which is in decline these days is: foreign graduate students. If US is going to make ends meet by exporting cutting-edge services, it shouldn’t be ignoring the ‘feedstock’. I am confused about how we intend to maintain market share in the one area where we might compete.

    This reminds me that in a low-tax environment, one has limited ability to use taxes as an incentive… if the benefit for getting a college education was anywhere near as large as the mortgage kickback, we might be facing a more benign kind of bubble. But maybe our policies are all about stability too (compare Phil above).

  • Posted by brad

    Former Treasury secretary Larry Summers said — correctly I think — that fixed exchange rates are very good at delivering the illusion of stability. They store up big shifts that can be unleashed suddenly.

    I don’t doubt Asian central banks value “stability” — the question becomes when does the price of the actions needed to maintain “stability” become too high. Obviously, it has not yet.

  • Posted by Silent E

    Interesting counterfactual: suppose that the US were not running huge fiscal deficits (no Bush tax cuts, etc.). Where would all the Asian savings go? And what wouid interest rates look like?

    Without the US Government demanding an extra trillion in foreign loans ove the last four years, the supply of available savings would have been even greater, and interest rates would be even lower. The housing boom/bubble might be even more supercharged!

    Would that money have had to come to the US, or would it have gone elsewhere? The absence of fiscal deficits (or at least, substantially smaller deficits, mostly for homeland security and defense) would’ve reduced downward pressure on the dollar, so Asian Central Banks would not have had to intervene so heavily to protect their currencies. But they would still have the savings – where does that money go?

    Or am I mistaken – in the absence of the Bush tax cuts, would we have had lower economic growth in the US and lower trade deficits? That would imply slower growth abroad too – and so less foreign savings.

    I’m not sure that any scenario would have led those acumulated foreign savings to be invested in their domestic markets to spur domestic demand to any greater extent than we see now. That sort of demand stimulation would require a political decision which so far we have not seen.

  • Posted by vorpal

    Brad:

    Given that we have had weak job growth, wouldn’t the process of paying back foreign debt create a lot of jobs in the US? Eventually, a dollar must be spent to pay the wages of a US worker?

    If we defaulted on our debt, wouldn’t we be shooting ourselves, because that would be the money spent on US goods and services?

    Since China has such huge employment problems ,wouldn’t it be better for them to never spend their dollars to ensure that pent up demand is spent in China and creates jobs there?

    I’m trying to wrap my head around this.

  • Posted by gillies

    “Interesting counterfactual: suppose that the US were not running huge fiscal deficits (no Bush tax cuts, etc.). Where would all the Asian savings go? And what wouid interest rates look like?”

    you cannot pose that question – because the ‘asian savings’ a r e the american deficit. a fiat currency with a monopoly ( the dollar / o p e c deal originally made by henry kissinger in 1974) has a technical advantage over all comers. that advantage is only effective when the additional created money is spent abroad. that spending becomes someone else’s income / savings. the so called ‘savings glut’ is a surplus which is the opposite side of the coin to the deficit.

    when do the savings end ? when the deficits end. when do the deficits end ? when dollar hegemony ends.

    and what do interest rates look like then ? there would be less fiat money creation. therefore less supply. and possibly less demand without this global liquidity stimulus ?

    i guess interest rates high – but do we know ? it depends what ended dollar hegemony, and how.

  • Posted by gillies

    “If we defaulted on our debt, wouldn’t we be shooting ourselves, because that would be the money spent on US goods and services?”

    if you defaulted, people would rightly not trust you. without foreign money flowing into the bond market, there would be a collapse of prices, implying a rise in interest rates.

    secondly, people would still want to trade with you – but only as barter or for cash on delivery. ( or at the point of a neo-conservative gun.) that would be fine – c.o.d. for both imports and exports. cuts both ways. but those trading partners would just have been hit by a loss of a massive chunk of their savings. you think their politicians would be able to face their electorates as allies and supporters of america ?

    ‘the rich cannot afford to pay the poor. be patient. support your american cousins. tighten your belts because they would prefer not to have the inconvenience of tightening their own.’

    even karl rove could not sell that product.

  • Posted by gillies

    future global press release ?

    “american economic policy experts have taken to discussing the pros and cons of defaulting on their nation’s debts. a fed spokesman who asked to remain anonymous said – patriotic americans may soon decide to default on their debts. it is time to stand up to the evil axis of credit. why should this money be paid over year by year to foreigners, when we need it ourselves, for essential household expenditure – (gambling in the property bubble) ?

  • Posted by Silent E

    “you cannot pose that question – because the ‘asian savings’ a r e the american deficit.”

    This makes no sense. If the Bush tax cuts did not happen, then the government would have taken more money in taxes as opposed to issuing debt. Unless you are arguing that EVERY DOLLAR taken in those taxes is a dollar that would have bought foreign goods (and thus contributed to the “savings glut”), it seems clear that the effect of those taxes would be to reduce private consumption of both foriegn AND domestic goods. So there would still be some foreign consumption, and thus some foreign reserve accumulation – but those reserves would not be needed to finance the trillion dollars of US fiscal debt generated in 2001-05.

    So where do those reserves go? Does this imply that, in the absence of the Bush tax cuts, interest rates would be LOWER than they are now?

  • Posted by gillies

    for many of the participants, the big players in the global economy, the united states is obsolescent, anyway. its people, as a nation, expendable. they do not value the american worker – they can get better value elsewhere. ask any multinational c e o.

    the discussion on default upon american debt suggests that the country is suffering a weakening of the moral fibre – a sole superpower which can overcome anything except mild financial discomfort.

    the agricultural economy yields to the manufacturing economy. then the manufacturing economy yields to the information economy. and then the information economy yields to a service economy for the poor, and a gambling economy for the rest.

    other countries, to a lesser extent, try to imitate this. the global gambling glut.

    no one is investing to develop china – they are hooked on gambling, and china just looks like a sure-fire bet. look how ready everyone is to pull out.

    something has softened america. is it television ? is it junk food ? mortgage the farm and head to the race track ? 150 years ago that was craziness. so what has changed now . . .?

  • Posted by Movie Guy

    David H. Levey and Stuart S. Brown: “Whichever perspective on the current account one favors, the United States cannot escape a growing external debt.”

    Perhaps not with existing trade and fiscal policies.

    If it is the case that the U.S. external debt continues to grow year after year, what happens?

  • Posted by Movie Guy

    gilles,

    What softened Western Europe?

    I lived there for twelve years. It has changed, too.

  • Posted by Movie Guy

    The Euro-zone and EU25 unemployment is higher than the U.S. situation.

    What’s the real problem?

    “Euro-zone seasonally adjusted unemployment stood at 8.9% in April 2005, unchanged compared to March, reports Eurostat, the Statistical Office of the European Communities. The EU25 unemployment rate was 8.9%.”

    “Eurostat estimates that, in April 2005, 13.0 million men and women were unemployed in the euro-zone and 19.3 million in the EU25. These are seasonally-adjusted figures in line with ILO criteria.”

    Euro-zone: Belguim, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Protugal and Finland.

    EU25: Belguim, the Czech Republic, Denmark, Germany, Estonia, Greece, Spain, France, Ireland, Italy, Cyprus, Latvia, Lithuvania, Luxembourg, Hungry, Malta, the Netherlands, Austria, Poland, Portugal, Slovenia, Slovakia, Finland, Sweden, and the United Kingdom.

    http://epp.eurostat.cec.eu.int/p…62005-EN- AP.PDF

    http://europa.eu.int/comm/eurost…oy/ lfs_base.htm

  • Posted by gillies

    “If the Bush tax cuts did not happen, then the government would have taken more money in taxes as opposed to issuing debt”

    the bush tax cuts were a massive stimulus to the things rich people spend money on – particularly investment. a good republican might argue that without that stimulus the economy would have grown less or merely moved sideways. so the tax take might not necessarily have risen.

    but i am not competent to argue what happens inside america. i try to argue a very big, very simple point -

    the american deficit (imports greater than exports – that deficit) is the opposite side of the coin to the asian ( and other countries’) export surpluses. the ‘savings glut’ is an unavoidable counterpart to the ‘spending glut’ and that spending is what causes the deficit.

    the spending glut is in turn the necessary result of dollar hegemony – (even if the dollar is allowed to fall by america and compliant trading partners, in which case the debt denominated in other currencies grows larger, presumably)

    fiat currency creation only provokes other countries to create counterbalancing money of their own. (competitive currency debasement) but a fiat currency with a monopoly, or virtual or partial monopolies such as the dollar / o p e c connection, and the dollar / military intervention connection, is a licence to print money,

    a licence to print money is only effective when the money gets spent, and money spent in a globalised economy tends to become other peoples’ ‘savings.’

    greed + spending glut = work to feed greed + savings glut.

    brad supplies the numbers.

    the creditors are eventually forced to face the midas conundrum – you cannot eat money.

  • Posted by gillies

    “What softened Western Europe?”

    we have junk food and television too. and property bubbles. and obesity and low tolerance for mild discomfort. when you crash – we will be coming right behind you.

  • Posted by gillies

    “The Euro-zone and EU25 unemployment is higher than the U.S. situation. What’s the real problem?”

    budget discipline and human rights. if we ran up similar debts and imprisoned the same percentage of our own that the u s does – we could boost our economy too.

    (are the imprisoned in the unemployment stats ? i am not clear about that.)

  • Posted by Stormy

    gillies,

    I have tried to find the source for the Kissinger 1974 dollars-for-oil deal. The best I can find is William Clarke—nothing in any official document. In fact, all Google searches lead back to the Clarke’s essay, usually as an explanation for Gulf War II…and the growing belligerency towards Iran. And Clarke points to Dr. David Spiro as his source: petro-cycling of dollars.

    Oil may be generally priced in dollars, but is it invoiced in dollars? Is it up to the buyer to convert his currency to dollars—and then pay in dollars?

  • Posted by brad

    Jim M — thanks for the feedback.

    Silent E. You are in good company, as the odds on favorite to be the next fed chair has made the very same argument. smaller deficit in us, lower world int. rates, higher housing prices globally, but particularly in the us, and more home equity to fuel (not mysterious) asset based consumption.

    What do i think? The argument is a bit too simple:

    1) We don’t know how responsive global interest rates are to a rise in US gov. savings, or how responsive housing is to a fall in the world equilibrium int. rate.
    2) a smaller deficit = less domestic demand growth, fewer imports and smaller trade surpluses in countries with pegs. that adds up to less reserve accumulation –
    3) I am not convinced that savings rates are independent of the exchange rate — i.e. a revaluation might lower China’s savings.
    4) even if global reserve accumulation was unchanged, and the net result of a smaller deficit was a stronger bid for agencies, that would still have consequences. returns on $ reserves would fall. that would make sterilization more costly — the int. cost of the sterilization bonds would exceed the int. earned on us assets. all that would add to pressure to intervene less and build up fewer reserves. that is a fancy way of saying = lower world rates = less savings in the rest of the world, not just more borrowing in the US.

    So i suspect there would be some offsetting effects — it would not be an “unchanged global savings glut” seeking opportunities exclusively in the us that drives down us borrowing costs and induces more us borrowing.

  • Posted by dsquared

    suppose that the US were not running huge fiscal deficits (no Bush tax cuts, etc.). Where would all the Asian savings go?

    These are not “Asian savings” in the sense of Mr and Mrs Chang putting something away for a rainy day. The flows going into the USA are the result of a specific state policy of “exchange rate mercantilism” on the part of China, whereby they make the bet that they can accelerate their industrial development by running large trade surpluses. The cost to them of doing this is made much smaller by the fact that the USA is prepared to accomodate their policy. If the USA were not running huge deficits, then it would not be prepared to accomodate such a policy, and so the Chinese government would not carry it out.

  • Posted by Alex

    “suppose that the US were not running huge fiscal deficits (no Bush tax cuts, etc.). Where would all the Asian savings go? ”

    I think we saw that scenario in the late 1990′s with the US in budgetary balance while mounting an ever growing trade deficit. Large FDI in US stocks and companies? Would the net result be an appreciation in the dollar/remimbi?

    Ironically perhaps a budget surplus in the US would lead to even higher consumption in China? Of course the rest of the world would probably suffer as the dollar appreciates and the world as a whole gets hit with a double punch: increasing nominal prices for commodities and an increasing dollar.

    Australia is in a similar situation and is currently running a budget surplus while the country runs up large trade deficits. In fact the government is even going to invest some that money in the Australian stock market! Why can’t governments do something useful with their surpluses and spend it on something worthwhile: for example developing hot or cold fusion?

    I think a budget surplus in light of large current account deficits would be a wonderful problem to worry about unfortunately it isn’t going to happen in the United States, at least for the foreseable future.