Brad Setser

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More government borrowing doesn’t necessarily mean more total borrowing

by Brad Setser
May 31, 2009

The United States is borrowing less from the rest of the world than it was. That is true even though the US Treasury is borrowing more from everyone, including more from the rest of the world.

The amount the US borrows from the world is the gap between the amount that Americans save and the amount that Americans invest at home. That turns out to be equal to the current account deficit. And for the US, it so happens that the current account deficit is about equal to the (goods and services) trade deficit. The trade deficit — at least in the first quarter of 2009 — was way down. In dollar terms, it was about half as big as it was in the first quarter of 2008. That implies that the US is borrowing far less from the world now than at this time last year.

Why hasn’t the expansion of the fiscal deficit pushed the amount the US borrows from the world up? Simple. American households and businesses are borrowing a lot less, so the total amount of money that Americans are borrowing isn’t rising.

A picture is generally more effective than words. The following chart shows borrowing by various sectors of the economy — households, firms and the government.** All data comes from the Fed’s flow of funds, table F1.


As the chart shows, the rise in government borrowing came even as other sectors of the economy were borrowing a lot less. Household borrowing peaked in 2006. Borrowing by firms actually peaked in 2007 — remember all the leveraged buyouts then. Borrowing by both households and firms fell precipitously in 2008. As a result, total borrowing by households, firms and the government fell in 2008.

The last data point in the flow of funds data is from the fourth quarter of 2008. Q1 2009 data isn’t yet available, but the fact that the trade deficit fell so much in Q1 2009 suggests that total US borrowing isn’t rising — at least not faster than US savings.

The fact that the rise in government borrowing has come even as other sectors stopped borrowing has made be a bit more sanguine than some about the ability of the US to find the financing it needs to sustain a large fiscal deficit.

But there obviously are still risks.

As households and firms rediscover their animal spirits and start to borrow more, the amount the government borrows needs to fall. Otherwise, total borrowing would rise, and the amount that the US needs to borrow from the world would rise.

More immediately, while the US is borrowing less from the rest of the world, it is still borrowing from the rest of the world. A smaller trade deficit is still a trade deficit, and financing that deficit requires ongoing inflows from the rest of the world. That means that some creditor needs to increase their exposure to the US.

Yet the crisis also has alerted China’s population — rather belatedly in my view — to the risks of lending to the US.*** The fiscal deficit is a lot more visible than the household deficit. That has had an impact on the popular debate inside China. So far the popular debate inside China hasn’t kept China’s government from continuing to add to its reserves and in the process finance the US. But it certainly has changed the tone of Sino-American discussions. Back in 2006 and 2007, China wasn’t talking about the need for the US to reduce its trade deficit by limiting the borrowing of US firms and households …

The dislocations associated with the crisis temporarily eased the financial pressures facing the US. Americans sold their foreign assets faster than foreign investors sold their US assets (in part because American money market funds stopped lending to European banks, forcing them to scramble for dollars cash). But those dislocations have eased — and with commodity prices rising on hopes that the emerging world will rebound quickly from the crisis, the US is likely starting to need to borrow more from the world just when private demand for American financial assets is starting to fade.

That isn’t terribly comfortable –even if it actually isn’t all that different from 2007.

At the same time, the available data (which admittedly lags developments in the economy) does not show that the US as a whole is borrowing more than in the past. The rise in government borrowing has offset a fall in private borrowing. And since Treasury rates now (even after last week) are well below Treasury rates back when private borrowing was far higher, it is pretty clear that the rise in Treasury borrowing didn’t induce the fall in private borrowing (crowding out). Rather, the rise in Treasury borrowing came in response to a crisis-induced collapse in private borrowing.

From 2004 to 2007, net borrowing by American households and firms averaged over $1.8 trillion. In q4 2008, it was less than zero. That is a rather large swing.

* Technically, a current deficit can be financed by selling equity rather than debt, so equating the current account deficit with the amount the US borrows from the world isn’t quite right. But in general the US has financed its deficit by selling debt not equity, so it isn’t a bad rough approximation.
** Firms are defined as non financial corprate businesses and nonfarm noncorporate businesses in table F1 of the flow of funds data. government includes state and local government.
*** The risks that China is taking financing the US now aren’t materially larger than the risks China took financing the (large) US trade deficit of 2006, 2007 and the first part of 2008 in dollars at low rates. So long as China’s government keeps its currency systematically below its market clearing rate, it risks large currency losses. The fact that most of the deficit then came from excesses in the household sector didn’t diminish the risk.


  • Posted by Cedric Regula

    Ok. That’s exciting. We can keep the blue line going more or less horizontal.

    Assuming that’s our goal, it is interesting to know how households, business and government stay so synchronized. Brad did point out it wasn’t crowding by government that pushed the other groups down. So it was stimulus and bank bailouts after the economy cratered that drove the green line up.

    I heard tax receipts went off a cliff too, so that’s another data series that could be added to this chart. That would give us more of a sense of how the government is borrowing because of weakness in the economy. It really isn’t all “stimulus”, or making up for previous levels of private sector demand. (I’m not getting near the stock market)

    Also, this makes a strong case that China has much less motivation to continue pegging. There is much less biz to get.

  • Posted by Twofish

    It was both that people stopped borrowing but rather than the financial system stopped lending.

    When the “shadow banking system” that makes up the vast majority of credit collapsed in Q4, lenders just stopped lending. The government borrowing that has happened was intended to make up for all of the missing lending.

    Also Paul Krugman wrote a simply dreadful article in the NY Times today about how all of this is Reagan’s fault. He points out that the debt/income ratio in the US is much higher now than in 1980. One rule that I’ve found useful is that when someone makes a point with two numbers, ask to see the whole data series.

    Krugman misses two points:

    1) the debt/income ratio for the US has been rising steadily since the 1940’s.
    2) the debt/income ratio of the US matches the pattern in every other industrialized country in the world

    So it’s very unlikely that it is Reagan’s fault.

    Also when people talk about Japan (or China), they often aren’t talking about Japan or China, but rather trying to use the “exotic other” to criticize local practices. So you have “thrifty foreigners and corrupt locals”.

    It turns out that Japanese households have a higher debt/income ratio than Americans.

  • Posted by Cedric Regula

    Here’s a very recent Roubini article. He says it’s bad if the blue line goes sideways.

  • Posted by Charles

    @ Twofish

    You miss two points in the OCC study :
    the rise in the debt/income ratio occurred in two distinct waves,
    from 1940 to 1960 : not surprising considering demographics and significant debt reduction from the government (from a maximum of 118% of GDP to around 50% in the 60’s).
    from 1980 onwards : the “Reagan effect” as per Krugman, and WITHOUT debt reduction from the government.

    Regarding the “multi-country aspect” . “every other industrialized country in the world” is actually US, UK, Japan, Canada and France. France displayed a significantly different pattern, and I would guess it was shared by Germany. Also, one should not underestimate the impact of the deregulation ideology promoted by Reagan across the world (in particular in the UK).

  • Posted by anon

    As a matter of interest, what types of liabilities were households issuing to the rest of the world?

  • Posted by DJC

    China Central Banks questions integrity of US Dollar currency

    From Bloomberg:

    It’s “very natural” for the world to be concerned about the U.S. government’s spending and planned record fiscal deficit, Chinese central bank advisor Yu Yongding said in emailed comments yesterday relating to a visit to Beijing by U.S. Treasury Secretary Timothy Geithner.

    It may be helpful if “Geithner can show us some arithmetic,” said Yu. “We need to know how the U.S. government can achieve this objective.”

    The deficit is projected to reach $1.75 trillion in the year ending Sept. 30 from last year’s $455 billion shortfall, according to the Congressional Budget Office.

    The U.S. needs a higher savings rate and a smaller deficit on the current account, which is the broadest measure of trade, or “another financial crisis triggered by a dollar crisis could be inevitable,” Yu said.

    China is the biggest foreign holder of U.S. Treasuries with $768 billion as of March. Premier Wen Jiabao called in March for the U.S. “to guarantee the safety of China’s assets.” Central bank Governor Zhou Xiaochuan has proposed a new global currency to reduce reliance on the dollar.

    Yu said U.S. tax revenue is not likely to increase in the short term because of low economic growth, inflexible expenditures and the cost of “fighting two wars.”

    China wants to know how the U.S. will withdraw excess liquidity from its financial system “in a timely fashion so as to avoid inflation” when its economy recovers, said Yu, now a senior researcher at the government-backed Chinese Academy of Social Sciences.

    He questioned whether there would be enough demand to meet U.S. debt issuance this year.

    Referring to the Federal Reserve “as the world’s biggest junk investor,” and to Chairman Ben S. Bernanke as “helicopter Ben,” Yu said the Fed has dropped “tons of money from the sky since the subprime crisis.”

    “The balance sheet of the Federal Reserve not only has expanded like mad but is also ridden with ‘rubbish’ assets,” he said.

  • Posted by RebelEconomist

    Good comment Twofish; I much prefer such enlightening comments to quibbles with other comments.

    Charles, I don’t think Mrs Thatcher needed any help with deregulation ideology from Ronald Reagan! We are quite responsible for our own mess here in the UK.

  • Posted by a

    2Fish: “Also Paul Krugman wrote a simply dreadful article in the NY Times today about how all of this is Reagan’s fault.”

    No, it’s not *all* Reagan’s fault. But he surely made it a lot worse – look at the graph in the link you provided. The slope of the graph starts shooting up during Reagan. Also, obviously, it’s at least household + government debt which is important.

    2Fish: “2) the debt/income ratio of the US matches the pattern in every other industrialized country in the world”

    If you look at the graphs, you see the U.K. leading the way. So blame Thatcher *and* Reagan. Does that make you happier?

  • Posted by Perry Mehrling

    Yes government borrowing has been substituting for falling business and household borrowing. It is illuminating also to look at what is happening to outstanding debt. Household share of non-financial debt reached its postwar peak of 44.3% in 2006 and has been declining ever since.

    For reference, business share of nonfinancial debt reached its postwar peak of 38.1% in 1981, and government share reached its postwar peak of 36.2% in 1993.

    This share pattern may be related to the step-function increase in total debt/GDP. Waves of financial innovation leave business and household sectors overleveraged and deleveraging, after which the government steps in?

  • Posted by bsetser

    Anon — Think Agency MBS! the mortages are household liabilities. they are bundled with an agency guarantee and sold to the rest of the world. Also “private” ABS — i.e. asset backed securities without an agency guarantee.

    but the chart shows total borrowing from the flow of funds, not who made the loan. much of the household deficit was financed indirectly — American private investors were net sellers of l-term treasuries to the world from 06 to q1 08 (meaning gov. issuance fell short of foreign demand), freeing up funds to invest in other types of US debt.

  • Posted by K T Cat

    As usual, another great post. My takeaway is that the purpose of our borrowing has changed. Simplified: People borrow to finance either lifestyle or homes. Businesses borrow to finance growth. Governments borrow to finance benefits. Your chart suggests that we can expect lower growth while the population learns to expects higher benefits.

  • Posted by K T Cat

    Addendum: borrowing increases debt servicing obligations. Lower growth decreases the ability to pay those. Someone, somewhere is going to have to increase their profits substantially to pay the interest on this debt. This chart shows pretty conclusively that such mundane matters are of little interest to us right now.

    That will change.

  • Posted by anon

    “The fiscal deficit is a lot more visible than the household deficit. That has had an impact on the popular debate inside China.”

    Glass half full – maybe someone should tell them they really don’t need to buy more net than what their current account surplus gives them. And there won’t be a treasury bond supply shortage to meet that requirement.

  • Posted by Rien Huizer


    Interesting comment. It does look like that. Somehow every mess left over from a clean up has been carefully embalmed.


    I do not think Reagan had much choice (or rather his government, I am to so sure he participated actively in the discussions). The situation inherited by Carter was already a mess and it got worse under Carter (as is likely to happen under the present administration if they do not come to their senses soon) Once Volcker had killed inflation, fiscal policy had to restart the economy and it worked for a while. Probably, probably the best combination for economic policy was the Clinton/Gingrich government. Good growth, good fiscal policy, no need to resort to the policies of unelected officials like the Fed Board of Governors.

  • Posted by ReformerRay

    A lot more data grubbing is needed to understand the issue Brad introduces. Begin with the formula for National Savings from the National Accounts – Savings = Investment + Trade Balance. To get those numbers from Table 1.1.5 and 5.1 we musts rearrange the numbers to eliminate government. When we do that we have:

    Year National Investment + Trade Balance
    2007 1,885 = 2593 + (-708)
    2008 1,820 = 2,489 + (-669)

    These numbers show national savings practically equal while U.S. borrowing decreased by around 700 billion between the two years (eyeballing Brad’s chart).

    Obviously, national burrowing is measuring something different from National Savings.

    Brad needs to do ‘some work to reconcile these two data sets.

    My approach is to argue that the Trade Balance and Investment are the causal factors in the above equation and that National Savings as shown in the national accounts may be an insignificant number that should be ignored. It is what we get when we subtract Consumption (both public and private) from GDP, or what we get when we add investment to the trade balance. It obviously doesn’t tell us anything about national burrowing.

    The change in the trade balance in the two years is +39 while the change in borrowing is

    I have long been in disagreement with the consensus view that Savings is the causal factor in the above equation. For that reason, I have resisted calls for more U.S. savings to balance the trade deficit (by Larry Summers and the head of the Institute for International Economics). To balance the trade deficit, you restrict imports (that is the only part of the system that is controlled by U.S. law).

  • Posted by ReformerRay

    The nice spacing between numbers that I put out was destroyed in the translation. Read the above with proper spacing and it will become clear.

  • Posted by FollowTheMoney

    We’ve seen what overextended borrowing has done to families and businesses that lived beyond there means in 04-07.

    Will see what happens to overtended nations that borrow beyond there means in 09-2010?

    My opinion is we’ll see some national defaults. Borrowing, beyond your means (regardless of family, business or country) will have it’s pain when the party ends.

    Enjoy the last dance, the credit cards tap still buys a few rounds while the DJ spins his last playlist.

  • Posted by guest

    The IMF study p 22 is not showing for the advanced G 20 an improvment of the public debts burden but a continuous up trend even when fiscal balance improvment are expected.
    I recommand a thorough reading of this interesting report

    The fiscal imbalances may improve only with a return to normal business cycle. When reading unemployment rising all over the world I fail to read more profits more incomes, but more debts serviced by fewer.

    There is misperception of the banks position, banks are always, always willing to fund good projects. They may not within this environment see many. They have already been quiet penalised when trying to front run the real economy. As noticed very often they tend in down cycle to shelter behind government funds umbrella (infrastructures).
    It means more capital outlays from government moneys.

  • Posted by Twofish

    RebelEconomist: No, it’s not *all* Reagan’s fault. But he surely made it a lot worse – look at the graph in the link you provided. The slope of the graph starts shooting up during Reagan.

    But a lot of the flatness of the debt/incomes of the 1970’s can be attributed to inflation. During the 1970’s nominal incomes shot up while debts remained constant.

    Blaming the current crisis on Reagan is a lot like when Republicans blame things on the Community Reinvestment Act of 1977. It ignores pretty much everything that happened since then.

    The other thing is that the deregulation ideology became fashionable in the 1980’s, because the regulation ideology of the 1970’s was just not working. The 1970’s is a fascinating period of financial history because it was the last major financial crisis in the Western world.

    I’m a great admirer of Ronald Reagan just like he was a great admirer of FDR. History moves in cycles, and I don’t see how you could have solved the problems of the 1970’s without Reagan-Thatcher like policies. But things go too far. I’m sure that everything Obama is doing is going to cause some serious problem in 2030, and they’ll be some commentator then who argues that the crash of 2030 was all Obama’s fault.

  • Posted by Twofish

    guest writes: I recommand a thorough reading of this interesting report.

    It is interesting, but you have to read anything from the IMF remembering that they have a “markets are good, governments are evil” ideology, that I think has been strong discredited by recent events. Reading what the IMF thinks about the world tells you as much about the IMF as the world, and one should also read Joseph Stiglitz and his thoughts on the IMF.

    One thing that makes this crisis different is that the IMF does not have the power to force through its recommendations, which fortunately limits the damage they can do.

    guest: There is misperception of the banks position, banks are always, always willing to fund good projects.

    No they aren’t. In boom times, banks are more than willing to lend money for insanely stupid things. In bust times, banks are totally unwilling to lend money to anything, even when they can. The fact that banks can and often do things that are irrational at the macro-scale is why I don’t think very much of the IMF’s recommendations or the the market idolatry that I sometimes see.

  • Posted by FollowTheMoney

    Great artile in reuters today, warning of Credit Crisis 2.

    “Rising US bond yields may spark Credit Crisis II”.

    @ Twofish, all sorts of troubles ahead, who knows how bad things are going to get. I expect a currency crisis to unravel, perhaps as early as in the Fall. U.S. Government spending is out of control, and countries are taking “modern protectionism”, devaluing currencies for export growth to unprecedented levels.

    Yes, sure the S&P may rally to 1,000, however there’s some serious global imbalances created by extreme government borrowing of some nations which need to be re-adjusted.

  • Posted by DJC.

    Brad Setser: “What separates China from the rest of the world is its incredibly low level of consumption relative to GDP,” says Brad Setser, a fellow at the Council on Foreign Relations in Washington. “What can China do that would most directly help the world economy during a period of very severe weakness? Get its consumption back up to 40 percent of GDP.”

    Mish Shedlock: Most of the so called savings glut in China is pure nonsense. The “Savings Glut” is nothing more than an optical illusion that confuses “savings” with “debt” while ignoring U.S. deficit spending, consumer credit binges, and trillions of dollars blown in Iraq, all in the face of Fed policies that discourage saving every step of the way.

    Furthermore (assuming one does believe China is saving on a massive scale) the idea that saving causes economic problems is patently absurd. Savings are not idle; savings provides money for investment and for others to consume.

    No, it is lack of saving that causes economic problems. And people like Bernanke, Krugman and now Brad Sester are promoting more spending as the way to save the world.

  • Posted by guest


    On markets are good

    few samples of how perceptive they are
    SP P/e? CAC Pe?.. Banks real P/L?, and needless to show how perceptive they were)
    I have zero interest in the equities markets.I would not understand how accurate they are, even when looking at their behaviours in the last six months 2009 (a 80 pct margin of error on the markets pricing).Not too many industries would survive those approximations, not too many individuals would survive in their jobs with such records.

    I am not sure that the IMF is making statements on those above markets.They much prefer a cobb douglas function.

    this leads me confortably to address your statement on IMF tropism

    On governments are evils

    I see ad nauseam the same and the same patterns 2007 2009 on bonds, stocks (mispriced)

    I see ad nauseam the same policies (one size fit them all), undertaken by governments and no improvments or structural changes.

    I see more of pro active governments intervention on financial markets than on any other issues, tax policies, labour cost, government cost.

    on IMF

    It is a difficult issue to advise governments not to bribe their way out through loose monetary policies,or taxes but structural changes.

    On Banks

    One would not make a career being different in the financial world. I read (bloomberg) that US Banks ceo s of investments banks were negociating their pay packages to be in line with each others (they may as well perform in line in their strategies) I maintain for having breathed for long the industry,the competition is keen and the industry overcrowded enough to drive them for survival.

  • Posted by locococo

    I say, Fear not for it is We who have the deepest and most liquid markets for risk-free assets in the world. Why borrow less, when we can borrow More? And more. And say: fear not. It is in fact Less and Less. And less. We will committ to bringing our fiscal deficits down. Over time. To a sustainable level. First. Then we believe in our strong currency. But before that we’re going to make Sure that We Repair and reform the financial system so that we sustain our own Confidence – I am quite confident in – from out of our BS. Say I.

  • Posted by FollowTheMoney

    Is it just me or is there an angry tone in Yu’s statement today? What’s this all about? Mr. Geithner going to come out firing or be is usual “don’t worry everything is just fine”?

    “I wish to tell the U.S. government: ‘Don’t be complacent and think there isn’t any alternative for China to buy your bills and bonds’,’’ Yu said in an interview yesterday. “The euro is an alternative. And there are lots of raw materials we can still buy.’’ Yu is scheduled to meet Geithner at the Grand Hyatt Hotel in Beijing today.

    The U.S. should take China’s interests into consideration “so that your own interest can be protected,’’ Yu said. “You should not try to inflate away your debt burden.” China could still diversify some of its Treasury holdings into euros or commodities, Yu added.

    “Yes, some people say the euro is very weak,’’ Yu said. “Okay, weak is good, we’ll buy very cheap.’’

  • Posted by Twofish

    FollowTheMoney: Is it just me or is there an angry tone in Yu’s statement today?

    There may be, but one thing important to remember is that Yu Yongding doesn’t currently hold any official position within the Chinese government. He *was* an adviser to the PBC, but his term ended a few years back.

    His position in Chinese society would be roughly the same as someone like Paul Krugman, Brad Delong, or for that matter Brad Setser. He gets quoted a lot by the press, but his views aren’t official, and they aren’t a sign of what the Chinese government is thinking.

    Another person that appears often in the news as a talking head is Chen Siwei. His position would be roughly equivalent to the head of the Senate Banking Committee saying something about monetary policy.

  • Posted by Twofish

    Also, one thing about the US and Chinese government is that anything that you read in the media often gets misinterpreted a “hint” of something.

    There’s no reason for the US and China to play these sorts of games with the media, and if either side were *really* angry about something, they’d scream at each other behind closed doors and then smile in front of the cameras.

  • Posted by Twofish

    FollowTheMoney: Who knows how bad things are going to get.

    There isn’t going to be blood in the streets by next fall.

    FollowTheMoney: I expect a currency crisis to unravel, perhaps as early as in the Fall. U.S. Government spending is out of control.

    No it’s not. Either one of two things are going to happen by 2010. Either the economy is still in trouble in which case, the Republicans are going to come back with a venagnance with massive tax cuts, or (and I think this is going to be likely), Obama is going to be seen as a hero, and is going to have massive tax increases on the rich. Remember, he got elected on a platform of increasing taxes on the wealthy.

    FollowTheMoney: countries are taking “modern protectionism”, devaluing currencies for export growth to unprecedented levels.

    Ummmmm…. If other countries start devaluing their currencies massively for export growth, then how does this work with a currency crisis in the United States?

  • Posted by FollowTheMoney


    Thanks for your input, rarely do you meet someone who’s as socialist as yourself. Hey some people like socialism, and well everyone in life has there opinion.

    Just remember, What made the United States great was the “land of opportunity”, not “the land of subsidizing my neighbors Escalade”.

    We’ll see if things work according to your crystal ball. But i think you’ll be in for a pretty big surprise in the Fall2009. Outside of just the immense U.S. borrowing and out of control Fed balance sheet DO NOT rule out increased tension with IRAN. Be patient. I’d say we’re in the 3rd or 4th inning of the crisis.

  • Posted by joebhed

    Why do we REALLY need all that sustaining and increasing amount of borrowing that somehow shows that things are okay?
    Without sustained borrowings, we jump into deflation, plain and simple.
    And while we can inflate the deflation, we just add to the deepening deflationary hole.
    It’s called the debt-money system.
    It is broken.
    We can’t “borrow” enough new debt-money fast enough to keep making the debt-service payments on the debt-money already out there.
    The debt-money system of the private fractional-reserve central bankers of the world is insolvent.
    Keep in mind the Black Swan method forward:
    Don’t let those who drove the school bus blindfolded and crashed it have another school bus.

    Read “How Debt Money Goes Broke”, with particular attention to the effects of decreasing corporate borrowing as the debt-money system implodes.

    Or, we can pretend that there is something beyond life-support for what we call the present banking and financial system. We can pretend that we don’t have to answer the tough questions that the Chinese are putting forward?

    We need a new money system.
    Plain and simple.
    The debt-money system is broken.

  • Posted by Rien Huizer


    It would make sense (too early probably, but in a couple of months it should be possible) to disaggregate gvt boring little ( routine budget, financial support to failed financial firms, TARP, F&S etc. What is clear is that gvt borrowing is going up but to what extent is that displacement of private sector borrowing where the underlying activity continues (eg finance to carry (distressed) financial assets that were already in the system, finance to businesses and consumers, etc) I see an anlogy with the disticition between “revenue” and “general obigation” debt in decentralized gvt finance. One would assume that the portion of the debt supported by private sector revenue is unlikely to cost the taxpayer much (except realizing losses on debt and businesses that were acquired too expensively).

    The danger of this (another risk of intervention that democracies are ill-equipped to manage) is that some way or another the resulting level of gvt debt begins to feel normal, making it even harder to manage the longer term risks to the US fiscal health residing in the entitlement programs.

    As to revenue generation: Mr Obama’s energetic pledge to have “the new GM” operate in private sector mode (for consumption by a variety of national and international audiences) should not impress anyone familiar with basic agency theory (and especially as applied to centrally planned economies, Kornai) and the reality that the compensation structure that is (politically) avaiable may very well not attract the most productive industry talent, even in the current market. It is even doubtful that such talent exists in the US, outside a few Japanese-owned firms who will probably not freely donate it to the US gvt. Or within the only well managed part of GM, Opel. Opel will be sold to a Canadian firm with a lot of support from the German gvt (and the German gvt will not assume any form of ownership) GM needs a new business model, different products, different distributors and maybe different workers. How is anyone working for the government going to do that? And who knows how many more sick giants will find their way to this fountain of youth? Budgetary transparency is more important than ever here.

  • Posted by ReformerRay

    I went to FRB Table F1 to see where Brad got his numbers. The title of the table is “Net Borrowing and Lending in U.S. Credit Markets”. Brad focused attention on borrowing by the Domestic non-financial sector. That sector provides real growth to the domestic economy. The domestic financial sector does borrow, mostly from itself. The main role of the domestic financial sector is to lend.

    If we go to lending, we see the following:
    Lending to the U.S. Credit markets (in billions)
    2007 2008
    Domestic Financial 3,067 2,439
    Rest of the World 1,015 461
    Total 4,082 2,890

    This means, I think, that the U.S. Credit Market borrowed 1 trillion dollars from overseas in 2007 and .5 trillion in 2008. Borrowing from overseas was cut in half between 2007 and 2008.

    I am not sure that this is the best source for finding out how much the U.S. is borrowing from other nations. However, it is a much better source than relying on assuming that Net Borrowing from overseas can be deduced from either national Savings or the size of the trade deficit.

    In a previous post, I showed that National Savings was practically the same in 2007 and 2008.

    Brad is in good company with the assumptions he uses. It is common. It is also wrong. Almost all writers agree with Brad. So, I am not picking on him. I am just trying to set the record straight.

    The correct assumption is that the level of Savings is determined by the level of the other variables in the formula. Savings is calculated by either subtracting Consumption from Gross Domestic Product or by adding together Investment plus the Trade Balance.

    The negative trade balance is paid for only once – when U.S. entities pay for their imports. The money that flows from the U.S. to foreign nations flows back to the U.S., according to accounting convention. That convention is realistic because almost no one prefers a non-interest paying piece of paper to what that paper can buy in the U. S. The return flow of dollars back to the U.S. does not change the Net International Investment Position of the two nations. Cash flows back to the U.S. Ownership of an asset existing in the U.S. flows back to the entity that sent the money.

    It is wrong to conclude, as do many people, that the negative trade balance forces the U.S. to borrow from other nations. The negative trade balance requires that ownership of assets existing in the U.S. be transferred overseas in the amount of the trade deficit. Whether the owners of these U.S. assets want to own U.S. Treasury certificates or a corporation or a farm or an apartment building or to keep their money in dollars is not determined by the financial flows. The owners of the U.S. assets do whatever they wish with the dollars sent to pay for the excess of imports over exports.

    The level of borrowing by the U.S. from other nations cannot be deduced from the size of the trade deficit.

  • Posted by bsetser

    Rien — i have the somewhat heretical view (but one that I think is well supported in the data) that the deficit in the non-entitlement budget (call it the stuff that is normally funded by income taxes rather than payroll taxes) will blow up faster than entitlements. social security is a source of financing for the rest of the government for another 10 years, and the long-term deficit in social security is manageable. payroll taxes would have to rise or benefits would need to be cut at some stage, but the adjustments aren’t beyond the scope of the feasible. medicare is another case, but as dr. orzag notes, the problem there is the growth in health care costs generally — so it really is a health care financing problem as much as a medicare financing problem. private insurance faces the same basic issues. by contrast, the non payroll tax portion of the government has been in structural deficit for a very long-time (pretty much since 1980, setting aside the .com years) and the politics of closing that structural deficit are a problem. project that deficit out for 100 years the way entitlements get projected out and you get real problems — especially once the captive financing from the social security trust fund goes away.

  • Posted by Twofish

    Rien: As to revenue generation: Mr Obama’s energetic pledge to have “the new GM” operate in private sector mode (for consumption by a variety of national and international audiences) should not impress anyone familiar with basic agency theory (and especially as applied to centrally planned economies, Kornai).

    China figured out a way out of that dilemma, and there are a lot of lessons in the way that China manages it’s SOE that can be applied to General Motors.

    Basically what you want are two separate organizations. One to exercise the ownership role of the government and the second to exercise the regulatory role of the government.

    As far as the ownership role, you have minority shareholders that play a watch dog role, and you establish a principle that the majority and minority shareholders have ownership rights in strict proportion to their investment. Also you encourage diversified state ownership so that you don’t have one official exercising all ownership rights.

    As far as regulatory role, you have the principle that any regulation applies equally to all the actors in an industry. So the auto regulator has to treat GM and Ford equally.

    So you get around principal-agent problems by diversifying actors.

    Rien: The reality that the compensation structure that is (politically) avaiable may very well not attract the most productive industry talent, even in the current market.

    So you have compensation decided by the board of directors that in a way that maximizes talent, since the board of directors is responsible for maximizing value, and if the US government as shareholder thinks that compensation is too low, then they are going to have a public fight with the private members on the board. If Treasury thinks that this is a big enough issue they can as shareholder fire the board, but this would be done only under the most extraordinary situations.

    If Congress thinks that CEO compensation is too high they can regulate compensation, but there is a principle that any compensation regulation applies equally to GM and Ford.

    China has already gone through a decade and a half of dealing with these issues. I suspect that the US will copy a lot of what China did, even if they don’t admit it, just like China in the late-1970’s copied a lot of what the US did, without admitting it.

  • Posted by Twofish

    FollowTheMoney: Thanks for your input, rarely do you meet someone who’s as socialist as yourself. Hey some people like socialism, and well everyone in life has there opinion.

    Socialist is a meaningless label, and putting an “ism” in front of people often leads you to misleading impressions of what they believe. For example, calling me socialist, would tend to imply that I like central planning and hate entrepreneurship, when I’m a big, big fan of markets, and I don’t think central planning works. Bureaucracies are good at some thing, but coming up with new and creative ideas is not one of them, and I think that society ought to encourage the creation of small and medium enterprises because those are the industries that generate economic growth.

    I happen to think that Ronald Reagan and Margaret Thatcher are two of the greatest statesmen of the twentieth century. I hate Mao Zedong. I’m a great fan of Ludwig von Mises and Friedrich Hayek. I think that von Mises was wrong about the credit cycle but spot on correct about the socialist calculation problem, and why central planning will not work.

    And I also happen to very, very proudly work on Wall Street, and thing most campus liberals are loony.

    FollowTheMoney: Just remember, What made the United States great was the “land of opportunity”, not “the land of subsidizing my neighbors Escalade”.

    This is kind of silly because the US massively subsidizes the auto industry through the gasoline tax and road trust fund. Also industrial subsidies tend to cause a lot of problems, and should be avoided. What the US has provided to General Motors shouldn’t be a subsidy but rather debtor-in-possession financing.

    FollowTheMoney: We’ll see if things work according to your crystal ball. But i think you’ll be in for a pretty big surprise in the Fall2009.

    Well yeah. I’d be surprised if I wasn’t surprised. About half the stuff that I think I know is dead wrong. I just wish I knew which half.

    My big prediction is that the US will end up owning General Motors for a lot longer than people now predict. If GM becomes a big basket case, it will turn into Amtrak. A big mess that no one can get rid of. If it turns out to be a big success, then people will ask “why sell it?”

    The standard rationale for privatization is that private companies are better run than state companies, but if it becomes obvious that GM is decently run, that rationale disappears, and the Federal government will be tempted to tap into GM corporate profits as a shareholder to pay for social security and medicare.

  • Posted by Rien Huizer

    Twofish: China figured out a way out of that dilemma, and there are a lot of lessons in the way that China manages it’s SOE that can be applied to General Motors.

    I know, but that does not mean that it would work well under very different circumstances. This is neither a low cost produces nor a leader in product development. It has (in the US, elsewhere the situation is a little more complex, Opel for instance may well make a good car company once it is rid of GM) many other weaknesses than just financial legacies and inefficient plants. Those weaknesses require inspired management. Not so sure the Chinese SOE structure with US characteristcs would do the trick. I had hoped that someone with Mainland roots would have been familiar with Kornai’s wisdon, especially his mixed economy observations.

    The jury is still out on whether or not the current SOE approach has viability in industries where competition is complex and where managers are facing scarcety of finance and labor for instance.


  • Posted by Twofish

    Huizer: I know, but that does not mean that it would work well under very different circumstances.

    There’s no reason that I can think of that it wouldn’t. The structure that China ended up with was to have the various public and private entities act the shareholders, and then apply American management theory to the corporatized enterprises.

    Basically public ownership within a pricing system in which access to capital is restricted.

    Huizer: I had hoped that someone with Mainland roots would have been familiar with Kornai’s wisdon, especially his mixed economy observations.

    Kornai was probably of the most important influences on Chinese economics, and a lot of the theoretical economic and practical work in the 1980’s and 1990’s in China was precisely how to avoid the soft budget constraint and other problems that Kornai identified. You really couldn’t and can’t read anything in China about Chinese SOE’s without running into the importance of prices and hard budget constraints.

    Conversely Kornai happens to think very highly of the Chinese economic system.

    The issue that the United States faces now is similar to the one that China faced between 1985 and 1995. State-owned enterprises exist. They aren’t going to be privatized anytime soon. That decision has been made. So rather than throw up our hands and give up, the point now is to go through the accumulated knowledge of what works and what doesn’t to make the best of what we have.

    Rien Huizer: The jury is still out on whether or not the current SOE approach has viability in indusrtries where competition is complex and where managers are facing scarcety of finance and labor for instance.

    The idea behind much of Chinese economic reform was that SOE’s would function better if they were forced to compete with private corporations, and if their access to finance and labor were restricted. One of the (several dozen) important parts of SOE’s was to change them so that they did not have access to infinite capital, because very bad things happen when capital is too cheap, which is Kornai’s point.

    Once access to external capital is limited, then SOE’s are forced to horde internal generated capital, which means they are forced to make a profit and thereby generate wealth.

    One of the reasons that the SOE sector in China is doing rather well in comparison to the “private” export industries, is that after the banks were reformed in 2000, the SOE’s were faced with restrictions on their access to external capital. By contrast, private export industries had access to vast amounts of overseas money which led to an export boom and bust.

    The problem with a lot of the discussion is that people assume that Chinese SOE’s look a lot like Soviet or Japanese corporations, when they don’t. The whole point was to change the incentives so that managers in the SOE’s would function a lot like managers in American corporations do, which is to maximum output given restricted inputs.

    The other thing that I suspect will happen with GM, is that the government will take over GM’s health and pension liabiities in the “old GM” leaving the “new GM” free to run a car company rather than an pension annuity company.

  • Posted by Twofish

    Also one thing that China has done is to separate out entities managing hard budget constraints from those that manage soft budgets. So while the provision of health care and pensions is a worthy cause, it needs to be separated from the entity making industrial resource allocation decisions.

    The role of General Motors is to make cars. It’s not in the banking industry, the health care industry, the unemployment benefits industry, or the pension industry. If they board of directors of General Motors is concerned about something other than making a profit, then something is wrong. It’s not the health care, pensions, banking, unemployment benefits, are unimportant, it’s that someone else should worry about them, and not GM. If the board of directors has to worry about health care every time it decides how to make a car, then it’s being distracted from its job.

    Also, if the US is copying the Chinese playbook, then we ought to see the US government assuming GM’s health care liabilities. The next step is when people start asking if the US government is funding GM’s health care liabilities, why shouldn’t it fund every one elses………

  • Posted by Rien Huizer


    I guess we are reading from the same page but have different associative thoughts. Anyway, If you believe that the GM case demonstrates a US (as opposed to Chinese, and there it needs to be tested, right now these companies are allowed to squirrel away so much earnings that they get the AAA syndrome (entrenchment) s well as a legacy of soft budget expectations) ttachment to credible commitments, I guess you are an optimist..

    Anyway, fine comments!

  • Posted by RebelEconomist


    Would it be possible and desirable to set a limit on the length and/or number of comments per post on this blog? There seems to be an increasing number of long, insubstantial, sometimes rhetorical comments which drown out and possibly deter more considered, informative and thought-provoking contributions. I am not in favour of banning any individuals or views, but some way of encouraging selectivity and brevity might raise the quality of discussion.

  • Posted by Howard Richman


    If you want to predict the current account deficit for this year, the best place to look is the latest actions of the Chinese State Council (the Chinese cabinet). In late May, they:

    1. Reiterated that they are going to keep their currency pegged to the dollar.

    2. Increased their export subsidies on high-tech, labor-intensive, and textile exports. In fact, they raised their export subsidies on textiles to 16%.

    Geithner’s response, in his speech at Peking University, was to call on China to increase its household consumption and “continue progress toward a more flexible exchange rate regime”.

    President Obama and Treasury Secretary Geithner live in a dream world in which they can talk China into changing its policies.

    I recommend, instead, that they enact an import certificates plan which ties American imports from China to Chinese imports from us.

  • Posted by Howard Richman


    Don’t worry about limiting comments. Your readers can skip over long comments while looking for shorter comments that are informative and helpful.


  • Posted by RebelEconomist


    It seems a shame to disregard comments simply because they are long, and I would hope that if commenters have to be selective, we would still get their more significant contributions, and written more carefully.

  • Posted by Twofish

    Huizer: Right now these companies are allowed to squirrel away so much earnings that they get the AAA syndrome (entrenchment) s well as a legacy of soft budget expectations).

    Absolutely, the very high corporate and individual savings rates in China are one legacy of the central planning era. Individuals saved during central planning, because you couldn’t use the money for anything. Chinese corporations get benefits from being big and having lots of cash because a big bank account means a bigger office, higher salary, and more fringe benefits.

    However, because these are the historical legacy of the central planning era, doesn’t mean that they are incompatible with the market or that they were determined by central planning. Russian consumers had the same habits of savings as Chinese consumers, but they had their savings destroyed in the 1990’s by hyperinflation.

    The incentives of Chinese SOE bureaucrats to produce big cash-rich companies means that if you have soft budgets, then they will try to make money by government patronage, but if that patronage stops, then they have to actually go out to create wealth.

    There is also the element of “political correctness.” No US government official in 2009 is going to say outright, we are copying China in managing General Motors, just like no Chinese government official in 1978 was going to say “let’s learn from the evil capitalists.” But they are. You aren’t going to see any Chinese officials on the board of GM, but there are ways of getting advice from Chinese SOE managers in ways that are politically correct (Fed asks Morgan-Stanley what to do, Morgan-Stanley asks the China Investment Corporation, CIC asks SASAC).

    A lot of it is returning the favor. Much of the way that China reorganized its SOE’s and banking system was copied from the Resolution Trust Corporation.

    Also, “political correctness” affects arguments in odd ways. In all my years of reading Chinese economic works, I have never seen any Chinese paper that has said the slightest positive thing about Japan. Most papers are “in what way has Japan mismanaged its economy?” If you think that Japan has a good idea, then you don’t talk about Japan, you say good things about South Korea.

    Curiously “political correctness” is why Kornai ended up so influential in China. Remember that in China in 1978, the Soviets were considered as evil as the Americans, because in Maoist thinking the Soviets were “evil revisionist capitalists.” So if you have a Hungarian economist bashing Soviet central planning as completely incompetent, then he becomes wildly popular in China. The basic decision in China in 1980 was whether to reinstitute Soviet central planning or to do something else. Kornai’s ideas were powerful arguments against Soviet central planning.

    Kornai is probably one of the most important and influential thinkers that has influenced Chinese economic reform. And Kornai very quickly gets you to von Mises and Hayek. Hungary is right next to Austria.

    One other thing is that you miss all of this if you just see the world in black and white. Americans in 1980 saw things in terms of Communism versus Democracy, in which China became “capitalist.” That wasn’t how Chinese saw things since in 1980 the political orthodoxy was that capitalism was evil and the Soviets were as capitalist as the Americans.

    In 1980, the argument against Soviet-style central planning was that by rejecting central planning that it would make China *more* socialist. Which if you understand the Chinese definitions and redefinitions of socialism, it has.

    And then you have Deng Xiaoping in the background, smiling and saying “I don’t really care what you call it, as long as it works.”

  • Posted by Rien Huizer


    Quite a speech. I knew that Kornai was well known among Chinese with a Western education and of a certain age, but I had not expected this enthusiasm. In fact I believe that Kornai would have expected China to have made little more progress on the road to modern insttitutions and proper solutions for extreme poverty, that is, by now, rather than have accumulation occur mainly in the areas run by the descendants of the late communist elite. There is more to Kornai than just car mechanics approach to the economic machinery (it is interesting that this autodidactic economist discovered so much of modern economics all by himself, trying to figure out what needed to be done (pardon the Leninist pun)). Kornai wrote (i cannot type so bear with me)

    ..In all of them the public sector plays an overwhelming role. and hence the countries must overcome similar obstacles if they want to proceed with the privatization of the economy. Although there are sporadic elements of a genuine market mechanism, the institutions, the legal support,and, no less lignificant, the culture and ethics of a well-functioning market are not yet developed. Prices, interest rates, and exchange rates are distorted…” (from “The Road to a Free Economy: Shifting from a Socialist System, the Example of Hungary” NY, 1990) My original reason for evoking Kornai was indeed his well known theory of soft budget constraints. Mentioning him here in response to your post was simply to highlight his equally useful, timely and utterly ignored (if you look at Hungary since 1990) advice to countries going away from state domination of the economy (as applicable to Hungary at the time of writing). It had a message for China too, and as far as I can see today, there are a few things left to be done. Even if the SOEs enjoy exemplary management that could give the bright sparks at GM a lesson or two (and I guess they could, but not uniquely..).


    You are right, too many irrelevant comments. Will do our best to be brief and topical next time.