Comments: A few notes

You write:

understand a large trade deficit is bad…humongous deficits are always bad, but I'm fuzzy on details..

A large trade deficit is not necessarily bad..bad is a subjective term and when discussing the macroeconomy, one must qualify the values associated with "bad" and "good" effects. In this case, the trade deficit is about 4.5% of the US GDP (48 B is a monthly number I am using the annualized number) , but the US GDP is the real "humongous number - over 11, 450 B).

From the 27 May Bureau of Economic Analysis release: "Current-dollar GDP -- the market value of the nation's output of goods and services -- increased 7.2 percent, or $197.6 billion, in the first quarter to a level of $11,459.6 billion."

Our trade deficit (current account deficit) is financed by what is called the capital account (capital account surplus). Foreigners purchase American assets (stock and bonds), and we purchase foreign assets. In recent years, foreigners' purchases of our assets have exceeded our purchases of foreign assets. In effect, we have traded paper assets for real goods and services.

So, is this bad? Again, depends on how you view it. Clearly, excess of imports over exports enable US citizens to consume more than we produce internally. Americans are free to benefit from the efficiencies, opportunities and consumer choice created in an economy open to world trade (which from a libertarian perspective is not such a bad thing). Also, foreign demand for our capital assets raises the demand for dollars (appreciation of our currency) and helps keep our interest rates low (relative) (I'll spare you the whole bond prices work inverse to interest rate primer).

Others might argue that the trade deficit reflects overconsumption (as indicated by a historically low personal savings rate and persistent government (at levels) deficits).

A little Macro 101: private saving plus government saving equals foreign sector saving. This identity always holds (by definition). It means that whenever our private saving is not sufficient to cover our government deficit, we are bound to run a trade deficit. In macroeconomics, we tend to view the trade deficit as resulting from an excess of domestic investment or domestic saving.

Some would argue that foreigners holding our debt is potentially bad. Of course, those debts are not secured by anything except the full faith of the US government (and its ability to tax)..so we could (in theory and one can imagine Alexander Hamilton turning in his grave) just decide to cancel the debt (would ruin our "credit" and drive up interest rates, but we could do it).

Now, we could "fix" the trade deficit - by saving more (so consuming less at both individual and government levels) - a nice little recession perhaps. Or we could tax more (thus lowering personal consumption and raising government savings (unless we spend the tax revenue)...we could employ protectionist policies to block imports (but face retaliation and (heaven forbid) the wrath of the WTO)..The federal reserve could intervene with monetary policy to depreciate the dollar (which in theory should make our exports cheaper and imports more expensive)..but you have governments such as China which tend to keep their currencies artificially low relative to other nations).

And this discussion just scratches the surface..But since you think a trade deficit is bad, I'm curious what policies you would recommend..

And deficits (or do you mean debts?) are not necessarily "bad"..It is a mistake to extrapolate what may or may not be good for an individual onto the macro economy. For example, from 1992 and 1997, the U.S. trade deficit almost tripled, while at the same time U.S. industrial production increased by 24 percent and manufacturing output by 27 percent. Trade deficits do not cost jobs (look at the employment numbers over the same period). In fact rising trade deficits correlate with falling unemployment rates. Far from being a drag on economic growth, the U.S. economy has actually grown faster in years in which the trade deficit has been rising than in years in which the deficit has shrunk (which isn't a suprise since a growing economy means generally more income and thus more consumption).

But to end on a different note (and perhaps something we may agree on), my non-profit added its name to a short letter urging support for Senator Durbin's amendment to the DoD Authorization bill that would reaffirm U.S. legal prohibitions on the use of torture. The amendment also requires DoD to
issue regs prohibiting the use of torture and send a report to Congress..The letter was done by the People for the American Way (although I qualified our support by adding my objection to their spam email! :)


Posted by Col Steve at June 15, 2004 12:03 AM

A little Macro 101

It's been more years than I care to admit to since I took economics, so we'd better step back to Macro 001: Macroeconomics For Dummies for a few minutes.

private saving plus government saving equals foreign sector saving. This identity always holds (by definition). It means that whenever our private saving is not sufficient to cover our government deficit, we are bound to run a trade deficit. In macroeconomics, we tend to view the trade deficit as resulting from an excess of domestic investment or domestic saving.

I'm missing something. Seems to me that those last two sentences contradict each other. The first says that low private savings (among other things) creates a deficit. The second says excess 'domestic' saving (which I assume is much the same thing) results in a deficit.

Some would argue that foreigners holding our debt is potentially bad. Of course, those debts are not secured by anything except the full faith of the US government (and its ability to tax)..so we could (in theory and one can imagine Alexander Hamilton turning in his grave) just decide to cancel the debt (would ruin our "credit" and drive up interest rates, but we could do it).

I'm not sure I can see that. It seems to me that canceling our debt would result in no debt for the Federal government to service, allowing taxes and interest rates to go down.

(Not that I'm advocating canceling our debt. Not even remotely. I'm just trying to understand.)

Now, we could "fix" the trade deficit - by saving more (so consuming less at both individual and government levels) - a nice little recession perhaps. Or we could tax more (thus lowering personal consumption and raising government savings (unless we spend the tax revenue)...we could employ protectionist policies to block imports (but face retaliation and (heaven forbid) the wrath of the WTO)..The federal reserve could intervene with monetary policy to depreciate the dollar (which in theory should make our exports cheaper and imports more expensive)..but you have governments such as China which tend to keep their currencies artificially low relative to other nations).

I think people would save if they could afford to, but if you have a choice between food and personal savings, most people will choose to eat. If you have to choose between helping an elderly parent with their monthly prescription drug costs and personal savings, most people will give Mom a hand.

The idea of "personal savings" is linked to "disposable income" and the change in real purchasing power of wages over the last twenty or thirty years.

I'm not certain exactly what constitutes government "consumption" in your example. Does this include only real products, or all government spending?

And this discussion just scratches the surface..But since you think a trade deficit is bad, I'm curious what policies you would recommend.

Hey! I never said I think deficits are bad, you know. I said I understood a big deficit was a bad thing.

At this point, I'm not convinced it isn't, but I'm a little smarter than I was before I read your replay, anyhow. J

But to end on a different note (and perhaps something we may agree on), my non-profit added its name to a short letter urging support for Senator Durbin's amendment to the DoD Authorization bill that would reaffirm U.S. legal prohibitions on the use of torture. The amendment also requires DoD to issue regs prohibiting the use of torture and send a report to Congress..The letter was done by the People for the American Way (although I qualified our support by adding my objection to their spam email! :)

We do agree on that one, yes. J

And, for the record, to everyone who's reading, I heard from TrueMajority who assured me they didn't hand out my e-mail address to anyone. They don't do that. I owe them an apology, and I'm offering now.

Posted by Anne at June 15, 2004 03:34 PM

private saving plus government saving equals foreign sector saving. This identity always holds (by definition). It means that whenever our private saving is not sufficient to cover our government deficit, we are bound to run a trade deficit. In macroeconomics, we tend to view the trade deficit as resulting from an excess of domestic investment or domestic saving

The last statement is not a contradiction, but I used "or" when I meant "over" and presented another part of the national income accounting I failed to explain. Investment in the macroeconomic world is NOT stocks, bonds, etc..it is capital spending by firms as well as inventories (planned or unplanned). The identity for the last sentence is

NX (net exports) = Savings - Investment

So, if S is low and I is high, NX (by definition) will be negative (trade deficit). Note the identity does not on its own lead us to the casuality - it just helps point us in the areas to research.

Sorry for the inattention to detail on my part.


It seems to me that canceling our debt would result in no debt for the Federal government to service, allowing taxes and interest rates to go down.

Well, two points here , but I understand you're not advocating cancelling the debt. Yes, the interest and principal obligations would fall. However, would you buy US Treasury bonds again if there was a chance the government would say at some point "Sorry, we've decided not to honor this debt?" Nominal Interest rates are in general a function of real interest rates + inflation + risk premium..In this case, the risk premium would soar. Would you lend money at the same rate to a person with a perfect repayment record as compared to someone who has declared bankruptcy? So, in the short-run, we could lower taxes, but in the future, without a reduction in spending, any more borrowing would raise future obligations signficantly.

The second point is an overwhelming majority of the debt is held by US citizens..so from a political standpoint, I'm sure nobody is going to be the one to announce all those savings bonds in your shoebox in the closet is now worthless.

"The idea of "personal savings" is linked to "disposable income" and the change in real purchasing power of wages over the last twenty or thirty years."

Yes, agree. In general, one can "consume" or "save" out of disposble income. The problem is (as was discussed at length in another post you had) we've become a consumer nation. And although you note the cases where some folks by necessity can not save, that is (1) not anywhere close to the majority (as measured by % of people below the poverty level or even a standard deviation above) and (2) their potential savings would not contribute signficantly (simply because a small part of the lowest income groups is going to be a small number (relative).

The issue is the overwhelming majority in the "middle class" who have come to favor consumption over even moderate savings. According to the last statistic I saw in the GDP releases, the personal savings rate was around 4%.

The census data shows the following for income levels in the US (it's dated a couple of years). The range represents income of 75% of the population (they have data on) divided into 20% intervals except the last range which is only a 15% interval.

24,000 41,127 $62,500 $94,150 164,104

So, 55% of people fall in the 41K to 164K range. I'm not sure I can agree with your point that most people would "choose" to save but are limited by necessity spending.

I recall an article a couple of years back in the Wash Post on how this couple complained that $100K just didn't go as far as it used to..I can look at my own life and ask whether I really need to pay $100 for 300 cable channels or could I get by on $50 for 100 channels and save the $50. Or do I really need $4 grand lattes every day?


Government spending (by macroeconomy definitions) consists of purchases of goods and services (mainly wages) and does not include government outlays for social security, unemployment insurance, or interest on the debt. Economists think of these, instead, as transfers, since no goods or services are involved.

Hey! I never said I think deficits are bad, you know. I said I understood a big deficit was a bad thing.

At this point, I'm not convinced it isn't, but I'm a little smarter than I was before I read your replay, anyhow. J

The answer is actually quite complex because running a trade deficit may be good or bad, sustainable or not sustainable, depending on the cause of the current account deficit and the ability of the nation to sustain the levels without triggering any form of currency or other macroeconomic/political crisis.

I guess the whole point of this rather long winded post was to make the case that you can't arbitrarily state

"I understand a large trade deficit is bad…humongous deficits are always bad"

without some qualfication on what you mean by "bad."

Posted by Col Steve at June 16, 2004 08:23 AM

I've gone along, for 10 years now, with the argument that free trade is good and a trade deficit can also be good. But I'm giving it up now. There does come a point when a deficit is so huge it represents an underlying pathology. The important thing is whether the deficit is less than growth or more than growth. If the economy is growing 3% a year and the deficit is 2% a year, then it is a sustainable deficit. But if the economy is growing 3% a year and the deficit is 4% a year, it is not sustainable. Deficits on the scale we have now are not sustainable. We are witnessing real damage being done to our long term financial health.

Posted by Lawrence Krubner at June 16, 2004 09:09 AM

Lawrence;
I might separate philosophically free trade from the deficit, although clearly the rules under which nations trade impact on the trade deficit.

But, you have hit upon the key points although 3% of a large number is greater than 4% of a much smaller number. I would disagree with you because the evidence points the other way. Nonetheless, the issues of sustainability and long-term impacts are important ones for policy debate. I'm a little disappointed that the current administration's budgets given the intent to lower taxes have not matched their rhetoric of the campaign ..although the Congress as well has not shown a desire to reign in spending.

Posted by Col Steve at June 16, 2004 03:29 PM

Col Steve -

I'm not sure we can have this discussion rationally if you're really pretending that an income of $41k and an income of $164k belong in the same "income range."

A married couple with one teenage child and an income of $41k is living dangerously close to the poverty line, even without four dollar cups of coffee and a hundred dollars for a monthly cable bill.

A married couple with one teenage child and an income of $164,000 is in another league entirely.

The fact that a lot of people don't make much money just means there are more people "living poor" than our society is willing to admit, it doesn't mean being in the middle of that 74% of the population means you have a "good" income.

In my (admittedly limited) experience, most people with kids are very worried about the future. They're very worried about saving for emergencies, college fees, auto insurance for a teenage boy, and those kinds of things. Given an income sufficient to allow them to save something against such events, they'd save.

I'd submit that we're both right. I'm right in saying that we shouldn't get fooled by hearing "income" numbers that sounded like a lot of money to us when we were young. $50,000 doesn't go far with a family.

And you're right in saying that people spend money on things not absolutely necessary when they could save it instead.

They could absolutely choose to buy a set of rabbit ears and watch just those broadcast stations they can get free, instead of paying for cable.

They could buy grocery store coffee instead of lattes.

They could change their own oil, spark plugs, and air filters instead of paying a mechanic.

They could take a bus to work, choosing to spend the extra hour or two of commuting time a day to save the $15/week in gasoline expenses, plus whatever their parking costs them.

They could buy everything "generic" or "store brands" to save a few cents on each item, cents that would add up to dollars each month.

They could skip theatre movies, choosing to attend only when shows they want to see hit the "dollar" theatres.

They could leave the air conditioning in their house off or turned up to 80 degrees and the heat turned down to 60 degrees, saving a fortune in utility bills.

There are a thousand things any of us could do to save money, but I maintain you're living on the poverty line if you have to watch every, single penny you spend in order to avoid disaster.

I think the question really should be, "If every day is a struggle to survive and lay aside a small surplus against future needs" then is our society today really, fundamentally different than it was when this was a "frontier" country and families raised a couple of cows and a pig and had a small vegetable garden, spending their summers and autumns working to lay in and preserve enough food to keep them from starving to death over the winter?

We have "civilization" now, but are we making any progress?

I think "progress" happens when we reach a place where every day is not a struggle to survive for 74% or more of the population.

Posted by Anne at June 18, 2004 01:00 PM