April 09, 2012
I know, it isn’t really secret. The Commerce Department publishes data on the trade deficit every month, but given the extent to which it is ignored in economic policy discussions, as for example in this otherwise thoughtful NYT column, it might just as well be secret.
The basic story is incredibly simple. If we are buying more from abroad than we are selling, this means that we have negative national saving. If we have negative national saving, then either the public sector must have negative savings (i.e. a budget deficit) or the private sector must have negative saving (we are investing on net more than we households and corporations save) or both must have negative saving.
Currently the trade deficit is close to 4 percent of GDP at $580 billion. If we were near full employment, it would likely be close to 5 percent of GDP or $750 billion a year. (At higher levels of GDP the trade deficit increases, other things equal, because we would buy more imports.)
To offset this gap we must have a large budget deficit. Alternatively, we can have the situation like what we had in the housing bubble years of the last decade or the stock bubble years of the late 90s when private investment exceeded private saving.
In the last decade this was accomplished through the bubble-spurred housing boom and the near zero savings rate as people consumed based on their bubble-generated housing wealth. In the 90s we got negative private savings as gullible investors threw hundreds of billions of dollars into dot.garbage. Savings also fell to near zero in that period as households spent based on their ephemeral stock-bubble-generated wealth.
Those who do not focus on the trade deficit, but nonetheless want full employment, either want large budget deficits or the negative private savings story seen in the bubble years. They may not understand this fact, but just like 2+3 being equal to 5, it happens to be true. There is no way around it.
The key to reducing the trade deficit is of course getting the dollar down. That will make our goods more competitive internationally.
This all is really simple, but it does require thinking for a moment or two. Repeating the Washington conventional wisdom gets one nowhere. (Okay, I don’t mean that literally — it can get you a high paying important job.) People actually have to think about how the economy works in order to understand it.
(btw, one painful item in the NYT piece was the discussion of housing equity. It is not coming back and there is zero, nada, no reason for thinking it will. There is no story that passes the laugh test in which house prices will have any substantial appreciation from current levels. They are now near trend levels; why would they rise back to their bubble levels?)
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