by Adam S. Posen, Peterson Institute for International Economics
Op-ed in Welt am Sonntag
July 19, 2009
English version © Peterson Institute for International Economics
For some years now, excessive American consumption has been held up by officials from thriftier nations like Germany as a subject of concern and derision. There clearly was something to this criticism. Not only were the macroeconomic data scary in terms of the low personal saving rate of Americans, but the culture seemed to be obsessed with wasteful, debt-financed consumption. My favorite example remains the article in People magazine (the United States' highest circulation celebrity/entertainment weekly) a year ago titled "Plastic Surgery for Real People," which was all about how average people were using credit card borrowing and home equity loans to pay for expensive discretionary cosmetic enhancements. It is no surprise that President Barack Obama has decried this culture and called for change in the US economic focus. This sounds long overdue to most German ears.
The economics underlying all of this is that when a country spends more than it earns, it has to bring in capital from abroad. It can do so by selling off assets to foreigners or by taking out loans. When the credit-based spending goes to useful investments, this can pay off well for both the borrowing country and its lenders. It is no different than when an individual or company borrows, uses the money to enhance its own future earnings potential, and comes out ahead even after paying back the loan. When a country uses the borrowed funds to simply consume more, however, just like an individual or company, it has nothing to show for the debt, and the debt burden just accumulates. The lenders then begin to worry about the ability of the borrower to pay back the money borrowed and become reluctant to lend more.
While the US economy has been importing capital for decades, it is only over the last ten years that the capital imports have been largely blown on consumption rather than primarily invested usefully. So in the 1990s, the current account deficits of the United States actually were a win-win for US households and foreign investors: The United States ended up with higher long-term income because the extra capital led to faster productivity growth, and foreign investors ended up with good returns on their money. This was reflected in the fact that although total US savings went down in the 1990s, personal savings remained well above zero; i.e., the capital imports were not going primarily to consumption.
That changed starting in 1999. The American personal saving rate sank below 4 percent and steadily declined from there until it was essentially zero for most of 2007. Over the same period, there was not much in the way of productive corporate investment. The housing boom and mortgage debt explosion was part of this shift. So the total amount of capital the United States was importing increased, the returns on how the United States spent that capital decreased, and the foreign debt burden of the United States rose markedly. Plastic surgery paid for by credit card was an apt characterization of what was going on, and the economic benefits were commensurately shallow.
This shift had two implications for Germany and other countries, including China, which net exported a great deal to the United States over this period. First, the American ability to keep consuming so much and thus importing so much was limited. In the individual self-interest of both American borrowers and foreign lenders, at some point US households would begin saving more. And that is what has now happened. The Bureau of Economic Analysis reports that the US personal saving rate reached a 15-year high of 6.9 percent in May. The saving rate has been increasing every month since August of 2008, when it was a mere 0.8 percent. Accordingly, at a national level, net exports to the United States have declined sharply over the last year, even when the US government has increased its overall borrowing, including from abroad.
Those net exports to the United States are likely to stay down, as least as compared with the last few years. Economists are not very good at predicting savings behavior, but our best guess is that the US household saving rate will stay about that high in coming years, and perhaps rise a little more before the US recession ends. Without any large increase in US corporate investment to come for a few years, and with the US government deficits to peak (I hope) in 2010, total US foreign borrowing will be declining further from here. If the United States is importing less capital, that will probably weaken the dollar and certainly will lead to lower imports of goods and services as a share of GDP even before the currency moves. This means that Germany and China are either going to have to find a different source of growth than depending upon US purchases of their exports, or adjust to growing more slowly.
Second, both the big exporters like Germany and China and the United States itself would be better off if we could return to the 1990s. In other words, while the closure of US trade deficits is preferable for everyone to wasteful overconsumption in the United States as seen recently, it is not preferable to the United States borrowing from abroad to invest productively. The failure of the US economy was not in maintaining a persistent trade deficit; the failure of the US economy was in wasting the money it borrowed from abroad in recent years. By the same token, the trade surplus status of Germany is not a virtue in and of itself. What matters is what is done with the capital that Germany sends abroad when it earns more than it spends. So while the end, at least for a while, of excessive consumption by US households may be pleasing to those who put a moral spin on economic behavior, they should not be too happy that the United States is cutting back overall.
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