September 16, 2004

Red Ink at Morning

Readers will likely find no topic more hideous than the trade deficit. And I agree! Sadly, though, it keeps forcing its way into the news -- yesterday the Commerce Department reported that the U.S. had hit a record trade deficit of $166.2 billion last quarter. For the moment, we're concerned with two main questions: What does the trade deficit have to do with politics, and What can be done about it?

First off, it's difficult to blame the deficit on George W. Bush. Most of our troubles caused by America's incurable refusal to save money -- at both the personal and federal level -- and this has been going on for twenty years. Americans (and American governments) spend and spend and spend, which raises the cost of money, boosts interest rates, attracts foreign capital, and thereby raises the value of the dollar. With a strong dollar, foreign products become relatively cheap, and we end up importing more than we export (about twice as much, to be precise). Not only does this harm our domestic manufacturing base -- not least because we have less money for investment at home -- but foreigners use all the dollars they receive to buy up American assets.

Or at least, they used to buy up American assets. During the late 1990s, foreigners rushed in to buy up tech stocks and other goodies. But ever since the bubble burst, a good chunk of the deficit has been financed by Asian central banks, who simply sit on all their excess greenbacks in order to keep the dollar strong, so that Americans will continue to buy Asian imports. Now, Asian banks get a terrible investment deal out of all of this, but as long as it stimulates their export base, they don't care much.

But we're very close to the point of disaster. The Institute for International Economics has argued that deficits become unstable when they reach 4 percent of GDP. We're at about 5 percent right now. Pretty soon, the Asian banks will care that they're buying up worthless T-bills. When that happens, banks will start ridding themselves of dollars, causing a rapid run on our currency and serious economic hurt (oil-driven inflation coupled with high interest rates and a sharp recession). In all likelihood, this is what happens if we try to let the market "sort out" the trade deficit.

In order to forestall that unhappy possibility, we need to start paring down the trade deficit right now. But what, exactly, could George Bush (or John Kerry) do? Some liberals have suggested trade tactics -- either forcing China to revalue its currency upwards or propping up trade barriers against imports. But neither will make a big dent in the deficit. (Trade barriers would only reduce the supply of dollars abroad, causing the dollar to rise and U.S. exports to become more expensive.) Alternatively, we can do what the Fed did in the late '80s and force the U.S. through a sharp economic slowdown relative to the rest of the world (so that foreigners start buying more stuff than we do). This works, but it also leads to very high unemployment, lower consumption, and other unpleasantness.

That leaves two "happy" options. First, we can try to boost national savings. For the government, that means getting rid of the budget deficit. (Each dollar of budget surplus boosts national savings by about 60-80 cents.) Unfortunately, no economist knows how to make people save more money. Bush's "personal savings accounts" and whatnot certainly won't do this -- William Gale and Peter Orszag of Brookings have noted that Bush's tax plans serve only to tax wages, not promote savings. So Bush is utterly wrongheaded as usual. But jacking up savings is a problem we need to tackle sooner or later.

The other way to cut down the trade deficit, as John Quiggin pointed out today, is to reduce oil imports by raising the gasoline tax. To fairly drastic levels. It would hurt, yes, and woe to the politician who dares propose it. But at this point, there's a big economic crisis lurking on the horizon, and we're in pressing need of a solution.

-- Brad Plumer 7:05 PM || ||