Monday, July 09, 2007

Debtor Nation

This month's Harvard Magazine includes a great article on the implications of America's current account deficit and negative savings rate.

The article addresses a key question - how much longer can the US continue to consume more than it earns? And equally importantly, how much longer will other nations continue to provide the US access to cheap capital by buying US Treasuries and holding US dollar reserves?

The long term fear is that a move away from US dollar reserves, ex. to Euros, will lead to a depreciated dollar, negative impact on US consumer purchasing power, and a rise in interest rates to attract capital back to the US.

The opening paragraph outlines the scope of the problem:

"In 2006, the infusion of foreign cash required to close the gap between American incomes and consumption reached nearly 7 percent of gross domestic product (GDP), leaving the United States with a deficit in its current account (an annual measure of capital flows to and from the rest of the world) of more than $850 billion. In other words, the quantity of goods and services that Americans consumed last year in excess of what we produced was close to the entire annual output of Brazil. “Brazil is the tenth largest economy on the planet,” points out Laura Alfaro, an associate professor of business administration who teaches a class on the current account deficit at Harvard Business School (HBS). “That is what the U.S. is eating up every year—a Brazil or a Mexico.”

As investors, entrepreneurs, and technologists, we have a vital interest in positive net savings rates that allow for investment in the future rather than debt service payments to cover historical obligations and spending.

If Gross Domestic Investment = Private Saving + Government Saving + Foreign Saving, then the low rate of private and government savings demands that we import capital. Future growth is conditional on investment in infrastructure, education, and health care. However, we as a nation are no longer saving; thereby forcing us to borrow abroad to fund our consumption and investment.

The key concerns are

1) that the debt service associated with the current borrowings drowns out the ability for net new investment or
2) foreigners stop providing us cheap capital and dollars available for investment (and hence growth) are limited.

It will be interesting to see how quickly the current account deficit becomes part of the public policy discourse and how politicians will wrestle with the enormity of the problem and complexity of the issues involved.


  1. Current account formula:

    Exports + Income and Current Transfer Credits + Capital Inflow = Imports + Income and Current Transfer Debits + Capital Outflow

    basically saying you have a CA deficit means that there is more Capital inflow than outflow. Thus since there is more net inflow into the US, it is a private sector market where investors want to invest (Pitchford Thesis).

    Savings rates are false numbers. Savings rate is personal disposable income minus personal consumption expenditure. Disposable is the key word there, your mortgage payment which tends to be approx. on average a third of an average citizen's income is not accounted for in the disposable income. Bernanke had some comments about this in his testimony to congress at the end of the first quarter.Related

  2. Current Account deficit? I prefer to think of it as a Capital Account surplus. Yeah! Foreigners want to invest in America... why is that not a good thing?

    I'm being a bit glib, but you have to admit, there is no way to really know if our over-consumption is driving the Current Account deficit, or if foreigners' strong desire to have their money invested in the safest and most productive economy in the world is causing us to over-consume to balance it out.

    Also, this issue has been part of public policy discourse since the Japanese bought our entire country in the 80's. That didn't turn out so bad.