Why is China an exception? It seems to me that if you want someone else to replace the US as a driver for global demand, China is the most obvious candidate. A low ratio of consumption to GDP and one expects a strong underlying potential rate of growth suggests the possibility, tho not the certainty, of sustained consumption led growth ... and China is big enough to matter.
One other point -- the net international investment position of the US is already negative (unless you add in dark matter). What will shift next year is the net income line/ net interest payments.
Nice post, and, as you know, I think the mechanics of the shift into the export sector that is required to bring the trade deficit down are a vastly underreported topic -- folks just assume it will happen, which is easy in a model but i suspect hard in the real world.
You're right that China is one of the best candidates to pick up the slack on global consumption. What I was getting at, but perhaps did not phrase properly, is that China is an exception in that it has been experiencing an extraodinary investment boom in recent years. So China does not need to boost investment further - it is already in danger of creating chronic overcapacity in several key industries - like steel, autos and cement, and the impact of this over-investment on the balance sheets of its still shaky financial sector is worrying. As you implied, China needs to make the shift form an investment and export led economic expansion to consumption driven growth.
Second, you are of course also correct that the US net international investment position has already turned negative - and it is merely the net interest income/payments that will shift into the red. My bad.
Listening to Mssrs Lipsey, Blinder and Roach yesterday I am baffled by Lipsey's apparent sanguine attitude toward what I thought was a general agreement amongst them that US savings rates must - and therefore will - rise.
Yet, in a briefing by a senior economist at HSBC several weeks ago regarding the State of the US Economy in general and the forecasted impact of of different real estate slowdown scenarios, he tossed out that current imbalances are approaching (maybe surpassed) the point at which - according to their all of their macroeconomic models - it would be beyond the capacity of the economy to adjust without severe contractionary impact. Essentially, there were simply no scenarios at which the imbalances could be meaningfully adjusted without major recession.
I hear lots of opinions based upon conjecture, but from the rigorous modeling point of view that you (or Brad) might have seen, do we in fact have the wiggle room that would validate Mr Lipsey's sanguine view that savings rates will rise without significant collateral damage?
Robert,
You're asking the 3 million dollar question, or in this case, the 800 billion dollar question.
As noted in the post, the current account balance is defined both as the difference between savings and investment and the sum of the trade balance and net transfer payments on the international investment position. For simplicity's sake, let's call this CA=S-I=X-M, where S is savings, I is investment, X is exports, and M is imports.
Let's take the left hand side of the equation first. How can the US increase its savings rate? Well, corporate savings, which are essentially retained earnings, are the only component of the net US savings rate that is still positive. But corporate earnings have been quite strong the past couple of years, and there's not a lot of scope for a huge increase in earnings there – especially if increased commodity prices start to eat into margins. The federal budget deficit, on the other hand, (the deficit being dis-saving) is large and looks set to rise in the near term, so there's not a lot of scope for increased savings there either. US consumers are also in the red, having taken advantage of a booming housing market to pull equity out of their homes and use the cash for consumption. Here there is a bit of scope for an improvement - US household savings rates (which are in fact negative) are at their lowest since the Great Depression, and the housing boom has likely peaked, making second mortgages and refinancing less attractive. If the housing bubble deflates in an orderly fashion, then hopefully US households can slowly increase their savings, but if the bubble bursts and a large wave of foreclosures follow, this could spell trouble.
Still, in the short to medium terms, all this means that the US will still have to depend on foreign financing to cover the shortfall. But there is another way that the S/I ratio can improve - a decrease in investment. If and when long-term interest rates rise, this will increase the incentive to save and decrease the incentive to invest. But if interest rates increase too far too fast, it will choke off investment – improving the S/I ratio, but also causing a recession. This is the hard landing scenario. Only if the US can increase its net savings rate while maintaining investment can the economy slide into a soft landing.
On the right hand side of the equation, the US also needs to improve its trade balance. Here the worry is that the US does not have the installed manufacturing capacity to ramp up exports enough to significantly shrink the trade deficit.
In short, the longer these imbalances continue, the harder it will be for the US economy to make the necessary adjustments without triggering a major recession. The fate of the real estate market and the shape of the yield curve are probably the two most important factors in determining whether we are in for a hard or a soft landing.
First off no one knows if it will be a soft or hard landing.
But common sense indicates that when everyone says it will be soft the likelyhood of the hard increases.
This is because people are less inclined to prepare or make their decisions based on realistic odds.
An analogy might be driving down a twisty road. In some places when you go off it will be pretty flat and the bushes are small, other places you can't see the bottom and all these experts say, "don't worry, if you go off the road it's just going to be a few little bumps."
You drive differently if you know about the cliffs. And if everyone pretend they don't exist then there is usually something wrong. Like Detroit saying 30 years ago and even now, "don't worry about these Japanese cars, we've got them beat."
Since then the inclination for faith based reality has increased, in Iraq and in the economy and elsewhere it has become the test of human decency (all others are America haters)of the ruling fringe of the Republican party.
cynic, perhaps you can expand more on the agricultural position. i have no way of conceptualizing 100 million dollar figures, but with us agricultural production overflowing silos in the countryside, given a sustained effort to dominate the global agricultural market and continuing subsidy regime, and making a huge assumption that the us can open the global ag market, is it not possible that ag exports can play a big part in filling holes?
on a wholly unrelated note, could you take a minute to remind us ignorants of the 'holy trinity' thing about currency pegs?
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I wouldn't worry too much about the CAD. It'll fix itself when China stops screwing with the dollar.
Until then, enjoy their subsidised plastic crap.
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