The Current Account "Deficit" Is the Messenger, Don't Shoot It!

What actions, if any, should countries with persistent current account deficits take to boost net exports? Is the use of any form of industrial policy ever justified?

The current account deficit is not something, per se, that countries should be worried about. Indeed, the word "deficit" is a misnomer. What a country's current account measures is the net amount of resources foreigners are investing in the country.

The term "Current account deficit" should be forever banned and replaced with "net domestic investment by foreigners."

When foreigners invest their assets (capital) in a country, say the U.S., they can do so by buying entire companies, parts of companies, or starting companies. In this case, they take back ownership rights called stock. They can also lend their capital to American entrepreneurs who invest their capital for them. In this case, they take back ownership rights called corporate bonds. Or they can lend their capital to the federal government, in which case they take back ownership rights called Treasury bills and bonds.

Assuming the act by foreigners of investing in the country doesn't lead either households or the government to consume more, every extra dollar foreigners spend on U.S. stock or private or government debt entails a dollar more of investment in the U.S.

So yes, foreigners may take back paper called "debt," but if the U.S. isn't borrowing to consume, the funds it receives from abroad will be invested. This means that every dollar of debt issued to foreigners is offset by an extra dollar of assets held by U.S. households, companies, or the government. So borrowing from abroad, does not, per se, mean the country's net indebtedness increases or, equivalently, that its net wealth declines.

If you are with me, repeat after me: "The bigger the current account deficit, the better!" Say it ten times until it rolls off your tongue and then email it to every blogger for the Economist who thinks otherwise.

Do they really think it would be better for the Chinese, for example, to invest in China or Africa or Iran or Europe or South America than in the U.S.? When more investment is done in the U.S., American workers have more and better capital (plant and equipment) with which to work. This makes them more productive and lets them earn higher wages.

Those who regal against Chinese investment in the U.S. must, at heart, think that we are borrowing from the Chinese to consume. But this is off base. The U.S. has a positive saving rate, albeit an incredibly low one. So if we want to consume more, we can do so without the help of the Chinese. All we need do is save less.

Now if every country in the world chose not to invest in the U.S., there would be a capital shortage in the U.S., making U.S. interest rates rise. This would most likely lead to even more U.S. consumption out of its output. The reason is that most of U.S. wealth is held by older people who are ripening on the vine and know it. So if the return on their wealth rises, they will spend the extra income rather than save it for the hereafter.

In economists' lingo, the income effects outweigh the incentive or substitution effects, leading to more, not less consumption. So banning net foreign domestic investment in the U.S. (making the current account deficit zero), will not only lead to lower wages for American workers, but also, most likely, a lower national saving rate.

If you've hung out with me so far, you've realized two things. First, anyone intent on keeping foreigners from investing in the U.S. in order to reduce the current account "deficit" is in need of a refresher course in economics. And second, and this is key, what we should worry about is not the extent of net domestic investment by foreigners (the more the merrier), but rather our country's national rate of saving.

As an American, I'm worried about the U.S. rate of national saving and have been for decades as I've watched it fall and then fall some more. There has been a lot of talk about the rise in the U.S. personal saving rate. But, as I explained in my last blog, the personal saving rate is a number in search of a concept. Like the government's fiscal deficit, you can make the personal saving rate as large or as small as you'd like by choosing your fiscal labeling appropriately.

The only saving rate measure that has economic meaning is the national saving rate, measured as national income less household and government consumption, all measured at producer prices. Look at the data at the back of the 2010 Economic Report of the President. Find the average value of national income for the first three quarters of 2009 (the fourth quarter isn't reported) in table B27 and subtract the average value of indirect taxes in column D. This gives you $11,297.8 in national income measured at producer prices for 2009. Now get the average of the sum of household plus government consumption over the three quarters and, again, subtract the average value of indirect taxes. This gives you $11,199.9 trillion in national consumption measured at producer prices. The difference between 2009 national income measured at producer prices and 2009 national consumption measured at producer prices is 2009 national saving for the U.S.

This amount is pretty darn small. It's only $97.9 billion or .87 percent of national income.

Earth to America! The U.S. is saving less than 1 percent of its national income! This is the lowest national saving rate recorded in the postwar period. The national saving rate in 1960 was close to 13 percent. Today, it's less than 1 percent.

No wonder foreigners are investing in the U.S. The U.S. is spending so much and saving so little that it can't take advantage of more than a miniscule fraction of its domestic investment opportunities. Were foreigners to stop investing in the U.S. to "cure" our current account "problem," we'd have essentially no domestic investment in the country.

So why is the U.S. saving so little? Simple. The U.S. government has been taking more and more resources from young savers and handing them to old spenders. Medicare and Medicaid benefits are direct transfers of consumption and are properly recorded as such in our national accounts. These transfers have been the biggest culprits in recent decades. Anyone interested in some documentation of this process should look at http://www.kotlikoff.net/content/understanding-postwar-decline-us-saving....

My bottom line? If the U.S. saved 13 percent of its national income like it did in 1960, we'd be running a current account surplus, not a current account deficit. The current account deficit is the messenger, not the message. The message is that America's oldsters are pigging out at the expense of its youngsters for whom, it appears, they could care less. Until America's fiscal child abuse stops and the country dramatically raises its national saving, foreigners will continue to invest ever larger sums in the U.S. And we should thank them for their saving grace.