The ‘great sucking sound’ revisited

I quickly get out of my comfortable depth when the discussion turns to macro-analysis and the mysteries of monetary policy. So I’m happy to conceed Stephen Kirchner’s more expert “criticism”:http://www.institutional-economics.com/ (18 August) of “Martin Wolf(Financial Times, subscription)”:http://news.ft.com/cms/s/488f2e14-f07a-11d8-a553-00000e2511c8.html over the global impact of the US current account deficit, now reaching 5 percent of GDP. But, if I’m not mistaken, Stephen is hitting an easy target: you can’t be dogmatic about what a ‘sustainable’ level of the US deficit might be when, plainly, investors around the world have an apparently unplumbed desire to hold US assets. Stephen is also right, I think, to point out that there could be some unhappy growth consequences for the rest of the world if the US “corrects” it’s trade/investment balance, whether or not by protectionist action (unless there is also a “sizeable rise in domestic demand” almost everywhere else, in Martin Wolf’s implausible alternative scenario). I would not be comfortable, however, with the idea that the rest of the world’s demand for dollar assets (including US debts) could validate almost any US approach to fiscal policy. The reason for my unease is that, having observed the US budget process at close hand and from a distance, I reckon that the US has no fiscal policy at all—most of the time. Certainly not one where Constitutional ‘checks and balances’ operate or where political feed-back is able to control its tendency to ‘racing’ conditions. In place of controls, the US budget process has temporary political settlements about spending increases interspersed with spectacular gestures of dissaving in the form of tax cuts. Fiscal policy stumbles from one budget cycle to another neither under the guidance of of the President’s plan (not in any recent Congress, anyway) nor wholly in the hands of the Congress of the day given the power of the PACs and the momentum of the fiscal flywheel of non-discretionary spending. Sometimes, as twice in the past decade, the temporary settlements don’t form quickly and the US Administration actually shuts down; to the bemusement of most of the rest of the country. There is almost a lack of accountabilty, it seems to me, for US fiscal control. Which may be why the US budget deficit now absorbs three quarters of private savings in the rest of the economy (itself down to rates that are post-World War II lows). It has been the United States’ (probably) enviable prerogative for many decades to count on foreigners’ dollar appetites to bankroll this ride; just as their desire to hold our dollar as a commodity proxy has probably saved our skin from time to time. But the difference in scale between our two economies, and their very different roles in world demand and supply, seems to me to provide no reason to take comfort—as Stephen does—from the (relative) size of our own current account deficits when considering the size of the USA’s external obligations. The consequences for trade and investment policy? Here I agree, again, I think with Stephen. ‘Protectionist sentiment’ is not driven by deficits. It’s endemic; an ubiquitious component of the poltical atmosphere like measles in a kindergarten that can flourish instantly for no discoverable reason. But there are real, rational consequences of the growing US deficit that seem to me to be grounds for concern. Probably the strongest is that the ‘great sucking sound’ coming from the direction of the USA is the sound of funds being pulled into the maw of US consumption from other economies. That means higher interest rates and lower investment elsewhere in the world including Australia. Former US Treasury Secretary Larry Summers “describes(National Perpsectives Quarterly)”:http://www.digitalnpq.org/global_services/global_ec_viewpoint/08-09-04.html the impact as the second greatest reason for ‘capital flight’ from many developing countries (the first is their own governance problems). Perhaps it’s only China that is, for the moment, relatively unafected. bq. Investment in fixed assets, the main driver of Chinese growth, accelerated sharply in July as the impact of government measures to cool economic activity began to wear off. Xinhua, the official news agency, said fixed asset investment from January to July rose by 31.1 per cent over the same period a year ago, significantly higher than the 28.7 per cent growth rate recorded for the first half. Figures for July alone were not published.(“Financial Times”:http://news.ft.com/cms/s/23701924-f041-11d8-a553-00000e2511c8.html) But this, too, could change …

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