Friday, December 03, 2004

I've always been skeptical of the Bush administration's commitment to cutting the budget deficit in half in four years. Yet it's not because of Bush's innate profligacy. It's because the only way the US can attract enough foreign capital to the country these days to float the massive and ever-growing current account deficit is to offer more and more government debt.

Back on November 19 I said,
Now it could be said that the US federal government must run massive budget deficits to attract capital from overseas. If foreign capital loses interest in US stocks and bonds, capital (either private or official) can still be attracted by selling treasuries. This, of course, is the great irony of the budget deficit debate to the degree that we're even having one in the US. If the federal government cuts its deficit in half in four years, how will we attract the capital necessary to run such massive trade deficits? For the 12 months through September 2004, 42% of all capital inflows to the country are into treasury notes. If we won't sell them our debt any longer, they might not bring their money at all.

Thus we wind up raising taxes, cutting government spending and consuming fewer imports (and thus fewer goods overall) all at the same time. Nice pickle we've gotten ourselves into.
Today in the Financial Times (sub. only), Wynne Godley and Alex Izurieta take the idea and run with it.
. . . private indebtedness, net lending to the private sector and asset values are all still relatively high while personal saving has shrunk almost to zero. But even if private net saving were to remain at its present level, an important conclusion follows. The rising balance of payments deficit implies that the budget deficit must get progressively worse from now on if stagnation is to be avoided.

Our conditional forecast of an 8.5 per cent balance of payments deficit in four years time translates into a 7.2 per cent budget deficit. If the net saving ratio were to recover to 1.8 per cent (a more neutral assumption) the budget deficit would have to be 10.3 per cent! These grotesque numbers have been mechanically derived, but they have an economic rationale: the projected balance of payments deficits would bleed the circular income flow so much that, if deep recession is to be avoided, budget deficits of this enormous size would be needed to fill the gap. . . .

If the balance of payments deficit continues to rise and if private saving does not deteriorate further, either fiscal policy will have to be progressively relaxed so the budget balance deteriorates even more, or the economy will face chronic stagnation, with dire consequences for the rest of the world.
The long and the short of it is that the US has a microscopic chance of getting out of its deficit and debt problems without recession. I would say it has a far less than 50-50 chance of getting out of them without an economic depression -- massive reductions in consumption, falling wages, work to export. After all, what's good structural adjustment for the goose is good for the gander.


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