Saturday, March 12, 2005

Is debt being forced upon the US?

Ben Bernanke seems to stretch his argument a bit when he tries to convince us that the string of current account deficits that the US has accumulated since the mid-90s are the result of a "savings glut" in the emerging markets.

Bernanke tells us that the crises that plagued emerging markets during the 90s and 00s (Mexico, Asia, Russia, Argentina) rendered these countries shy to consume, and therefore they had plenty of savings left over that they need to invest somewhere else.
In response to these crises, emerging-market nations either chose or were forced into new strategies for managing international capital flows. In general, these strategies involved shifting from being net importers of financial capital to being net exporters, in some cases very large net exporters.
These capital exports had to go somewhere, and it turns out that most of those capital exports wound up in the US, where they inflated equity and housing prices, and depressed interest rates, thus encouraging consumption. outside U.S. borders--such as the financial crises that induced emerging-market countries to switch from being international borrowers to international lenders--have played an important role in the evolution of the U.S. current account deficit, with transmission occurring primarily through endogenous changes in equity values, house prices, real interest rates, and the exchange value of the dollar. One might ask why the current-account effects of the increase in desired global saving were felt disproportionately in the United States relative to other industrial countries. The attractiveness of the United States as an investment destination during the technology boom of the 1990s and the depth and sophistication of the country's financial markets (which, among other things, have allowed households easy access to housing wealth) have certainly been important.
I have many problems with his arguments, but here I will focus on only one. It is difficult to believe that emerging market crises were major protagonists in this dilemma for two reasons. The first is that emerging markets have been having periodic balance of payments crises for centuries, and time has shown that emerging market borrowing is extremely resilient. The second reason follows Bernanke's own argument. He states that correcting the US fiscal deficit will not do much to improve the current account deficit because
to the extent that a reduction in the federal budget resulted in lower interest rates, the principal effects might be increased consumption and investment spending at home rather than a lower current account deficit.
I agree with this point, and moreover it should apply to emerging markets as well. If the emerging markets follow policies that increase their creditworthiness (accumulation of international reserves, prudent fiscal spending, etc) their current accounts should be moving into deficit, not surplus. This is because their citizens will spend rather than save. After all, there is a tremendous amount of repressed consumption in these countries that is ready to be unleashed.

We need a better explanation for the current account deficit, Mr. Bernanke.

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