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Greg Mankiw's Blog: Is the U.S. Trade Deficit a Problem?

Greg Mankiw now has a weblog. This is very welcome: we are going to get a lot of high-quality free ice cream--with lots of chocolate sauce, nuts, and whipped topping as well--out of his joining the chorus.

Nevertheless, let me follow the first rule of the internet, and complain about the quality of the free ice cream that Greg is offering us. Greg still has a tendency to speak... well, let me elliptically say that he has a tendency to speak over-elliptically.

For example:

Greg Mankiw's Blog: Is the U.S. Trade Deficit a Problem?: An important issue facing the U.S. economy today is the trade deficit. There are at least three points of view among professional economists about the trade deficit and the associated inflow of capital that the United States has experienced in recent years.

One point of view suggests that the trade deficit is no big deal. If Japan were to start buying large quantities of steel, lumber, glass, and furniture from the United States, we would call that an export and our trade deficit would shrink. But if instead Japanese investors buy office buildings in New York made of American steel, lumber, glass, and furniture, that purchase is a capital account transaction. Because there no reason to prefer that Japanese buyers take delivery of their steel, lumber, glass, and furniture in Tokyo rather than New York, one can argue that we shouldn't be terribly concerned about the trade deficit.

As far as I can tell, this is close to the view that Ben Bernanke has expressed when he suggested that the U.S. trade deficit reflects a "global saving glut." With so much saving in the rest of the world, it is natural that foreigners would want to invest some of that saving in the United States rather than on their own shores. And there is no particular reason that we should object to their doing so. (A similar view is expressed in this article by economist Donald Boudreaux.)

A second point of view is that the trade deficit and the accompanying capital inflows are a problem because they are a financial crisis waiting to happen. Paul Krugman has pushed this perspective in his New York Times column. More than two years ago (January 6, 2004), Krugman wrote: "The traditional immunity of advanced countries like America to third-world-style financial crises isn't a birthright. Financial markets give us the benefit of the doubt only because they believe in our political maturity -- in the willingness of our leaders to do what is necessary to rein in deficits, paying a political cost if necessary.... If this kind of fecklessness goes on, investors will eventually conclude that America has turned into a third world country, and start to treat it like one. And the results for the U.S. economy won't be pretty."

In essence, Krugman is saying that we risk a hard landing of sudden capital flight. Of course, this catastrophe scenario hasn't materialized, lending some credibility to the Bernanke "What-me-worry?" hypothesis. The nice thing about such crisis predictions, however, is that they are probabilistic, so Paul would surely just say we've been lucky--so far.

My own view of the trade deficit and capital inflows is somewhere between Bernanke's and Krugman's. I don't rule out the Krugman financial crisis scenario, although I would bet against it. In fact, I am betting against it in my personal portfolio, where I am happily holding U.S. equities and dollar-denominated bonds. But I am not quite as sanguine as Bernanke has been.

My view is that the trade deficit is not a problem in itself but is a symptom of a problem. The problem is low national saving. Given that national saving is low, I am not eager for the trade deficit to disappear, because that would mean that domestic investment would need to fall to the low level of national saving. But I do think it would be good if the trade deficit were to disappear accompanied by an increase in national saving.

By "increase in national savings," Greg Mankiw is saying--elliptically--that he wants to see (a) an increase in thriftiness on the part of American households coupled with (b) tax increases and (c) significant spending cuts. It would be a good thing if his discourse were less elliptical.

Moreover, I don't think that Greg is completely accurate when he describes his position as between that of Bernanke and Krugman. As best as I can judge, Ben Bernanke believes that (a) desired private savings in Asia is higher than investment and (b) there are very attractive investment opportunities in the United States hence (c) asset prices in the U.S. are appropriately high and (d) capital flows into the U.S. are sustainably strong and (e) U.S. households are taking appropriate advantage of high asset prices to consume more now and save less in the future. Paul Krugman believes that (a) governments in Asia are short-sightedly accumulating dollar-denominated financial assets at an unsustainable rate and (b) investment opportunities in the U.S. are not all that attractive hence (c) asset prices in the U.S. are inappropriately high and (d) capital flows into the U.S. are unsustainable and carry significant risk of financial crisis because (e) U.S. households are spending at an unsustainable rate.

Greg's position does not split the difference between these two. Greg's position appears to me to be that (a) desired private savings in Asia is higher than investment and (b) there are very attractive investment opportunities in the United States hence (c) asset prices in the U.S. are appropriately high and (d) capital flows into the U.S. are sustainably strong but (e) U.S. households are short-sightedly consuming more now and saving less for the future than they would if they really knew what they were doing. It is not clear to me whether Greg's (e) is the result of households' not understanding that the government's budget deficit--its excess of spending over taxes--is in the long run their savings deficit, or is the result of simple household myopia even leaving the government's finances to one side. What is clear is that Greg thinks that, given low U.S. savings, it is better to have a trade deficit than not to have a trade deficit.

I am, in fact, not sure how to characterize all these positions in a helpful way. I think Barry Eichengreen has come closest to doing so at http://www.rgemonitor.com/blog/setser/122658.