Dials Moving Into the Red Zone

At the end of 2000 I said that while the U.S. trade deficit was a worry, there was still plenty of time to deal with it. It was very important that it be resolved by the world economy "balancing up" rather than "balancing down." And I would have put the chance of a major dollar-based financial crisis at only one-in-a-thousand.

By the end of 2003 I said that the chance of a major dollar-based financial crisis was one-in-a-hundred, and it was time for keeping that probability from growing any higher to become the highest economic policy priority.

By the end of 2004 I thought that the chance of a major dollar-based financial crisis was one-in-ten.

Now I think that the chances are one-in-five. It is still possible that we may escape unscathed: the dollar could fall by nearly half without foreigners ever demanding an expected-depreciation premium in interest rates, the foreign currency-denominated value of U.S. foreign debt could melt away, and the exchange rate stage could drive an export-driven boom that brought trade into balance as higher import prices shrunk imports. We did it in the late 1980s, after all--although starting from a disequilibrium only half as large as our current one.

Brad Setser writes:

Brad Setser's Web Log: Don't worry, be happy. Trade deficits do not matter so long as US hhousehold wealth is rising: Michael Mandel thinks I am making a big mistake, albeit a very, very common one - worrying about rising US external debt rather than celebrating rising US household wealth.

Brad is making the very very common mistake of taking the value of U.S. assets--that is, our wealth--as a fixed number, so that everything that goes to foreigners is less for Americans. That is, he's treated wealth as a zero-sum game.

In fact, U.S. wealth has historically grown at a pace which far exceeds the size of the current account deficit. As the economic pie gets bigger, there's enough to feed our foreign friends while keeping an ever-growing piece for ourselves.

Since 1952 household net worth--that is, assets minus liabilities--has increased by an average of 7.4% annually, or 3.7% in real terms. That includes real estate booms and real estate busts, bull markets and bear markets. This annual percentage gain translates into a huge increase in net worth, in dollars. Household net worth today is just under $50 trillion, according to the Federal Reserve.

...If US household wealth is rising, should we worry if US external debt is also rising?... [W]hat would happen if US... long-term rates... were to rise substantially?... Too much of US household wealth depends on the interest rate for me to feel very comfortable. At some point, the United States foreign creditors are likely to want an interest rate high enough to compensate them for the risk of future dollar depreciation. A country that outsources savings will likely have to offer foreign investors a positive real return (over time) in terms of their local currency, not in dollar terms....

The US likely will have a current account deficit of close to 7% of GDP by the end of 2005, and even if that deficit started to fall, the US would still need to finance a very large current account deficit for some time. That might not be much fun if interest rates were high.

Of course, there are scenarios where the US trade deficit falls and US interest rates stay low. For example, the US consumer could give out, pushing the US economy into a recession.... But low interest rates, constant household wealth, no growth and stagnant (if not falling) household income is hardly a comforting prospect....

The US net international investment position... is likely to be more like 30% of US GDP at the end of 2005. And it is poised to keep on rising so long as the US runs large trade deficits. Exports as a share of US GDP, in contrast, are no higher now than they were in 1997, when the US had a lot less external debt. I think that matters. Remember that external debt ultimately is a claim on the United States future export revenue. New homes -- and higher prices on existing homes -- won't help pay the interest on the US external debt. A new Boeing production line would.... It is not clear that the United States capacity to generate future export revenue to pay its external debt is set to rise as fast as its external debt looks likely to rise. Call me old fashioned. I think the external debt to exports ratio still matters.

Comments

[Nicholas Weaver]

1 in 5? I'd actually vote worse, just based on gut feeling: If there is any decision the administration might make to improve or worsten the situation, they will never improve and only make things worse.

[John Quiggin]

I'm not sure which Brad I'm reading here. I think the part quoted to Brad S should run further

[W. Kiernan]

When Brad Setzer says that U.S. household wealth is rising, does that include the value of the house? According to the "Fair Market Value" the Hillsborough County Tax Assessor assigns my house this year I could get almost twice what I paid for it in 1995 if I sold it today.

Then what? Either I'd have to buy a new house at double price or go live in a tent. If the house in which my family lives gets more valuable while the rest of our wealth stays the same, and if I insist upon living indoors, I'm no better off; in fact, since my property taxes go up I'm poorer than before.

[nate]

Prof DeLong

If you are right, borrow against your home and use the US $s to buy an international stock index?

[AllenM]

Hmm Brad you are slowly coming around to the shrill folks of neverland who believe we are in for a humdinger of a crisis. What next? Buy gold? Real Estate is a total chimera. Remmber you can sell and rent, and with a surplus of housing in some areas, you can do very well letting somebody else take all of the costs of owning for a meagre- sometimes nonexistent return. International stocks are a question- but the real question is who will be brave enough to buy asia during the next disaster? That will make you real money- oh wait we have no real money- we have computer blips that we send for oil and goods- life is delightful!

[masaccio]

The CNOOC acquisition of Unocal is the first serious problem we have because of the enormous amount of US debt accumulated by the Chinese: they will not be content to hold promises to pay, they will want physical assets. Next up: Weyerhauser. Soon enough, GE. Globalism really coming home to roost.

And, I do not see any evidence that wealth is accumulating anywhere except in the highest brackets, unless you count bass boats and four-wheel vehicles as wealth.

[Dwight Cramer]

Perhaps the trade deficit is a good thing and is a major contributor to the stability of the international economic order rather than a bad sign of a global economy profoundly out of balance. Start with the premise that the United States of America is in an era of relative (emphasize relative, not absolute) economic decline, and that there are other economies around the world that are emerging as more significant global actors than they were previously.

How do you manage this transition? First, don't get hung up or otherwise choke on the premise. (Instead, recall the European economic miracle of the mid-twentieth century, which somehow seemed less threatening than Chinese growth, but, nonetheless. . .).

As far as I can tell, a long term U.S. trade deficit and large inflows of foreign capital serve the needs of a variety of other sovereign actors very nicely. And anything that gives some of those actors, in particular, a bigger stake in an orderly global economy is definitely a good thing.

[David Ricardo]

..."the dollar could fall by nearly half without foreigners ever demanding an expected-depreciation premium in interest rates, the foreign currency-denominated value of U.S. foreign debt could melt away" ...
Precisely ! for a devaluation to accomplish it´s goal it has to take everybody by surprise, it´s the only way to melt away US denominated debt, if they are not taken by surprise most will hedge or take provisions, also, once a devaluation occurs, hopefully with an overshoot, interest rates don´t have to rise because nobody will be expecting a further devaluation, for the currency is already cheap. It is important to remember that a rise in interest rates means a devaluation of the currency for two reasons: 1) the present value of anything denominated in that currency is worth less, and being redundant but worth noting: 2) The future value of that currency is worth less. Therefore, third world countries that raise interest rates with the intention to postpone a devaluation are in fact devaluing the currency.

Caveat lector: Ceteris Paribus !

[David Ricardo]

..."the dollar could fall by nearly half without foreigners ever demanding an expected-depreciation premium in interest rates, the foreign currency-denominated value of U.S. foreign debt could melt away" ...
Precisely ! for a devaluation to accomplish it´s goal it has to take everybody by surprise, it´s the only way to melt away US denominated debt, if they are not taken by surprise most will hedge or take provisions, also, once a devaluation occurs, hopefully with an overshoot, interest rates don´t have to rise because nobody will be expecting a further devaluation, for the currency is already cheap. It is important to remember that a rise in interest rates means a devaluation of the currency for two reasons: 1) the present value of anything denominated in that currency is worth less, and being redundant but worth noting: 2) The future value of that currency is worth less. Therefore, third world countries that raise interest rates with the intention to postpone a devaluation are in fact devaluing the currency.

Caveat lector: Ceteris Paribus !

[James Kroeger]

Many “anti-Republican” economists have expressed a great deal of concern about America’s chronic Current Account deficit. For example, in his July 13 blog entry, Brad DeLong reminds us of his key concern, “Remember that external debt ultimately is a claim on the United States future export revenue.” If true, this would mean that—if America were ever to want to be a net lender to other countries for some unexplained reason—we would be forced to consume less domestic production in order to sell products to foreigners, in order to pay our debts. Unfortunately, he is quite mistaken.

DeLong’s statement is based on a certain theoretical assumption that bears no resemblance to the reality we see in international financial institutions. The assumption? That foreign investors/sellers will insist on payment in their own currency. When we embrace that assumption, then all of the arguments of foreign trade alarmists achieve some plausibility. But if all the foreign owners of American debt and all foreign exporters are always quite happy to be paid in dollars, then—contrary to DeLong’s assertion—Americans would never need to export anything in the future in order to make interest payments to foreign bond holders or to buy any imported good/service.

Japanese bankers discovered long ago that it was no great hardship to sell all the Yen to American importers that they might want [at an exchange rate favorable to Japanese manufacturers]. If they had been obsessed with lending out their reserves to only Japanese customers, this would have been a problem [as American demand for Japanese products soared]. Instead of simply holding their accumulating dollars in an idle account, they decided to earn some interest by lending their dollar holdings to the least risky borrowers they could find in America: the US government. That is why foreign banks own so many Treasury securities.

What dollars are the Japanese and Chinese banks lending to America? Dollars that don’t really have much value in their own countries (exceptions noted). It is reasonably accurate to say that, conceptually, American dollars never leave the country when they are given to either American or Japanese or Chinese banks in exchange for foreign currency. They are a very real part of the banking reserves that are available for lending in America. In seeking ownership of American assets, Japanese and Chinese bankers are simply some people who are just as eager to lend to Americans as American bankers are, but perhaps a little more risk averse.

What DeLong and other good-intentioned economists need to ask themselves is this: Would the United States of America be less vulnerable if the federal government only borrowed from American banks & financial corporations? Why would that simple distinction affect the amount of reserves that are available for lending in the United States? It wouldn’t. Chinese and Japanese bankers are not suddenly going to want to liquidate their interest-earning American assets in a move that is guaranteed to worsen their nations’ terms-of-trade. They are all simply international bankers who have some dollar-denominated assets in their portfolios.

Give it some thought, guys…

[MTC]

Mr. Kroeger -

You write:

"Chinese and Japanese bankers are not suddenly going to want to liquidate their interest-earning American assets in a move that is guaranteed to worsen their nations’ terms-of-trade."

The operative words in your sentence are, as you yourself are aware, "suddenly" and "want". Dr. DeLong would agree with you that the Chinese, Japanese or any other major holder of American assets would not want to suddenly repatriate their holdings (as the desires of minor holders, see the behavior of the Norwegians in March-May of this year). Sudden mass repatriation would lead to sudden large depreciation and the general destruction of the value of the assets.

What Dr. Setser, Dr. DeLong and others are worried about is that the dollar holdings will have to be repatriated "eventually." This problem is inescapable: unless the creditors dollarize their economies or receive payment in U.S. goods & services exports, they will face a crunch: their assets will be in dollars but their expenses will be in their own currencies.

The very frightening problem is that in currency collapses, each individual tries to get his or her money out before everyone else. The resultant rush to get out before the crowd, pushes the collapse backward in time. Simultaneously, the tremendous privileges enjoyed by the U.S. have given the U.S. dollar tremendous momentum, holding the dollar high despite a U.S. debt and deficit profile reminiscent of a Latin American train wreck nation. These two waves are hurtling toward each other: the one forward in time, the other backward. Should they meet, the fall of the dollar will be brutal, unexpected and uncontrollable.

[George W Bush]

Yeah, Yeah, Yeah - bother me about this when the odds get to 3-1, will yah?

[hilzoy]

Brad: Was there anything in particular that made the general alarm ramp up a notch recently? (Genuinely curious.)

[Glen Bowman]

I am a historian and not an economist, but as far as I know the US trade deficit has persisted since around 1976, and there have been past times in which the deficit spiked downward. And yet there has not been a dollar crisis.

Point blank: Is there ANY evidence of correlation between the value of the US dollar and the level of the trade deficit? If not, how can anyone accurately consider placing odds.

[christo]

Hey, thanks Prof. Delong, now I find out you're worried. I've been reading this blog since December wondering the entire time why I never see signs of anxiety.

Here's a first corrective monetary step, ask Mr. Keep the ship of moral hazard steady Greenspan to resign, immediately. So many liberal economists appreciate his work, don't you know. Then get Volcker in there to care take till somebody else reality based can step in. Greenspam's one of the main enablers to W's binge governating. Helo money Bernanke takes over, I should look into Canadian citizenship process like my pal Ron has already accomplished.

Normally back in Taiwan, I just feel out of it. Now in beautiful Massachusetts for a two week stay, driving south to Cape Cod Monday night on Rt 3, suddenly there's a line of cars barreling down the break down lane at 60 mph, traffic a little heavy, no time to wait during cocktail hour. To me it looks the selfish bastards are starting to break down the rules of society. After ten minutes I was hitting 70 to 80, all is well.

Ah, folks, dollar drops by half, that'll probably mean other bad things happen to the economy. The consumption end of the economy dries up, we can turn endless shopping malls into badminton courts. You'd have to hawk a Picasso to go to Europe. Ah, American salesman, you speak Chinese, you have the funniest accent. Next time down for a recession and drop in the Tao Jones cult, the Chinese will be looking to buy chip manufacturing companies, buy the patents, the technique and move it all to China, who needs the believing in free market American engineers? One of those will cost less than Unogo.

[christo]

From Kroeger above, "Japanese bankers discovered long ago that it was no great hardship to sell all the Yen to American importers that they might want [at an exchange rate favorable to Japanese manufacturers]."

My understanding of the dollar/yen exchange rate from the book Dollar/Yen, don't you know, is the yen has been continuosly forced to appreciate under political pressure from the U. S.

Read elsewhere why a chronic trade deficit with Japan wasn't as dangerous as the present growing piece of work with China. Try some of the recent posts at Stetser.

The only Americans who borrow yen are financiers who borrow at 0%, use the leverage to buy U. S. bonds, and sleep at night as the long term trend is the yen appreciates against the greenspanback. Bernanke just prints 'em like wallpaper in a pinch as needed.

Kroeger's post is drivel.

[jerry]

Boeing is subject to your approved Walmart/free trade costs as much as the next guy.

The 787 will mostly be made overseas and assembled here in the states.

If you would like to see a new Boeing production line, you may wish to think more about how free trade provides the wrong incentives.

Fair trade, not free trade. Don't subsidize the race to the bottom.

[Michael Carroll]

Perhaps one of these geniuses will tell us what exactly the dollar is supposed to fall against?

Gold? Yeah I really need some new jewelry

The Euro? I heard that constitution actually got a yes vote the other day.

Pound Sterling? I won't even go there.

Don't tell me... the Yuan, that's right-the Yuan. Now, I must have been the first person in the world to ever think that. Excuse me, I need to call my broker.

[Movie Guy]

THE RED ZONE

Global Rank Order - 2004 External Debt

http://www.cia.gov/cia/publications/factbook/rankorder/2079rank.html

United States $ 8,525,671,000,000 * gross
United States $ 2,542,000,000,000 ** official BEA net
United States $ 4,000,000,000,000 *** possible net

United Kingdom $ 4,710,000,000,000 (2003)
United States $ 2,542,000,000,000 ** official BEA net
Italy $ 913,900,000,000
Spain $ 771,100,000,000
China/HK $ 650,900,000,000
Canada $ 570,000,000,000
Australia $ 308,700,000,000 (3rd quarter, 2004 est.)
Portugal $ 274,700,000,000
Brazil $ 219,800,000,000
Russia $ 169,600,000,000
Korea, South $ 160,000,000,000
Argentina $ 157,700,000,000
Mexico $ 149,900,000,000
Indonesia $ 141,500,000,000
Iraq $ 125,000,000,000
India $ 117,200,000,000
Poland $ 99,150,000,000
Israel $ 74,460,000,000
Greece $ 67,230,000,000
Sweden $ 66,500,000,000 (1994)

China $ 233,300,000,000 (3rd quarter 2004 est.)
Hong Kong $ 417,600,000,000 (June 30, 2003 est.)
China/HK $ 650,900,000,000

* - U.S. Treasury
Gross external debt as of 6 July 2005
http://www.treas.gov/tic/debta305.html

** U.S. BEA 05-31, June 30, 2005
U.S. Net International Investment Position at Yearend 2004
http://www.bea.gov/bea/newsrel/intinvnewsrelease.htm

*** possible external net debt - $3.5 T to $4.0 T

Global Rank Order - 2004 Trade Balance

http://www.cia.gov/cia/publications/factbook/geos/xx.html#Econ

United States ($ 681,000,000,000)
United Kingdom ($ 92,200,000,000)
Spain ($ 49,500,000,000)
Mexico ($ 8,400,000,000)
France ($ 700,000,000)
Taiwan $ 5,100,000,000
Italy $ 7,100,000,000
Switzerland $ 9,600,000,000
Singapore $ 18,800,000,000
Belgium $ 20,700,000,000
China/HK $ 22,900,000,000
Malaysia $ 24,200,000,000
Korea, South $ 36,400,000,000
Netherlands $ 40,400,000,000
Canada $ 59,500,000,000
Russia $ 69,590,000,000
Japan $ 137,000,000,000
Germany $ 176,600,000,000

China $ 30,700,000,000
Hong Kong ($ 7,800,000,000)
China/HK $ 22,900,000,000

Global Rank Order - 2004 Exports

http://www.cia.gov/cia/publications/factbook/rankorder/2078rank.html

Germany - $ 893,300,000,000
China/HK - $ 851,200,000,000
United States - $ 795,000,000,000
Japan - $ 538,800,000,000
France - $ 419,000,000,000
United Kingdom - $ 347,200,000,000
Italy - $ 336,400,000,000
Canada - $ 315,600,000,000
Netherlands - $ 293,100,000,000
Belgium - $ 255,700,000,000 (2003 est.)
Korea, South - $ 250,600,000,000
Mexico - $ 182,400,000,000
Singapore - $ 174,000,000,000
Spain - $ 172,500,000,000
Taiwan - $ 170,500,000,000
Russia - $ 162,500,000,000
Switzerland - $ 130,700,000,000
Malaysia - $ 123,500,000,000
Sweden - $ 121,700,000,000
Saudi Arabia - $ 113,000,000,000

China - $ 583,100,000,000
Hong Kong - $ 268,100,000,000
China/HK - $851,200,000,000

Global Rank Order - 2004 Imports

http://www.cia.gov/cia/publications/factbook/rankorder/2087rank.html

United States $ 1,476,000,000,000
China/HK $ 828,300,000,000
Germany $ 716,700,000,000
United Kingdom $ 439,400,000,000
France $ 419,700,000,000
Japan $ 401,800,000,000
Italy $ 329,300,000,000
Canada $ 256,100,000,000
Netherlands $ 252,700,000,000
Belgium $ 235,000,000,000
Spain $ 222,000,000,000
Korea, South $ 214,200,000,000
Mexico $ 190,800,000,000
Taiwan $ 165,400,000,000
Singapore $ 155,200,000,000
Switzerland $ 121,100,000,000
Austria $ 101,200,000,000
Malaysia $ 99,300,000,000
Australia $ 98,100,000,000
Sweden $ 97,970,000,000

China - $ 552,400,000,000
Hong Kong - $ 275,900,000,000
China/HK - $ 828,300,000,000

Global Rank Order - 2004 Industrial Production Growth Rate Percentage

http://www.cia.gov/cia/publications/factbook/rankorder/2089rank.html

06. China 17.10
17. Taiwan 12.20
20. Singapore 11.10
22. Indonesia 10.50
23. Malaysia 10.20
24. Korea, South 10.10
49. Ireland 7.00
54. Japan 6.60
57. Russia 6.40
63. Brazil 6.00
64. New Zealand 5.90
69. Sweden 5.50
72. Norway 5.20
82. Switzerland 4.70
86. United States 4.40
101. Mexico 3.80
103. Belgium 3.50
106. Austria 3.30
117. Spain 3.00
127. Germany 2.20
129. Finland 2.00
132. Canada 2.00
133. Australia 1.90
136. France 1.70
143. Hong Kong 1.00
146. United Kingdom 0.90
147. Netherlands 0.80
150. Italy 0.70

[liberal]

Glen Bowman wrote, "I am a historian and not an economist, but as far as I know the US trade deficit has persisted since around 1976, and there have been past times in which the deficit spiked downward. And yet there has not been a dollar crisis."

But how often was the trade deficit sustainably on the order of 5% of GDP?

I can't quite recall if it was that bad in the 1980s.

[Reader]

I wish, oh lordy how I WISH I hadn't just re-read Chapter 3 of Robert Collins' _More_.

[nate]

"The only Americans who borrow yen are financiers who borrow at 0%, use the leverage to buy U. S. bonds, and sleep at night as the long term trend is the yen appreciates against the greenspanback. Bernanke just prints 'em like wallpaper in a pinch as needed."

I am not sure I understand this.

If I borrow yen and use it to buy U.S. bonds, I eventually have repay the yen. In the future, if I redeem the U.S. bonds to repay yen, and the dollar has depreciated vs. the yen, I will not make money.

If someone in the U.S. wants to sleep well at night, they probably live in a house that is paid in-full (no mortgage) with some diversified savings and investments. They probably do not use credit cards excessively. They probably live below their means and do not have lots of financial commitments. They probably do not borrow foreign currency and invest it in U.S. bonds - i do not see how this would help one sleep well at night.

[nate]

If i understand DeLong and some of the stuff on this blog, it seems like someone would borrow U.S. dollars and use the dollars to buy foreign currencies or assets correlated to foreign currencies (vs. using the borrowed U.S. dollars to consume stuff in the U.S. such as clothes, expensive entertainment, fancy trips, etc).

[anne]

Nate:

"If someone in the U.S. wants to sleep well at night, they probably live in a house that is paid in-full (no mortgage) with some diversified savings and investments. They probably do not use credit cards excessively. They probably live below their means and do not have lots of financial commitments. They probably do not borrow foreign currency and invest it in U.S. bonds."

Nicely done. The Japanese wish for much of the last 15 years has been for a stable Yen value against the dollar. The dramatic appreciation of the Yen from 1985 to 1990 may well be a significant reason for the subsequent economic malaise in Japan. So, the Yen is highly stable against the dollar and Yen may well be borrowed at a low rate and used for speculative purposes by hedge funds.

[anne]

The dollar has in fact strengthed dramatically against a basket of currencies this year. Levels are about where they were a decade ago. Just now owning dollars has been a fine hedge, but that is now. Notice that international stock markets have adjusted to declining domestic currency levels. There is a strong bull market in stocks in domestic currency terms in most major markets, though as usual Japan is an exception.

[anne]

The Morgan Stanley Europe Index is up over 13% in domestic currency terms this year, while up about 1% in dollars. But, then look at the dollar against the Euro. This compensation of stock values is interesting and comforting.

[anne]

Crises are made of many elements, not the least of which are political, and though there are fierce government and trade deficits, and though the dollar will in time weaken significantly for the trade deficit will insure this, we cannot guess when. The Euro which may have seemed an alternative to the dollar as an exchange currency 8 months ago, now appears politically less stable than the dollar. Japan is not about to allow a currency value increase, and China.... The dollar may well hold for an extended period, but nonetheless our debt problems are real and will eventually worsen in the absence of novel fiscal policy.

[anne]

What is impressive is the strength of international stock markets including increasingly our own given the growth weakness in Europe, housing weakness in Britain and Australia, and a Federal Reserve tightening cycle that has extended over a year and will continue. Middle capitalization and value stocks are especially robust, and several sectors including REITs have gained sharply. A fair number of international markets are up well over 10% in domestic currency terms so far this year.

[anne]

The Vanguard REIT Index shows astonishing strength through this Fed tightening cycle. The index is up well over 10% so far this year no matter the warnings on real estate and no matter the difficulty REITs are haing with operating earnings. Property prices increases and REIT values increase along.

[nate]

Sometimes markets move quickly and predictively, ie stock markets will rally heading into a recession or slowdown, and may stall during or coming out of a recession. Weakness around the world means interest rates will not increase tons, which may be good for the stock markets.

Things like m&a may affect mid-caps - companies get bought-out, consolidated, etc.

In the last week in the U.S., "growth" has been making some relative gains on "value". True growth companies at a p/e ratio of 20-25 may not be bad deals (then again they might be too high - not sure).

[James Kroeger]

From christo above, “My understanding of the dollar/yen exchange rate from the book Dollar/Yen, don't you know, is the yen has been continuously forced to appreciate under political pressure from the U. S."

(This in response to my statement that, “Japanese bankers discovered long ago that it was no great hardship to sell all the Yen to American importers that they might want [at an exchange rate favorable to Japanese manufacturers].")

Let me clarify my point. When I said it was “no great hardship” for Japanese bankers to freely use their yen reserves to maintain a weak yen relative to the dollar, I meant only that “market forces” were not compelling them to sell yen at higher prices. The “natural market consequences” of not insisting on more dollars per yen in the face of greater yen demand were rather painless: booming economy, low unemployment, etc. In the absence of “government interference”, Japanese bankers have faced no compelling reason to accommodate an appreciation of the Japanese yen.

In another effort to discredit my arguments, christo blurts out, “The only Americans who borrow yen are…” This spasm of incoherence was apparently inspired by my comments that, “If they had been obsessed with lending out their reserves to only Japanese customers, this would have been a problem [as American demand for Japanese products soared]. Instead of simply holding their accumulating dollars in an idle account, they decided to earn some interest by lending their dollar holdings to the least risky borrowers they could find in America: the US government.

Although I did not specifically refer to Americans borrowing yen, christo apparently inferred that I had when I said the words, “lending out their reserves.” No, I was not careful to mention in that sentence that by “reserves” I meant all of the reserves held by Japanese banks, including dollar and other holdings, but I did refer to the dollar holdings of Japanese banks in the very next sentence.

I found this christo non sequitur particularly amusing. Either he/she is having difficulty concentrating these days, or he/she intentionally penned an irrelevant statement that he/she hoped would nevertheless be interpreted as a damning indictment of my comments.

Christo apparently has a special interest in insulting others. I would advise him/her to not let this failed attempt be too discouraging. Insults can be effective, but one really needs to avoid humiliating oneself in the effort. Please try again…

[jm]

Brad wrote, "The US net international investment position... is likely to be more like 30% of US GDP at the end of 2005. ... Remember that external debt ultimately is a claim on the United States future export revenue. ... I think the external debt to exports ratio still matters."

The problem is that the major players in this farce are sovereign governments not subject to any external accounting discipline. If the governments involved were US corporations, their leaders would all be on their way to Club Fed along with Bernie Ebbers. The Asia-US economic situation is simply the same as the telecom bubble era vendor financing schemes, on a Brobdignagian scale. They loan us the money to buy their stuff, and we reciprocate by buying all we can. Both sides claim to their "stockholders" that business is great. If Worldcom and Global Crossing et al had been able to print their own money, and there'd been no outside agencies to stop the fraud, Nortel and Lucent would still be crowing about monstrous profits.

Long-term, the dollar debt the Asians hold is valueless except to the extent that the dollars can buy US goods, services, and/or assets.

[nate]

http://finance.yahoo.com/q?s=luv

[nate]

the debt and trade positions are somewhat of a complement (intl. people trust lending to the U.S.) and also a concern. some sort of "proximate cause" or "shock" that disrupted the current routine might cause some change and pain.

however,the u.s. has a history of scrambling and solving big opportunities with amazing speed and innovativeness. one has to maintain hope for the future of the U.S. economically.

[anne]

Markets can turn in any session, and the bond market is a better indicator of economic health than the stock market, nonetheless the international bull market that began in October 2002 continues and appears to be broadening from value to growth. The most important indicator here may be the continued low long term interest rates. But, profits have been growing well for several years and continue to grow well.

[nate]

Profits today may be growing based on more "conservative" or "realistic" or "understated" assumptions, vs. assumptions 3-5-10 years ago (see publicly disclosed assumptions on pensions).

i am not that great at following bond markets. what in particular do you follow in bond markets?

[James Kroeger]

MTC: “This problem is inescapable: unless the creditors dollarize their economies or receive payment in U.S. goods & services exports, they will face a crunch: their assets will be in dollars but their expenses will be in their own currencies.”

I’m not sure I understand why you are [implicitly] saying that Japanese/Chinese owners (largely banks) of US Treasuries would be forced to “dollarize their economies” if they were not able to obtain interest payments from the Treasury Department in yen? The more dollars they obtain from sales of yen, the more they can expand their banking operations in the US. I would think that the expense of running a Japanese bank branch in New York would be in dollars; not yen.

Maybe if there was a catastrophic international crisis, like, say...World War III, the Japanese might want to convert all of their dollar-denominated assets into yen, but that’s about the only scenario I can imagine that would cause such a drastic move. (If THAT happens, then currency stability is going to be the least of the world’s problems.) Until such disasters occur, Japanese bankers are simply bankers who hold yen assets and dollar assets and other assets.

They’ll lend yen to those who want to borrow yen and they’ll lend dollars to those who want to borrow dollars. A speculative run on the dollar is theoretically conceivable, but I rather doubt that any such run could overcome the combined efforts of the BOJ and the Fed to stop it. It just ain’t going to happen, since the BOJ and the Fed have virtually unlimited resources available to them.

I can only surmise that we’re hypothesizing a spasm of gross incompetence at the highest levels? I find that almost impossible to imagine. I really don’t see why it would be difficult for the Fed and the BOJ to stop the nightmare run on the dollar that everyone is fretting about.

[anne]

There is a statistical game played with analyst profit estimates that are more conservative than they expect. This is ongoing and generally predictable. There are several games to be played in thinking about bond yields, though simply asking if a long term Treasury yield below 4.2% is either an investment limit or offers a return that would be competitive with a diversified stock portfoil over 1o years is enough to decide whether interest rates are encouraging for stock market investors.

[nate]

does southwest airlines have any intl flights? think of the future opportunities (and risks) ...

http://finance.yahoo.com/q?s=luv

[nate]

analysts are subject to so many macro and micro changes that it becomes hard to hold them too accountable for earnings forecasts. company management can pretty easily, intentially or unintentionally, make analysts look silly.

[anne]

Think of investing in airlines, then think a whole lot more about never ever investing in airlines. Never ever. Good grief.

[nate]

"Never ever" .. i see an opportunity for unconventional success.

http://finance.yahoo.com/q/bc?s=LUV&t=my&l=on&z=m&q=l&c=%5EGSPC

Check out the Southwest Airlines financial reporting. They use stock options and other things in intersting ways. The hedging of fuel oil to date has not disappointed either.

You could recently buy 100 shares of Southwest (LUV) for around $1,400. What do you think it will be worth in 10 years? 20 years?

[touche]

Household debt is rising by about $1 trillion per year, so I assume that households are responsible for most of the new debt to foreigners.

Most ominous are the growing ratios of household debt to GDP and to disposable personal income:

Ratio of Credit Market Debt to
Year Q GDP DPI
1997 1 65% 90%
1998 1 66% 90%
1999 1 67% 92%
2000 1 68% 93%
2001 1 71% 97%
2002 1 76% 101%
2003 1 80% 108%
2004 1 83% 113%
2005 1 86% 118%

[nate]

touche

to be contrarian:

if I have a salary of $40,000, and I purchase a house for 1.18 (118%) of my salary, am I overly leveraged? (am I interpretating 118% correctly)

what if someone pays 300% of his salary for a home, and has parents (biological and in-law) that have homes that are either paid in-full or minimal debt (and no real net debt)

if tax rates were ever to increase in the future (as Professor DeLong advocates?), tax shields would become even more valuable and homes more attractive.

[Ari]

Mere foolishness. Thinking of a poorer long term investment than an airline, unless you wish to use a leveraged buyout to build your own, is rather difficult.

[nate]

http://finance.yahoo.com/q/bc?s=UALAQ.OB

someone out there probably bought United stock for around $1.00 per share (maybe even less than $1) toward the end of last year. Today it is around $1.50-$1.60 per share.

>50% return (excluding transaction fees). less than one year.

Ari, do you have some bigger fish you can put on the scale for everyone?

[nate]

anne

the point about lt interest rates of 4.2% or so and flattening...

think about buying a diversified basket of dividend stocks. the dividends may be close to teh same rate as the lt interest rate yield. adjusted for taxes, it may get even closer.

then think: dividends may also be increasing faster than interest rates. are dividend-paying stocks valuable? i suppose if dollars devalue massively and real estate doubles or triples, you would be better off investing in real estate with interest-only loans vs. dividend paying stocks...

[anne]

Agreed. Given the low level of long term interest rates there has long been been considerable reason to buy dividend paying stocks in energy and utility sectors, or real estate investment trusts. A 1% dividend in large companies would just take a 3% capital gain on average over the coming 10 years to be a preferrable after tax investment to the long term Treasury. Well, look at the return on equity of a basket of large drug companies.

[Movie Guy]

Brad DeLong made an important post.

U.S. net external debt has more than doubled since 2001.

And let's be clear. U.S. fiscal policy changes alone will not correct the external debt problems. Not even close.

U.S. trade policy is the biggest issue not receiving any significant attention. Just look where it's taking us.

We have less than ten years to address this situation before we go over the cliff.

Our principal problem with regard to trade is not China. It is U.S. trade policy, including outsourcing support initiatives. The result is simple. Massive annual trade deficits.

2004 External Debt

United Kingdom $ 4,710,000,000,000 (2003)
United States $ 2,542,000,000,000 ** official BEA net
Italy $ 913,900,000,000
Spain $ 771,100,000,000

2004 Trade Balance

United States ($ 681,000,000,000)
United Kingdom ($ 92,200,000,000)
Spain ($ 49,500,000,000)
Mexico ($ 8,400,000,000)

2004 Exports

Germany - $ 893,300,000,000
China/HK - $ 851,200,000,000
United States - $ 795,000,000,000
Japan - $ 538,800,000,000

2004 Imports

United States $ 1,476,000,000,000
China/HK $ 828,300,000,000
Germany $ 716,700,000,000
United Kingdom $ 439,400,000,000

[anne]

Should there be a sharp decline in the dollar the question would be whether long term interest rates would increase. Real estate prices will not gain or even hold with rising long term rates. Though I do not know whether there is a real estate bubble in America, or selected limited bubbles, there is an awfully high price to be paid for property just now, and I think Alan Greenspan is keeping this in sight and needs to be most cautious.

[nate]

Even given the U.S. govt relatively recent extension of medicare to drugs, it probably helps to have a well-diversified basket of drug companies(Merck)

One idea that is interesting to me within the dividend discussion: Does one look for 1) dividend growth or 2) dividend yield?

The pro dividend growth camp: some think future dividend growth is more important than current dividend yield (%). Companies with high dividend yields (cash dividend per share as a % of share price) are trading at a relatively low stock prices for a reason and one would be better suited with dividend growth stocks, which tend to have lower dividend yields . Anne's input of investing in large companies with 1% yields seems akin to this.

The pro dividend yield camp: go for yield. Some depressed or distressed securities are set to rebound (regression to mean). Inevitably I see some financial companies popping up in this set of stuff - Citigroup, Jp Morgan Chase, Bank of America.

[nate]

i lean toward going for yield based on regression to the mean. however, based on this logic, one may want to go for dividend growth (see data below). alas i am caught in a conundrum.

Vanguard Equity-Income (VEIPX)
Yield*: 2.54%
http://finance.yahoo.com/q/pm?s=VEIPX
->5-Year Average Return: 5.35%

--------------------------------------

Vanguard Dividend Growth (VDIGX)
yield: 1.81%
http://finance.yahoo.com/q/pm?s=VDIGX
-> 5-Year Average Return: -0.54%

[anne]

What I try to do is follow a set of rather conventional companies and given the strength of the franchise they have form a sense of future value. When a current value seems reasonable I add to my portfolio. I can always buy a sector fund from Vanguard to gain more protection and I can of course buy a broader index. Financial companies have also been attractive recently.

[nate]

anne or anyone else-

can and will you help me with my conundrum? (see previous post on this blog posting)

[save_the_rustbelt]

Bush/Clinton/Bush had a great idea.

Let's encourage the destruction of millions of American manufacturing jobs, and build political concensus by making up fairy tales about millions of new high value service jobs just around the corner.

Great idea, should do wonders for the trade deficit.

[nate]

leaning toward dividend yield...

http://www.chicagotribune.com/business/chi-0507140209jul14,1,6948814.story?coll=chi-business-hed&ctrack=1&cset=true

anne - invest in Abbott?

[Charles]

Anne and Nate,I see a potential problem with the reasoning on dividend bearing stocks.

Dividends can only be sustained by rising profits.

Trade imbalance-driven currency devaluation is supposed to stimulate export industry and therefore be self-correcting. On the other hand, currency devaluation tends to make it more difficult to borrow, raising interest rates and making capital investment more difficult.

There is very little the US can export at an advantage at almost any price. Labor costs have been hacked back and hacked back to the point that personal savings are low and personal debt high. The only way to seek an advantage is by substituting labor-- at radically reduced wage rates-- for capital. The labor markets are not so slack as to permit that at the moment.

So, how would a currency crisis (vs. gradual devaluation) unfold? At least temporarily, one can guess that capital inflows would slow, interest rates would rise, and growth would drop. Import-dependent industries would be hurt the worst: retail probably most of all. Purely domestic dividend-bearing stocks might no longer be able to pay dividends. International stocks would do better, perhaps increasing foreign market share at the expense of domestic sales. But the world economy, which is heavily-dependent on American demand, would also drop. So, all dividend-bearing stocks would be hurt. The best position might be foreign bonds.

Or maybe not. We see the risks in the American economy. We don't see risks in foreign economies because they are less transparent. China is facing environmental and social pressures that could bring it to its knees in the next decade. As we have seen, many Pacific countries such as Indonesia are vulnerable to earthquakes and tsunamis. Russia may face a crisis of governance that will hurt it economically. On and on one looks and sees risk everywhere.

I think the best advice for investors is: diversify both by industry and by region and stay liquid enough that you are not forced by a crisis such as job loss into selling short. But I don't think there's any way that Americans will escape unhurt by what unfolds. There will be many people who will rue putting George Bush in charge of the American economy.

[nate]

"U.S." dividend-paying corporations:

- have international operations

- can hedge if necessary (and have tons of resources to hire smart finance people)

[nate]

"At least temporarily, one can guess that capital inflows would slow, interest rates would rise, and growth would drop. Import-dependent industries would be hurt the worst: retail probably most of all."

agree "retail" could be at risk in some sort of crisis-

[Glen Bowman]

Movie Guy wrote

"But how often was the trade deficit sustainably on the order of 5% of GDP?

I can't quite recall if it was that bad in the 1980s."

The trade deficit did not hit 5% in the 1980's, and did not do so until the last year or so. But why is 5% such an important level? It begs the question as to what is the ideal level? Zero?

If the trade deficit is so important, then why did the US dollar rise in relative value during the early to mid 80's, and the mid to late 90's, when the trade deficit sharply expanded? If there is a correlation, I have yet to see it. The same with interest rates, which have steadily declined at the same time the trade deficit steadily expanded. Conversely, the stock market has tended to do well when the trade deficit has deepened.

If I am wrong, then someone please show me evidence correlating trade deficits and the dollar. Until then I am going with my own theory that the trade deficit has no predictive value but instead is simply a barometer of the strength of the US consumer economy, for in a good economy, why wouldn't consumers want to buy more and more (cheaper and higher quality) foreign goods?

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5184&u=186|5|...

Great Egret in Flight
New York City--Central Park, Harlem Meer.

[Movie Guy]

Glen Bowman -- Movie Guy wrote

"But how often was the trade deficit sustainably on the order of 5% of GDP?

I can't quite recall if it was that bad in the 1980s."

----

liberal at July 14, 2005 02:30 AM authored those remarks. I did the numbers post above his remarks.

[Movie Guy]

Glen Bowman -- "If I am wrong, then someone please show me evidence correlating trade deficits and the dollar. Until then I am going with my own theory that the trade deficit has no predictive value but instead is simply a barometer of the strength of the US consumer economy, for in a good economy, why wouldn't consumers want to buy more and more (cheaper and higher quality) foreign goods?"

I believe that you are going to be in for an unpleasant surprise later on.

We're in big trouble.

[Glen Bowman]

Movie Guy,

I am not interested in any appeals to fear.

Please, show me the evidence. I want to learn. :-)

[anne]

Robert Rubin explained that there are different trade deficits; s strong dollar deficit that is based on a strong economy such as we experienced from 1995 to 2001, and a weak economy deficit. We were not dependent on foreign central bank purchases of our debt in the 1990s, but we are dependent on foreign banks now. There will be a time when the cost of purchasing American debt will increase, for unlike the 1990s we have a structural government deficit that overshadows household saving. The trade deficit cannot be expected to grow indefinitely without higher interest rate costs, but that does not mean now.

[anne]

No appeal to fear, by the way, for I have been bullish for several years and continue so, but the structural government deficit we have is not indefinitely sustainable without increased revenue. Spending cuts will not be sufficient.

[Charles]

Nate, I am aware that international corporations have international operations. You might want to re-read the post to pick up the fine points.

Anne has hit the point. During the 1990s, imported capital went to business investment. Now it is not. If capital importation helps to increase an economy's productive capacity more than the cost of capital, it's a good deal. If it is used for consumption, it is not good.

Glen, you need to look at the current account, not the trade deficit. For a time in the 1980s, export of services such as financial services kept the CA in balance. And, as in my comments above, it depends on what imported capital is used for.

[anne]

Brad DeLong:

"It is still possible that we may escape unscathed: the dollar could fall by nearly half without foreigners ever demanding an expected-depreciation premium in interest rates, the foreign currency-denominated value of U.S. foreign debt could melt away, and the exchange rate stage could drive an export-driven boom that brought trade into balance as higher import prices shrunk imports. We did it in the late 1980s, after all--although starting from a disequilibrium only half as large as our current one."

The reference here is to the Plaza Accord of September 1985 which led to such a dramatic decline in the relative value of the dollar. But I have suspicions that the currency effect was most harmful to Japan and moderately harmful to Germany and Britain, and I can not imagine another agreement to foster an orderly dramatic decline in the dollar. The long term problem we have really bothers me, for I find no obvious political-economic resolution. When the Brads worry, we had best take them seriously.

[nate]

charles writes... "Purely domestic" and "fine points"

-my two bullet points in the 11:35 am posting were not necessarily related. however, you may be good to call me on this and make sure I realized this.

- it would be nice to get some macro statistics on how common purely domestic, dividend-paying corporations exist (#, how widely held, market cap as % of total market cap). it would also be nice to know how many of these exist in the Vanguard Equity Income or Vanguard Dividend Growth fund.

-So the risk would be domestic retail companies with dividends?

-Given e-trade type accounts, abundance of education, and insurance -> even small-time corporations with entirely domestic sales could probably find a way to hedge risk and make distributions to owners even in the event of a $ collapse.

-If domestic retail operations would have a harder time during a devaluation crisis, maybe these retail stores should proactively seek out a risk-sharing agreement with stores in other countries that would benefit from a devaluation of the US dollar (some sort of swap based on a notional amount)

-i looked up costco financials to learn more about retail company dividends. For the most recent full fiscal year (ended August 2004), costco paid out around $94 million in dividends, out of net income of around $880 million. Is this is a small payout ratio?

-Per Costco's cash flow statement at yahoo finance, this was also the first fiscal year where Costco ever paid a dividend ($0 dividends for prior years). So for years prior to making any dividend payment at all, costco's stock price did not collapse.

-It looks like around 327 of 417 Costco stores are in the U.S., with the remaining stores in 5 other nations (with Canada getting most of the stores).

-In some sort of crisis where everyone shops at goodwill and ebay, wears hand-me-downs, and grows his or her own food -> costco u.s.a. might still probably survive and be more resilient than people think (and could probably survive a dividend reduction)

[Ari]

Interesting, Nate.

[Charles]

First, Nate, I agree with you that some retail stores might benefit from a collapse of the dollar, while others would not. When one says that retail will be the hardest hit, this is an average. Alcohol sales and gun sales might well rise, even as Gameboy sales drop.

As for Costco, I have some doubts about your analysis. You might want to look at the competitive analysis given by Smartmoney (click on the link associated with my name). They list a payout ratio of 14.5% for Costco. Costco's payout ratio is middle of the pack. But of course payout ratio is not what an investor would look at. An investor would be much more interested in the total return, dividend yield, PEG, forward P/E and other statistics. In an industry or market where growth is stagnant, growth-related statistics like PEG are irrelevant, and dividend yield is the whole megillah.

I think it's unrealistic for domestic retail companies to negotiate an international currency risk-sharing agreement. There are ways to hedge against risk. But anything beyond the most basic sort of diversification involve a significant overhead.

If you're interested in doing the sort of statistics you describe on domestic, dividend paying corporations, SmartMoney has screens that might be able to give a rough cut. Memberships are reasonably affordable, if you can stand using a service that employs Donald Luskin to provide economics analysis.

[Glen Bowman]

Charles wrote

"During the 1990s, imported capital went to business investment. Now it is not. If capital importation helps to increase an economy's productive capacity more than the cost of capital, it's a good deal. If it is used for consumption, it is not good."

Personally I have no credit card debt, and would be embarrassed if I became so messed up financially that I had to pay credit card interest on consumer goods (15% a year on that Burger King Whopper and fries lunch I had last November). In that way, I would agree with you.

That said, I would agree with you in the larger sense IF capital were expensive, and IF American business were suffering because of a capital shortage (it's not--another reason why supply-side is inappropriate now), but since they're not, I would not. Whether something is a "good deal," I think, is contingent upon its cost. Capital right now is much cheaper and widely available than it was in the 1980's and 1990's. If Americans can get more for their money by investing directly in American business (true for the past three years) or in real estate (bubble or not), then why not accept the gift of cheap capital from Japan, China, etc? Where else are they going to put it? In 10 year Japanese bonds (return-free risk?)? In aging Europe?

If lenders were so concerned about getting their money back from Americans buying consumer goods on credit, they would ask more for their risk. I trade the 10-yr on occasion, and I have yet to figure out why it is still yielding only 4 percent, despite several short-term interest rate hikes. But it is what it is. And it has been this way for a while. Interest rates were sky high back when the US was the world's largest creditor, and now they are dirt cheap now that we are by far the world's largest debtor.

If rates were hiked, and Americans bought fewer (imported) consumer goods, then the trade deficit would surely lessen, but would our economy be better off? Would that make it easier for us to pay back our debts to foreign (and domestic) lenders?

Charles also said "Glen, you need to look at the current account, not the trade deficit. For a time in the 1980s, export of services such as financial services kept the CA in balance. And, as in my comments above, it depends on what imported capital is used for."

I did (do), and while the current account deficit is historically large in terms of GDP, how do we know that it is too "high"? And what level, then, is the ideal?

At some point, of course, the debt will have to be paid off. Probably someone is going to have to raise taxes. I imagine that Republicans hope that it will be the Democrats, so they can perpetuate the nonsense that Republicans are the sensible stewards of the economy, whereas the Democrats just like to raise taxes (to clean up Republican "governance"). For all we know, perhaps lenders are already pricing that in. I am certain they know that we CAN pay it off, if our leaders take the initiative.

[Movie Guy]

Glen Bowman -- "If rates were hiked, and Americans bought fewer (imported) consumer goods, then the trade deficit would surely lessen, but would our economy be better off?"

It is not necessarily the case that our trade deficit will decline in dollar terms as interest rates rise. Sure, import unit volumes of finished goods would probably decline based on reduced consumer purchases, but the overall trade deficit may remain at similar dollar levels or actually increase.

The absence of U.S. domestic manufactured substitute goods for some of the finished products creates a problem.

I wouldn't count on the trade deficit declining in dollar terms.

[Movie Guy]

Glen Bowman -- "Movie Guy, I am not interested in any appeals to fear. Please, show me the evidence. I want to learn. :-) "

Generally, you won't find trade policy posts as main discussion subjects on econ blogs because mainstream economists are oddly unwilling to discuss the basics, details, and the pros and cons of U.S. and WTO trade policies in broad terms. Some of them probably aren't well versed in the specifics of such formal trade policies. A number of economists whom I speak with on a personal basis acknowledge that they haven't read the WTO documentation, for example.

CAFTA, most recently, is a slight exception. Very slight, though. Brad DeLong posted two CAFTA articles that I noted... Few econ blogs other than those by labor economists touched the subject.

Here's some information that may help you pull together the bigger picture.

The following link will take you to seven separate posts and sublinks dealing with various aspects of trade and trade policies. (start at the third post in the comments)

"May 25, 2005 - A new open thread":

http://www.roubiniglobal.com/setser/archives/2005/05/a_new_open_thre.html#comments

1. The Trade of Tribes

2. USA Trade Policy

3. International Trade Policy

4. Transnational Corporations

5. China: WTO - USA - China

6. Globalization and Trade Policy

7. Discussing the Effectiveness of Trade Policy Decisions

----

Trade with China, as one example:

China's Industrial Policies Conflict with WTO Rules, Experts Say

http://usinfo.state.gov/eap/Archive/2005/Jun/02-648829.html

2004 Report to Congress on China's WTO Compliance

http://www.ustr.gov/assets/Document_Library/Reports_Publications/2004/asset_upload_file281_6986.pdf

Foreign Trade Barriers - China

http://www.ustr.gov/assets/Document_Library/Reports_Publications/2005/2005_NTE_Report/asset_upload_file469_7460.pdf

----

U.S. labor force issues:

http://economistsview.typepad.com/economistsview/2005/07/time_for_a_chan.html

http://delong.typepad.com/sdj/2005/07/four_out_of_fiv.html

http://www.marketwatch.com/news/story.asp?guid=%7BA4486D2F%2DD56A%2D402C%2DB769%2DC400D88B208D%7D&siteid=mktw

"If labor force participation rates had improved as much during this recovery as typical, between 1.6 million and 5.1 million more people would be in the labor force, Bradbury concluded."

"If those people were counted in the labor force but not working, the jobless rate would have been somewhere between 6.5% and 8.7%, rather than the 5.4% reported by the Labor Department in the three months from November 2004 to February 2005."

"An 8.7% unemployment rate would represent considerable slack in the labor market," Bradbury said.

-----

Eliminating the fiscal deficits alone will not correct our larger problems. That's just wishful thinking.

Basically, we're on a course which will hollow out more of our lower to mid level labor force in terms of skills, retention and wage levels. Same story for many meaningful investments in domestic production operations other than future robotics and related automated procedures. Meanwhile, household savings rates are minimum. And once consumer credit extension is reduced or reaches various cap limits, consumers will have limited ability to continue consumer spending growth without additional income sources. Consumer credit debt is already high. And this doesn't include mortgage debt which, in some instances, may roll over on homeowners should local housing markets reverse pricing directions. Las Vegas is such an example (See Calculated Risk's blog for details; posted this week).

While we can continue to ship goods and services production overseas and/or purchase similar goods and services from foreign corporations, the end result will be a widening of the gap between U.S. imports and exports, if exports do not outgrow imports. And our exports are not growing as quickly as imports. As we ship more production overseas, the general likelihood that U.S. exports will outgrow imports diminishes. Which, in turn, addresses part of the point Brad DeLong is making with regard to external debt. Exports are the vehicle which cover the external debt, otherwise the debt becomes part of our growing current account deficit.

Other than from Congress, we're not reading or hearing much discussion about trade policy as a root cause. Economists raised in the religion of free trade apparently haven't any interest in challenging their faith...regardless of the trade imbalances now facing the United States. "All is well..." But, of course, that's a falsehood except in certain corporate circles (principally outsourcers and Asian foreign goods importers). Elsewhere in American society, the economic cracks are becoming apparent. The next major recession will reveal more problems.

We have no more than ten years to address the trade policy problems. After that, we're in big trouble on the trade front and elsewhere. The federal, state, county, and municipal programs requiring greater revenue streams in the future, if unchecked, will result in massive deficit spending unless additional revenue streams are identified. Concurrently and thereafter through 2025, pension funds, institutions, and other sources will be attempting to cash out bond holdings or offer new bond sales at about the same time to support growing levels of retiree obligations and other program funding needs. In other words, there will too many bonds on the market competing with federal bonds (new and debt rollover). And so on. One big mess.

This is not the time to be creating additional fiscal, trade, and current account deficits. We are supposed to be building up surplus positions for future known and anticipated obligations. We're not doing that... Living and spending for the minute. Little more.

Yes, Glen. We're in big trouble.

I hope that you do read the links and sublinks.

[Glen Bowman]

Movie Guy,

I will read the links later.

A few observations:
1. Much of the info that you mention is not new. It is not inside information. Therefore it almost certainly has been factored in to the markets. Why, then, are yields on long-term debt (10 year, 30 year--among the most efficient period) still so low? Even as Greenspan plays catch-up, hiking up short-term rates, long-term rates barely budge (indeed, they have gone down).

If the pessimistic scenario you have described were so likely, I would expect interest rates to be much, much higher. If one is going to loan money to such a bad risk, one is going to demand a high return.

[Movie Guy]

Long term rates aren't going up because foreign interests (principally foreign central banks) are dumping some of their U.S. dollars holdings for Federal bonds and notes. Large quantities of U.S. dollars.

And some central banks are hedging their domestic currency positions.

It's that simple.

When they abandon the U.S. Fed securities as primary reserves, the ten year rate Fed bond rate will move up.

[Charles]

Glen asks, "If rates were hiked, and Americans bought fewer (imported) consumer goods, then the trade deficit would surely lessen, but would our economy be better off? Would that make it easier for us to pay back our debts to foreign (and domestic) lenders?"

Under conditions as they are, I believe our economy would be better off if rates were raised. Rates are unnaturally low. This is because the United States has persuaded the rest of the world that low rates are necessary to win the so-called war on terror. This is not as completely ludicrous as the rest of Administration policy. Al Qaida has no chance of beating us militarily. They can, however, damage the base of our military strength: our economy and our freedoms. The world has decided, both for this reason (and for more venal ones like recycling trade surpluses), that it is better to give the United States a few years of easy credit. Most of the money has been coming from central banks and therefore does not represent a market evaluation of the creditworthiness of the US.

That said, low rates are causing economic distortions without producing business investment. People who are likely to lose their newly-acquired homes in an economic downturn are acquiring them. Personal debt has risen to levels never seen in modern America. Liquidity needs to be removed from the system, either through taxes or through rates tp force investment decisions to be made more rationally. While I would prefer it be through taxes, especially on the very wealthy (say, those with $100 M assets or $1M income per year), at this point, that isn't going to happen.

Glen further asks, "while the current account deficit is historically large in terms of GDP, how do we know that it is too "high"? And what level, then, is the ideal?"

There is no simple answer, as I'm sure you know. What's most important is why the CA deficit is run. If it is to increase the productive capacity of a nation, it's generally good. If it is to finance consumption, it's generally bad. That's why Argentina has a financial crisis while Venezuela does not. Venezuela imported capital to finance the development of an asset. Argentina blew the money on corruption and an artificially high living standard.

Glen asserts that "At some point, of course, the debt will have to be paid off. Probably someone is going to have to raise taxes."

While the national debt needs to be stabilized and perhaps paid down (but never paid off), and while taxes almost certainly need to be raised, this is separate from the issue of the CA deficit/surplus. The US is running a CA deficit because it is not producing what the world wants at prices the world is willing to pay. It is running a governmental deficit because taxes have been lowered as military spending (and pork and corruption) has been raised.

[Movie Guy]

Glen,

I didn't intentionally provide you with a pessimistic scenario. I provided you with a realistic analysis of where we are and where we are headed. And why.

If you intend to read the MarketWatch article, you need to read it quickly. Otherwise, the link will not work.

Your notion that the markets factor everything in is amusing. The typical span of attention in the U.S. markets runs anywhere from 2 to 24 hours. The markets are now operating like casino city. Little realism there. The representatives are not focused on the long view.

By the way, there are efforts underway to shift out of U.S. treasuries, by the way. Try Google news for info.

When things change later on, we'll hear plenty of talking heads explaining that no one saw this coming. "If only we knew..." Pure BS, of course. But we will hear it anyway.

[nate]

Charles:

"As for Costco, I have some doubts about your analysis."

The feeling side of me is hurt, but the thinking and rational side realizes my talk is cheap.

Earlier I posted "costco paid out around $94 million in dividends, out of net income of around $880 million". If you take 94 and divide it by 880, you get 10.6%, vs. the Smartmoney ratio you quoted me of 14.5%.

I looked up the payout ratio per a Coscto “S&P Stock Report” and it was “11%” for 2004.

(Anne- can you verify? Vanguard should have access to this report I referenced)

SOURCE OF MY #s:
->I got the $94 million estimate from this site (more precisely it was $92,137 - see "dividends paid" line in cash flow statement): http://finance.yahoo.com/q/cf?s=COST&annual
* traced this # to Costco annual report

->I got the $880 million from either one of the two following site (the bottom of the "income statement" or the top of the "cash flow" statement)(more precise – $882,393):
http://finance.yahoo.com/q/cf?s=COST&annual
http://finance.yahoo.com/q/is?s=COST&annual
* trace this # to Costco annual report

RECONCILIATION:
->http://biz.yahoo.com/e/050616/cost10-q.html ….

Maybe the Smartmoney payout ratio of 14% was based on the 15% increase in dividend in year 2005 (15% increase).

-> it is not clear if Smartmoney calculated the payout ratio on a diluted per share basis or in aggregate (me). This also might make a difference. I tried calculating the payout ratio for 2004 on a fully-diluted per share basis and did not get close to 14% (the smart money number)

DEFINITION OF PAYOUT RATIO:
The definition of payout ratio can be found at these two sites:
http://www.finance-glossary.com/terms/payout-ratio.htm?id=1098&ginPtrCode=00000&PopupMode=false
http://www.investopedia.com/university/ratios/dividendpayoutratio.asp

[liberal]

Glen Bowman wrote, "The trade deficit did not hit 5% in the 1980's, and did not do so until the last year or so. But why is 5% such an important level? It begs the question as to what is the ideal level? Zero?"

The question is, "what is sustainable in the long run?"

As far as I can tell from reading the web, 5% is not sustainable in the long run.

[Charles]

It certainly was not my intention to hurt your feelings, Glen. Smartmoney is not infallible and what matters is not the precise number but a comparison of companies. You asked if the payout ratio was low, and so I answered as best as I could.

The more important point is that the payout ratio is not that interesting a statistic, since it is affected by so many factors. I suggested some other numbers that might be of more interest to an investor. Costco got away with not paying dividends because the total return (or at least that anticipated by investors) was good.

[anne]

Sorry, but I am on vacation and so have and do not have an Internet connection by turns. The value of a share in a company is not simply determined by actual dividends, but the prospect of dividends or share buybacks beyond that needed to redeem options by the company. berkshire Hathaway has never paid a dividend or bought back shares, but the potential is there and so the stock is value on the excellent potential.

[Glen Bowman]

Movie Guy said

"Your notion that the markets factor everything in is amusing. The typical span of attention in the U.S. markets runs anywhere from 2 to 24 hours. The markets are now operating like casino city. Little realism there. The representatives are not focused on the long view."

I have to ask, How do you KNOW this? Yes, people hold stocks for less than a year, on average, but we're talking about long-term govt debt. Big difference. Even if the bondholder, the one who actually bought the bills/bonds at auction, decides to bail, that does not really change the bond itself. Nor does it change the truth: those in the business of lending money to the federal government--one of the largest markets in the world, many participants of which invest millions a year in (the hopes of) creating an advantage in information--believe that in the next ten years, the US government is such a safe investment that they will accept what seems to be an absurdly small interest rate on their capital.

Can I explain this? No. I have theories, but they mean little, as all do. It is what it is.

Thanks again for taking the time to post the links! :-)

[Glen Bowman]

Charles,

Much of what you say is true, but some of the facts that you mention have been cited repeatedly for many years(especially during the late 1990's, when pundits were predicting a Great Depression-like disaster). I quibble with the idea that these facts necessarily mean that a "crisis" is inevitable, that we can game (1/3 odds of a crisis--based on what?). I agree that Greenspan left the liquidity tap on for too long, but, then again, why is inflation still so low, despite a sharp spike in energy costs, and despite GWB's seemingly cavalieer "guns and butter" approach to the federal budget. I also think that there are real estate bubbles in parts of the US, and some people who buy at the top (wherever that will be) are going to get burned (just like those who bought the QQQQ in March 2000 lost money). But why does this necessarily have to lead to a general crisis? What about another alternative: gradually rising rates, and a gradual letting of air out of the bubble? Taxes are raised, in time, to pay off our debt.

Maybe those who are lending money to the federal government at 4 percent over 10 years already have considered this. Either way, the market has voted. We'll see if it is wrong.