Watch Carefully, Grasshopper...

The fear is that the large current U.S. trade deficit--$800 billion a year or do, 6% of GDP plus--is setting us up for a possible big financial crisis. Large trade deficits, the argument goes, don't stay large for long periods of time. When they shrink, they often shrink because of (a) sharp currency declines or (b) deep recessions.

CEA Chair Eddie Lazear uses misdirection to try to calm this fear. And he manages to snooker Greg Mankiw--which is, as a rule, quite hard to do.

Greg writes:

Greg Mankiw's Blog: Lazear on the Trade Deficit: CEA Chair Eddie Lazear testified at the Joint Economic Committee today. An interesting excerpt:

I would like to point out the historic record suggests that countries can be in a current-account deficit or a surplus situation for very long periods of time. New Zealand and Australia have had deficits for decades. Australia in particular has been running a current account deficit that has created a level of foreign indebtedness equal to about 72 percent of their GDP, whereas our foreign indebtedness was only about 21 percent of GDP in 2004 (most recent available published data). Yet, the Australian economy has been very strong and growing at robust rates over the past decades. Australia's real GDP has grown at an average rate of 3.5 percent over the last decade.

Note that Eddie is not saying that a country can run a very large trade deficit "for very long periods of time... decades.... Australia in particular..." He is saying that a country can run a very large current-account deficit--the sum of the trade deficit plus the net flow of income payments on net domestically-owned capital located abroad. Australia has a large current account deficit: 5.9% of GDP. Australia has a relatively small trade deficit: 1.9% of GDP. The difference--4% of Australian GDP--is the net flow of interest, dividends, and retained earnings that Australia pays to foreign owners of Australia-located capital.

Why does this matter? Let me turn the microphone over to the excellent John Quiggin:

The Economists' Voice: John Quiggin, University of Queensland: [M]uch analysis confuses the current account deficit and the goods and services deficit.... A number of countries — notably Australia and New Zealand — have run current account deficits of this magnitude for years.... This has led some commentators to suppose that the present U.S. position can be sustained indefinitely. But as time passes and income payments owed to foreigners mount, the current account deficit will become larger than the goods and services deficit. In order to have a stable current account deficit, a country must run a goods and services surplus to keep its net foreign debt from growing faster than GDP.... A substantial current account deficit can continue indefinitely. A substantial goods and services deficit cannot, because it generates an exploding current account deficit.... The U.S. current account deficit must be stabilized relative to GDP, and this means that the goods and services account must sooner or later return to balance or surplus. But what will the adjustment process look like?... Any significant reduction in the [trade deficit]... appears likely to require very large changes in market prices or U.S. income levels...

Let's back up. What's going on here? Eddie Lazear and his political masters hope that listeners will take Eddie's (correct) statement that countries can run large current-account deficits for a long time, infer (incorrectly) that the large U.S. trade deficit can also be sustained for a long time, and conclude that there is today little reason to fear that the U.S. trade deficit might trigger a macroeconomic catastrophe.

Did it work? Yes--at least on Greg Mankiw. For the title of Greg Mankiw's post is "Lazear on the Trade Deficit." Not "Lazear on the Current Account Deficit." Lazear says the current account deficit can continue for a long time. Mankiw hears him to be saying that the trade deficit can continue for a long time. The statement Lazear says is true. The statement Mankiw hears is false.

Pay close attention, Grasshopper. See the misdirection? Watch carefully, and you too might grow up to be Chair of the Council of Economic Advisers under a Republican president...

Comments

[save the rustbelt]

Hey, trading away a large chunk of American manufacturing in a big rush may not have been such a swell idea after all.

But then the workers knew that long before the economists.

What price progress?

[jerry]

It is very hard for me to believe that Mankiw was confused by the difference between the trade deficit and the current account deficit.

Isn't this like a physicist or chemist forgetting the first law of thermodynamics?

Me? I am confused by this all of the time. But I don't have a Ph.D and a reputation as the author of the bestest econ textbook of all time.

[Jon]

I'm confused, how can you build up a significantly negative net international investment position (as Australia has) without large and persistent trade deficits?

[Cal]

I assume that you (the Professor) knows Mankiw or knows people who know him well. Do you guys call him up or send an email that says, "hey yuts, you had your head up your butt on that one," so that Mankiw can either stand by his statment or correct it?

[jeffrey harris]

I am an American-Australian dual national, and have lived in both places. Brad's description of the structural difference in the current account deficits of the US and Australia is accurate and important. Well worth propagating.

There is another factor. Just a month ago, Australia paid off its entire govt debt and is now in the black. Long term, Australia has to find a way to export more high value goods (rather than resources, which it does, brilliantly, now), but its financial situation lays the ground work for this to happen.

In contrast, the US has dual trade and budget deficits, and, these days, imperial pretensions. We get away with this because we hold the reserve currency.

But once upon a time, so did Britain. I think it is important to compare and contrast the US now and Britain in the early 20th century and see what we can learn. Niall Ferguson has done some of this from a political history point of view. Perhaps Prof. Delong can provoke a discussion of the economic history.

Best regards

JHH

[Bruce Wilder]

"he manages to snooker Greg Mankiw--which is, as a rule, quite hard to do."

Greg, as a practiced liar, usually being the snooker-er . . .

[Captain Video]

Being a pathological misleader seems to be a crucial job requirement for being a member of the Bush Administration. Mankiw clearly has not yet recovered from his stint of shilling for Bush.

[Jake]

Do you all sincerely believe people on the other side of the political spectrum, such as Dr. Mankiw, to be evil? Do you Really think they go to work everyday thinking, "Man, I can't wait to further ideas that I believe hurt people"?

Dr. Mankiw drew attention to something he ideologically leans toward, but turned out to be false. That in itself does not mean that he "lied" or intentionally deceived anyone. He just needed to read more carefully. He made a mistake.

If people were labeled as liars everytime they made a mistake of this nature, we'd all be liars.

The previous comments take away from any hopes at a larger debate and subsequent understanding.

They also let readers know the true purpose of your comments are not directed at the rather abstract goals of increasing the pool of knowledge, changing peoples' minds to the "correct" line of thinking, or even just bettering the world. They are instead tools to make the commenters and like-minded readers feel better about their side of the argument. Opponents that are inherently "evil" are much easier to rally against.

In short, blame him for his oversight. Hold him accountable in his comment seciton. Do not take the cheap route by suggesting it was intentional deception.

[theCoach]

Jake,
Mankiw has a long history of forgetting basic economics when it is to the advantage of the Bush administration.

[Kimmitt]

Do you Really think they go to work everyday thinking, "Man, I can't wait to further ideas that I believe hurt people"?

No, I think they feel like the wind is blowing the way it's blowing, and they may as well take advantage.

[Mike]

The CENTRAL problem here is the (rigged) currency market(s), stupid...

----------

US dollar hegemony has got to go

By Henry C K Liu
(Asia Times April 11, 2002)

There is an economics-textbook myth that foreign-exchange rates are determined by supply and demand based on market fundamentals. Economics tends to dismiss socio-political factors that shape market fundamentals that affect supply and demand.

The current international finance architecture is based on the US dollar as the dominant reserve currency, which now accounts for 68 percent of global currency reserves...

http://www.atimes.com/global-econ/DD11Dj01.html

----------

...The very same rigged market(s) that ALL the world's central bankers, ('cheap' labor loving) CEO's of (mostly 'Western') Transnational Corporations, various (hedge, trust & retirement) fund managers, as well as a whole generation of US politicians, pundits and ('established') 'classical' economists have come to know and love.

[andres]

Brad, you're being highly unpatriotic: you have to support our dollars by not being the source of damaging leaks of (not-so)classified information. Does the Bush adm. have anything they can "out" you with?

More seriously, it is entirely possible that both Lazear and Mankiw realize quite well that the US-NZ-Australia comparison is flimflammery, but they are trying to throw any mental barriers they can in the way of a general dollar selloff until Archangel Ben and Saint Henry can straighten out our macroeconomic mess. That is also upping the stakes: the more b.s. you throw at markets in an attempt to prevent panic, the less credible you will be after the panic starts.

[Matt]

I think I got it.

It is OK to rent a house, indefinitely. It is not OK to rent a house indefinitely and take pieces of the house apart to sell as used lumber, covering the rent expense.

[old ari]

I am not sure that Snooker is the correct metaphor, it is more prestiditation.

[anne]

Notice, by the way, that the value of the dollar against other developed market currencies is only 2.01% lower than precisely a decade ago. If there is to be an adjustment of significance, the decline in dollar value has not begun.

[anne]

Niall Ferguson takes the view that while the extent of American internal and external debt appears a serious problem, the political dominance of America cushions us against significant losses in currency value and possibly resulting long term interest rate increases. The analogy used is that of colonial empire Britain which only experienced currency problems when British political dominance was clearly ending and ended.

[Emma Anne]

"Do you guys call him up or send an email that says, "hey yuts, you had your head up your butt on that one," so that Mankiw can either stand by his statment or correct it?"

I think that is what this post is. :-)

[Jake]

old ari:

"I am not sure that Snooker is the correct metaphor, it is more prestiditation"

Are you sure it wasn't prestidigitation?

Are you also sure that, like your spelling error, Mankiw didn't just make a mistake?

I realize that politicos are occasionally corrupted and that the Bush Administration is CERTAINLY not an exception to that rule.

I also agree, and mentioned in my original comment, that Mankiw wrote the post and quoted the article because it meshed with his political/ideological leanings.

However, you are all making a substantial leap in suggesting he intentionally confused the two concepts.

I want to emphasize again that you are all simply trying to make yourselves feel better and more sure about your arguments by labeling "opponents" as evil. In doing so, you are taking a cheap route to explaining behavior.

Read Richard Hofstadter's "Paranoid Style": http://karws.gso.uri.edu/JFK/conspiracy_theory/the_paranoid_mentality/The_paranoid_style.html

Notice it was written in 1964. No doubt, it is now applicable to modern left-wing Bush Admin conspiracy theorists.

[meno]

Note also that our NZ govt (and the Howard govt of our cousins in Oz) are running large surplusses.

As JHH notes above, the Oz govt just paid off its debts and is in the black. Depending on just how you do your acccounting (about which there's a political fight going on, of course) NZ either did the same last year or will do so this year.

That's necessary for our govts, as otherwise the interest rates would kill them. We don't get the free pass on low rates for treasury bonds that you yanks do.

Meanwhile my mortgage rates here in New Zealand are around 9%. We've always had higher interest rates than you yanks.

[Cranky Observer]

Wow, that is a lot of posts! Does anyone else get the impression that Brad wanted to scroll that outsourcing discussion right off the page? ;-)

Cranky

[Cranky Observer]

> Do you all sincerely believe people on the
> other side of the political spectrum, such
> as Dr. Mankiw, to be evil? Do you Really
> think they go to work everyday thinking,
> "Man, I can't wait to further ideas that I
> believe hurt people"?

What about the titans of the Gilded Age? Clearly they built a lot that was good for the country (not to mention themselves), but as they rolled along in their (gilded) carriages they must have seen the poor, sick, and injured literally dying in the gutter. What did Andrew Carnegie think when he gave a man a dollar as compensation for loss of his hand, then fired him for being unable to perform his duties? Knowing the man would starve to death as a result? Did Carnegie consider himself evil?

What did Greenspan think when he pushed the Social Security tax increase through, which of course fell on the lower half of our society, told them that Social Security would be "secured", then a few years later OK'd spending the surplus on folly? And then testifed as to how we "must" cut benefits? You claim that the people taking those actions, which benefit the few at the expense of the many, do not consider themselves "evil". OK, I believe you. What DO they think about how their actions affect the 80% of Americans who do not have trust funds and other unearned income to draw upon?

Cranky

[anne]

Meno, please explain further. I have noticed for several years that the New Zealand central bank seems the most inflation wary of any central bank, and New Zealand long term interest rates are the higest among developed nations with corresponding limits on growth and stock gains. Why should this be?

The New Zealand stock index has badly trailed Australia's for a decade, but I do not understand why. Despite the high interest rates the currency is losing relative value. Curious.

[anne]

Brad DeLong:

Australia has a large current account deficit: 5.9% of GDP. Australia has a relatively small trade deficit: 1.9% of GDP. The difference--4% of Australian GDP--is the net flow of interest, dividends, and retained earnings that Australia pays to foreign owners of Australia-located capital.

Where Australia has a large net income from foreign investments, this year America's income from foreign investment has turned negative adding to the trade deficit; a seemingly serious matter, though not yet received in the markets as serious.

[Mads Keller]

It makes so much more sense when people read what the other side writes.

I have not read Delongs point deeply, but it sounds fair. So to get things moving, one should look at what a guy from Mankiw's blog says and then reasond it out. The following is from the comments sektion from Mankiws blog.

mvpy said...

DeLong has just put up a completely flawed argument about persistence. Contrary to what he says, the US a large trade deficit CAN be sustained for a very, very long time. To support his feeble case he invokes another piece which says

"But as time passes and income payments owed to foreigners mount, the current account deficit will become larger than the goods and services deficit."

a) While the US has greater foreign liabilities than assets, the US still has a net positive flow on interest payments. That is, the return on our foreign assets way exceeds the return on our foreign liabilities; our foreign assets are risker and by simple CAPM arguments command a higher return. This is crucial and its no coincidence. Foreigners invest here since we're the safest bet in town. DeLong paints a picture of mounting payments on foreign debt which is patently untrue.

The piece also says:

"a country must run a goods and services surplus to keep its net foreign debt from growing faster than GDP...."

b) Our net foreign asset position can change substantially simply due to a fall in the dollar or asset price changes. Point is, of our liabilities are denominated in dollars and our foreign assets denominated in foreign currency. Our net foreign asset position can improve markedly without ANY change in the trade deficit. This point, again is crucial. There is a great paper by Gourinchas and Rey on this point.

[Barkley Rosser]

anne,

While the income part of the current account went negative in the fourth quarter of last year, it actually went positive again in the first quarter of this year. People like brad setser have been arguing and speculating about this at length, with that old bugaboo, the "dark matter" hypothesis rearing its weird head again.

In any case, one cannot run persistent enormous trade deficits without that income part of the current account deficit finally going negative and potentially getting really unpleasant. New Zealand just had a big currency crash.

[anne]

Barkley Rosser:

"While the income part of the current account went negative in the fourth quarter of last year, it actually went positive again in the first quarter of this year....

"In any case, one cannot run persistent enormous trade deficits without that income part of the current account deficit finally going negative and potentially getting really unpleasant."

Continuing, while corporate savings are near record levels, personal saving is minimal, so we cannot look for enough international investment to provide sufficient income to limit the effect of the trade deficit.

Thank you, for being precise. New Zealand has a monetary policy that is a muddle to me, however :)

[William Rhoads]

Another thing the U.S. has that Australia does not have is 10 million illegal immigrants, most of whom are sending remittances back to their home countries. Net negative unilateral current transfers were about $25 billion in the 2005 fourth quarter; they were $83 billion in 2005 and only $59 billion in 2000. None of the plans in Congress would let the families of illegal immigrants come to the U.S so that remittances would drop, it is physically impossible to deport 10 million people, and most doubt that the flow of illegal immigrants will be stopped.So the level of unilateral transfers will continue to increase, adding to the negative balance on current account..

[padcrasher]

I'd love to read a reply to Mads keller's post of a rebuttle to Brad from another website.

From Anne's reply to another post. I'm guessing this point a) is not correct as we have gone negative with the income part of the current account as recently as the 4th Quarter? So we can't count on postive flows in the respect in the future?

[a different chris]

Umm, Jake, can you go back and read your first comment? You managed to start out claiming that it was "unreasonable" to tar somebody a liar for a statement that the group consensus feels is false, even when you seem to agree that he is wrong and agree that he is a person of high qualifications in that field.

But fair enough.

Yet then, with a beautiful show of complete self-obliviousness you managed to neatly categorize not only the blog owner but every one of dozens of regular commenters based on ONE comment by ONE commenter.

This is not the sign of somebody that's too bright, so I don't think your lying about Hofstadter, instead I will suggest you re-read him very, very slowly because this mysterious "Left" you speak of is pretty much always the damn target of said "paranoid style", not the source.

Even, sometimes especially, when it barely exists.

>The previous comments take away from any hopes at a larger debate and subsequent understanding.

They also let readers know the true purpose of your comments are not directed at the rather abstract goals <

[derrida derider]

"Another thing the U.S. has that Australia does not have is 10 million illegal immigrants, most of whom are sending remittances back to their home countries ..." - William Rhoads

Don't know much about Australia, do you mate? We've got more immigrants per capita than you and, yes, they do remit a lot of money.

[reason]

Look at the trade deficit as percentage of exports and the situation looks even worse. Australia is a much more open economy than the US.

[Jake]

A different Chris:

"Yet then, with a beautiful show of complete self-obliviousness you managed to neatly categorize not only the blog owner but every one of dozens of regular commenters based on ONE comment by ONE commenter."

Are you honestly going to try and say that the aggregate of commenters on this website (including the author) do not frequently call conservatives liars? Are you really going to try and say that only "ONE commnet by ONE commenter" refered to the opposition as a liar?

"This is not the sign of somebody that's too bright, so I don't think your lying about Hofstadter, instead I will suggest you re-read him very, very slowly because this mysterious "Left" you speak of is pretty much always the damn target of said "paranoid style", not the source."

First of all, I resent your insinuation that my intellect is somehow below yours - try to get over yourself before commenting again. I am sorry to say it, but you are personifying the elitism of leftists that turns so many people away from your point of view. YOU ARE NOT BETTER THAN EVERYONE ELSE. Starting off with that assupmtion blinds you to other points of view.

Now, onto the actual argument.

Any and all conspiracy theorists regarding the Bush Admin follow the framework outlined in Hofstadter's articles: Limitless funding, superhuman capabilities, intricate secret network, evil intentions, et cetera. Bush does this as well, only the objects of his "paranoid style" are the terrorists.

Hofstadter's choosing examples involving the extreme right does not mean it is exclusive to the right. I know, I know, he says that the right has been prone to using it. But again, I would argue that it is not exclusive to the right, by any means. Look at the left's characterization of Big Business, for instance.