Never in modern history has the world’s leading economic power tried to do so much with so little. A saving-short US economy has long pushed the envelope in drawing on foreign capital to subsidise excess consumption. But now Washington is upping the ante as it opens the fiscal spigot to cope with post-Katrina reconstruction at the same time it is funding the ongoing war in Iraq. Could this be a tipping point for America’s shoestring economy?
The saving-investment identity, one of the cornerstones of macro analysis, frames the economics of this debate. For any economy, saving is emblematic of the willingness to defer current consumption in order to invest in the future. America’s problem is that it no longer saves. Its net national saving rate – the combined saving of individuals, businesses, and the government sector (all adjusted for depreciation) – has fallen to a record low of only 1.5% of GNP since early 2002.
By contrast, this same national saving rate averaged 7.5% over the 40-year period, 1960 to 2000. Unwilling to cut back on investment, a saving-short US economy has become increasingly dependent on surplus foreign saving in order to grow. That means it has had to run massive external deficits in order to import this foreign capital. A current account deficit that hit a record 6.4% of US GDP in early 2005, and that will easily pierce the 7% threshold in the months ahead, underscores how far the US has had to stretch offshore in order to make ends meet. This is the essence of the shoestring economy – a United States that is lacking the saving cushion needed to fund future growth and ward off the impacts of more immediate shocks.
Unfortunately, that noose is about to get a good deal tighter. Asset-dependent consumers were running a negative personal saving rate to the tune of -0.6% of disposable personal income in July 2005. Not since the Great Depression of the early 1930s have US households been stretched that far. Yet, today, few seem worried about this development. Conventional wisdom has it that “rational” consumers have uncovered new and permanent sources of saving in the form of rapid asset appreciation – first equities and now homes.
However, just as a post-equity bubble shakeout challenged that complacency five years ago, there is good reason to fear a similar outcome when the housing bubble bursts. Meanwhile, the energy shock of 2005 is likely to take the personal saving rate even further into negative territory as US households defend their lifestyles in the face of rising expenses for transportation, electricity, and heating. The American consumer is on the leading edge of the shoestring economy.
The government sector is in a similar position. While a cyclical rebound in the economy has led to a temporary improvement in the federal budget position, the combination of Katrina-related assistance and energy-driven impacts on economic growth – to say nothing of the ongoing expenses of US occupations in Iraq and Afghanistan – point to a renewed widening of government budget deficits.
So far, the Bush Administration has hit Congress with $62 billion in supplemental spending requests in the immediate aftermath of Katrina. The risk is that these disaster-relief appropriations are only a down-payment on the final tab, which eventually will span the gamut – from infrastructure repair and reconstruction of housing and commercial areas to massive environmental clean-up efforts.
In the politically-charged post-Katrina environment, any semblance of fiscal discipline has vanished into thin air. Next year’s federal budget deficit is currently projected at -2.4% of GDP; a conservative estimate of a post-Katrina budget could easily push that figure into the -3.25% to -3.5% range – virtually identical to peak cyclical shortfalls hit in 2003-04. And, of course, additional costs can also be expected to fall on state and local governments. That means that the overall government sector, which was running a negative net saving rate to the tune of -2.1% of GNP as of the second quarter of 2005, is about to become an ever-greater drag on national saving. That will put the shoestring economy under even greater pressure.
Nor can business sector saving be counted on as a buffer to the same degree it has been in recent years. Not only do profit margins appear to have peaked – the after-tax profits share of corporate GDP remains slightly below cycle highs of 2003 – but the combination of rising unit labour costs and higher energy-related outlays could well push the earnings share lower in the months ahead. Add in a demand shortfall driven by some consolidation of discretionary consumption in the face of sharply higher retail energy costs, and it seems reasonable to look for a significant reduction of the business saving rate well into 2006. In a climate of government and household sector dis-saving, that only underscores the further downward pressures likely on overall net national saving.
Global considerations could well compound the problem. That’s because up until now the US has had free and easy access to the rest of the world’s pool of surplus saving. That could be about to change. Japan and Germany – the second and third largest economies in the world, which collectively account for 56% of the world’s surplus saving – both seem to be on the cusp of sustainable recoveries in domestic demand. That would tend to draw down their current-account surpluses, which are running at 3.3% of GDP in Japan and 3.8 % in Germany – thereby leaving less foreign capital available to fund America’s external deficit. That could lead to renewed downward pressure on the dollar and concomitant upward pressure on US interest rates – increasingly problematic outcomes for overly-indebted American consumers. That would only tighten the noose on America’s shoestring economy.
Yet “resilience” has become the mantra of consensus thinking about a post-Katrina, energy-shocked US economy. Just as the United States survived the potentially disruptive impacts associated with the bursting of the equity bubble, the carnage of 9/11, and a series of unprecedented corporate accounting scandals, most believe it can ward off the blows this time, as well. That is certainly a possibility.
But I think it is equally important to appreciate the differences between this shock and the others noted above. From a pure macro standpoint, the energy shock of 2005 is less of a psychological blow than terrorism, equity wealth destruction, and a loss of confidence in corporate leadership. Higher energy product prices are, instead, more of a direct hit on household purchasing power and business costs. And they put immediate pressure on a US economy that is lacking the saving cushion needed to withstand the blow.
One of two things has to happen – either the US attempts to maintain its current lifestyle and places a greater claim on surplus saving elsewhere in the world or there is a consolidation of discretionary spending by American households and businesses, alike. Either outcome puts increased pressure on an unbalanced world – the former ups the ante on the long-overdue US current account adjustment, whereas the latter triggers a growth slowdown in the remainder of a US-centric global economy. The trick is to figure out the most likely avenue of venting – and how this bears on the presumption of America’s so-called natural resilience.
The macro conclusions are inescapable: a saving-short US economy that runs a massive current account deficit is effectively living beyond its means. It not only relies on foreign saving to fund domestic growth, but it also lacks the capacity to invest in public goods that may be needed to safeguard its future. Lacking in domestic saving, the shoestring economy is also biased toward chronic under-investment in infrastructure – leaving itself vulnerable to “breakage.” Whether that breakage comes from within (i.e., Katrina) or from the outside (i.e., terrorism), the shoestring economy runs the risk of being unprepared to ward off such blows in a fragile and dangerous world. An energy shock exacerbates the imbalances that produce such vulnerability. This draws into serious question the resilience that financial markets now seem to be banking on.
By Stephen Roach, Morgan Stanley economist, as published on the Global Economic Foru