Global: The Day after Tomorrow
Stephen Roach (New York)
Unlike most of my fellow citizens, November 3 will not find me waking up at home to “morning in America.” Instead, I’ll be spending a sleepless night on yet another airplane, full of apprehension over the outcome of a bitterly contested presidential election. Hopefully, the morning after will bring a clear-cut verdict. Whatever your preference, another cloud of ambiguity is the last thing the world’s greatest democracy needs. Yet with Wednesday morning also comes the proverbial cold shower -- a wake-up call that cuts through the fiction of campaign rhetoric and focuses on the heavy lifting that now lies ahead. My concern is that whoever wins, the next four years are going to be unusually challenging from the standpoint of America’s economic stewardship. We can only hope that the victor is up to the task.
In the financial markets, we endlessly debate the prognosis for next quarter’s numbers -- GDP, earnings, inflation, and the like. Our fixation on the here and now reflects both the difficulties of longer-term forecasting as well as the short-termism of the investment community. Each quarter that we escape a problem, the greater the comfort level as to what lies ahead. Such myopic risk assessment misses the forest for the trees. In my view, the US economy is an accident waiting to happen. That’s the message to be taken from a record shortfall in national saving, a record current-account deficit, record levels of household indebtedness, a record deficiency of personal saving, and outsize government budget deficits. The emphasis is on the word “record.” Never before has the United States pushed the envelope to this degree on such a wide array of economic imbalances.
The politicians haven’t touched these issues in Campaign 2004. That’s hardly surprising. After all, the resolution of imbalances may actually imply some personal economic sacrifice -- not exactly the approach that attracts votes. Just ask Jimmy Carter or Walter Mondale. But the campaign is now over. The rhetorical flourishes hopefully will subside. And America will wake up the day after tomorrow with the most daunting economic agenda it has faced in a generation. Then, the real debate can begin.
I continue to believe that the national saving construct offers the most comprehensive framework to understand many of America’s toughest economic challenges. I focus, in particular, on the net national saving rate -- the combined saving of households, businesses, and the government sector. For, macro purposes, such saving is best viewed in “net” terms -- that is, after subtracting out that portion of gross saving that goes toward depreciation, or the replacement of worn-out or obsolete capital stock. It is a basic accounting rule of economics that saving must always equal investment. The net national saving rate provides a clear sense of how much society is setting aside out of current income generation in order to fund the net growth in new productive capacity -- the sustenance of future economic growth.
The verdict from America’s net national saving rate is nothing short of frightening: It fell to a record low of 0.4% in early 2003 and has since rebounded to just 1.9% as of mid-2004. While official 3Q04 estimates are not yet available, a sharp plunge in the personal saving rate to 0.4% (from 1.2% in the second quarter), in conjunction with diminished corporate profits growth and outsize government budget deficits, points to a further decline in overall national saving. These trends leave America’s net national saving rate in the 1-2% range over the 2003-04 period -- all-time lows by any standard. Such anemic saving speaks of a nation that is living well beyond its means, as those means are defined by America’s domestic income generating capacity. A record-low saving rate also ties together many of America’s other economic problems:
* Current-account gap. Lacking in domestic saving, America imports foreign saving to fund economic growth. The US must run massive current account deficits to attract that capital. With the external deficit having risen to 5.7% of GDP, the US is now absorbing over 80% of the world’s surplus saving -- requiring $2.6 billion of capital inflows each business day to fund its domestic saving shortfall.
* Budget deficit. Budget deficits matter much more when the private sector doesn’t save. Lacking in private saving -- especially personal saving -- the unprecedented shift in the Federal budget deficit has accounted for the bulk of the recent shortfall in national saving. Unlike the late 1990s, when “good” current account deficits were needed to fund a US investment boom, today’s “bad” external deficits arise out of a need to fund both government and personal profligacy.
* The asset economy. Private saving rates are down, in large part, because households and businesses view asset appreciation as a proxy for long term saving. Yet the fragility of asset markets draws this key presumption into question. That was certainly the lesson of the equity bubble of the late 1990s and could well be the case if the current property bubble bursts.
* Household debt. Asset appreciation has been diverted away from saving and increasingly used as a means to fund current consumption. Yet such purchasing power can only be extracted from property by debt accumulation. This has taken household indebtedness to record highs; over the past four years, the expansion of household liabilities has been fully 65% larger than the growth in America’s overall GDP.
* Productivity risks. With outsize government budget deficits and no personal saving, there is little net saving left over to finance productivity-enhancing business capital spending. This has already taken a worrisome toll. Stripping out depreciation of obsolete capacity, net investment in the business sector in 2003 was 60% below levels prevailing in 2000 -- a serious warning flag on the productivity front.
* Trade frictions and protectionism. As stressed above, rock-bottom national saving spells massive current-account deficits. Not surprisingly, a record trade deficit accounted for fully 92% of America’s current account deficit. Consequently, courtesy of America’s fiscal profligacy, trade deficits, for all practical purposes, are made in Washington. And so, too, is the heightened import penetration that puts pressure on domestic job creation and spawns protectionist risks.
* Demographic perils. Savings imperatives are all the more urgent as America’s aging generation of baby-boomers now nears retirement. In 2000, 12.4% of the total US population was 65 years and older. Over the next 25 years, this ratio is projected to explode by nearly 50% to 18.2%. The implications of a record shortfall of domestic saving are all the more vexing in the context of this demographic time bomb.
The task ahead is not to bemoan the past but to address what needs to be done to face a very challenging and risky future. The national saving framework provides some obvious and important answers. First, fix the budget deficit. This has been the major swing factor in the stunning erosion of US domestic saving over the past four years. Political posturing on matters of tax reform or entitlements expansion must now be put aside in the post-election period; tax increases and expenditure cuts -- however unpopular -- are the only way out. Politicians, of course, don’t want to tell you that. Yet a saving short- US economy is utterly incapable of growing its way of a deep budget hole. The heavy lifting of deficit reduction is an urgent imperative -- especially in the early months of any political cycle.
Second, let the dollar go. For an unbalanced world, rebalancing can only occur through a change in relative prices. The dollar is the world’s most important relative price, and, in my view, it has nowhere to go but down. Dollar depreciation is also part and parcel of a classic current account adjustment. A weaker dollar will inevitably lead to higher US real interest rates -- providing long overdue restraint to interest-rate sensitive and asset-driven spending of American consumers and businesses. That will then lead to a rebuilding of national saving, thereby lessening the need to run large current-account and trade deficits that have, in turn, led to heightened protectionist risks. A weaker dollar will also put long overdue pressure on the rest of the world to stimulate its own domestic demand -- both by embracing structural reforms and by backing away from the increasingly reckless and destabilizing recycling of foreign exchange reserves into dollar-denominated assets.
There are no quick fixes for America. Yet political campaigns are designed to give voters just such an impression. The day after tomorrow, this charade should come to an end. And just in time, I might add. In my view, 2005 could well be a year when many of America’s imbalances reach their tipping point. A failure to act would be the greatest tragedy of all. Looking at America’s problems through the lens of subpar saving suggests that deficit reduction and a weaker dollar should be at the top of the list of potential remedies -- remedies that, by the way, will have critical implications for world financial markets. Certainly, more can be done. But I can’t think of a better place to start.
On a personal note, I have to add that I have found this election campaign deeply disturbing. The tone of the debate is what troubles me the most. It has fanned a polarization in America and around the world that is right out of some of the darkest pages of history. It didn’t have to be that way. Out of the devastating tragedy of September 11 came a remarkable spirit of bipartisan solidarity. America was united and the world came together -- not just in grief and sorrow but also in hope for collective renewal. I remember being stuck in Europe in the days immediately after the attack on America, unable to return home at a time when I wanted nothing more. I was warmly embraced by our long steadfast allies, with a compassion and sincerity that deeply touched me. Their hearts were open and caring. Their home was my home.
That spirit has been squandered. Americans are at odds with one another, with a deep and worrisome intensity. And the world sees us in a stark, adversarial light. The cynics say this is just politics -- that such divisiveness is the norm, especially during times of war. I beg to differ. Today, polarization is playing on the character of America -- in the end, any nation’s most precious asset. Sadly, that character is now at risk, both at home and abroad. As dawn breaks the day after tomorrow, that will be the first thing on my mind.
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