Global: Spending Capital Wisely
Stephen Roach (New York)
In his post-election press conference of early November, President Bush famously said, “I’ve earned capital in this election and I’m going to spend it…” In his second inaugural address, the President gave every indication of sticking with this promise. This could be a very challenging commitment insofar as economic policy is concerned. While Mr. Bush is hardly lacking in political capital, financial capital is another matter altogether for a saving-short US economy. That poses two critical and related questions: Who will foot the bill for these bold initiatives? Will they solve America’s biggest economic problems?
An important hint to the answer of both questions was contained in the recently released November data on US trade and capital flows. The trade deficit, of course, ballooned to a record $60.3 billion, whereas net foreign buying of long-term US securities surged to $81 billion in the same month. These numbers hardly came out of thin air. In my view, they are telltale signs of the only incremental funding option available to a saving-short US economy -- the need to import surplus saving from abroad and run massive current-account and trade deficits in order to attract that capital. They provide a very direct answer to the first question: As long as America’s domestic saving rate remains woefully deficient, any policy proposals which exert a further drain on aggregate saving will have to be funded by foreign savers.
That takes me to the second question -- America’s most serious problem. In my view, it’s all about saving. Unfortunately, recent trends are especially worrisome on that front. The net national saving rate -- the combined saving of households, businesses, and the government sector all adjusted for the depreciation of worn-out capital -- stood at just 0.9% in 3Q04 (latest official data point) and has averaged only 1.5% since early 2002. That’s a record low in the modern-day post-World War II experience of the US economy. The recent plunge in national saving reflects the combined impacts of an extraordinary compression of household saving -- the personal saving rate was only 0.5% in 3Q04 -- and an unprecedented deterioration in government saving as the federal budget swung dramatically from surplus to deficit over the past several years. In a world where saving must always equal investment, a chronic saving shortfall eats away at the sustenance of long-term economic growth for any nation. For that simple reason, I continue to believe that America’s saving deficiency is its most serious economic problem.
It is against that backdrop that I believe we must evaluate the basic thrust of the economic policy agenda of the second Bush Administration. And from that perspective, I have serious misgivings. Under the general rubric of the so-called “ownership society” -- privatization of social security, healthcare saving accounts, lifetime retirement accounts, private pension revamping, and tax reform -- a major reworking of economic policy is being proposed. My concerns are not about the philosophical and political merits of this debate. It’s hard to quibble with the noble objectives of ownership -- asking individuals to take on greater responsibility for their own economic destiny. Instead, my concerns are those of the steely-eyed national income accountant. What worries me as I put on my green eyeshade are the impacts of shifting ownership on national saving. In my view, these proposals do basically nothing to address America’s biggest problem -- an unprecedented shortfall of national saving.
At its best, the ownership society is saving-neutral -- it merely rearranges the deckchairs by shifting the mix of national saving from one segment of the economy to the other. The risk, however, is that the ownership-society policy agenda entails transitional costs that could exert a significant near-term drain on aggregate saving for an already saving short US economy. For example, the privatization of social security requires transitional funding by the federal government in the range of $50 to $100 billion per year, according to our estimates based on the findings of the President's 2001 Commission to Strengthen Social Security. A similar point can be made with respect to so-called supply-side tax reforms -- one-off reductions in marginal rates that are presumed to have “self-financing” revenue paybacks in those ever-elusive out-years. To the extent the ownership policy agenda enlarges the budget deficit, there could actually be a worsening of America’s current-account and external-funding conundrum. Such an intensification of global imbalances could lead to further downward pressure on the dollar, raising the possibility of reduced foreign appetite for dollar-denominated assets.
I would feel much better about the direction of economic policy -- as well as the outlook for the US economy -- if Washington’s primary focus was on boosting national saving through a credible program of government deficit reduction and increased personal saving. Yet in their politically-inspired zeal for reform, politicians are leaning the other way and overlooking what the US economy needs most -- a new approach to saving policy. Up until now, the focus has been on creating new saving vehicles -- such as IRAs and 401Ks -- that simply shift saving from one type of account structure to another without raising the overall level of personal or national saving. I worry that social security privatization, healthcare saving accounts, or lifetime retirement accounts would do precisely the same thing -- siphon off saving from other assets. Instead, incentives need to be directed at lifting the level of aggregate saving rather than rearranging the micro pieces of the puzzle.
Largely for those reasons, I now favor a consumption tax -- specifically a national sales tax (see “How to Fix the World,” Special Global Economic Study, January 2005). This would have the simple but powerful effect of providing a one-time shift in the relative price calculus between aggregate spending and saving. In my view, that is precisely what the saving-short American consumer needs. With the consumption share of US GDP currently in excess of 70% -- an unprecedented breakout from the 67% average over the 1975 to 2000 interval -- and with the personal saving rate hovering around zero, excess consumption has become a way of life. Unlike other consumption taxes -- like a European-style value-added tax -- a national sales tax is administratively simple to implement and collect. And it doesn’t take much in terms of creating exemptions at the lower end of the income distribution to deal with concerns of regressivity and equity. Moreover, with personal consumption expenditures in excess of two-thirds of US GDP, a national sales tax would have the added advantage of broadening the revenue base -- offering hope for the government on the deficit-reduction front, as well. A national sales tax is not a panacea to all that ails a saving-short US economy, but it has the potential to provide enhanced leverage for both the consumer and government components of the aggregate saving equation.
Yet fiscal policy can’t do the job alone. In my view, America’s national saving agenda also needs higher real interest rates. Most importantly, a normalization of real rates would challenge the excesses of the Asset Economy, which have encouraged consumers to substitute wealth creation for income generation as a means to achieve overall life-cycle saving objectives. The persistence of rock-bottom real rates only exacerbates that distortion and, in my view, adds further to the world’s imbalances (see my 17 January dispatch, “The Real Interest Rate Conundrum”). A persistence of unusually low real interest rates also raises the risk of asset bubbles and the possibility of post-bubble shakeouts that could be very destabilizing to asset-dependent savers/ consumers. Finally, a reversion to more normal real interest rates would provide a much more attractive return for traditional saving vehicles. The real interest rate conundrum is central to the saving paradox, in my view. The challenge for this aspect of the policy fix falls very much on the shoulders of the world’s central banks.
National saving is the sustenance of any nation’s longer-term growth potential. To the extent that any one nation puts an outsize claim on the global saving pool, it is impinging on the growth potential of others. America, which currently absorbs about 80% of the world’s excess saving, is running precisely that risk. Nor can an aging US population afford to shrug off the lack of saving for much longer, especially with the retirement of some 77 million baby-boomers about to commence in earnest within the next decade. The beginning of a new presidential administration is always a great opportunity for debate on the key policy issues that will shape the course of the US for the next four years. A national saving agenda is the most urgent imperative, in my view. New economic policy proposals should be evaluated on the basis of whether they pass a saving-enhancing litmus test. Saving-short America needs to do a much better job in spending its capital wisely.
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What Roach fails to understand is that when not if housing crashes, the loss of jobs stimulus, along with the accompanying deflation, etc will push "real rates" to the moon at a time when bankruptcies will be soaring. It will be interesting to watch him change his viewpoint, most likely after most of the damage has been done.
Mish |
