Tuesday, January 8, 2008

Doubletalk

Secretary of the Treasury Henry Paulson appeared on Squawk Box on cable channel CNBC on January 8, 2008.

Paulson was asked if his good relations with China contributed to the recent appreciation of China’s currency. He credited China for letting its currency appreciate against the dollar, which is helping U.S. exports, but said that China needed to do more to liberalize its financial system.

Paulson did not blame China’s undervalued currency as the principal source of the U.S. trade deficit with China. He attributed it to a more fundamental problem, namely, the low level of domestic savings in the United States. In economic jargon, the gap between U.S. domestic investment and saving takes the form of a surplus on the capital account (net inflow of foreign capital). In accounting terms, a capital account surplus has to be offset by a current account (largely trade) deficit. Higher domestic savings would reduce U.S. dependence on foreign capital (foreign savings), thereby reducing the trade deficit. However, higher domestic savings comes at the expense of domestic consumption.

It is the fear of lower domestic consumption that gives rise to concern about a recession. In this regard, Paulson was asked if the U. S. should adopt a fiscal stimulus package (cut taxes and/or increase government spending) and cut interest rates to prevent the economy from falling into recession. He replied that he was not prepared to comment on interest rates, which falls under the ambit of the Federal Reserve Board. Nor would he discuss the specifics of a fiscal stimulus until the president had made up his mind.

A fiscal stimulus that increases the budget deficit constitutes an increase in government dissaving (that is, the government has to borrow more to pay its bills). Coupled with lower interest rates to spur consumption means a reduction in household saving, the fundamental problem that causes the trade deficit in the first place.

In the short run, fear of recession, especially in an election year, invariably exceeds concern about low domestic savings. The problem is that "for the moment" always seems to trump the need for more saving.

1 comment :

Sebastian Wisniewski said...

Good point Dr. Rabushka, and a total miss by '...tommy shannon'. There are so many people out there blaming China (or something/someone else) for the deficit, outsourcing, low value of the dollar... Instead of understanding that it isn't the free market's fault, populists gain ground. In my opinion (see "How to Make Americans Economically Savvier?" on http://wisniesw.blogspot.com/), many big economic problems boil down to basics really: be frugal, save, don't spend the money that you don't have, hope for the best, be prepared for the worst... Lack of fiscal conservatism and laissez-faire economics is bound to lead to a spiral of troubles.