Feb 27th 2018

The Myth of Sound Fundamentals

by Stephen S. Roach

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of a new book Unbalanced: The Codependency of America and China.

NEW HAVEN – The spin is all too predictable. With the US stock market clawing its way back from the sharp correction of early February, the mindless mantra of the great bull market has returned. The recent correction is now being characterized as a fleeting aberration – a volatility shock – in what is still deemed to be a very accommodating investment climate. After all, the argument goes, economic fundamentals – not just in the United States, but worldwide – haven’t been this good in a long, long time.

But are the fundamentals really that sound? For a US economy that has a razor-thin cushion of saving, nothing could be further from the truth. America’s net national saving rate – the sum of saving by businesses, households, and the government sector – stood at just 2.1% of national income in the third quarter of 2017. That is only one-third the 6.3% average that prevailed in the final three decades of the twentieth century.

It is important to think about saving in “net” terms, which excludes the depreciation of obsolete or worn-out capacity in order to assess how much the economy is putting aside to fund the expansion of productive capacity. Net saving represents today’s investment in the future, and the bottom line for America is that it is saving next to nothing.

Alas, the story doesn’t end there. To finance consumption and growth, the US borrows surplus saving from abroad to compensate for the domestic shortfall. All that borrowing implies a large balance-of-payments deficit with the rest of the world, which spawns an equally large trade deficit. While President Donald Trump’s administration is hardly responsible for this sad state of affairs, its policies are about to make a tough situation far worse.

Under the guise of tax reform, late last year Trump signed legislation that will increase the federal budget deficit by $1.5 trillion over the next decade. And now the US Congress, in its infinite wisdom, has upped the ante by another $300 billion in the latest deal to avert a government shutdown. Never mind that deficit spending makes no sense when the economy is nearing full employment: this sharp widening of the federal deficit is enough, by itself, to push the already-low net national saving rate toward zero. And it’s not just the government’s red ink that is so troublesome. The personal saving rate fell to 2.4% of disposable (after-tax) income in December 2017, the lowest in 12 years and only about a quarter of the 9.3% average that prevailed over the final three decades of the twentieth century.

As domestic saving plunges, the US has two options – a reduction in investment and the economic growth it supports, or increased borrowing of surplus saving from abroad. Over the past 35 years, America has consistently opted for the latter, running balance-of-payments deficits every year since 1982 (with a minor exception in 1991, reflecting foreign contributions for US military expenses in the Gulf War). With these deficits, of course, come equally chronic trade deficits with a broad cross-section of America’s foreign partners. Astonishingly, in 2017, the US ran trade deficits with 102 countries.

The multilateral foreign-trade deficits of a saving-short US economy set the stage for perhaps the most egregious policy blunder being committed by the Trump administration: a shift toward protectionism. Further compression of an already-weak domestic saving position spells growing current-account and trade deficits – a fundamental axiom of macroeconomics that the US never seems to appreciate.

Attempting to solve a multilateral imbalance with bilateral tariffs directed mainly at China, such as those just imposed on solar panels and washing machines in January, doesn’t add up. And, given the growing likelihood of additional trade barriers – as suggested by the US Commerce Department’s recent recommendations of high tariffs on aluminum and steel – the combination of protectionism and ever-widening trade imbalances becomes all the more problematic for a US economy set to become even more dependent on foreign capital. Far from sound, the fundamentals of a saving-short US economy look shakier than ever.

Lacking a cushion of solid support from income generation, the lack of saving also leaves the US far more beholden to fickle asset markets than might otherwise be the case. That’s especially true of American consumers who have relied on appreciation of equity holdings and home values to support over-extended lifestyles. It is also the case for the US Federal Reserve, which has turned to unconventional monetary policies to support the real economy via so-called wealth effects. And, of course, foreign investors are acutely sensitive to relative returns on assets – the US versus other markets – as well as the translation of those returns into their home currencies.

Driven by the momentum of trends in employment, industrial production, consumer sentiment, and corporate earnings, the case for sound fundamentals plays like a broken record during periods of financial market volatility. But momentum and fundamentals are two very different things. Momentum can be fleeting, especially for a saving-short US economy that is consuming the seed corn of future prosperity. With dysfunctional policies pointing to a further compression of saving in the years ahead, the myth of sound US fundamentals has never rung more hollow.


Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Copyright: Project Syndicate, 2018.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

May 24th 2019
Waging a war against Iran, or even thinking of doing so, is sheer madness. Trump has thus far wisely rejected the warmonger National Security Advisor John Bolton’s outrageous advice. Waging another war in the Mideast, this time against Iran, would have not only disastrous consequences for the US but will also engulf our allies from which they would suffer incalculable human losses and destruction. Bolton was the architect behind the devastating war in Iraq in 2003, which inflicted more than 5,000 US casualties and a cost exceeding two trillion dollars, allowed Iran to entrench itself in Iraq, and gave way to the rise of ISIS.
May 24th 2019
The private Tasnim news agency reports from Iran that in a speech to thousands of university students, Iran’s clerical leader Ali Khamenei made an unusual and extraordinary criticism of president Hassan Rouhani and foreign minister Mohammad Javad Zarif over their handling of the 2015 Joint Comprehensive Plan of Action or deal on limiting Iran’s nuclear enrichment program.
May 21st 2019
Extract: "Brexit, after all, is as much a Kremlin project as it is anyone else’s. Putin wants to divide Europeans, and in the UK, Brexit has succeeded in dividing Britons like nothing since the Corn Law debates almost 200 years ago. Putin wants the EU to fragment, and Brexit is causing the biggest crack yet in the bloc’s history. Putin wants to sow doubt about the legitimacy of traditional news sources; pro-Brexit media consistently promote lies as truth and inveigh against reputable papers like the Financial Times as elitist enemies of the people."
May 16th 2019
Iraq’s population when invaded was 26 million. Iran’s population today is 81 million..........Whereas Iraq’s neighbors– Turkey, Iran and Saudi Arabia in particular– had been mauled by Saddam and so did not strongly oppose Bush’s invasion, Shiite Iraqis, many Syrians, the Hazaras of Afghanistan, and the some 40 million Shiites of Pakistan would support Iran.
May 15th 2019
It’s time that economists, pundits, and politicians start looking holistically at life in our times, and take seriously the long-term structural changes needed to address the multiple crises of health care, despair, inequality, and stress in the US and many other countries. US citizens, in particular, should reflect on the fact that many other countries’ people are happier and less worried, and are living longer. In general, those other countries’ governments are not cutting taxes for the rich and slashing services for the rest. They are attending to the common good, instead of catering to the rich while pointing to illusory economic statistics that hide as much as they reveal.
May 8th 2019
"........Meanwhile, Trump is leaving the door open for Russia to come to his aid again in 2020. The White House and congressional Republican leaders have been blocking a bill to secure US elections against foreign attacks. And administration officials have been instructed not to raise the issue of Russian interference with the president, lest it cast a shadow on his legitimacy.  The next phase in this affair is already coming into focus. Barr, with the help of Trump’s golfing buddy Lindsey Graham, the Republican chair of the Senate Judiciary Committee, is now enlisted in peddling the president’s fantasy that the Mueller investigation was a “witch hunt” orchestrated by “deep-state” supporters of Hillary Clinton. Once again, current and former FBI agents will be targeted, either because they expressed criticism of Trump or because they opened a national security investigation into a hostile power’s meddling in the US presidential election (which continued in the 2018 midterms). FBI director Christopher Wray, commenting on the Mueller report, said that the Russians are “upping their game” for 2020. "
May 7th 2019
We are witnessing the loss of biodiversity at rates never before seen in human history. Nearly a million species face extinction if we do not fundamentally change our relationship with the natural world, according to the world’s largest assessment of biodiversity.
May 4th 2019
Accusing Iran of being a rogue country bent on acquiring nuclear weapons, supporting extremist groups and terrorism, persistently threatening Israel, and destabilizing the region in its relentless effort to become the dominant power may well all be justified. The question is, what would it take to stop Iran from its destabilizing activities and help make it a constructive member of the international community, and avoid military confrontation with either the US or Israel or both?
Apr 29th 2019
Some of the most famous scientific discoveries happened by accident. From Teflon and the microwave oven to penicillin, scientists trying to solve a problem sometimes find unexpected things. This is exactly how we created phosphorene nanoribbons – a material made from one of the universe’s basic building blocks, but that has the potential to revolutionise a wide range of technologies.
Apr 28th 2019
Easter visitors to London have found some streets and buildings occupied by “Extinction Rebellion” activists, warning of climate catastrophe and rejecting “a failed capitalist system.” Followers of central bank thinking have seen the governors of the Bank of England and Banque de France warning that climate-related risks threaten company profits and financial stability. Both interventions highlight the severity of the climate challenge that the world faces. But warnings alone won’t fix the problem unless governments set ambitious but realistic targets to eliminate carbon dioxide and other greenhouse-gas emissions, backed by policies to ensure the targets are achieved. Zero net CO2 emissions by 2050 at the latest should be the legally defined objective in all developed economies.
Apr 25th 2019
LONDON – Russian efforts to influence European elections have received plenty of media attention. But the same cannot be said of interference by conservative Christian groups based in the United States, some with links to President Donald Trump’s administration and his former adviser, Stephen Bannon.
Apr 24th 2019
.............the version of the report released is only the start of wide-ranging and intensive House investigations.
Apr 17th 2019
On the night of April 15, 2019, in Paris, the emotions were raw. “Notre Dame is burning, the whole of France is crying, the whole world is crying,” said Archbishop Michel Aupetit of Paris. “It’s terrible, frightening, painful, a tragedy, a nightmare.” “This place leaves no one untouched. When you enter this cathedral, it inhabits you,” said Anne Hidalgo, the Mayor of Paris, in front of the burning monument. “We will rebuild,” said the Rector of Notre Dame, “we will rebuild.”
Apr 15th 2019
High-level political purges are gathering pace in Russia. The latest evidence came in late March, with the arrests of Mikhail Abyzov, a former minister for open government affairs, and – two days later – Viktor Ishayev, a former Far East minister and ex-governor of Russia’s Khabarovsk region. Unsurprisingly, the arrests of such senior figures is having a chilling effect among the country’s elites. The authorities have now arrested or imprisoned three former federal government ministers and a supporting cast of regional officials
Apr 8th 2019
The reaction to this type of paternalism, sensible and well-meant as it usually was, came in the form of petulant populism. Like a child who refuses to eat his spinach, just because his mother claims it is good for him, supporters of Trump, Brexiteers, or Baudet want to give the finger to the politics of virtue. That is why Nigel Farage, the chief promoter of Brexit, likes to be photographed with a glass full of beer and a smoldering cigarette: if the virtuous elite want us to drink less and quit smoking, let’s have another and light up.
Apr 8th 2019
Chinese President Xi Jinping seems to be on a roll. He has sent a rocket to the dark side of the moon, built artificial islands on contested reefs in the South China Sea, and recently enticed Italy to break ranks with its European partners and sign on to China’s Belt and Road Initiative. Meanwhile, US President Donald Trump’s unilateralist posture has reduced America’s soft power and influence. China’s economic performance over the past four decades has been truly impressive. It is now the main trading partner for more than a hundred countries compared to about half that number for the United States. Its economic growth has slowed, but its official 6% annual rate is more than twice the American rate. Conventional wisdom projects that China’s economy will surpass that of the US in size in the coming decade. Perhaps. But it is also possible that Xi has feet of clay.
Apr 2nd 2019
"......as prime minister, May called a snap election in the name of helping her deliver Brexit. She openly dismissed anyone opposing Brexit – which at the very least meant the 16.5m who had voted remain – as “playing games with politics”. In hock to the hardline Brexiteers within her own party, May pushed a for a version of Brexit that would make this small group of around 100 or so individuals happy, regardless of what millions out in the country thought."
Apr 1st 2019
The financial crisis occurred in 2008 because deficient regulation allowed huge risks to develop within the financial system itself. But the depth of the subsequent recession, and the long period of slow growth that followed, was the result not of continued financial system fragility, but of the excessive leverage in the real economy that had developed over the previous half-century. Between 1950 and 2007, advanced economies’ private-sector debt (households and companies) grew from 50% to 170% of GDP and adequate growth seemed attainable only if debt grew far more rapidly than nominal GDP. After the crisis, loan growth turned negative and remained depressed for many years, not because an impaired financial system lacked the capital to extend credit, but because overleveraged households and companies were determined to pay down debt even if interest rates were zero. The same pattern was observed in Japan in the 1990s.
Mar 28th 2019
The American people should have known that something was awry when President Donald Trump’s attorney general, William Barr, announced on Friday, March 22, that he had received special counsel Robert Mueller’s report and would provide a summary of its findings to certain congressional leaders over the weekend. We should have asked: Why Barr’s summary and not Mueller’s? Presumably, Mueller had attached one to his report. It turned out there was a propagandistic reason for this unusual arrangement: Barr issued the best possible interpretation of Mueller’s report – from the president’s standpoint – including perhaps even a twist on what Mueller had said and intended. This allowed the president and his backers to propagate and celebrate what Mueller didn’t say: that the report’s conclusions were a “total exoneration” of Trump. In fact, even Barr’s brief summary, quoting Mueller’s report, said, “While this report does not conclude that the President committed a crime, it also does not exonerate him.”