“In real life, some problems are so daunting they are ignored until the collision occurs. The inadequacy of New Orleans’s levees and the erosion of its barrier islands offer one painful example. The U.S. economy’s increasing debt to the rest of the world offers another.” — David Wessel, Wall Street Journal, September 29, 2005
David Wessel, the Wall Street Journal’s resident debt and trade-deficit scold, has used his column the last two weeks to editorialize about how the U.S. can save its economy from what he deems a Hurricane Katrina-like crash. The catch here is that to avoid the awful future that Wessel and most “reputable economists” clearly foresee, U.S. citizens must countenance an economy-wide collapse that wipes out stock-market values and wages, while China must endure a deflationary recession. That, or maybe Wessel’s theories are full of holes.
To begin, Wessel bemoans the fact that the U.S., once a creditor country, now owes the rest of the world $2.5 trillion, and talks of steps to “wean the U.S. from growing dependence on the savings of Asians and Europeans.” His characterization itself is misleading.
As evidenced by the low interest rates the rest of the world charges us, it’s very clear not only that foreigners get in line to lend to us, but that they do so eagerly. Wessel however sees the 73 percent fall in the yield on the 10-year Treasury since the early 1980s as evidence of “complacency and denial among politicians and financial markets.”
He also fails to point out that the path to our present debt situation has been a prosperous one, with inflation, interest rates, and unemployment all falling from double-digit rates to levels not often seen in modern times. The supposed debt explosion also coincided with a bull market that saw the Dow rise from 743 in 1982 to over 10,000 today. While not high by the standards of the late 1990s, the Dow and the S&P 500 both presently trade at P/E multiples of 18. Given Wessel’s apocalyptic predictions, either the stock markets are extremely stupid, or Wessel’s reasoning is extremely shaky. More anecdotally, would any reader lend to a person or country supposedly on the verge of collapse at such low rates?
In the grand tradition of all debt-worriers, Wessel uses the low U.S. savings rate to trot out the familiar canard that the U.S. “consumes more than it makes.” What Wessel and others can’t seem to explain is how we Americans supposedly save nothing, yet at the same time manage to get wealthier and wealthier every year. Indeed, data last month from the Federal Reserve show that U.S. household net worth hit a record of $49.8 trillion, up roughly $5 trillion in the last year alone. Notably, those gains were split almost equally between residential real estate and financial assets.
The counterintuitive answer to those who worry that Americans are destitute is that so long as U.S. assets appreciate, our savings rate will be low. This will be the case because capital gains from appreciated assets will by virtue of compound interest nearly always outpace current savings.
In short, the best way to boost the savings rate would be for both the housing and stock markets to collapse. Americans experienced just such a thing in the early 1980s when stocks were still mired in a multi-year slump and home prices were crashing. Amidst those capital losses, the savings rate unsurprisingly reached double digits.
Turning to Wessel’s solutions, he would first demand a “big upward move in China’s currency” to make Chinese goods more expensive for U.S. consumers. His reasoning is pretty remarkable considering last month marked the 20th anniversary of the Plaza Accord and a 36 percent upward revaluation of the yen against the dollar. The Japanese were our “enemy” back then for shipping us quality goods at low prices, and our reward to them for making our lives better was a twenty-year deflationary recession. Also, and unsurprisingly since there’s virtually no correlation between currency values and trade balances, our own trade deficit with Japan has continued to rise.
On the U.S. side, Wessel would like to see the U.S. devalue the dollar and increase taxes. To his credit, he at least acknowledges the obvious: that a weaker dollar and higher marginal rates “will slow the U.S. economy.” On the other hand, if recession, a stock market and housing collapse, and a depressed and angry China are what it takes to get the world to stop making us low-priced goods, lending us money at low interest rates, and investing heavily in our assets, maybe things aren’t as bad as Wessel assumes.
History shows they aren’t. While most would presumably like to at the very least see federal spending and debt shrink, present debt levels are microscopic relative to the size of the U.S. economy. As for trade-deficit fears, Adam Smith once wrote about commercial countries, and the fact that every single one’s demise had been foretold based on “an unfavorable balance of trade.” In short, trade-deficit worriers have been predicting collapse for centuries and have yet to be proven right.
Wessel concludes that it would be “imprudent” to hope for a “miracle” that would save the U.S. economy from a Katrina-like demise. More miraculous would be that our economy survives the “solutions” offered up by well-meaning but ill-informed commentators.
–John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.