EconoMonitor

Nouriel Roubini's Global EconoMonitor

Orwellian Chutzpah and Doublespeak in the Economic Report of the President: the US Current Account Deficit Becomes the “US Capital Account Surplus”

Paul Krugman has recently written about the Bush Administration attitude of changing unpleasant facts that do not square with its ideological biases. A recent example was the attempt to use the nebulous concept of “dynamic scoring” to “prove” – using “voodoo economics” cabal – that tax cuts actually increase revenues while all respected empirical studies show that such cuts reduce, on net, tax revenues.

But the latest example of this Orwellian doublespeak is the Economic Report of the President (ERP) published today by the White House Council of Economic Advisers. Its chapter on international macro issues is titled “The U.S. Capital Account Surplus” when the more appropriate and honest title would have been “The U.S. Current Account Deficit” . While Ben Bernanke’s name is nowhere in this year’s ERP, his heavy hand in this chapter – and the rest of the ERP – is clear. His March 2005 speech on the global current account imbalances being due to a “global savings glut” rather than, in large part in 2000-2004, due to the U.S. fiscal deficit is the intellectual baseline for this “US Capital Account Surplus” interpretation of the US international financial position.

The thesis is clear: we do not run a current account deficit; we run a capital account surplus because the rest of the world wants to invest in the high productivity high growth U.S. Of course, the appropriate economic causality is here reversed. The logical causality is that, if we save less than we invest and if we spend more than we have income, we will run a current account deficit and we will have to borrow  from the rest of the world to finance it. But our borrowing – now mostly in the form of debt as net FDI and equity inflows have been sharply negative for the last few years – turns in the Orwellian language of the ERP into a “capital account surplus”. Of course, as the BOP is by definition in balance, a current account deficit needs to be financed with a capital inflow that is defined as a capital account surplus. But having the Chutzpah to title this deficit as a capital account surplus and then go on for the entire chapter to interpret all of the global current account imbalances as a matter of capital exporting countries (i.e. countries who run current account surpluses) and capital importing countries (i.e. the few countries who run current account deficits) is to confuse cause and effect. 

Also, the “capital inflow driven by superior U.S. returns” interpretation of the global imbalances ignores a few unpleasant facts.

First, the inflow is mostly in the form of debt – i.e. borrowing – rather than equity – FDI and equity portfolio inflows; such equity flows have been outflows out of the U.S. to the tune of $200b net per year for the last few years. So much for the foreigners investing in our superior capital.

Second, the performance of the US equity markets since 2000 has been dismal both in absolute terms and relative to returns in emerging markets and even Europe and Japan. So much for the superior returns on U.S. assets.

Third, the fact that U.S. net factor income payments have been until now positive in spite of the U.S. being a net debtor country is explained by the fact that recorded returns by the U.S. on its foreign assets are much higher than foreign returns on their holding of U.S. assets. So much for the superior returns of the high growth U.S. assets.  

Fourth, most of this “inflow” (call it more properly borrowing binge) is coming on net not from willing private foreign investors wanting to invest in U.S. assets but rather from political agents, i.e. foreign central banks that are oblivious to the low returns on U.S. Treasury bills and bonds (and capital losses once the dollar falls) and are lending cheaply to the U.S. Treasury. So much for the rest of the world wanting to buy U.S. assets and we thus generously running a current account deficit to accommodate this portfolio demand for U.S. assets.

The ERP makes a token passing remark to the fact that the US capital account “surplus” is matched by a shortfall of savings relative to investment. But after grudgingly acknowledging that a shortfall of public savings (i.e. a fiscal deficit) may cause a current account deficit, it goes – like Bernanke did in his glut speech – on trying to argue – based on a calibration, not econometric, study  done by the Fed – that fiscal policy has little effect on the current account. Of course, if you build and calibrate a  simulation model where infinitely lived agents are Ricardian, by definition you will get the result that fiscal policy has no effects on the current account (it is like proving the result by assuming it by the choice of Ricardian consumers).

Contrast this “un-named Bernanke” interpretation of the US current account deficit as a capital account surplus with the serious concerns recently expressed by the New York Fed President Tim Geithner about the unsustainability of the US current account deficit. So, if you want straight talk rather than doublespeak about the US current account deficit, read Geithner. Bernanke has promised to use plain English rather than the Delphic oracle language of Greenspan; but if the ERP is an indication, we may be in for plain English doubletalk about the current account, the budget deficit, the relation between asset prices and monetary policy, the lack of savings, the housing bubble and a few other unpleasant facts and vulnerabilities in the U.S. economy. We will see his testimony to Congress this week…

 

20 Responses to “Orwellian Chutzpah and Doublespeak in the Economic Report of the President: the US Current Account Deficit Becomes the “US Capital Account Surplus””

HKFebruary 13th, 2006 at 11:20 pm

Really amazing is the ability of some economists to doubletalk like those officials in “1984” written by George Orwell.  However, the fact that the US current account deficit is now largely financed by central banks rather than by the private sector does not necessarily guarantee that the current account rather than the capital account is the cause. Certainly, the US current account deficit is not financed by the “willing private investors”, but may be financed by the equally “willing public investors”, which is the thesis of the Bretton Woods 2.  Therefore, in order to refute the doubletalk, a more subtle analysis is needed. And then, it is not easy, because everything is determined in a general equilibrium way. Some criteria of “passivity” of public sector investors must be established, and it must be empirically confirmed.  One thing is clear. Crude savings glut hypothesis can be refuted, since there are no superior returns of US assets, nor strong demand by foreign private investors for US assets. But the BW2 thesis is difficult to refute. It may only disappear when it unravels, which is almost a tautology!

Dave ChiangFebruary 14th, 2006 at 10:10 am

Stephen Roach writes an excellent editorial today about the dangers of Asset bubbles, and the implication for America’s economic future. Capital has been massively misallocated, and structural deindustrialization has permanently damaged the US Economy. My comment; both the Greenspan Federal Reserve and Bush Administration continue to get a free pass for gross mismanagement of the US Economy.    Stephen Roach  http://www.morganstanley.com/GEFdata/digests/20060213-mon.html#anchor0

GuestFebruary 15th, 2006 at 5:07 am

Nouriel: I am amazed by this writing of yours. You seem to suggest that “because the national accounts say that current and capital accounts must offset, then OF COURSE running a CA deficit implies a KA surplus”. But national account identity occurs as a result of voluntary actions! If NOBODY wants to send capital to the US, then the US CANNOT run a current account deficit. That is, you cannot borrow if nobody lends to you. The question for you, Nouriel, is why are foreigners so stupid to lend to the US if it is such a bad deal for them? Cheers from upper west Manhattan   Xavier

JaredFebruary 15th, 2006 at 8:28 am

Xavier,  10% of our Treasuries are owned by the Chinese. The Chinese are very risk adverse with their reserves. They don’t care about their reserves growing through high interest rates, they only want their reserves to be stable. However, their reserves will grow by the Chinese continued manipulation in the exchange rate market (maintaining the low exchange rate that currently exists between the Yuan and Dollar). As long the dollar doesn’t sky dive, the Chinese will continue on their happy (but un-sustainable) road to export-led growth.  -Jared

hyalyFebruary 15th, 2006 at 8:29 am

Does any body know how much of our CA is financed by the oil revenues? I hear a lot about the huge oil revenue in the ME, but no body knows where it is going?

CharlieFebruary 15th, 2006 at 9:37 am

Hang in there. Eventually you’ll be proven correct. Japan kept up their BWII regime for what, 15 years? They stopped when China took over. China looks like they may repeat Japan and keep it up for another 15. It doesn’t matter what our deficits are. The central bank of China sees bigger risk in civilian unrest due to lack of jobs than currency losses. It’s easier to create Yuan and give it to banks, if needed, than to quell a billion or so unhappy people. As long as China is devaluing their currency, other asian nations have to do the same to compete with them. I don’t see an end to this in the near term.  I agree that the report is misleading, but what do you expect? This is coming from the same group that claimed Iraq has weapons of mass destruction that were going to terrorists who were ready to use them at any time. We had to invade as quickly as possible.  

Raimund Dietz - ViennaFebruary 15th, 2006 at 10:11 am

I find the interpretation by the President absolutely correct. First: There is a saving glut in the world. Second: the USA actually is the most attractive country of destination for moneys in the world. These two factors lead to the inflow of capital and generates the currenct account deficit. Hence the USA, in his president´s view, are simply seen as victim of the misallocation of international capital. I have only two questions: First, why there are so many idiots investing their money into USA though they never will earn a penny, not to speak of getting back any money. That is, why are markets so irrational?) Second: Why does the government allow becoming a “victim” of the irrationality of international capital markets that the their governments were so busy to deploy? I miss any political responsibility. (Raimund Dietz, Vienna, http://www.rd-coaching.at)

W. Raymond MillsFebruary 15th, 2006 at 10:40 am

“These two factors lead to the inflow of capital and generates the currenct account deficit”  This sentence expresses the fallacy that underlies the President’s report.  The inflow of capital is always larger than the capital account, which, by definition, is equal (theoretrically) to the current account.  For example, in 1991, the U. S. had an inflow of 67 billion dollars but a balance on the capit account of 4.8 billion (composed of -3.7 billion of the current account and a statistical discrepancy of -1.1 billion). For the last decade or so, the inflow of capital has greatly exceeded the gain in the capital account. That is because the gain on the capital account is limited to the sum of statistical discrepancy plus the current account.  Berneke and all his supporters need to read the textbook “International Economics” by Krugman and Obstfeld. The data quoted above is found on page 319 of the Third Edition.

gbushFebruary 15th, 2006 at 10:54 am

Nouriel, According to this morning’s TIC data release for 2005 as a whole, “foreign official purchases” of U.S. assets totaled $114.7 billion in 2005 or 10.9% of total foreign purchases which were $1.05 trillion. In 2004 foreign official purchases were $235 billion or 25.7% of total purchases. Private net purchases of U.S. assets increased 37.1% from 2004 to 2005. Central banks have greatly reduced their purchases of U.S. assets over the last 12 months but private foreign investors have more than taken up the slack. The largest capital inflows have been in to U.S. corporate bonds while purchases of U.S. treasuries were also solid. This makes perfect sense. The U.S. economy has preformed very well relative to its major trading partners, the Fed has tightened policy to a far greater extent than other major central banks and U.S. companies have very attractive balance sheets. U.S. corporate bonds and U.S. treasuries offer a high risk-adjusted return to international portfolio investors. So I disagree with you when you imply that the U.S. current account deficit is funded almost exclusively by “political agents”. This is plainly untrue.  Secondly, there is considerable evidence that the budget deficit is not a key determinant of the current account deficit. Here’s just one study on that subject: http://www.cbo.gov/ftpdocs/40xx/doc4002/2002-5.pdf  The budget deficit improved in the mid to late 1990’s and the current account deficit widened considerably. The budget deficit has also improved in the last year but the current account deficit has again widened. The CA is primarily driven by the relative economic growth rates of the U.S. and the rest of the world (on a trade-weighted basis) and not by the U.S. government budget position.   On the larger issue of what should be done about the U.S. current account deficit I propose this thought experiment: if the U.S. could implement a policy that would raise its trend rate of GDP growth (say, by improving its labour market performance) should it do so? If it does, what will happen to the current account deficit?  Conversely, if the rest of the world pursued a policy that worsened its labour market performance and thus lowered its trend rate of growth, what would happen to the U.S. current account deficit? If the current account deficit widened as a result, should U.S. policymakers do anything about it?   The only way for the U.S. to materially reduce its current account deficit is to pursue policies that will slow down its trend rate of economic growth. On that score, the cure would certainly be worse than the disease. Then again, perhaps all of this talk about “unsustainable global imbalances” is really just Orwellian speak for “major U.S. tax hike”.  Greg in Canada 

gbushFebruary 15th, 2006 at 10:54 am

Nouriel, According to this morning’s TIC data release for 2005 as a whole, “foreign official purchases” of U.S. assets totaled $114.7 billion in 2005 or 10.9% of total foreign purchases which were $1.05 trillion. In 2004 foreign official purchases were $235 billion or 25.7% of total purchases. Private net purchases of U.S. assets increased 37.1% from 2004 to 2005. Central banks have greatly reduced their purchases of U.S. assets over the last 12 months but private foreign investors have more than taken up the slack. The largest capital inflows have been in to U.S. corporate bonds while purchases of U.S. treasuries were also solid. This makes perfect sense. The U.S. economy has preformed very well relative to its major trading partners, the Fed has tightened policy to a far greater extent than other major central banks and U.S. companies have very attractive balance sheets. U.S. corporate bonds and U.S. treasuries offer a high risk-adjusted return to international portfolio investors. So I disagree with you when you imply that the U.S. current account deficit is funded almost exclusively by “political agents”. This is plainly untrue.  Secondly, there is considerable evidence that the budget deficit is not a key determinant of the current account deficit. Here’s just one study on that subject: http://www.cbo.gov/ftpdocs/40xx/doc4002/2002-5.pdf  The budget deficit improved in the mid to late 1990’s and the current account deficit widened considerably. The budget deficit has also improved in the last year but the current account deficit has again widened. The CA is primarily driven by the relative economic growth rates of the U.S. and the rest of the world (on a trade-weighted basis) and not by the U.S. government budget position.   On the larger issue of what should be done about the U.S. current account deficit I propose this thought experiment: if the U.S. could implement a policy that would raise its trend rate of GDP growth (say, by improving its labour market performance) should it do so? If it does, what will happen to the current account deficit?  Conversely, if the rest of the world pursued a policy that worsened its labour market performance and thus lowered its trend rate of growth, what would happen to the U.S. current account deficit? If the current account deficit widened as a result, should U.S. policymakers do anything about it?   The only way for the U.S. to materially reduce its current account deficit is to pursue policies that will slow down its trend rate of economic growth. On that score, the cure would certainly be worse than the disease. Then again, perhaps all of this talk about “unsustainable global imbalances” is really just Orwellian speak for “major U.S. tax hike”.  Greg in Canada 

CassandraFebruary 15th, 2006 at 12:59 pm

Dr Roubini,  (1) Bernanke (& posse) talk of “savings glut” as if it were some kind of stable intermediate-term equilibrium. Yet the very label “glut” seemingly implies something is askew with supply that is divergent from some expectated equilibrium. What gives?   (2) You said: “The only way for the U.S. to materially reduce its current account deficit is to pursue policies that will slow down its trend rate of economic growth. On that score, the cure would certainly be worse than the disease”   Are you suggesting that on some kind of society-wide DCF measure of overall welfare, that a smaller corrective recession to-day is less preferable than a larger contractionary adjustment in the future? Is this somehow an incorrect characterization of our choices faced as we are with reversing behaviour & policies that are evidently unsustainable?    

W. Raymond MillsFebruary 15th, 2006 at 1:15 pm

“Nouriel: I am amazed by this writing of yours. You seem to suggest that “because the national accounts say that current and capital accounts must offset, then OF COURSE running a CA deficit implies a KA surplus”. But national account identity occurs as a result of voluntary actions! If NOBODY wants to send capital to the US, then the US CANNOT run a current account deficit”.  The U. S. will run a current account deficit any time our imports exceed our exports. The numbers for the current account are collected from U. S. customs officials and are what they are regardless of the Capital Account. The capital account MUST adjust to the level of the current account.   When imports exceed our exports by 712 billion dollars, that requires that foreigners have in their possession 712 billion of U. S. financial assets – usually in the form of dollars. In the normal course of events, these dollars ultimately are returned to the U. S. to be exchanged for other U. S. assets that are more useful than the dollars. Foreigners return dollars to the U. S. because they prefer other U. S. assets to dollars.  No mystery to this and no preference for U. S. assests over other countries assets. They own U. S. assets due to the trade deficit – that is the reason they swap them for other U. S. assets.

W. Raymond MillsFebruary 15th, 2006 at 1:31 pm

“The only way for the U.S. to materially reduce its current account deficit is to pursue policies that will slow down its trend rate of economic growth”.  The above sentence assumes that the U. S. is the only country in the world that is unable to limit the number of imports that come into the country. It is obvious that the trade deficit could be reduced by reducing the level of imports.  The second erronous assumption is that protectionism (protecting a specific domestic industry) is the only was imports can be reduced. Not so. Tariffs can be applied to ALL imports from a limited number of nations (say the 5 that account for 60% of the U. S. trade deficit).  The only reason the U. S. does not limit imports is that Congress and the President do not want to do so. In turn, the current policy is a result of lack of serious thinking about international trade and the resulting destruction of a part of the manufacturing sector of the U. S. economy.

GuestFebruary 15th, 2006 at 2:44 pm

Given the track record and ideological DNA of the Bush Administration I don’t see how anyone could trust information prepared and released by their offices. No matter how we characterize the numbers monetary and fiscal policy makers still have the twin deficits to sort out and a highly leveraged asset bubble to deflate.

W. Raymond MillsFebruary 15th, 2006 at 8:21 pm

The assumption that the capital account controls the level of the current account has been widely believed by economists for years. That does not make it correct. It is in error. That assumption reverses the real causation.   The level of the capital account can only be deduced from the level of the current account (plus the error term). The actual measurement is to subtract all the outflows from the U. S. from all the inflows. Those inflows that are not produced by the trade deficit are asset-to-asset transfers, which, by definition, do not change the financial status of either trading partner. By contrast, the current account is measured directly by the reports of U. S. customs officials.  The total inflow of capital funds is not the same as the capital account. The level of total inflows bears no relation to the level of the capital account.  How could a whole profession accept, for years, this blunder?

CharlieFebruary 16th, 2006 at 2:35 pm

Greg In Canada,  You can’t trust the “foreign official purchases” numbers. Many foreign central banks purchase US debt via intermediaries. If you look at the official numbers, our biggest debt purchasers are private citizens in England and the Caribbean. Obviously this can’t be right. There’s a lot of money flowing from the Mid East and asian governments being deposited in accounts in England and caribbean islands and that money is invested in US debt. If you look at the change in official foreign reserves of USD help by foreign central banks, it’s way higher than official US purchases. China alone added around $200Bil in US reserves in 2005.  The budget deficit improved in the mid to late 1990’s and the current account deficit widened considerably. The budget deficit has also improved in the last year but the current account deficit has again widened. The CA is primarily driven by the relative economic growth rates of the U.S. and the rest of the world (on a trade-weighted basis) and not by the U.S. government budget position.  The budget deficit isn’t the only factor in determining the CAD. Sometimes our budget deficit can decrease, but our trade deficit increases more than our budget deficit decreases so our overall CAD goes up. This is what happened during the later Clinton years. Any time the US Gov’t has a treasury auction in which foreign entities buy up US Gov’t debt, it adds to the CAD. The only time a gov’t auction won’t add to the CAD is if the debt is purchased by US entities, which never happens any more.

Alan ReynoldsFebruary 16th, 2006 at 3:13 pm

I am impressed the longevity of alarmist hard landing scenarios, which have been consistenly wrong now for more than two decades.   The latest version worries that something awful would happen if foreign official purchases of U.S. assets slowed. Table B-103 in the Economic Report shows exactly what happens when that happens — nothing, absolutely nothing.   Foreign official assets increased by $394.7 billion in 2004, then abruptly slowed to an average of just $48.7 billion in the first three quarters of 2005. So where’s the hard landing?

Carl IconFebruary 16th, 2006 at 4:23 pm

I have long been impressed by Mr Reynolds protestations of Martha Stewart’s innocence, which have proven consistenly wrong now since her original accusatons.    His latest version suggested that nothing awful should happen since she didn’t break any laws. But the jury showed exactly what happens when someone breaks the law — something, something absolutely awful like prison.    

W. Raymond MillsFebruary 16th, 2006 at 8:08 pm

The fundamental issue underlying this discussion is the direction of causation. If causation goes only from the curreent account to the capital Account, as I maintain, the guys that are looking to inflows of funds into the U. S. as a cause of the trade deficit are barking up the wrong tree. That included Bermeke and the Economic report of the President, Wilson above “Any time the US Gov’t has a treasury auction in which foreign entities buy up US Gov’t debt, it adds to the CAD.”, gbush ” The only way for the U.S. to materially reduce its current account deficit is to pursue policies that will slow down its trend rate of economic growth”.

TegorMarch 17th, 2006 at 10:51 pm

Nouriel,   Your assertion that dynamic scoring is voodoo is either made for politcial motivations or out of ignorance. Dynamic scoring is legitimate are of research within economics.   Your doomsday speak is getting old. You have been wrong for too long to be a credible voice. You are the one who needs to revisit his beliefs about how the economy works. I advise you to accept that using tautological reasoning is NOT economic reasoning. It’s just textbook rhetoric.   I would offer that you explain why we are so far from equilibrium. Maybe you should read some of Brian Author’s or Day’s work on non-equilibrium dynamics.   I will go a step further and say that your failure to employ any modeling structure reduces your assertions to simplistic logical arguments that are not sufficient to cope with a multi-dimentional problem.   In summary, your piece sounds more like a politcial rant than a fact based argument from an economist. If you wish to rant please don’t refer to yourself as an economist. Just refer to yourself as Dean.   PS. Looking smarter than Bush is not hard but you are failing.