Nov 1 2004

The Budget Deficit’s Bigger Brother

Editorialists ignore looming trade gap

Everyone knows the federal budget deficit is a lurking danger, a dagger pointed at the heart of our economy. We know this in large part because newspaper editorials keep telling us so. The budget deficit is one of the few issues on which editorialists feel free to challenge both political parties, where they regularly advance their own proposals instead of simply reacting to the plans put forward by politicians. It’s a subject that inspires them to appeal to “vision” and “boldness” and “radical reform,” instead of the tepid me-too-ism that they normally serve up. Media pundits play the role of perpetual scolds, always on the alert for signs of deficit backsliding, or “fiscal indiscipline,” on the part of political leaders.

Thus the extravagant rhetoric. To the New York Times, deficits are “huge” (5/2/04), “mounting” (3/18/04), “mushrooming” (3/18/04), a “travesty” (5/23/04); they have “exploded” (9/3/04). For the Washington Post, the “stunning deterioration” (9/14/04) in the fiscal account has yielded a “looming budget crisis” (8/17/04) and “monster deficits” (8/16/04)—so “scary” (9/14/04), so “deadly” (8/17/04), that all we can do now is sorrowfully contemplate “the inevitable pain of extricating the country from this fiscal hole” (7/26/04).

Pundits give two reasons for their continuous alarm over the deficit. The first is that, as the Washington Post wrote, the budget gap is “sentencing the nation” to “punishing interest costs” in the future (8/17/04). In other words, taxpayers will end up paying the costs of today’s deficits tomorrow. The second reason, as the New York Times tells us (2/12/04), “is the stuff of Econ 101 orthodoxy: If the government gobbles up too much credit, it drives up the cost of capital for the rest of us.” As a result, deficits are “endangering the economy” (Washington Post, 9/14/04) and pose “a threat to the nation’s long-term economic health” (New York Times, 3/18/04).

Big and bigger

The federal budget deficit is certainly big. The 2004 gap between federal spending and receipts is forecasted to be $415 billion, about 3.5 percent of this year’s GDP. (All budget statistics are taken from the Congressional Budget Office.) And it shows no signs of going away, with red ink predicted to continue through 2014, albeit at a shrinking rate. Assuming that George W. Bush’s tax cuts are made permanent and allowing for likely changes in the alternative minimum tax and discretionary spending, the deficit can be expected to rise.

The budget gap does impose interest costs on taxpayers. It also, as the Times wrote, “gobbles up credit”—that is, it dips into the pool of national savings, thus lowering the amount available for private investment. But there is something strange about the editorialists and their alarm about government borrowing. They are studiously ignoring a much larger deficit than the one in the federal budget, one that promises even higher interest costs and represents an even greater drain on national saving: the trade deficit.

Last year’s current account deficit—a broad measure of the foreign trade and payments imbalance—was more than $530 billion, as compared to a budget deficit last year of $375 billion. In 2004, it has risen further, and is expected to total more than $584 billion by year’s end. (Unless otherwise indicated, all balance of payments data are from the Commerce Department’s Bureau of Economic Analysis.)

Although it is seldom explained in news coverage, the trade deficit, like the budget deficit, represents actual borrowing: To finance last year’s trade gap, Americans had to borrow $530 billion from non-Americans. These loans come mostly in the form of bond sales: Foreigners buy billions worth of U.S. corporate, mortgage and government bonds, in effect lending Americans the money they need to import more from the rest of the world than they export.

Since the trade deficit results in foreign borrowing, it also results in foreign interest payments. Last year, Americans paid out more than $261 billion to foreigners to service the foreign debt. At the moment, those interest costs are balanced out by the mirror-image payments that foreigners must make on American-owned assets abroad. But the latter consist mostly of factories and businesses in other countries, many of them established decades ago.

Americans are not acquiring nearly enough new assets of this kind to balance the skyrocketing rate of foreign borrowing.

That’s why, under conservative assumptions, the net interest payments Americans make to the rest of the world are projected to increase rapidly from essentially zero today to more than 1.5 percent of GDP by 2008 (Levy Economics Institute, Strategic Analysis, 8/04). And that figure is expected to keep growing. It must also be kept in mind that while the federal debt is owned mostly by Americans (resulting in interest payments transferred from the U.S. government to U.S. taxpayers), the trade deficit is, by definition, owed entirely to foreigners, who receive all of the interest payments.

Changing the subject

So is the trade deficit “sentencing the nation” to “punishing interest costs”? If it is, you probably haven’t read about it in an editorial lately. The Washington Post editorial section, for example, which coined the above phrase about the federal deficit, has barely addressed the trade deficit this year. The New York Times published one editorial about it.

Whenever the subject is broached, the blame is invariably brought back to the budget deficit. A January 5 Times piece noted the growing trade gap but the editorialists, immediately after reporting the grim facts, hurried back to the topic closer to their hearts: “The Bush administration and Congress could have greatly enhanced the economy’s prospects if they had been more responsible in their spending.”

After a Group of 7 meeting last February where the U.S. current account deficit was a subject of concern, the Post (2/8/04) ran an editorial that did call the trade gap “scary,” but its prescription was predictable: “A responsible U.S. administration would do its part by cutting the federal budget deficit, because government borrowing is a large part of what drives U.S. dependence on foreign capital.” Another Times column (1/12/04) picked up on a recent IMF report warning the U.S. about its current account deficit. This was adduced as a sign of “Washington’s fiscal recklessness.”

This conflation is partly a legacy of the 1980s, when both gaps were rising, giving rise to talk about “twin deficits.” The catchphrase fostered the impression that the budget deficit somehow causes the trade deficit, conveniently allowing pundits to prescribe fiscal retrenchment as a cure for the trade gap. This notion has reappeared now that the deficits are again rising in tandem.

But, in fact, at any given time a nation can experience one deficit and not the other. For most of the 1960s, for example, the U.S. ran large trade surpluses even as the government was in deficit. In the ’90s, the opposite happened: The budget gap vanished, and even turned into a large surplus, yet the trade deficit climbed to historically unprecedented proportions. Clearly no direct relationship exists in practice.

Selling “free trade”

If the budget deficit is not the cause of the trade deficit, what is? By definition, a trade deficit is equal to the gap between saving and investment. Last year’s $530 billion current account deficit represented the portion of U.S. investment that Americans were unable to finance domestically due to insufficient national saving. Because we had to borrow from abroad to pay for that investment, we will not be able to fully enjoy its benefits in the future.

Instead, we will have to devote an increasing share of the benefits to paying off the debt we incurred to finance the investment in the first place.

If that sounds familiar, it should. It is almost exactly the same reasoning that leads editorial pages to denounce government borrowing as a threat to the economy: “Persistent, large deficits slow economic growth by raising interest rates and dampening private investment” the Post wrote (1/27/04). “Continuing high deficits will further threaten job creation and living standards,” explained the Times (8/12/04). Yet just as with the budget deficit, the trade deficit means higher consumption today at the expense of lower consumption in the future.

If editorialists were truly so concerned about the risks to future prosperity, one might expect them to pound the table at least as loudly about the trade gap as they do about the budget deficit. They are always complaining, after all, about politicians who ignore the economic realities of the budget in order to pander to their political constituencies. The Post has condemned both Bush’s tax cuts (“shortsighted and reckless,” “stuffed with giveaways”—8/17/04) and Kerry’s stance of “cavalierly promis[ing]” not to cut Social Security benefits (9/14/04). “That may help him get elected; it won’t help him govern,” the paper sniffed.

But the editorialists, too, are hawking a political product: free trade. Warning about the danger of the trade deficit, however real the economic threat, is politically awkward, given the anxieties about trade the subject elicits. As the Washington Post (3/27/00) was quick to warn in an editorial during the boom: “In the past, government has tried to fight trade deficits with protectionism.” But “trade barriers,” the paper sternly observed, “do nothing to cure the root cause of a trade deficit.”

Who pays?

That may or may not be true. But a glance at the solutions that editorial pages do endorse reveals starkly where their priorities lie. Both the trade and budget deficits are thought to weaken the economy by causing low national savings. Fixing the problem is simple, in principle: Americans have to spend less on consumption goods, a broad category that encompasses everything from college educations for the poor to luxury cruises for millionaires—and includes both private purchases and government services. Out of all these myriad options, the editorial pages have made their favorite targets clear: health care and Social Security.

The New York Times (4/4/04, 10/2/04) has proposed cutting Social Security cost-of-living increases, increasing the retirement age and raising payroll taxes on both poor and affluent workers: “To us, the best reform packages are the fairest. They contain proposals that do not grasp for all of the needed revenue from high-income taxpayers, and are not overly reliant on benefit cuts for the elderly.”

The Washington Post (8/17/04) aimed its fire at Medicare: “The good news is that huge savings are possible in this area,” it cheered. Citing an academic study showing that some regions spend much more on Medicare than others, the paper recommended cutting health spending in the high-cost areas. This could be done, for example, “if the feds capped the number of heart surgeries or MRIs in each region.” The only problem, of course, is that “it would take huge political will” to do this: “Enforcing efficiency will not be easy”; “retirees would stage a revolution against ‘rationing.’” The Post expressed hope “that this political constraint could somehow be overcome.”

In other words, behind the papers’ ostensibly neutral, “Econ 101” warnings about economic realities lie unmistakable choices about who should get what. Rather than propose, say, taxes on luxury goods, new levies on the rich, or finding ways to extract monopoly profits from drug companies—all proposals that would require plenty of the vaunted “political will” the pundits so relish—the editorial pages want to reduce the consumption of people who rely on Social Security and Medicare for their health and welfare.

Well-fed opinion writers may talk a good game about “tough choices” and “inevitable pain.” But the pain always seems intended for somebody else.