From the open part of the FT website at <http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1042490855041&p=1012571727088>
No way to run the world's biggest economy By Stephen Roach Published: January 16 2003
The US economy is on the brink of deflation. Thankfully, Washington is trying to come to the rescue. The Federal Reserve has led the way. Now the Bush administration and Congress are set to administer a fiscal stimulus worth $100bn, or 1 per cent of gross domestic product, over the next year.
If anything, this might be too little. With US GDP-based inflation at 0.8 per cent, its lowest for nearly half a century, policymakers should err on the side of excessive short-term stimulus. That can always be corrected if and when the economy is on the mend.
But the US economy also faces profound longer-term challenges. At the top of the list is a chronic shortage of saving - the driver of capital formation and the sustenance of any economy's economic growth. America's net national saving rate - the sum of personal, business and government saving after depreciation is deducted - plunged to a record low of 1.6 per cent of GDP in the third quarter of 2002. That is less than a third of the average of the 1990s and a sixth of the rate of the 1960s and 1970s.
Ever-widening federal budget deficits run the risk of a further plunge in national saving. That trend was evident long before the latest fiscal stimulus proposals. In the first quarter of 2000, the budget was in fact in surplus to the tune of 2.3 per cent of GDP and the net national saving rate stood at 6.4 per cent. By the third quarter of 2002, the budget had swung into a 1.8 per cent deficit - a deterioration in the fiscal balance that accounted for 85 per cent of the depletion in overall national saving since early 2000. Without offsetting higher private-sector saving - not exactly the goal of consumption-oriented policymakers - a steady stream of budget deficits could push national saving even lower.
That would be an unfortunate turn of events. To the extent that US growth cannot be financed by domestic saving, foreign investors must provide alternative funding. The US gets that capital by purchasing goods from overseas, the root cause of its massive trade deficits. Yet, in the end, this is a fool's game. America is running a record balance of payments deficit amounting to 5 per cent of its GDP. Rising budget deficits that lead to a further depletion of national saving will take the external financing gap up to at least 6 per cent, requiring the US to attract about $2.5bn of foreign capital each working day in 2003.
Ever-widening federal budget deficits not only reduce America's ability to finance investment but also leave it increasingly dependent on foreign lenders to close the financing gap. Overseas investors now own more than 18 per cent of the total market value of long-term US securities and 42 per cent of outstanding Treasury bonds - up dramatically since the 1990s. This is no way to run the world's dominant economy. A US short of savings simply cannot afford another era of fiscal profligacy without suffering the results of a sharply weaker dollar and/or a marked correction in other asset prices.
[a "sharply weaker dollar" = sharply higher interest rates if the necessary foreign lending is to continue under such circumstances AND "a marked correction in other asset prices" = bankruptcies & layoffs in the US. a recipe for a panic - JM]
Tax reform, including the elimination of double taxation of dividends, is long overdue. But the Bush administration's proposals need to be judged against the yardstick of national saving objectives. Without a recovery in savings, 10-year revenue loss estimated to be in excess of $360bn would prove hard to bear. Moreover, dividend tax cuts are hardly the best vehicle for a short-term stimulus. Payroll tax reductions would put more cash into the hands of consumers.
Most worrying is the temptation, prevalent in Washington, to use the same recipe that got America in trouble in the first place: overvaluing the stock market, thereby recreating the bubble-induced excesses it prompted in the real economy. Both the Fed and the Bush administration seem more than willing to embrace stock market targeting as a means to jump-start a sagging US economy. And the Democrats' plan urges a stimulus to business capital spending - the last thing that a deflation-prone economy awash with excess capacity needs. This is a film we have all been to before.
["a deflation-prone economy awash with excess capacity" - have to check to see if Morgan Stanley subscribes to MR]
The US needs a sizeable short-term stimulus to prevent deflation. But a US economy short of savings cannot afford the luxury of several years of tax cuts and depleted revenues associated with reforms, even if these reforms are long overdue. Nor can it risk the pitfalls of stock market targeting. Those policymakers in Washington who think it can, have yet to learn the lessons of the roaring 1990s.
The writer is chief economist of Morgan Stanley