The third area of concern is the question of sustainability, and I promise this will be my last entry on this accursed subject (at least for now). One of the things that worries most obervers about the US trade deficit, even if they think it is currently manageable, is whether it is sustainable. If the US runs trade deficits equal to 5% or more of GDP forever, they worry, at some point external debt levels will accumulate to the point where the US will be unable to pay, except at a terrible cost to domestic consumption and wealth.
This is true arithmetically only as long as the total value of US assets grows less than the amount of the US current account deficit. I have no idea if this is or isn't happening, but it seems to me that one of the consequences of foreign investment in the US historically has been that total US wealth always climbs faster than foreign claims on US wealth, and I see no reason to assume it isn't still happening. If this is indeed happening there is no reason why US trade deficits cannot go on forever, as they have for most of our history.
But they won't go on forever anyway. I already mentioned that on the eve of WWI the US was the world's leading debtor nation, and it is worth noting that it was the world's leading creditor nation four years later. How did that happen? Obviously enough the European belligerents had to liquidate their US investments profitably accumulated over generations in order to pay for the war. They then ran substantial trade deficits with the US during the war, resulting in a massive accumulation of US claims against them.
I think something like this is going to happen in the next few decades -- not because of war but because of something that will have any equally dire economic impact. Europe, Japan, China and Russia all face severe demographic crises which will probably entail rising consumption levels and flat or declining production as their working populations decline as a share of total population. That means they all are likely to run long term trade deficits at some point in the future as they work themselves through their crises.
The US on the other hand is the only major country, besides India, that doesn't have a serious demographic crisis looming (it has a pension crisis, with which it is often confused, but that is a different thing). With its deep markets and flexible and safe financial system, it is the only country against which the others can accumulate claims, and these claims will be worked out in the form of increased US export in the future.
By allowing these countries to accumulate claims against the US (i.e. by running trade deficits with them), the US is actually helping to create the necessary conditions which will allow for a smooth transfer over the next few decades. It is also worth pointing out that foreigners' trade surpluses with the US today are what will finance their trade deficits in the future, and as these countries age the goods and services they will need -- including health, technology, and information-related services -- are precisely the things that the US does better than anyone else.
When does this future take place? It's hard to say, but it is worth noting that after watching its dependency ratio deteriorate sharply from the 1950s to the 1970s, China saw a dramatic improvement in its dependency ratio from the mid-1970s until now (as the one-child policy eliminated the young from the number of dependents). This improvement in the dependency ratio will reverse itself around 2010 and begin to deteriorate dramatically as the shortage of children becomes a shortage of workers. So worrisome are the numbers that several China scholars have called for even higher foreign reserves to help China pay for this future demographic crisis and have warned that a declining working population will soon place significant wage pressure on manufacturers.
Keep at the "accursed subject!" I cannot think of one more important in todays world and it seems very few people are focused on it. If you are correct (which I think you are), they soon will be. I would like to know your thoughts on (1) how you think the domestic "crunch" inside China will unfold; (2) assuming the U.S. imposes a tariff of some sort, will this trigger the "crunch;" finally, what is the Chinese end-game? i.e. how do they see themselves getting out of this dilemma? Sorry, I have more questions; just discovered your blog.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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December, 2007
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