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July 12, 2005
More on Wealth, Trade and Productivity
Brad Setser disagrees with my post "Not so scary? Why national wealth matters"
He has two objections. First, that the end of the global savings glut will raise interest rates and reduce national wealth.
The US would be in trouble if global savings just stopped flowing into the US at current rates. Higher interest rates would simultaneously: increase the burden of servicing the existing stock of US debt, make it harder to raise the financing needed to sustain ongoing external deficits and reduce US household wealth.
Brad's second objection is that I should be comparing external debt to external assets, not domestic assets.
Remember that external debt ultimately is a claim on the United States future export revenue.
New homes – and higher prices on existing homes – won’t help pay the interest on the US external debt. A new Boeing production line would.
Of course, the US could sell off some of the new homes now being built in the US to its foreign creditors to pay down its debt – but that only really works if the United States’ creditors ultimately want to come and live in the US.
Before addressing Dr. Setser's individual objections, let me make a big point first (I call him Dr. Setser because he was nice enough to call me as Dr. Mandel). The Federal Reserve publishes data on household wealth, which is what I used. But the wealth of a country can also be thought of as the flow of future returns on its assets, discounted appropriately. These future returns include profits, interest, and the use value of residential real estate.
If we expect the economy to grow faster in the future, then it's reasonable to expect that future profits, interest payments, and the use value of residential real estate will grow faster as well (assuming that everything stays at the same share of GDP). That would lead to a higher estimate of today's wealth.
Guess what? Over the past ten years, there's been a dramatic increase in expected sustainable productivity growth. Back then, the consensus of economists was that the U.S. could sustain an annual whole-economy productivity gain of roughly 1% a year. Today, the expectation is that 2% is roughly the right rate of sustainable productivity growth.
A little calculation shows that a shift from 1% long-term productivity growth to 2% long-term productivity growth produces a 40% increase in real wealth (Assumptions: 75 year time horizon, labor force growth following the intermediate scenario of the Social Security Trustees, real interest rate of 2.5%)(Note: a 4% real rate still gives a real wealth increase of 30%).
To put it differently: If productivity was still growing at the slower rate, household net worth today might be closer to $35 trillion, instead of the current $49 trillion. In real terms, household net worth would be at 1996 levels.
Isn't that interesting?
I see the increase in U.S. wealth as something real, based on expectations of future productivity growth. And I see the influx of foreign capital as an attempt to tap into the future expected growth of that wealth.
From that perspective, I disagree wholeheartedly with Dr. Setser's second objection, that I should only be comparing external debt with external assets. In a world with diminishing home bias, there's less and less difference between domestic assets and external assets, especially for a country like the U.S. Foreigners buying U.S. homes and renting them out is no different than Toyota opening up a factory in the U.S., or Intel opening up a factory in Ireland.
Dealing with his first objection is a bit more complicated. I can imagine a world in which productivity accelerates in Japan and Europe, so that they become more attractive places to invest. In that event, real wages and consumption in those areas should pick up as well. In such a world, the global real interest rate might very well rise.
But I'm afraid that I can't view a world in which our main trading partners finally manage to dig themselves out of the productivity doldrums, and create more domestic demand, as ultimately a bad thing for the U.S. An increase in global wealth can only be a plus.
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For what it is is worth, the Argentines made similar arguments from 99-01 when anyone asked about their (ugly) external debt to exports ratio:
"From that perspective, I disagree wholeheartedly with Dr. Setser's second objection, that I should only be comparing external debt with external assets. In a world with diminishing home bias, there's less and less difference between domestic assets and external assets, especially for a country like the U.S. Foreigners buying U.S. homes and renting them out is no different than Toyota opening up a factory in the U.S., or Intel opening up a factory in Ireland."
I don't think financial globalization/ reduced home bias has eliminated the basic constraints created by the balance of payments. External debt ultimately is a claim on future US export revenues -- reduced home bias may make it possible to accumulate more external debt in the past. But as Bill GRoss has pointed out, that jsut means more of future US GDP (and specifically US export production) will have to be devoted to paying US foreign creditors in the future.
If US net external debt stabilizes at 50% of GDP, and that debt carries a 5% nominal rate (and there are no gains from intermediation on the portion of US gross debt offset by gross external assets), the US would need to devote 2.5% of its national income to servicing its external debt. that is a transfer out of the US.
And i suspect it matters whether than is 25% of US export revenue (X = 10% of US GDP), or 10% of US export revenues (x = 25% of US GDP).
I also suspect it will be hard to run a 6% of GDP trade and transfers deficit AND a -2.5% of GDP balance on income. that produces a current account deficit of 8.5% of GDP, rising external debt to GDP, and rising net interest payments.
Posted by: brad at July 13, 2005 06:50 AM
The Argentina economy did not have strong productivity growth before its crisis--it was a very different situation.
And if the U.S. needs to devote 2.5% of GDP to servicing its external debt, that doesn't seem terribly distressing to me, as long as the U.S. economy is growing.
Posted by: Michael Mandel at July 13, 2005 03:10 PM
May I add that Agentina's debt are denomiated in US$, and Argentina had no control on the exchange rate of its debt?
p.s. I prefer to use the current market value to prove your point that there will be surplus growth in GDP to finance the debt/interest payment. As I believe Discounted Cashflow can be controversial (some discussions in
) However, one probably has to show that, without these debts, the GDP growth will be smaller. And that the amount of growth related to such debt is larger than the interest due.
this could probably be done by comparing the ROCE in US vs the interest rate for the bonds
Posted by: sun bin at July 14, 2005 02:49 AM