Receive free US economy updates
We’ll send you a myFT Daily Digest email rounding up the latest US economy news every morning.
The writer is a finance professor at Peking University and a senior associate at the Carnegie China Center
While much of the debate about limiting US government debt assumes that rising debt is a consequence of profligacy on the part of Washington policymakers, the problem is in fact structural. Americans are forced to choose between rising debt and higher unemployment largely because of the level of income inequality in their country — exacerbated by the large US trade deficit — that has sharply reduced the consumer demand for American businesses and manufacturers.
The rise in income inequality is the key driver of debt. Because the wealthy save a much larger part of their income than do workers or the middle class, and use a much smaller part for consumption, rising income inequality automatically reduces overall consumption and forces up savings by effectively transferring income from high consumers (ordinary Americans) to high savers (the wealthy).
If the higher resulting savings funded higher investment by US businesses, this would be a good thing for the economy. Lower consumption would be balanced by higher investment, with total demand remaining the same in the short term and rising in the longer term as more investment caused growth to accelerate.
But must more savings lead to higher investment? This belief is at the heart of supply-side economics, but while it was true many decades ago, when business investment was mainly constrained by scarce savings and the high cost of capital, it is no longer true today, when it is constrained mainly by weak demand. Business investment has not risen in line with the savings of the wealthy.
This creates a problem for the economy. If lower consumption is not balanced by higher investment, total demand must decline, and in response businesses will cut back on production and fire workers. To prevent this from happening, Washington typically does one of two things.
First, the Federal Reserve can implement policies that encourage household borrowing to fund additional consumption. In that case, the reduction in the income share of ordinary Americans is balanced by an increase in their borrowing, so the same level of consumption can be maintained.
Second, Washington can itself borrow and use the proceeds to replace the demand lost by the reduction in household consumption. Borrowing is effectively the opposite of saving, and by increasing the fiscal deficit, the US can undo the adverse consequences of rising savings among the wealthy.
There is a third option for many economies. If a country’s savings rise faster than its investment — or if demand declines relative to production — it can export the excess production in the form of a trade surplus.
But the US cannot do this. Because of its open and well-governed financial markets, the rest of the world prefers to offload its excess savings there so the US is a net importer, not a net exporter, of savings. This will happen as long as foreign central banks, businesses, oligarchs and owners of financial assets can employ their surpluses in unfettered access to American stocks, bonds, factories and real estate.
These net inflows push up the value of the dollar and make US manufacturing less competitive, so rather than run trade surpluses to manage the country’s excess savings, the weak demand created by income inequality is exacerbated as America runs the trade deficits needed to absorb excess foreign production. To stop unemployment from rising, either the Fed must encourage even more household debt or Washington must run even larger fiscal deficits.
The mistake lawmakers make is to assume that rising debt in the US is the consequence of irresponsible behaviour on the part of American households and the government. In fact, it is a structural problem, and the choice Americans face is not between more debt and less debt but rather between more debt and more unemployment.
As long as Americans are willing to accept high levels of income inequality and large trade deficits, this is the trade-off the US must continue to suffer. To get debt under control without raising unemployment, Americans must eliminate downward pressure on demand by reversing several decades of policies that favour income inequality or that allow foreigners to dump their excess savings and excess production into the US.
That is why for all the excited debate, debt ceilings won’t limit the rise in US debt. They just allow Congress to pretend that it is doing something meaningful about America’s surging debt burden.
link
