The Continental Economics Institute Cash & Currencies Market Commentary. December 2006
Antony Mueller: Easy Money is the Drug for Pipe Dreams and Sand Castles
In 2005, the U.S. current account deficit reached 800 billion U.S.-dollars or 7 per cent of the U.S. gross
domestic product, and for the year 2006 we have to expect an even higher level. By any standards, this is a
frightening level, and the outlook is even worse, because there is no tendency in sight for a gradual reversal.
What we have to expect is that the re-balancing act will occur in a dramatic fashion, as a sudden collapse of
the dollar and the bond market. The collapse may be as outstanding as it is suggested by the size and
persistence of the US trade deficit.
In a macroeconomic accounting framework, the current account deficit reflects insufficient national savings
in relation to investment.
(EX – IM) = (SPR – IPR) + (TA – G)
NX = S - I
When leaving aside the unilateral transfers, the current account balance is given by exports (EX) minus
imports (IM) and is equal to private savings (SPR) and public savings minus private investment. Public
savings reflect the government budget balance in terms of government income (TA) and government
expenditure (G). Private and public savings together form national savings (S). This analysis point to
insufficient savings as the counterpart to a negative trade balance:
-NX = S < I
However, this conclusion is not as obvious as it may seem. Likewise as saying that there are insufficient
savings, one can also put forth the proposition that “too high” investment are the “cause”, and one might also
add that high investment can really be no problem because it is investment that brings about economic
growth. In this line of thinking the U.S. trade deficit would reflect the strength of the U.S. economy, and
instead of being a sign of weakness the deficit is an indicator of strength.
Other observers take the analysis even a step further and look at the equations above through the balance of
payments accounting. One can simplify the balance of payments (BP) by concentrating on the two sub-
balances of the current account (NX) and the financial and capital account (CF):
BP = NX + CF = 0
By this equation a negative NX would imply a positive CF. This simply means that the trade deficit is being
financed by a positive capital flows. However, one can also read the equation the other way around. Then the
inflow of capital would be the “cause” for the negative trade deficit.
This short analysis gives a list of the arguments that are put forth as to the “worry” and the “no worry”-position
regarding the trade deficit.
The no-worry position would interpret the figures and formulas in the way that it is high U.S. growth and
therefore strong investment that comes along with the trade deficit. The trade deficit by itself is no reason to
worry. On the contrary, it is actually the sign that the U.S. economy is strong.
In the context of the balance of payments accounting framework one could strengthen even more this line of
reasoning by arguing that the trade deficit reflects the positive capital flows that in turn show the high degree
of confidence that foreign investors have.
Putting these two lines of thinking together, the argument says that the U.S. trade deficit represents no
reason to worry, but on the contrary is the symptom of the strength of the U.S. economy as it is borne out by
the readiness of foreign investors and the strong real investment activity. The U.S. economy is growing and it
will continue to grow in the future and therefore neither private debt (low private savings) nor high
government debt (negative public savings) will pose a problem.
Most of the “worry”-positions will argue the other way round. In their view, the trade deficit is the result of
insufficient private and public savings. Their argument then says that the debt accumulation that comes with
insufficient savings is unsustainable. Some time in the future, foreign lenders will stop and the debt pyramid
comes crashing down.
In the Austrian perspective, all of these kinds of analyses are highly superficial. They focus on aggregates
that hide more than they reveal. And although the formulae may be of some help in structuring the analysis,
they are deceiving when it comes to detect the deeper roots and consequences of what has been going on.
What do these kinds of analyses leave out? It is mainly the aspect of capital. By neglecting capital and its
structure, the typical economic analysis is either too macro or too micro. Capital is the missing link between
the micro and the macro-analysis, and only by integrating capital into the analysis can one come up with a
solid result.
Where does capital fit into the context? First of all, the distinction must be made between capital as an
entrepreneurial plan, as an ordered structure of capital goods aimed at profits and financial capital, either in
the form of monetary savings or as an access to credit.
Under a fiat monetary system, money can be created by the central banks and in the commercial banking
system. In such as system, the money available need not represent authentic savings and it does not need
to reflect time preference. In the modern system, a loose monetary policy by the central banks and the private
banking sector affect the loan market on both ends: for the consumer and the business investor. Both sides
of the production structure, those nearer to consumption and those further away, i.e. the more roundabout
processes, get impulses. Both groups receive a signal from the monetary markets that says that there are
sufficient savings available. However, this is a misleading message. The consumer is duped into asking for
more consumption credit and businessmen are forced by the competitive pressure to load up on investment
loans.
Like a person who loads up on loans is said “to live beyond his means”, a similar situation occurs under
highly expansive monetary conditions for the whole economy. The apparent prosperity is built on sand. The
collapse of the dream castle is inevitable and the return to realistic possibilities becomes the more painful
the longer the excess has been going on.
(C) The Continental Economics Institute