Releveraging Does Not Equal Clear Skies
Tim Duy, via Hatzius at Goldman Sachs, thinks that the consumer will be ready to releverage by the end of next year:
“I think fiscal policy should refrain from deleveraging until the private sector is ready to relever. When will that be? Jan Hatzius of Goldman Sachs expects that releveraging to begin in the second half of 2013 – see his interview with Joe Weisenthal. If so, then the first half of 2013 will be stormy, but the sky will clear toward the end of the year and into 2014.”
Duy’s forecast may end up being right, but it’s hard to see how a releveraging cycle would be an indication of clear skies. After all, we just went through an epic credit binge, during which the personal saving rate fell to nearly zero percent, as consumers bid up a colossal bubble in the real estate market.
In fact, consumers are already saving too little. At only 3.4 percent, the personal saving rate is still way below levels witnessed in the 1950s, 60s, and 70s, when American consumers saved close to 10 percent of their income.
The difference between then and now? Well, the trade deficit, obviously:
Look, the next few years are going to be crucial. We can either get back to full employment through a reduction in the trade deficit (via an increase in foreign demand), or we can inflate another asset bubble. At more than 5 percent of GDP (that is, if the economy were at full employment), the trade deficit is simply far too large to be offset responsibly by other sectors in the economy. This is why we needed a $10 trillion stock-market bubble as well as massive amounts of equipment-and-software spending in the late-1990s to achieve full employment, and why we needed the largest real-estate bubble the world had ever seen in the mid-2000s to bring the unemployment rate down to just below 5 percent.
The trade deficit obviously isn’t going to normalize overnight. Economic theory would predict that the ultra-low interests rates of the past few years should have led to a gradual reduction in the value of the dollar, eventually closing the deficit – this story, however, gets complicated when half of the developing world pegs its currencies to the dollar at low rates. But that’s a prolonged process.
In the near term, we should look to support demand through higher public deficits. Since the markets are currently willing to lend to the US government for almost nothing in return, we should be taking advantage of the opportunity by spending more money on things like infrastructure, education, and research. Then later, when the dollar falls enough and when the trade deficit closes, we can worry about reducing budget deficits.