US saving deficit leads to trade deficit
The US trade deficit in June was near record levels. Considering that oil prices and US consumer spending were at record levels in June, this was not exactly unexpected. Consumer spending's rising share of the US GDP in particular -- and its corollary, a declining personal saving rate -- has been a major driver of the expanding US trade deficit in the past several years.
On 12 August, the US Commerce Department reported that the US trade deficit for June was US$58.8 billion on a seasonally-adjusted basis. That is the second highest monthly deficit in 2005 and the third highest on record.
The record oil prices in June, when NYMEX crude oil futures broke through US$60 a barrel, was a major contributor to the increase in the deficit. Petroleum imports hit a record US$19.9 billion as imported crude oil prices in June averaged US$44.40 a barrel.
However, non-petroleum imports were also very high. The June figure of US$45.0 billion was the second highest on record.
The reality is that US consumer spending is at very high levels, and high overall imports largely reflect this fact.
Earlier, on 2 August, the Commerce Department had possibly given a taste of what was to come in the trade report when it reported that personal consumption expenditures for June had hit a seasonally-adjusted annual rate of US$8,723.5 billion, the highest on record and close to all-time highs even as a percentage of GDP. As a result, the personal saving rate for the month dropped to zero percent.
The fall in the personal saving rate to zero can be considered a milestone event. It is part of a longer decline in the US personal saving rate that began in the 1980s, as the following table illustrates.
There are several reasons given by economists for the fall in the personal saving rate.
One explanation involves the "wealth effect". Rising asset prices -- in stocks for the past two decades or so until arrested in 2000, and in housing more recently -- caused Americans to feel wealthy and feel more able to spend.
Another explanation is the rise in labour productivity since the 1990s. With persistent productivity increases, Americans became more confident of continually rising income, encouraging them to spend more.
A third explanation is that innovations in finance has given Americans increased access to credit, which enables them to increase spending.
A fourth explanation is the fall in interest rates over the past two decades or so. Together with money illusion, it makes people think that they are getting lower returns on saving and incurring lower cost in using credit, thus discouraging them from saving and encouraging them to use credit instead. Lower interest rates also feed into higher asset prices and reinforce the wealth effect.
Whatever the reason, if the saving rate continues to decline into negative territory, consumer spending will very likely take an increasing share of GDP, and that must translate to a rising trade deficit unless other components of the GDP -- investment and government spending -- are sacrificed. As it is, the past years' rise in consumer spending and concomitant fall in the personal saving rate has contributed to a rise in the trade deficit from an average of 1.5 percent of GDP from 1991 to 2000 to 4.5 percent thereafter.
Common sense tells us that the personal saving rate cannot keep falling and the trade deficit cannot keep rising indefinitely. Eventually, Americans will run out of personal wealth and national assets.
How can investors position themselves for the eventual reversal in trends? Here are a few ideas.
A reversal of the falling saving rate implies a reduction in consumer spending and a probable slowdown in growth, even possibly a recession. This suggests a move out of equities.
A reversal of the rising trade deficit implies a weaker US dollar. This suggests a move into foreign assets.
Both might be associated with higher interest rates, at least initially, which suggests a move out of bonds.
The problem is that while common sense tells us that there will eventually be a reversal in the trends, it does not tell us exactly when that will take place. The United States is big and rich enough relative to other countries to be able to afford to run down its wealth for a long time.
A rise in interest rates might be the signal of an impending reversal in consumer spending. In this regard, the Federal Reserve seems willing enough to lend a helping hand. It certainly has been reversing its loose monetary. On 9 August, the Federal Reserve raised its target for the federal funds rate by 25 basis points to 3.5 percent, its tenth such hike since June last year. It also released a statement simultaneously suggesting that it would continue do so for at least a while more.
Having said that, longer term interest rates -- the ones that matter to consumers -- have stayed stubbornly low despite the Federal Reserve's persistent raising of the federal funds rate. Instead, the rate hikes appear to be attracting capital into the US and boosting the US dollar, hardly a recipe for correcting the trade deficit.
So investors who position themselves now for the eventual reversal of the declining saving rate and rising trade deficit might have to be very patient.
On 12 August, the US Commerce Department reported that the US trade deficit for June was US$58.8 billion on a seasonally-adjusted basis. That is the second highest monthly deficit in 2005 and the third highest on record.
The record oil prices in June, when NYMEX crude oil futures broke through US$60 a barrel, was a major contributor to the increase in the deficit. Petroleum imports hit a record US$19.9 billion as imported crude oil prices in June averaged US$44.40 a barrel.
However, non-petroleum imports were also very high. The June figure of US$45.0 billion was the second highest on record.
The reality is that US consumer spending is at very high levels, and high overall imports largely reflect this fact.
Earlier, on 2 August, the Commerce Department had possibly given a taste of what was to come in the trade report when it reported that personal consumption expenditures for June had hit a seasonally-adjusted annual rate of US$8,723.5 billion, the highest on record and close to all-time highs even as a percentage of GDP. As a result, the personal saving rate for the month dropped to zero percent.
The fall in the personal saving rate to zero can be considered a milestone event. It is part of a longer decline in the US personal saving rate that began in the 1980s, as the following table illustrates.
| Average personal saving rate % | |
| 1961 - 1970 | 8.5 |
| 1971 - 1980 | 9.6 |
| 1981 - 1990 | 8.7 |
| 1991 - 2000 | 4.7 |
| 2001 - 2005 (June) | 1.8 |
There are several reasons given by economists for the fall in the personal saving rate.
One explanation involves the "wealth effect". Rising asset prices -- in stocks for the past two decades or so until arrested in 2000, and in housing more recently -- caused Americans to feel wealthy and feel more able to spend.
Another explanation is the rise in labour productivity since the 1990s. With persistent productivity increases, Americans became more confident of continually rising income, encouraging them to spend more.
A third explanation is that innovations in finance has given Americans increased access to credit, which enables them to increase spending.
A fourth explanation is the fall in interest rates over the past two decades or so. Together with money illusion, it makes people think that they are getting lower returns on saving and incurring lower cost in using credit, thus discouraging them from saving and encouraging them to use credit instead. Lower interest rates also feed into higher asset prices and reinforce the wealth effect.
Whatever the reason, if the saving rate continues to decline into negative territory, consumer spending will very likely take an increasing share of GDP, and that must translate to a rising trade deficit unless other components of the GDP -- investment and government spending -- are sacrificed. As it is, the past years' rise in consumer spending and concomitant fall in the personal saving rate has contributed to a rise in the trade deficit from an average of 1.5 percent of GDP from 1991 to 2000 to 4.5 percent thereafter.
Common sense tells us that the personal saving rate cannot keep falling and the trade deficit cannot keep rising indefinitely. Eventually, Americans will run out of personal wealth and national assets.
How can investors position themselves for the eventual reversal in trends? Here are a few ideas.
A reversal of the falling saving rate implies a reduction in consumer spending and a probable slowdown in growth, even possibly a recession. This suggests a move out of equities.
A reversal of the rising trade deficit implies a weaker US dollar. This suggests a move into foreign assets.
Both might be associated with higher interest rates, at least initially, which suggests a move out of bonds.
The problem is that while common sense tells us that there will eventually be a reversal in the trends, it does not tell us exactly when that will take place. The United States is big and rich enough relative to other countries to be able to afford to run down its wealth for a long time.
A rise in interest rates might be the signal of an impending reversal in consumer spending. In this regard, the Federal Reserve seems willing enough to lend a helping hand. It certainly has been reversing its loose monetary. On 9 August, the Federal Reserve raised its target for the federal funds rate by 25 basis points to 3.5 percent, its tenth such hike since June last year. It also released a statement simultaneously suggesting that it would continue do so for at least a while more.
Having said that, longer term interest rates -- the ones that matter to consumers -- have stayed stubbornly low despite the Federal Reserve's persistent raising of the federal funds rate. Instead, the rate hikes appear to be attracting capital into the US and boosting the US dollar, hardly a recipe for correcting the trade deficit.
So investors who position themselves now for the eventual reversal of the declining saving rate and rising trade deficit might have to be very patient.
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