More Doug in Senegal, and why you shouldn’t worry about the deficit

  It seems as though I start a lot of posts with the words “it seems.”  I will try to rectify this in the future. 

Ditto, “so,” a verbal tic I blame on my unbridled admiration for Doug Muir, who has, by the way, written a little more about Senegal.  He tells us about the Mourides, a powerful Muslim sect of which I am embarrassed to say I knew nothing.  He bemoans the crappy state of Dakar’s airport, and receives in turn a useful warning from Bernard.  Finally, he wraps his trip with a discussion of W, railroads, France, birds, the CFA franc (e.g., France yet again, although he doesn’t say so), the weather, the expats, and the clothes.  I am pretending not to be annoyed at not getting a shout-out on the France tip, which means that pique is not the reason why I am not explaining the story of the Senegalese railroads under French colonial rule. 

Which brings us to the U.S. federal deficit.  You hear a lot of worring about how interest rates are going to rise from all this wild borrowing.  Where will the money come from?  We are doomed, doomed!!  No links, because I actually like and respect many of the people doing the worrying.  But they need not.

I just had a colleague in my office with the latest BEA numbers, worrying about just that.   Where will the money come from?  So I pulled out a spreadsheet and showed him.  In the first quarter of 2009, annualized personal savings came to $620 billion, or 5.7% of personal income.  Total savings (again, annualized) came to $1,273 billion, or 9.1% of GDP. 

Personal savings is only going up.  If we assume that nominal GDP growth is flat in 2010 (meaning, most likely, that real GDP keeps falling), a rise in the personal savings rate to 10% will produce $468 billion of additional savings.  Retained earning are also likely to rise, say from 4.6% to 5.0% of GDP.  That’s another $47 billion.  Total of $515 billion in new savings ... just as the federal deficit is projected to fall by $393 billion.  Plenty of wiggle room should private investment rise (one can hope) or the current account deficit fall (which seems likely).  A rise in real interest rates does not seem like something we need to worry about.

Rather, what we need to worry about is a continuing shortfall in demand.  What if Americans don’t substitute domestic consumption for imports?  Final demand will fall.  What if domestic investment doesn’t quickly rebound?  (It was $2 trillion in 2008, a full 25% higher than in the beginning of 2009.)  Final demand will fall.  In that situation, we might be wishing for another round of stimulus, rather than worrying about the deficit. 

UPDATE:  The May numbers just came out from the BEA.  Looks like the personal savings rate hit 6.9% that month.  We are on track to exceed 10 percent in 2009, and in my opinion the country will permanently return to 1970s savings levels.  That said, past performance does not always predict future results.  Any counterarguments?

Comments

[Doug M.]

Pretending not to be annoyed at not... wait, I missed. What did I miss?

Doug M.

[Noel Maurer]

Dude, I can't /tell/ you. If I did, I could no longer pretend to not be annoyed!

[David Allen]

"You hear a lot of worring about how interest rates are going to rise from all this wild borrowing. Where will the money come from? We are doomed, doomed!! No links, because I actually like and respect many of the people doing the worrying. But they need not."

I think you're overconfident.

I see two routes to (dangerously) rising interest rates from here. You hinted at one above:

"Final demand will fall. In that situation, we might be wishing for another round of stimulus, rather than worrying about the deficit."

One of the problems with the government as borrower/consumer of last resort is that it moves credit risk from the American economy as a whole to the American government. Uncle Sam can pay rising debt service in three ways:

1. Tax rates hold steady and the economy grows = good.

2. The economy stagnates but tax rates are increased = bad.

3. Expansionary/inflationary policies = higher interest rates.

The other route is the carry trade.

Go back to scenario 2 above. If American investments are yielding bupkis, Americans will send their money abroad.* Reading between the lines of Brad Setzer's blog, that's already happening. This will add to the downward pressure on the dollar and the upward pressure on interest rates for dollar denominated investments. Including Treasury securities.

I'm not saying that interest rate problems are inevitable, but avoiding them will be harder than you say.

*I know the carry trade hasn't caused inflation in Japan. But the carry trade that was popular last year, short dollar/long oil, certainly contributed to inflation in the US.