Op-ed: “Twin Deficits” Threaten US Economy

I sent in the Op-ed below to the New York Times in October 2001, arguing that the Bush/Greenspan tax cuts to stimulate the economy back then were unsound.  The argument is relevant today.  Bush and Greenspan argued that they saw budget surpluses as far as the eye could see.  I argued that their forecasts were based on rosy assumptions, which, if they failed to obtain, could lead to “twin” budget and trade deficits, undermining long-run performance of the American economy. The Times never printed it. 

Allow me to relate it today’s economy. 

In America we consume more as a nation than we produce.  We have to borrow the difference, which roughly speaking is the trade deficit. If you think of the US economy as consisting of three sectors — the government, corporations, and households — in 2001, corporations were heavily in debt, investing too much, ultimately leading to the technology (dot.com) bust. 

To avoid recession, Bush/Greenspan decided to juice up the other two sectors — households and the government, which were in relatively good shape, i.e. their debt was not high.  So, the Fed lowered interest rates, allowing households to borrow like crazy to buy homes; and Bush cut taxes, turning government surpluses into deficits. 

Today, we have a financial crisis, due largely to the Greenspan-juiced speculative bubble in real estate (his recent book is disingenuous, because Sir Alan and the Fed held interest rates near 1% for far too long, causing the bubble in real estate, which is now bursting).  The federal government wants temporary tax relief to support household and corporate spending, thereby softening the economic slowdown. 

Luckily, unlike in 2001, the corporate and government sectors are in relatively good shape; it’s the household sector that has too much debt.  The fiscal and monetary stimulus that is under way may be needed temporarily because the financial crisis is quite serious, risking a potential breakdown in the credit markets, as financial firms take huge losses and many institutions have lossed credibility.


However, longer term, the problem that America doesn’t save enough remains.  Ben Bernanke, when he was a Bush economic adviser and angling to please his boss so as to get the nomination as Fed chairman, argued that it was not that Americans don’t save enough, but rather that the rest of the world saved too much (the famous “savings glut”).  Can you believe it?!  All Americans were doing was duly borrowing foreigners’ excess savings! 

I believe policies are needed to encourage Americans to save more (including a weaker US dollar). This would ultimately reduce the heavy trade deficit and American reliance on borrowing abroad.  Read the op-ed below.

Note that in 2001 when I wrote it, the forecast for the current account deficit, a broad measure of the trade deficit, was for it to be over 4% of GDP.  In 2006 it had worsened to over 6% of GDP.  So, the need to get back on track for higher US savings clearly remains.  The US government has a little room — but not a lot — to juice the economy today with tax breaks. The US government sector runs an overall deficit of 2.5-3% of GDP (which is not huge), with a debt of under 60% of GDP, also not huge, but not very low either.  By contrast, Germany’s government is more or less in balance, though its government debt is higher, at around 65% of GDP.  

Op-ed draft sent to the NY Times in 2001: 

While Washington debates how to spend America’s budget surpluses, the red flag that has been missed is the steady growth in America’s trade deficit. Sovereign credit analysts take into account the balance of trade because of the risk of a sudden decline in a country’s currency and a sharp recession.  By raising national savings, government budget surpluses can help reduce trade imbalances and put the country on a more sustainable growth path.

The U.S. current account deficit (a broad measure of trade) widened from 1.5% of GDP in 1995 to an estimated 4.3% of GDP last year [2000] amid strong economic growth. This has been financed by foreign investors in pursuit of superior returns on American assets.  Notably, the country’s debt to foreigners rose from 37% to an estimated 50% of GDP over the same period.

Most forecasters anticipate a rate of growth of the U.S. economy of over 2% in 2001, down from 5% in 2000.  A correction in American asset prices (e.g., in the U.S. stock market), in conjunction with an inventory buildup, caused this slowdown.  If such a slowdown is short-lived, then moderate economic growth could continue with a reduced reliance on foreign money.

Hence, a simultaneous easing of monetary and fiscal policies, which is the talk of the town in Washington these days, may not be called for. 

The opening of the floodgates to a fiscal stimulus could already be irreversible.  The rush to join the call for tax cuts and spending increases is reminiscent of the atmosphere in Washington in 1981, when, with a president of one party and a congress partially controlled by the other party, policies were adopted that resulted in years of large budget (and trade) deficits.  The so-called “twin deficits.”

Projections of growing budget surpluses in the coming years rest on continued strong productivity gains, driven by technological innovation.  Should the U.S. economy revert back to its performance during the 1975-95 period, then these budget forecasts would be too rosy.

Hong Kong and Singapore are two countries that generated fiscal surpluses for years.  As a result, they were in a good position during the Asian crisis to jumpstart their economies. Should the U.S. slowdown be more dramatic than expected, fiscal and monetary policies could be eased more dramatically. 

One must bear in mind, however, that the creditworthiness of the United States government remains among the strongest in the world.  Its external debt is denominated in its own currency, the U.S. dollar, which the government can print and tax. Its economy is well-known for its diversity, dynamism and wealth, and there has been a dramatic improvement in public finances. Yet, to insure against unforeseen negative developments, including sluggish productivity growth, and to protect America’s entitlement programs, such as Social Security, a less expansionary fiscal policy than the one being debated in Washington may be called for.  


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