America Overdrawn

The U.S. economy is the world's economic engine. But with American citizens saving less and Washington spending more, that engine is now running on fumes. Together, these trends could ignite trade protectionism and threaten global economic integration.

Upon departing Washington in 2001, I did not leave behind controversy or politics. But, for the last three years, neither the U.S. budget deficit nor the dollar’s fluctuations have been a major preoccupation of mine. As treasury secretary, I observed that the global economy depended on the U.S. economy, that the U.S. economy depended on the consumer, that the consumer depended on the stock market, and that the stock market depended increasingly on 30 or 40 stocks. I also remarked that the main thing we had to fear was the lack of fear itself, and that the world economy could not fly forever on a single American engine.

Some of what I observed as treasury secretary still rings true. The world is, if anything, even more dependent on a single American engine than it was then. Unfortunately, the lack of fear is no longer our greatest problem. There is much in the current U.S. economic situation and its implications for the global economy that should preoccupy us.

Globalization has been a boon to the U.S. economy, but America’s spending addiction now threatens to undermine that virtuous global economic cycle. The country that is more economically central than it has been in decades is borrowing more than any other country in the world. In many respects, the world economy is dependent on an American engine that is running on fumes. Unless it is brought under control, the U.S. savings crisis will soon be the world’s problem.

National borrowing is the difference between what the United States spends (through, for example, purchases of imports, investment in infrastructure and inventories, and government budget deficits) and what the United States saves (the combination of private savings and any government surpluses). Economists call this figure the current account balance. For the U.S. economy, the figure is now a startlingly large deficit: around 5 percent of U.S. gross national product. 

Even more disturbing than the raw figures is the nature of the current imbalance. There are classic tests for knowing when a rising current account deficit should concern us and when it is less alarming. A current account deficit that finances investment in industries producing goods traded abroad, for example, is more tolerable. But the United States’ current account deficit increasingly finances consumption and investment in sectors that do not produce goods for international trade, such as real estate. The character of the investors in U.S. debt is also changing — for the worse. Short-term investors, who are less predictable and have more uncertain motives, finance an increasing share of the U.S. current account deficit. These changes are warning signs that U.S. spending is approaching a critical stage.

The formation of today’s savings crisis has been a public-private partnership of the most perverse sort. Private saving rates have been declining for many years; today’s Americans appear to be more inclined to consume and less inclined to save than their predecessors. Americans are putting aside only 1.3 percent of U.S. national income each year, the lowest level since the post-World War II period. But government red ink is the primary culprit. The federal budget deficit now absorbs three quarters of the private saving generated by the rest of the economy. So far, the U.S. public has not shown much concern with the politics of sound budgeting on either the tax or spending sides. Regrettably, the attention to the nation’s financial vulnerability that characterized the 1992 U.S. election seems to have faded, even though that vulnerability is much more acute today. Americans have seen government budgets bounce bewilderingly from record surpluses to record deficits in a few years. In a political atmosphere dominated by fears of terrorism, the public can be forgiven for thinking that reducing America’s financial vulnerabilities can wait. But U.S. leaders will not have that excuse any longer.


If this savings drought looked like a temporary phenomenon, it would be less worrying. Unfortunately, there is no evidence that the U.S. public will become thriftier any time soon. And on the government side, the looming retirement of the baby boomers and the expected spike in Medicare and Social Security costs mean that the government will have a difficult time cutting spending. Serious tax increases are, of course, politically unpalatable. 

The consequences of the savings gap will soon become apparent. Because the United States isn’t saving, Americans are not putting their money to work for them. Returns from otherwise valuable investments in business and technology increasingly end up in non-U.S. hands. The emerging economies of Asia, in particular, are actively accumulating claims on the United States by gobbling up U.S. treasury bills, much as European states hoarded gold centuries ago. Much has been made of U.S. dependence on foreign energy, but the country’s dependence on foreign cash is even more distressing. In a real sense, the countries that hold U.S. currency and securities in their banks also hold U.S. prosperity in their hands. That prospect should make Americans uncomfortable.

There is something odd about the world’s greatest power being the world’s greatest debtor. It is true, of course, that the foreign governments and investors financing the superpower spending spree have no incentive to bankrupt the U.S. economy by suddenly dumping their dollar reserves. The ensuing financial crisis would seriously damage their own economies as well. But having finally emerged from the Cold War’s military balance of terror, the United States should not lightly accept a new version of mutually assured destruction if it can be avoided.

Even laying aside financial doomsday scenarios, the uniquely important position of the U.S. economy means that its debt burden will be exported in less obvious but still quite destructive ways. First, low national savings in the world’s strongest economy may exacerbate capital flight from developing countries. Although governance problems in many parts of the developing world are the leading cause of such flight, America’s voracious appetite for investment drains off some capital that might otherwise end up in the countries that need it most. The problems don’t stop there. As the International Monetary Fund warned in a January 2004 report, further increases in the U.S. public debt ratio could raise real interest rates in industrial countries by an average of 0.5 to 1 percentage point in the coming years. Higher interest rates would in turn weaken global investment. 


If the United States wakes up to its financial vulnerability in the wrong mood, the result would be a nasty bout of protectionism, which could quickly spread around the world. Historically, strong protectionist pressure accompanied heavy U.S. dependence on foreign capital. Think about the increase in protectionism in the early and mid-1980s with the twin trade and budget deficits; or in the early 1990s, when low U.S. savings and a rise in the current account deficit sparked alarm about Japan. Today’s current account deficit is substantially larger in both absolute and relative terms.

A long and counterproductive attempt to roll back the global economic liberalization of the last several decades may be on the horizon. Unfortunately, much of the moral and intellectual energy of younger Americans — those who will have to confront the hard choices ahead — is directed against globalization. This predisposition is often a product of environmental, cultural, and fairness concerns very different from those that animate traditional economic protectionists. But the effect of anti-globalization sentiment may be to strengthen the hand of those seeking to rebuild economic walls. And if there is one proposition on which economists agree, it is that protectionism hurts prosperity. Increases in tariffs and other measures will hit poorer countries most brutally, but rich nations will suffer as well.

Navigating out of the current financial predicament will require careful U.S. policy on several fronts. A more sensible fiscal approach is an obvious starting point. The U.S. government can also do more to alert citizens to the dangers of low private savings in an era of rising life expectancies, skyrocketing medical costs, and diminished government benefits. Like any debtor, the United States will need help from its creditors as well. Regardless of what one thinks about the Iraq war or about recent U.S. foreign policy more generally, everyone should agree on the importance of rebuilding Washington’s rapport with foreign governments.

The administration that takes office in January must convince creditors that keeping a financial stranglehold on the world’s only superpower is not in their long-term interests. At the same time, it must fend off protectionism at home in a difficult political environment. The United States is in for a long and difficult economic adjustment. Recognizing the U.S. savings crisis must be the first step in that process.

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