Published in the Financial Post, December 15, 2004, p. FP-17.

 

Government Deficits Matter, Others Don't
by
Pierre Lemieux

 

The deficit of the current account in the U.S. balance of international payments deepened again in October. After Alan Greenspan, the chairman of the Federal Reserve System, recently commented about the US$166-billion third-quarter deficit, the pundits were aghast. This is, at first sight, puzzling. Consider two categories of people: all blue-eyed and all non-blue-eyed individuals in the world. Call the two groups the Blues and the Non-Blues. Suppose that the United Nations measured the net annual saving or borrowing of all individuals in each group, and summed them up over the respective groups. Assume that, last year, the Non-Blues borrowed more that they lent, which is the same as saying that they consumed more than they earned or that they imported more from the Blues than they exported to them; of course, the converse is true for the Blues. There would be no reason to worry about the current account deficit of the Non-Blues and the corresponding surplus of the Blues. Each individual made his own decisions, signed his own contracts, and will have to live with them. Period. The same reasoning applies if the two groups find themselves in two different countries within arbitrary borders. There is no reason to worry about the current account deficit of the Americans, or about the current account surplus of the Canadians (now at $10-billion per quarter). These measures have no normative significance. Only if we think that “countries” are something over and above their individual residents do these measures provide cause for worry. In short, the current account deficit is a purely political concept. Look at the problem in another way. The total balance of payments of a country is necessarily in equilibrium. The difference between imports and exports (the current account) will be automatically compensated by equivalent net capital flows (the capital account): The current deficit will be financed by net capital inflows, or the surplus will finance net capital outflows. This is because each individual and firm take care of their own individual balances of payments. As usual with supply and demand, prices (exchange rates, interest rates, inflation or deflation) will mediate the adjustment process. The insignificance of the current account deficit is easy to see if we peek behind the veil of money and look at the underlying exchange of real goods and services. As John Stuart Mill said two centuries ago, “an imported commodity is always paid for directly or indirectly with the produce of our own industry.” For groups, however defined, as for individuals, consumption is paid for by production or by borrowing. Likewise, imports are financed by exports or by capital inflows, which are themselves only delayed exports, as the lenders will, one day or another, want to be reimbursed. Contrary to the current account deficit, the government deficit, which is a different beast, does represent a real problem, if only because some taxpayers will eventually be forced to reimburse it, willy-nilly. In the meantime, financing the deficit crowds-out private domestic investment and requires increased capital inflows from the rest of the world. “Reducing the federal budget deficit (or preferably moving it to a surplus),” Greenspan said wisely, “appears to be the most effective action that cold be taken to augment domestic savings.” One reason why people continue to worry about the current account deficit is that it may trigger austerity policies or protectionist measures from the state. This testifies to the enormous power of the contemporary state, as does the impact on financial markets of pronouncements by a central bank tsar like Greenspan. Current-account talk may also be a faddish mode of expression (like, say, political correctness) or a sort of co-ordination and signalling device for investors. Other important reasons have to do with special interests trying to benefit from state intervention. Domestic producers have a protectionist interest in the state worrying about imports. The state apparatus itself has incentives to make the populace believe untold catastrophes will happen if it does not manage the macroeconomy. What would mankind do without Greenspan? The concept of current account deficit exists mainly to justify state intervention and the arbitrary borders it imposes.