The U.S. Is Sliding Down an Investment Slope
In the recent article “Investment Falls Off a Cliff,” the Wall Street Journal reported that half of the 40 biggest publicly traded corporate spenders in the U.S. have announced plans to curtail capital expenditures this year or next year. A slowdown in demand, in particular, in such export markets as China and the eurozone, and uncertainty with respect to longer-term federal fiscal policy have been cited among the reasons for slowing down or delaying corporate investment projects. While the above arguments are logical from a short-term perspective, it is also worth taking a look at the current investment situation in the U.S. from a longer-term macroeconomic perspective and that of the current global macroeconomic imbalances.
For more than a decade now, China has had a sizable current account surplus, while the U.S. has been running an even larger current account deficit. In macroeconomic terms, this also means that savings have exceeded investment in China while the opposite has been happening in the U.S. This has resulted in China accumulating net foreign assets and the U.S. seeing its Net International Investment Position deteriorate. As at the end of 2011, the value of foreign liabilities of U.S. residents exceeded the value of their foreign assets by more than USD4 trillion. At the same time, the foreign assets of the residents of China exceeded their foreign liabilities by almost USD2 trillion.
To prevent the above imbalances from growing, both countries would as a minimum need to bring their current accounts back toward balance. Doing that and maintaining economic growth at the same time would require China to consume and import more, while the U.S. would need to increase its output and exports. The alternative way of rebalancing – China producing and exporting less and the U.S. consuming less would be a recipe for economic contraction.
The need for China to change its economic growth model from an export and investment driven to a consumption driven one has been discussed extensively (see, for example, Yongding or Chovanec). It is far from certain that China will be able to complete this transition without experiencing a considerable economic slowdown in the process. However, the other side of the required rebalancing is at least as important, but has recently attracted less attention. Namely, the U.S. would need to shift the emphasis in its economic growth model away from consumption and towards production and exports, which would also require considerable investment both on the company level and in the public infrastructure.
Recent evidence, however, suggests that while U.S. GDP growth has surpassed its pre-crisis level, investment has been declining. A comparison with China would not be appropriate due to differences in growth rates and the level of economic development, but even a comparison with the EU-15 is not flattering to the U.S. A look at the Gross Fixed Capital Formation to GDP ratio shows that since the onset of the financial crisis in 2007 the U.S. has been lagging behind the EU-15 countries with respect to investment in long-term assets (see chart below).
Also, the weight of construction sector in total value added has been consistently lower in the U.S. than in the EU-15 and has been declining since 2007 (see chart below). Not all investment or construction enhances the potential output of an economy. However, public infrastructure investment in the U.S. stands at 2.4% of GDP, half the level it was 50 years ago and half the level in Europe (Thomasson, The Economist). This is everything else but logical, in particular, given the record-low levels of long term interest rates. As Peter Orszag put it in a discussion at the Buttonwood Gathering, the current level of the 10-year Treasury yield and the current state of the JFK airport should not coexist.
The way the U.S. has dealt with the financial crisis – by running large budget deficits, keeping down interest rates and performing several rounds of quantitative easing – has often been contrasted favorably with the “austerity” approach in Europe. However, the massive fiscal and monetary stimulus also appears to have been an obstacle to structural change in the U.S. economy; in particular, it has failed to revive investment and prepare for the much needed transition from a consumption-oriented growth model to a production-oriented one.
Private investment has not been stimulated by extremely low interest rates. Uncertainty about the future investment climate remains high. Perhaps if Congress and the president could cooperate and make a credible commitment to resolve the long-term debt problem and increased certainty about future government taxation, spending and borrowing would increase private investment. However, acting in ways that take account of future costs and benefits has not been a strong suit for recent Congresses or presidents. They have only begun to take account of the “fiscal cliff” that will appear at the end of next month. Nor have they been able to agree on major new infrastructure spending, as Thomasson has pointed out.
Unless the situation is reversed quickly, this means bad news for both the U.S. and the global economy down the road. If insufficient investment results in the U.S. having to adjust by lowering consumption rather than increasing output, the rest of the world will also have to adjust in a way that is reducing growth; namely, produce less.
Bureau of Economic Analysis of the U.S. Department of Commerce, „U.S. Net International Investment Position at Yearend 2011”, June 26, 2012
Chovanec, Patrick, “Silver Linings in China’s Slowdown”, August 6, 2012
The Economist, “Life in the Slow Lane”, April 28, 2011
Thomasson, Scott, “Encouraging U.S. Infrastructure Investment”, Council on Foreign Relations, April 11, 2012
Yongding, Yu, “China’s Rebalancing Act”, Project Syndicate, September 26, 2012
Wall Street Journal, „Investment Falls Off a Cliff”, November 19, 2012
12 Responses to “The U.S. Is Sliding Down an Investment Slope”
Not clear why we need private investment at some arbitrary level to have a healthy economy. Most of our heavy industry has been off shored, after all.
Burk, so true about the trillions of dollars of US supranational firms' investment in China-Asia since the '90s. Well over half of US "exports" go to US firms' subsidiaries and client contract producers abroad, and a portion of oil "imports" comes from US oil companies' production abroad. The current account balance accounting is a mess and does not properly account for US supranational goods, trade credits, and financial investment/speculation associated with the Anglo-American imperial trade regime since the '80s.
And then there's the issue of so-called "dark matter", which at least in part addresses the massive capital investment by US firms abroad and the implied requirement for China's central bank to hold US Treasuries as reserves against US firms' growing deposits (China's money supply in Yuan terms is 180% of GDP and subject to contraction hereafter) in China that are not directly convertible to dollars.
When the US firms realize China's growth (that they created) is over and trade is set to contract (that they will precipitate), the firms will want to pull their non-convertible Yuan deposits out in dollars, which will require the People's Bank of China to do a book entry swap of US Treasuries (will be reported as "China selling US Treasuries!!!") with the Fed and primary dealers to provide the necessary liquidity for US firms to expatriate dollars back to the US or in the form of euro or Eurodollar deposits outside the US (Caribbean banking centers).
China's economy will most certainly "rebalance", but not in the way most economists expect. Once FDI flows reverse by as little as 1-1.5% of GDP, China faces a Great Depression-like contraction in fixed investment, production, exports, money supply ("exogenous shock"), employment, bank loans, and asset prices. The "rebalancing" won't occur by design but by default via investment and exports crashing and consumption making up a larger share of a smaller GDP.
An arbitrary level of investment is not necessary, but at this stage of a business cycle, investment is usually rising, rather than falling. This pattern is consistent with the evidence
that recoveries from recessions that coincide with financial crisies are slower than others.
It is also consistent with the slow growth in total employment and the persistence of high levels of unemployment. Since short-term interest rates are near zero, and the Fed has announced its intention to keep them at that level until 2015, it indicates the ineffectiveness
of monetary policy to stimulate investment. It is also consistent with the high current level of uncertainty shown by the index of Nicholas Bloom of Stanford University.
Just how exactly does America bring its account back towards balance?
Color me a cynic, but I find it absolutely impossible to believe any of the current players in the 'fiscal cliff debate' will be capable of doing anything more than kicking the can down the road – no matter what they agree to.
That includes the House, the Senate and the Executive branch.
Americans made a tragic mistake by basically re-electing the same knuckleheads that haven't been able to figure it out before.
There are serious problems in measuring the balance of payments, and the high level of trade in components and intra-firm trade contributes to the problem. It has been demonstrated that the accounting rules used by U.S. authorities exaggerates the value of imports coming from the China. The case of i-Phones and products that contain components made in 10-15 different countries greatly overstate the contribution of China.
More skeptics, including Daron Acemoglu and James Robinson (Why Nations Fail, 2012) are expecting China's growth rate to diminish, but growth below China's average remains above the average growth rate for the world as a whole.
Yes, Congress could contribute to rebalancing by increasing government saving by reducing the government's budget deficit, but they have shown no inclination to do so.
U.S. fiscal policy of the last decade or so has drifted away from its 200 year old policy of preventing the national debt/GDP ratio from trending upward. The ratio tended to rise during wars and decrease afterward without there being a clear trend. Congresses and Presidents have gotten away from this policy, and it is difficult to see why the same President and a similar Congress will fundamentally alter their fiscal policy.
"Grand Demand" in our consumer system is indelibly dependent on "consumers" having "discretionary" money to spend.
Good paying lost jobs; new jobs (when available) paying less than old; negative equity home values; skyrocketing health care costs; newer jobs precluding any kind of decent health care benefits…….and on, and on, and on.
NOTHING will change until American consumers reduce their debt.
Also there is a growing "social consciousness" in the general public that "something is terribly wrong" with our political/economic policies, both foreign and domestic.
The FED has been pumping money into this maniacal consumer system since the crash of '87.
Until we "downsize" all of our debts we will continue to flounder.
Re: China: Chins is slowing down. That is a fact.
Yes, there is historical evidence that debt cycles exist for the U.S. Large increases in total debt (private plus government) have preceded severe recessions. U.S. private debt has
already diminished (deleveraging), but government debt relative to GDP has not. There is also increasing evidence that the quality of government policy (especially related to spending, taxing, and borrowing) has diminished in the last decade. China's growth rate has decreased from 9% to 7% recently, but 7% is still greater than the recent negative growth rate in the Eurozone or the 1-2% in the U.S.
Tom, I'm glad you mentioned the falling rate of infrastructure investment along with other forms of investment. A couple of days ago Edward Luce had an excellent piece in the FT about the sad state of US infrastructure. ( http://www.ft.com/intl/cms/s/0/bc6f228e-34c9-11e2… )
One way policymakers should be looking at the problem is to realize that the country has an infrastructure deficit as well as a budget deficit. The aim should be to improve the health of the total balance sheet of the economy as a whole, not just the part that is recorded as federal liabilities. We don't do the next generation any favor if we leave them with a smaller level of public debt at the expense of a more decrepit infrastructure.
Putting aside the question of whether total government spending is excessive, the composition of spending is inefficient. Economists frequently mention potential high payoffs from infrastructure and R&D, but Presidents and the Congress continue to spend more on transfer payments and military adventures that produce little national defense. The empirical evidence that finds government debt beyond a threshold to reduce the growth rate may reflect the crowding out of productive government investment by debt service payments that claim an increasing share of spending.
If the re-balance in China produces a depression, as you suggest; it seems that the US Govt and it's people would do well by shorting Chinese stock. I seem to remember reading that even though many people were hurt by our Great Depression that were still great riches that were made.
We do not expect a depression in China, and the reduction in real economic growth that
has already occurred has been a drop from plus 9% to plus 7%. This slower growth would still leave China as a faster grower than the U.S. and faster than the average country in the world. The Chinese stock market is a bit of a puzzle. The Shanghai market has been depressed for some time relative to the growth in output. There are controls on the amount of money that people can take out and into China. However, the Wall Street Journal has reported large outflows of money by Chinese citizens, which is consistent with your point about selling Chinese assets short.