we end up with a residual that consists of Americans' net new
claims on, or net new debt to, foreigners—that is, our current account surplus
or deficit.*
But before consolidation, the ratios of both financial surpluses and financial
deficits of individual U.S. economic entities—households, businesses,
and governments—relative to their incomes, on average, have been
on the rise for decades, possibly even since the nineteenth century.1 For
most of that period, deficits of some U.S. resident economic entities were
almost wholly matched by surpluses of the remaining economic entities.
Our current account balances were accordingly small.* What is special
about the past decade is that the decline in home bias, coupled with significant
capital gains on homes and other assets, has fostered a large increase in
U.S. residents' purchase of foreign-produced goods and services, willingly
financed by foreign investors.
Aggregate net claims against foreigners only (our current account) is an
incomplete statistical picture of the degree of potential economic stress. It
may understate or overstate a pending problem for an economy as a whole.
Indeed, if we lived in a world where sovereign or other borders were disregarded
for transactions in goods, services, and assets, measures of stress
of the most narrowly defined economic units would be unambiguously the
most informative. Nation-defined current account balances have important
special uses relating to exchange rates, but I suspect the measure is too often
used to signify some more generic malaise. That is a mistake.
*Actually, there are a few small capital transfer reconciling entries needed to achieve the current
account balance.
tThis is true whether we use the income of individual entities or the nation's gross domestic
income or its equivalent gross domestic product. There is no income loss in the consolidation
of individual incomes into a national total.
tOn e exception was America's post-Civil War current account deficits, largely reflecting foreign
financing of the vast railroad network that accounted for much of U.S. economic activity
through the end of the century.
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THE AGE OF TURBULENCE
The trade and financing imbalances have been growing within the borders
of the United States for some time. They reflect increasing specialization
of economic function, which goes back to at least the beginnings of the
Industrial Revolution. Movement away from economic self-sufficiency of
individuals and nations arose from the division of labor, a process that continually
subdivides tasks, creating ever-deeper levels of specialization and
skill and, as a consequence, improves productivity and standards of living.
Such specialization fosters trade among the nation's economic entities and,
as it did even during the earliest days of commerce, with our international
trading partners.
Over time, ever-growing proportions of U.S. households, nonfinancial
businesses, and governments, both national and local, have funded their
capital investments from sources other than their own household income,
corporations' internal funds, or government taxes. In early America, almost
all of that financing originated with U.S. financial institutions or other U.S.
entities. The debt of U.S. residents to foreigners was small. The growing
(and risk-prone) tendency to borrow in anticipation of future income by a
significant proportion of Americans is reflected in a persistent rise in both
household and corporate assets and liabilities relative to income.
A detailed calculation by Federal Reserve Board staff employing data
from more than five thousand nonfinancial U.S. corporations for the years
1983 to 2004 found that growth in the sum of deficits of those corporations
where capital expenditures exceeded cash flow persistently outpaced
the growth in corporate value-added. The sum of surpluses and deficits,
disregarding sign, as a ratio to a proxy for corporate value-added exhibits an
average annual increase of 3.5 percent per year.* Data on the dispersion
of the financial deficits of U.S. economic entities aside from nonfinancial
corporations are sparse. A separate and less satisfactory calculation of only
partly consolidated financial balances of individual economic entities relative
to nominal GDP exhibits a rise over the past half century in the ab
*The surpluses (and deficits) are measured as income before extraordinary items, plus depreciation,
minus capital expenditures. The proxy for corporate value-added is gross margin, or sales
less cost of goods sold.
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CURRENT ACCOUNTS AND DEBT
solute sum of surpluses and deficits that is 1.25 percentage points per year
faster than the rise of nominal GDP.*
The increase in the dispersion of the imbalances of the economic entities
within U.S. national borders appears to have flattened somewhat over
the past decade, according to calculations using data from the partly consolidated
financial balances. Since the current account deficit accelerated
during those years, it is plausible to assume that the overall process of
dispersion of imbalances of U.S. economic entities continued but with
an increasing proportion of deficits of U.S. households, businesses, and governments
being financed from foreign rather than domestic sources. This is
certainly obvious in the financing of our federal budget deficit and of business
capital expenditures.1 In short, the expansion of our current account
deficit during the past decade arguably reflects the shift in trade and financing
from within the borders of the United States to cross-border trade
and finance.
Thus, the story of the erosion of our current account balance is a story
of domestic financial imbalances that spilled out across sovereign borders
in the early 1990s, at which point they were measured as rapidly rising cur
*The measure estimates saving less investment imbalances among the seven consolidated nonfinancial
sectors recorded in U.S. macroeconomic statistics: households, corporations, nonfarm
noncorporate business, farms, state and local governments, the federal government, and the rest of
the world. I include the "rest of the world" sector because it measures surpluses or deficits of
U.S. residents even though they reflect the accumulation of net claims on, or of obligations to, foreigners.
The other six sectors reflect net claims on, or obligations to, domestic residents only.
We do have considerable data on the consequences of surpluses and deficits: levels of unconsolidated
debt and assets. The tie, of course, would be exact only if some economic entities
always ran a deficit and the remainder always ran a surplus. Then, cumulating the deficits
would yield the change in unconsolidated debt outstanding and cumulating the surpluses
would yield the change in assets. If that were true, we could infer the degree of dispersion from
estimates of unconsolidated assets and liabilities. Indeed, during the past half century, with the
exception of the unusual period 1986-91, when the collapse of the savings-and-loan industry
distorted the debt figures, the rate of change in both assets and liabilities relative to nominal
GDP does rise. That in itself is not proof of rising dispersion, but it is merely another statistic
that is consistent with my presumption of a rise in dispersion that over the long run has exceeded
the rise in nominal GDP.
tBetween 1995 and 2006, the proportion of nonfinancial corporate liabilities owed to foreigners
rose markedly as a percentage of total nonfinancial corporate liabilities. The proportion of
US. Treasury obligations owed to foreigners rose from 23 percent to 44 percent over those
years. Foreign lending to U.S. households has always been negligible.
3 57
THE AGE OF TURBULENCE
rent account deficits. Any balance that starts with a surplus (as it did in
1991) and becomes a deficit that rises rapidly is always a cause of concern,
and almost inevitably becomes a political issue. But unless it matters greatly,
for example, whether a U.S. resident corporation finances its capital outlays
from foreign rather than domestic sources, the most relevant measure of
imbalance should combine both domestic and foreign funding. The stress
on U.S. economic entities has arguably increased little with the shift in the
source of their financing. The rise in the ratio of imbalances (both foreign
and domestic) to GDP is a much more modest and less scary trend than
that exhibited by its foreign component (the current account) alone.
Many U.S. businesses, for example, previously purchased components
from domestic suppliers but have switched in recent years to foreign suppliers.
These companies generally view domestic and foreign suppliers as
competitive in the same way that they view domestic suppliers as competing
with each other. Moving from a domestic to a foreign source affects
international balance-of-payments bookkeeping but arguably not macroeconomic
stress. To be sure, firms and workers that lose sales will be adversely
affected, at least until they can be reemployed in more competitive
uses. But that is no different from the fallout from domestic competition.
The one significant difference in a shift to cross-border suppliers is the effects
of exchange rates during the adjustment process and beyond. From
the perspective of individual stress, however, those effects are similar to
those of a change in price of a key purchased component.
Additional evidence that surpluses and deficits of resident economic
entities of the United States have indeed been rising relative to incomes
over the past century is found in the increase in assets of financial intermediaries
relative to nonfinancial assets and to nominal GDP. It is these financial
institutions that have largely accepted deposits and made loans to
match the financial surpluses and deficits of U.S. residents. Households
have deposited the income they did not spend in commercial banks and
thrift institutions, for example. The lending of those deposits enabled others
to finance investments in homes and capital equipment and plant. Consequently,
the size of these institutions can act as an alternative proxy
for such surpluses and deficits. Indeed, one can surmise that it has been
the need to intermediate these expanding surpluses and deficits that has,
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CURRENT ACCOUNTS AND DEBT
over the generations, driven the development of our formidable financial
institutions.
Since 1946, the assets of U.S. financial intermediaries, even excluding
the outsized growth in mortgage pools, have risen 1.8 percent per year relative
to nominal GDP. From 1896 (the earliest date of comprehensive data
on bank assets) to 1941, assets of banks, by far the dominant financial intermediaries
in those years, rose 0.6 percent per year relative to GDP.
Implicit in a widening dispersion of financial surpluses and deficits of
individual economic entities is the expectation of increasing cumulative
deficits for some and, hence, a possible accelerating rise in debt as a share
of income or its equivalent, GDP* From 1900 to 1939, nonfinancial private
debt in the United States rose almost 1 percent faster per year on average
than nominal GDP. World War II and its aftermath inflated away the
real burden of debt for a while; the debt-to-GDP ratio accordingly declined.
The up-drift in the ratio, however, resumed shortly thereafter:
from 1956 to 1996, nonfinancial business debt rose 1.8 percent faster at an
annual rate than gross business product, and from 1996 to 2006, 1.2 percent
faster.+
A rising debt-to-income ratio for households, or of total nonfinancial
debt to GDP, is not, in itself, a measure of stress. It is largely a reflection of
dispersion of a growing financial imbalance of economic entities that in
turn reflects the irreversible up-drift in division of labor and specialization.
Both nonfinancial-sector assets and debt have risen faster than income over
the past half century. But debt is rising faster than assets; that is, debt leverage
has been rising. Household debt as a percentage of assets, for example,
reached 19.3 percent by the end of 2006, compared with 7.6 percent in
1952. Nonfinancial corporate liabilities as a percentage of assets rose from
28 percent in 1952 to 54 percent by 1993, but retreated to 43 percent by
*Cumulative deficits of individual economic entities will increase net debt—that is, gross debt
less financial assets. In the large majority of instances, gross debt will rise with net debt.
tThe trend toward intracountry dispersion of financial imbalances is likely occurring not only
in the United States but in other countries as well. The existence of such a trend is suggested
by the rise in unconsolidated nonfinancial debt of the major industrial economies, excluding
the United States, over the past three decades, which has exceeded the growth of GDP by 1.6
percentage points annually.
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THE AGE OF TURBULENCE
the end of 2006, as corporations embarked on a major program to improve
their balance sheets.
It is difficult to judge how problematic this long-term increase in leverage
is. Since risk aversion is innate and unchanging, the willingness to take on
increased leverage over the generations likely reflects an improved financial
flexibility that enables leverage to increase without increased risk, at least
up to a point. Bankers in the immediate post-Civil War years perceived the
necessity to back two-fifths of their assets with equity. Less was too risky.
Today's bankers are comfortable with a tenth. Nonetheless, bankruptcy is
less prevalent today than 140 years ago. The same trends hold for households
and businesses. Rising leverage appears to be the result of massive
improvements in technology and infrastructure, not significantly more risk-
inclined humans. Obviously, a surge of debt leverage above what the newer
technologies can support invites crises. I am not sure where the tipping
