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  Lack of US domestic saving cause of trade deficit  



China is the latest scapegoat for all that ails the American middle class. At least, that is certainly the conclusion that can be drawn from spending any time these days in Washington.

Unfortunately, the US body politic has long had a penchant for such "scapegoatism" when it comes to trade policy. Remember the Japan bashing of the late 1980s? And of course, just three years ago there was an outcry of concern over India as the lightning rod of the new threat of white-collar offshoring.

The politics of congressional-led China bashing fit into this inflammatory climate all too neatly.

There are three leading anti-China approaches currently under consideration by the US Congress - two very similar efforts in the Senate and a somewhat different approach in the House.

At present, it appears that Congress has deferred immediate consideration of these initiatives, although the two Senate versions have both been cleared by overwhelming bi-partisan "mark-ups" in both the finance and banking committees.

The probability of passage by veto-proof margins - either in the next two months or early next year - remains over 60 percent, in my view. It is difficult to say which version will prevail in the end, or what type of hybrid might emerge from a conference committee.

But it is important to lay bare the assumptions embodied in Congress's penchant for China bashing in order to understand where this approach is coming from and what unintended consequences it may well trigger.

First and foremost, the debate is grounded in very legitimate concerns over the increased economic insecurity of middle-class American workers. Real wage stagnation is at the top of the list.

In the second quarter of this year, inflation-adjusted median weekly earnings for full-time US workers were unchanged from levels prevailing seven years ago in the second quarter of 2000.

Yet over that same period, productivity in the non-farm business sector recorded a cumulative 18 percent increase. Contrary to one of the basic axioms of economics, American workers have not been paid their just reward as measured by their productivity contribution.

As voters, workers are holding their elected representatives accountable for this extraordinary macro disconnect. And politicians are scrambling to come up with both reasons and solutions.

At the top of the political answer column is trade and globalization. Congress is presuming that America's record foreign trade gap - namely an $838 billion deficit on merchandise trade in 2006 - has been a decisive factor in squeezing both jobs and real wages of middle-class American workers.

America's bilateral trade deficit with China accounts for, by far, the largest slice of the overall imbalance - 28 percent of the total US merchandise trade deficit in 2006 and about 31 percent of the cumulative shortfall in the first eight months of this year. However, just count up the countries in deficit with the US in 2006, and you will come up with a list of at least 40 of them.

Yes, China has the biggest of America's bilateral trade deficits. But in fact the congressional math of the blame game is fatally flawed. Stripping out the China gap still leaves a US trade deficit of over $600 billion in 2006 - a number nearly three times as large as the shortfall with China. So assume for the moment that Congress "fixes" the Chinese piece of the US trade deficit - a dubious assumption.

It follows that the so-called currency fix now being contemplated by the US Congress is equally preposterous - presuming that pressure on a bilateral cross rate will solve a multilateral deficit. All that will do will be to send a relative price signal that will shift the mix of the deficit elsewhere - and most likely to a higher-cost producer.

That is like rearranging the deck chairs on the Titanic. And, of course, it is also the functional equivalent of a tax hike on middle-class America - the aggrieved victim in all this.

The multilateral characteristics of the US trade deficit are the smoking gun to this problem. And it is painfully clear what the root cause is an extraordinary lack of US domestic saving. America's net national saving rate - the combined saving of individuals, businesses, and governmental units adjusted for depreciation - averaged a mere 1.5 percent of national income over the five years ending in 2006.

That is the lowest national saving rate for a five-year period in modern US history and apparently the lowest saving rate for the hegemonic power in world history. Lacking in domestic saving, the US must then import surplus saving in order to grow and run massive current account and trade deficit in order to attract the capital.

Of course, in Washington, it has long been easy to duck the facts and weave a good yarn. China bashing, I am afraid, is largely a by-product of that predilection. But it is actually far worse than that. Who is really to blame for inadequate saving - the root cause of the US trade deficit?

Washington is at the top of that list, in my opinion, with its penchant for budget deficits, consumption incentives, and an asset-based saving mindset that has been underwritten by the Federal Reserve.

China bashing is also emblematic of a deeper problem that grips the US body politic - an unwillingness to embark on the heavy lifting of education reform and other investments in human capital that are required to equip American workers to compete and prosper in a brave new world.

Instead of investing in a hard-pressed work force, Washington apparently believes in shielding US workers from low-wage talent pools in the developing world. The doubling of the world's labor supply that has occurred in the past two decades has evoked a response of fear and protectionism.

Sadly, that puts America at grave risk of becoming more insular and inward looking. Yet over the long sweep of US economic history, our workers have actually done best when they are pushed to their limits by a risk-taking, entrepreneurial, and innovative society.

By blaming others for our own shortcomings - especially on the saving and human capital fronts - America runs the very real risk of losing its most special edge of all, an indomitable economic spirit. By shirking its responsibility for putting US saving policy on a sound path, Congress is, instead, now veering toward the slippery slope of protectionism.

Finally, just a word about China, where I spend an awful lot of my time these days. China is a living miracle of economic development. The world has never seen anything like the transformation of the Chinese economy that has occurred over the past 15 years. This extraordinary development trajectory is based primarily on a steadfast commitment to market-based reforms - something that Washington as the bastion of capitalism should applaud, not criticize.

But China also has a new strength - one that takes a page right out of our own experience in the US. Dynamic private companies are now springing up all over China; of the 16 new Chinese companies that Morgan Stanley has brought public so far this year, 15 of them are private.

For China, the newfound spirit of its privately employed workers and businesspeople is contagious and very reminiscent of that which has long been central to the American dream. Yes, like any economy, China has its share of problems and risks, many of which have been emphasized. Structural imbalances, environmental degradation, and income disparities are all openly debated in China these days.

Currency policy has long been a topic of discussion in official Chinese policy circles as well. But, despite its remarkable progress, China is still a very poor country with many other important things on its plate. Therein lies a critical difference between the two perspectives: Washington's penchant for the quick fix singles out the Chinese currency as a lightening rod in the great middle class globalization debate.

China, by contrast, views the currency issue not as an end in itself but as one of many pieces in the broad mosaic of financial reforms. That leads to a completely different perspective from both sides that has now boiled over in the form of trade frictions.

Ironically, in contrast to American intransigence on the saving issue and the multilateral trade deficit it has spawned, China is making important progress in relieving this source of tension.

As China puts its financial system increasingly on a market-based footing, its leaders have given every indication the currency regime will follow. The shift to a managed float in July 2005 was an important first step in that direction.

At the same time, China is taking dead aim on the imperatives of a consumer-led growth dynamic - a very different economic structure that will boost imports and thereby reduce its destabilizing trade surplus. For China, the timing and sequencing of these moves are being considered with due deliberation, but mainly with an eye toward keeping its embryonic financial system stable.

There are clear risks in this approach - excess liquidity and asset bubbles are most obvious in this regard. But these are China's risks to accept and manage rather than our place to dictate the terms of engagement. China's pace may not fit America's political imperatives, but whose fault is that?

Globalization is full of opportunity and challenge, as well as fear and risk. But in the end, globalization is nothing more than trust-trust in economic partners to act out of collective interests in making the world a better and more prosperous place. I fear that a China-bashing US Congress has lost sight of this noble objective at great peril.

The author is chairman of Morgan Stanley Asia





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