Wednesday, December 27, 2006

a frightening prosperity

Steven Pearlstein of the Washington Post, my favorite economic columnist, has a good piece tying together income inequality and the global economy. He says much the same as the IMF and our own Federal Reserve tell us, but in a helpful, big-picture way, and, he avoids drawing simplistic conclusions. Here's the link and some excerpts:
Of Public Debt and Private Wealth
By Steven Pearlstein
Wednesday, December 27, 2006; Page D01

With Democrats about to take charge on Capitol Hill, we're going to be hearing a lot about the widening income gap between rich and poor. ... As [this great national debate] plays out, it's important to remember that there isn't one correct analysis or any silver-bullet solution.

In that spirit, I'd like to toss out an idea borrowed from a reader in Canada with no particular training in economics but an intuitive sense about the connection between trade flows and income inequality. The idea goes something like this:

In terms of the global economy, the elephant in the room for much of the last 25 years has been the large and persistent U.S. current account deficit (loosely, the trade deficit), which this year is likely to exceed $800 billion. Roughly speaking, the richest country in the world spends 106 percent of its income.
Here, Pearlstein points out that China, other Asian countries, the oil-exporters, and countries from which we buy commodities all have accumulated lots of US dollars. They know they can't sell the dolllars (convert to local currency) without causing havoc with their own economies so they repatriate the dollars by investing them in US Teasuries, stocks, real estate, etc. -- a lot of the investment being made trough hedge funds and the like. He also points out that the US stock markets are at all-time highs largely because of this foreign investment.
So what does this have to do with income inequality? Quite a bit, actually.

We've known for a long time that increased trade with low-wage countries depresses wages of workers who produce goods and services now imported. A trade deficit equal to 7 percent of economic output obviously magnifies that effect.

But as the trade deficit is depressing wages at the bottom, it is now boosting incomes at the top by significantly inflating the value of stocks, bonds and real estate -- assets whose ownership is concentrated heavily in the hands of high-income people. By buying and selling these assets, and borrowing against them, these people have been transforming their paper wealth into spendable (and measurable) income at a record pace. ...

It would be an exaggeration, of course, to argue that our large and persistent trade deficit is the major factor in rising inequality. ... But in the coming debate, we need to remember that [wealthy Americans] are the lucky beneficiaries of a runaway trade deficit and the bubble-prone economy it has created.
The following chart from the Bureau of Economic Analysis shows foreign investments in the US and US investments abroad. About it, BEA says "Foreign-owned assets in the United States were $12,702.5 billion at yearend 2005, compared with $11,547.4 billion at yearend 2004. The -$333.0 billion change in the net investment position from yearend 2004 to yearend 2005 was largely due to record private net foreign purchases of U.S. securities, including U.S. Treasury securities, and to the depreciation of most major foreign currencies against the dollar, which lowered the dollar value of U.S.-owned assets abroad."
{click to enlarge}

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