Our capital account surplus

A recent Associated Press headline said, "Current account trade deficit posts unexpectedly large improvement." It fell 6 percent.

But why assume that was an improvement? After all, the current account deficit "improved" during every recession, and even moved into surplus during the worst recessions of 1975 and 1980-81.

The Economist's survey of world forecasters estimates the current account deficit will reach 7.3 percent of gross domestic product in Spain this year and 5.6 percent of GDP in Australia. I think the U.S. current account deficit will be about 6 percent. The flip side is that 61/2 percent of GDP measures the difference between foreign investment rushing into America minus U.S. investment flowing abroad. We have a large capital surplus, otherwise known as a current account deficit.

What do countries with large capital account surpluses have in common? Economic growth over the last year was 3.1 percent in Australia, 3 percent in Spain and 3.6 percent in the United States. The expected current account deficit is smaller in the United Kingdom (2.7 percent), yet British economic growth is also slower (2.2 percent). India's current account deficit is running about 2 percent of GDP. By contrast, Germany has a perpetual current account surplus and a pathetic economic growth rate long been stuck close to 1 percent.

Since third-quarter 2003, U.S. exports of goods alone have risen 9.7 percent annually in real terms -- more than double the 4 percent growth of real GDP. Real imports of goods rose 9.2 percent. The U.S. is a big exporter of plastics, aircraft, specialized industrial machinery, scientific instruments, corn, cotton and soybeans. But producing and shipping such products requires importing oil and natural gas.

In April 2006, imported oil and natural gas accounted for 34 percent of the U.S. merchandise trade deficit, not because we guzzled more oil. There was 7 percent less crude oil imported than a year earlier, yet the cost was 18 percent higher.

One of the most persistent myths about semi-free trade or globalization is that countries with trade deficits must be losing manufacturing jobs to countries that run trade surpluses. Japan and Germany have run chronic trade surpluses for many years, particularly in manufactured goods, making it easy to test this theory.

From 1992 to 2005, the Bureau of Labor Statistics says, the number of manufacturing jobs fell 16.3 percent in the United States, from 20.1 million to 16.3 million. But manufacturing jobs fell 24.1 percent in Germany (from 10.7 million to 8.1 million) and by 27.2 percent in Japan (from 15.7 million to 11.4 million).

Chronic trade surpluses were a sign of capital flight, not industrial might. Since 1992, industrial production has increased 11.5 percent in Japan, 18.9 percent in Germany and 59.7 percent in the United States. People in Japan and Germany sold goods to the U.S. to get the dollars needed to invest in the stronger U.S. economy.

So long as people are free to invest wherever they like, global balance is literally impossible. Yet several economists have made careers out of fretting about "global imbalances." They never define current account surpluses as "imbalances," which puts all the emphasis on belt-tightening among vigorously expanding economies, rather than pro-growth policies among the laggards.

In advocating a Federal Reserve policy "predisposed more toward tightening," Stephen Roach of Morgan Stanley frets, "There is always a chance it's too late -- that America's imbalances are so advanced, the only way out is the dreaded hard landing." A hard landing means lower stock and housing prices, yet lower asset prices is precisely what Mr. Roach wants the Fed to accomplish.

In a startling confusion of cause and effect, he worries the United States must "run massive current account and trade deficits in order to attract foreign capital." Investors are attracted to countries because of their current account deficits?

That previously cited AP report said: "The concern is that the current account deficit could grow so high that foreigners would become less willing to hold U.S. assets. If they began dumping their U.S. holdings, it could depress stock prices, send U.S. interest rates higher and cause the dollar's value to fall sharply."

That "hard landing" mantra seems to be the equivalent of the phrase "Hare Krishna" for some economists, who never tire of repeating it. But what does it mean? If foreigners "dumped" U.S. stocks and bonds, who would they sell to and how would they be paid? If they could somehow sell U.S. assets only to Americans, foreign investors would suffer a capital loss at the expense of American bargain-hunters.

Regardless of where the buyers lived, those foreign sellers of dollar-denominated assets would be paid in dollars -- they would have dollar cash and the buyers would have dollar assets. Why would the dollar fall? Not because of the current account deficit, because the hard landing argument insists that, if the current account deficit could not be financed, it could not exist. Besides, if there were any connection between current account deficits and exchange rate movements, it would be child's play to make billions by speculating on exchange rates.

Why would those who supposedly rushed to liquidate U.S. assets in exchange for dollar cash be eager to swap those greenbacks for euro or yen? That might make sense if they wanted to invest in European or Japanese stocks and bonds, yet those markets always collapse whenever U.S. markets merely tumble. In any case, dips in the prices of U.S. stocks make them cheaper and more attractive to world investors, not less attractive.

What about foreign governments? Official capital inflows fell 48.6 percent from 2004 to 2005, yet nothing noteworthy happened as a result. The inflow of foreign official money invested in the U.S. dropped from $147.6 billion in first-quarter 2004 to just $19 billion a year later, but the hard landing crowd did not even notice. When foreign central banks stop buying U.S. Treasury bills and bonds, someone else buys them. The demand for U.S. bonds is huge, as proven by their low yield.

There are doubtless many things worth worrying about. But the interminable bleating about current account deficits, global imbalances and hard landings is once again sounding remarkably similar to fearing the sky is falling.

Alan Reynolds is a senior fellow with the Cato Institute and is a nationally syndicated columnist.