- The Washington Times - Monday, February 27, 2006

For the first time in history last year, the sum of the nation’s trade deficit ($726 billion) and federal budget deficit ($320 billion in calendar 2005) exceeded $1 trillion.

By definition, a budget deficit must be financed by borrowing. The same is essentially true for a trade deficit, which is the principal component (about 90 percent) of the more expansive current-account deficit. Indeed, as Ben Bernanke described the process in his inaugural congressional testimony as chairman of the Federal Reserve Board, “The immediate implication of [the current-account deficit] is that the U.S. economy is consuming more than it’s producing, and the difference is made up by imports from abroad, which in turn are being financed by borrowing from abroad.”

Now, because personal saving was negative last year, there was little money from the household sector available to finance the budget deficit. Thus, not only was the trade deficit financed by borrowing from abroad; so too was virtually the entire federal budget deficit. As a result, through a record-level increase in their net accumulation of U.S. long-term securities, foreign investors lent America more than $1 trillion in 2005. (U.S. long-term securities include Treasury notes and bonds; U.S. government agency bonds, including mortgage-backed securities from Ginnie Mae, Fannie Mae and Freddie Mac; corporate bonds; and corporate equities.) It was no coincidence that last year’s sum of America’s trade and budget deficits ($1.046 trillion) so closely approximated foreign investors’ net purchases of U.S. long-term securities ($1.048 trillion).

Never before had Americans borrowed so much from abroad. Indeed, for the first 25 years after World War II, America was a major net creditor. Even after trade deficits became chronic in the early 1970s, net foreign investment in U.S. long-term securities remained negligible for decades. That began to change in 1995. However, from 1995 through 2000, net foreign purchases of U.S. long-term securities helped to finance soaring American business investment, which increased by 80 percent over that six-year period. Meanwhile, during the same time frame, the federal budget balance moved from a $203 billion deficit in fiscal 1994 to a $236 billion surplus in fiscal 2000.

Since 2000, American borrowing from abroad (i.e., annual net foreign investment in U.S. long-term securities) has steadily increased from a bit less than $500 billion in 2001 to more than $1 trillion last year. But it has not financed a major expansion in business investment, whose 2005 level was only 4.5 percent above business investment in 2000. Instead, America’s foreign borrowing has been necessary to finance the $600-billion-per-year reversal in the fiscal balance (fiscal 2000’s $236 billion budget surplus versus an average 2003-05 budget deficit of $370 billion) and the consumption-related doubling of the current-account deficit (from $416 billion in 2000 to an estimated $840 billion in 2005). And the trends are worsening.

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