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July 06, 2005
Not so scary? Why national wealth matters
In a post called "Selling off little pieces of yourself," Brad Setser worries that the U.S. will have to auction itself off in order to pay for the $800 billion current account deficit.
If the US wanted to fund its current account deficit by selling equity, it would need to sell off the equivalent of 40 Unocal's a year -- whether Chinese state firms, European firms, Japanese insurers or Saudi princes
Sounds scary, right? Unfortunately, Brad is making the very very common mistake of taking the value of U.S. assets--that is, our wealth--as a fixed number, so that everything that goes to foreigners is less for Americans. That is, he's treated wealth as a zero-sum game.
In fact, U.S. wealth has historically grown at a pace which far exceeds the size of the current account deficit. As the economic pie gets bigger, there's enough to feed our foreign friends while keeping an ever-growing piece for ourselves.
Since 1952 household net worth--that is, assets minus liabilities--has increased by an average of 7.4% annually, or 3.7% in real terms. That includes real estate booms and real estate busts, bull markets and bear markets.
This annual percentage gain translates into a huge increase in net worth, in dollars. Household net worth today is just under $50 trillion, according to the Federal Reserve. A 7.4% increase--the average for the past 50 years--would correspond to a $3.4 trillion increase in wealth. That means we could cover an $800 billion current account deficit, and have plenty left over.
Even if we assume that households are responsible for all of the federal government's debt, and we adjust for inflation, that doesn't change the calculation much. Here's what the past year looked like:
Over the past year, the net worth of households has increased by $1.6 trillion, in 2005 dollars, even after we subtract out the rise in public debt and adjust for inflation. (Moreover, the extra debt to foreigners is presumably already built into these numbers, in the form of corporate and government debt).
Interestingly, the increase in wealth has historically been fairly consistent, as these things go. Here's a chart of the ten-year growth rate of real household net worth (the last data point is the first quarter of 2005):
The real growth rate of household wealth has gone as low as 2% per year during the weak productivity years and as high as 6% per year at the height of the boom. Even if household wealth only rises by 2% in real terms, or 4% in nominal terms, that's enough to cover the current account deficit, though only barely.
My conclusion: As long as productivity growth stays strong, national wealth will grow fast enough to sustain these current account deficits. The biggest danger is a slowdown in productivity growth.
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Wealth is not always liquid. A job layoff and the refusal of banks to give you a loan against assets(home equity) because you have no income to repay the loan, could force you to sell that "wealth" at a discounted rate. Multiply that single layoff by thousands in a recession and the US's true wealth would decrease while it's liabilities( deficits) would not. Cash flows do matter.
Posted by: denny at July 24, 2005 12:39 PM
Comment on Wealth is not always liquid.
Capital wealth is like energy. It's extremely difficult to destroy it. Rather it just moves from one form to another. The sun creates light, which is turned into heat when it hits the ocean. Heat gets transmitted into the air. This causes the air to move. The kinetic energy in the air is put back into the ocean when it is picked up and pushed onto a city. Eventually it is radiated out into space where people think it is gone but it is just spread too thin to see.
The wealth that the person lost in the sale is picked up by the real estate agent and his/her broker, the investor who buys the home, the inspector, the new bank and it's employees, and the title company and the people who work there. These people spend that wealth on a thousand things in a thousand places. Soon, people think the wealth is gone but it is just spread too thin to see.
Posted by: Joe at September 2, 2005 08:12 PM
Wealth is not like energy. It can be destroyed. Just ask anyone who lived through the Great Depression.
Posted by: Michael Thompson at March 10, 2006 10:01 PM