Who's financing our deficit?
ASK THIS | December 06, 2004
The American press is starting to get wise to the risks presented by towering deficits. Here is the first of five questions reporters should be asking about who's lending us all this money, why, and for how long? (See the entire series.)
By Brad Setser
Q. Why is the U.S. running a large trade deficit, and who is financing that deficit?
The U.S. is running a large trade deficit because it consumes lots and saves little, while the rest of world tends to consume less and save more. Consequently, we end up importing more goods than we export, and we borrow from the rest of world – effectively, importing their savings -- to make up the difference. This imported savings helps to finance the federal government’s budget deficit, helps to provide the credit that allows consumer spending to rise faster than household pay and helps to finance business investment here in the U.S. In the process, we are running up our external debt – that is to say the debt the U.S. owes to the rest of the world – at a very rapid pace.
A very large share of the money we need to run a trade deficit comes from foreign central banks, not from private investors. Two economists at the New York Federal Reserve Bank, working off data collected by the Bank of International Settlements, recently estimated that foreign central banks provided $440 billion of the $530 billion in foreign financing the U.S. needed in 2003. We don’t have data for this year, but I would guess that foreign central banks are providing a comparable amount – roughly $450 billion – of the $650 billion or so we are likely to need this year. If we had to borrow that much money from private investors abroad, we would have pay higher interest rates.
Any way you look at it, we are borrowing a lot of money from abroad, and the lion’s share is coming from foreign central banks. We are still a lot richer than China, but right now China is financing us, not the other way around – in large part because China saves an awful lot more than we do.