Michael Dennis has a question…

…via Tyler Cowen:

The fact that the US is running a persistent trade deficit and experiencing significant net capital inflows seems like very strong evidence that we are not in a traditional Keynesian situation, where we have ‘excess saving.’

If we have excess saving, why are we having a capital inflow rather than a capital outflow?

If combined private and public demand were below the economy’s productive capacity, why are we running a trade deficit? Doesn’t the existence of a persistent trade deficit indicate that our demand is in excess of our supply?

Very much not our grandma’s recession.

There’s an important assumption here that Dennis should make explicit – that trade deficits are only a demand-side issue. But the marginal propensity to import is as critically decided by supply-side issues. For example, as American shale production booms, we will become a net exporter of oil.

But there’s an even more important distinction. Remember, back in Keynes’ time, gross national product was the preferred measure of economy. Indeed, only in 1991 did the United States switch to domestic product as the standard measure.

In this case I submit that the former is definitely a better framework for understanding demand. Foreign capital inflow finances development in America, and is definitely a good thing (of course, for a global reserve it is inevitable). But they are also a foreign claim on future domestic earnings. Assuming easy repatriation of profits, they will ultimately be used to increase consumption – hence demand – in some other country, moderated only by that country’s marginal propensity to import from America.

Investment is just deferred consumption. But that linearity is correct only for American residents. In fact, trade deficit by itself probably doesn’t tell us much about aggregate demand at all. He says “Doesn’t the existence of a persistent trade deficit indicate that our demand is in excess of our supply.” Conversely, I’d say the sovereign of the only big global reserve currency is bound to run trade deficits. (Think about it this way: there’s excess savings in the domestic currency – that’s infinitely more important).

Increased demand for oil creates a captive demand for American dollars, only exacerbated by a global safe-asset shortage. Therefore capital inflow is inevitable. I’d argue this is more structural than nominal, and hence not really pertinent to demand, per se. Actually, since the financial crash, the trade deficit has fallen. So if you follow Dennis’ syllogism, wherein a trade deficit implies more a check on excess saving, then we’re actually saving more. That is net capital inflow relative to GDP has fallen.

Since there’s been overall deleveraging in America. The logic does not add up at all. The only way to make it work is to use what is an inappropriate use of “we”. Remember, this is tautological, as the accounting identity goes: private financial deficit + public financial deficit + foreign financial deficit = 0.