Paul Krugman sifts through the clues regarding the causes and potential consequences of our growing trade deficit. When the clues are assembled and evaluated, the crime appears bigger and more problematic than first reported:
CSI: Trade Deficit, by Paul Krugman, Deficit Puzzle Commentary, NY Times: Forensics are in. If you turn on the TV during prime time, you're likely to find yourself watching people sorting through clues from a crime scene, trying to figure out what really happened.
That's more or less what's going on right now among international finance experts. The crime in question is the U.S. trade deficit, which ... reached an amazing $805 billion last year. The mystery is how we've been able to run huge deficits ... with so few visible adverse consequences. And the future of the U.S. economy depends on which of two proposed solutions to the mystery is right.
Here's the puzzle: the trade deficit means that America is ... spending far more than it earns. ... To pay for the excess of imports over exports, the United States has ... borrowed more than $3 trillion just since 1999.
By rights, then, the investment income ... that Americans pay to foreigners should be a lot larger than the investment income foreigners pay to Americans. But according to official statistics, the United States still has a slightly positive balance on investment income.
How is this possible? The answer, almost certainly, is that there's something wrong with the numbers. ... But depending on ... what's wrong, the U.S. economy either has hidden strengths, or it's in even worse shape than it seems.
In one corner are economists who think the official statistics miss invisible U.S. exports ... of intangibles like knowledge and brand-name recognition, which allow U.S. companies to earn high rates of return on their foreign investments. Proponents ... claim that if we counted [this] ..."dark matter," much of the U.S. trade deficit would disappear. ... But ... U.S. companies operating abroad don't, in fact, seem to earn especially high rates of return.
Why, then, doesn't the United States seem to be paying a price for all its borrowing? Because according to the official data, foreign companies operating in the United States are remarkably unprofitable, earning an average return of only 2.2 percent a year.
There's something wrong with this picture. As Daniel Gros of the Center for European Policy Studies puts it, it's hard to believe that foreigners would continue investing in the United States "if they were really being constantly taken to the cleaners."
In a new paper, Mr. Gros argues — compellingly, in my view — that ... foreign companies are understating the profits of their U.S. subsidiaries, probably to avoid taxes, and that official data are ... failing to pick up foreign profits that are reinvested in U.S. operations.
If Mr. Gros is right, the true position of the U.S. economy isn't as bad as you think — it's worse. The true trade deficit ... isn't $800 billion — it's more than $900 billion. And America's foreign debt ... is at least $1 trillion bigger than the official numbers say.
Of course, optimists have a comeback: if things are really that bad, why are so many foreign investors still buying U.S. bonds? ... But I have two words for those who place their faith in the judgment of investors...: Nasdaq 5,000.
Right now, forensic analysis seems to say that the U.S. trade position is worse, not better, than it looks. And the answer to the question, "Why haven't we paid a price for our trade deficit?" is, just you wait.