Charge! (Or Not)

Fed Chairman Ben Bernanke testified before congress this week and highlighted one of the big future worries facing the economy.  What will be the impact of all this government borrowing on the near and long term economic look and the financial markets?  Brad Setser put the deficit explosion into perspective in his blog at the Council of Foreign Relations on June 2.

The story is clear. Government borrowing has increased dramatically. It topped 15% of GDP in the last two quarters of 2008. In 2007 and early 2008 it was more like 3% of GDP. But private borrowing has fallen equally sharply. Total borrowing by households and firms fell from over 15% of GDP in late 2007 to a negative 1% of GDP in q4 2008.

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Both charts highlight the risk that worries me the most. In both the early 1980s and the first part of this decade, both the private sector and the government were large borrowers. And in both cases, borrowing rose faster than domestic savings, so the gap was filled by borrowing from the rest of the world. The trade and current account deficit rose. In the early 1980s, the US attracted inflows by offering high yields on its bonds. More recently, it did so by borrowing heavily from Asian central banks, together with the governments of the oil-exporting countries. But now yields are low (even after the recent rise in the yield on the ten year Treasury bond), and need to be low to support a still weak US economy. And China (and others) are visibly uncomfortable with their dollar exposure; banking on their continued willingness to finance a large external deficit seems like a stretch.

The challenge this time around consequently will be to bring down the government’s borrowing as private borrowing resumes.

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