Economic Report of the President 2006

Report Plays Down Economic Woes

Bush Advisers Stay Upbeat
Amid Record Trade Deficit,
Low Personal-Saving Rate
By GREG IP
February 14, 2006; Page A2

WASHINGTON -- The U.S.'s rock-bottom personal-saving rate and record trade deficit aren't major worries, the White House said in its latest economic review.

Striking a more optimistic tone than many economists, the Economic Report of the President said the decline in the personal-saving rate last year to post-Depression lows "may not be cause for alarm." It blamed much of the trade deficit on other countries that save too much, rather than the U.S. saving too little.

The report, released yesterday, is prepared annually by the Council of Economic Advisers. Much of this year's report was prepared while new Federal Reserve Chairman Ben Bernanke was still the council's chairman, but he recused himself from preparing the forecast, which was first released last fall. It sees economic growth of 3.4% this year, unemployment at 5% and inflation at 2.4%.

As is customary, the report provided the administration's interpretation of current economic issues and the role of its proposed policies, rather than suggesting new policies.

ECONOMISTS' VIEW



See and download forecasts for GDP, inflation, productivity, employment and interest rates in the latest WSJ.com forecasting survey.Last year, household spending exceeded after-tax income, producing a negative saving rate for the first time since the Great Depression. The rate of household saving in 1980 was 10%. The White House report said the decline is "potentially misleading" because it doesn't reflect how the rising values of houses and stocks make households feel more financially secure and willing to spend.

The report said baby boomers and their children are wealthier than boomers' parents were at the same age. But it cautioned that future generations might live longer and face bigger health-care bills.

Other economists warned about taking comfort in higher household wealth. "It's too sanguine to equate capital gains with cash-flow saving -- they're not the same," said Alan Auerbach, economist at the University of California at Berkeley.

To live off capital gains, a retiree would have to sell the underlying asset. But for many, selling their home is impractical. While high housing prices might enrich the elderly, moreover, they can hurt younger families who have yet to buy a home.


Former Fed Chairman Alan Greenspan has noted that "capital gains do not finance capital investment," because they exist only on paper. Americans don't save enough to both buy those assets from future retirees and finance new investment, forcing the U.S. to directly or indirectly sell assets to foreigners or borrow from them. The assets might remain in the U.S., but a growing share of the income they generate would go to foreigners, Mr. Auerbach said.

The report identified two risks to Americans' retirement security: the weak state of defined-benefit pensions, and Social Security's large unfunded liabilities.

The report also played down concerns over the nation's current-account deficit, the broadest measure of trade in goods, services and investment income between the U.S. and the rest of the world. That deficit was an annualized $751 billion through the first nine months of last year, or a record 6% of gross domestic product. It is financed by borrowing from, or selling assets to, countries that are running current-account surpluses.

The report pinned those surpluses largely on flaws in foreign economies. It said slow population growth and an overhang of excess capital in Japan have depressed investment and thus the demand for savings. In Germany, it said, "structural rigidities" have reduced "opportunities for profitable investment." And in China, the absence of a "strong safety net" and "well-developed financial markets" has kept saving high. The report suggested that high saving can lead to lax bank lending and problem loans.

The report said the U.S. draws in so much foreign capital to finance its current-account deficit because of strong economic growth, a sound business climate, and large, efficient capital markets. It acknowledged the federal budget deficit has contributed to U.S. demand for foreign savings, but cited Fed research that plays down the magnitude.

William Cline, senior fellow at the Institute for International Economics, a Washington think tank, criticized the report for suggesting the deficit is due largely to "factors outside the U.S. and in time this will all take care of itself." He said it lacks "recognition that we have to take corrective action because most of the problem is from our own sources," such as the large budget deficit and the high level of the dollar. The report does state that the U.S. should keep trying to "reduce its fiscal deficit," and the currency systems of China and other countries should be "liberalized."

The report's sanguine view of current accounts appears to reflect the thinking of Mr. Bernanke, who previously has attributed the current-account deficit to a "global savings glut."