Household borrowing and the US current account deficit

I think I might have spotted a historic first - the Guardian is right on economics, and a good blogger wrong. Larry Elliott says:

Consumers have been using their homes like ATMs - borrowing against rising prices - but this cannot go on forever. The US economy needs quite a prolonged period in which consumer spending grows more slowly than the economy: that is the only way that the trade deficit is going to be reduced...
The US has struck a Faustian bargain with its trading partners, particularly China, responsible for about one third of the $700bn-plus trade total last year. As the American economist Tom Palley puts it: "US consumers get lots of cheap goods in return for which they give over paper IOUs that cost less to print."

Sudha Shenoy replies that the share of consumer goods in imports has declined, and that of  production goods has risen. She says:

The present US trade deficit/capital inflow cannot be the result of irresponsible, high consumption.

However, if we look at the flow of funds data (page 7 of this pdf), we see a different picture - the US current account deficit is largely the counterpart of household borrowing, as Larry says. They show that foreigners made a net financial investment in the US economy of $781.1bn in 2005. The biggest counterpart of this is households' negative net financial investment of $622.3bn - their savings have been less than spending on housing and consumer durables.
This fact is easily reconciled with the pattern of US imports. The latter are determined by comparative advantage, not by the identity of the person who borrows.
For example, if an American borrows to buy US-made goods, whilst an American factory spends its profits on imported capital equipment, imports will be of capital goods, whilst the current account and trade deficit will be the counterpart of household borrowing. 
However, none of this means Larry is right to suggest that we should worry.
1. It doesn't follow that household borrowing caused the current account deficit. The causality may be the other way. Maybe the US deficit is caused by a willingness of Asians to buy US assets - for reasons discussed by Michael Dooley and Ricardo Caballero (pdf). This has driven real interest rates down, and so encouraged household borrowing.
2. It doesn't follow that American households are irrational to borrow. "Living beyond your means", for a while, is rational, if you expect future incomes to grow fast, or if you want to buy new durable goods today and consume their services in future.

Comments

[Alex]

You really like flow-o-funds data, don't you?

[chris]

It's not that I love em - it's just that others ignore them, and I want to redress the balance.

[spencer]

The composition of trade is because of comparative advantage in one product over another and has nothing to with the issue of over consuming or under investing.

[Laurent GUERBY]

Flow of fund shows that USA gov debt is only 25% of USA total debt (including business and households) which is at more than 200% of GDP.

Since those debt are potential substitute, it is quite dishonnest to talk only about government debt.