Federal Reserve flow of funds table F105 shows that the cost of state and local government to citizens has been steadily escalating over the last five years.

Taxes and other receipts of state and local government increased 2.7% in 2002, 5.5% in 2003, 6.2% in 2004, and 6.7% in 2005.

Most state and local government are not allowed to run a fiscal deficit and increases in expenses are passed on to citizens as higher taxes and other receipts.

The government, in calculating the Consumer Price Index, does not include the cost of increased taxes.

The rising cost of state and local government is an example of ‘hidden’ inflation. (See: Fiddling the CPI)

Federal Reserve flow of funds table F105 does not include the cost of retirement funds for government employees and therefore inflation of state and local government costs is probably greater.

(See: Consequences: Rising Home Values, Land Costs, and Pension Benefits.)

The correct answer to this question is, “Of course, the U.S. trade deficit is not sustainable.”

But then, what is? Neither the Roman nor the British Empire endured. Economic and political phenomenon eventually fade and die. Indeed, the U.S. trade deficit, one day, like everything else will be a thing of the past.

A more practical question would be, “How much longer might the U.S. trade deficit last? One year? Ten years? Thirty years?”

Some observers may presume that the demise of the trade deficit is imminent, perhaps by the end of 2006; but, it this reasonable?

The trade deficit has been growing for thirty years — which almost qualifies as a Keynesian ‘long-run’ . Since no clear mechanism exists whereby the trade deficit must end in, say, six months or a year, it could be that in thirty years our children will still fret about a trade deficit that has grown even larger.

The longevity of the U.S. trade deficit is quite germane to Capital Flow Analysis, since it is the dollars earned by foreign exporters that support the price of American bonds.

(See: “Trade Deficits Have Depressed Bond Yields for Twenty Years.”)

It is worthwhile to speculate about the sustainability of the trade deficit.

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Since the 1980s, the U.S. trade deficit has been a constant force in the American economy, rising more some years than others, while corporate bond yields have been generally falling.

The flow of funds table for “Rest of the World” (F.107) shows that the excess of imports over exports has resulted in an increase in U.S. financial assets owned by foreigners.

These accounts also demonstrate the preference of foreign investors for fixed income securities and the dominant role that the trade deficit has played in the U.S. bond market.

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