Economics focus
Stop worrying and love the deficit
Nov 27th 2003
From The Economist print edition
America's current-account deficit poses few dangers,says Alan Greenspan,Except to
Europeans
IN THE past year the United States has run up a current-account deficit of more
than $500 billion,Some think that the line of credit extended by the rest of the
world to America is dangerously long,As Kenneth Rogoff,formerly chief economist
of the International Monetary Fund,puts it,foreign creditors give poor countries
“just enough rope to hang themselves”,but they are giving the Americans,enough
rope to tie the noose around their neck several times.” Most countries with a deficit
of such size would find the downward pressure on their currencies and the upward
pressure on bond yields irresistible,They would be forced to cut their expenditure and switch their
spending from imports to domestic production,
But for America the gallows do not beckon yet,according to a recent speech* by Alan Greenspan,
the chairman of the Federal Reserve,at a conference sponsored by The Economist and the Cato
Institute,Admittedly,Americans' demands on the world's savings are greater than ever,But Mr
Greenspan argues that,thanks to spreading globalisation,the pool of savings on offer in today's
global capital markets is deeper and more liquid than ever,The markets continue to furnish America
with the money it needs without demanding higher yields in return,
In a recent paper? Michael Dooley,of the University of California at Santa Cruz,and David Folkerts-
Landau and Peter Garber,of Deutsche Bank,come to the same sanguine conclusion from opposite
premises,the deficit is manageable not because today's world is unique but because it replicates
the post-war Bretton Woods era,America is once again at the centre of an international monetary
system,On the periphery,where post-war Europe once stood,now stands East Asia,with its
cosseted capital markets and fear of floating against the dollar,The players have changed,but the
rules of the game are much the same,
Under Bretton Woods,the Europeans,as they regained their exporting strength,amassed ever
greater dollar claims on America,Similarly,under today's,revived” Bretton Woods system,the East
Asians hoard their export earnings in low-yielding dollar assets,such as Treasury bills,What East
Asia hoards,America happily spends,the inflow of Asian capital keeps American interest rates low
and demand high,Moreover,America tends to spend its cheap East Asian loans on cheap East Asian
goods,America and Europe used to enjoy a similar relationship,As Jacques Rueff,a French
economist,put it in 1965:,If I had an agreement with my tailor that whatever money I pay him
returns to me the very same day as a loan,I would have no objection at all to ordering more suits
from him.”
America gets more suits,but what do the East Asian tailors get out of it? Yields on safe,dollar
assets are low and the opportunity cost is high,given better returns at home or elsewhere,Messrs
Dooley,Folkerts-Landau and Garber argue that East Asia's governments are accumulating dollar
assets as a by-product of a strategy of export-led growth,East Asia is prepared to forgo better
returns in order to keep its exchange rates down and export demand up,This allows the region's
industries to compete on world markets and attract foreign investment,To stretch Mr Rogoff's
metaphor,the rope East Asia extends to America is not a noose but a tow-line,which will gradually
pull Asian economies towards greater prosperity,
Others,such as Ronald McKinnon of Stanford University,think that American profligacy has trapped
East Asia into running current-account surpluses,The region is forced to acquire dollar assets in
order to avoid exchange-rate appreciation and deflation,Under the original Bretton Woods system,
Mr McKinnon points out,America borrowed on a short-term basis from Europe,but lent long,
making enormous direct investments in the rebuilding of Europe's war-blasted capital stock,These
days America (direct investments in China notwithstanding) borrows short in order to spend,
Slow change,or slower
The $500 billion question,however,is whether America's deficit is sustainable,The authors believe
that the current system can endure,but that it will change,East Asia will continue to lend to
America until the surplus labour in its hinterlands is absorbed into its export industries,its financial
system has matured and its currencies are ready to float,And after East Asia has graduated from
the economic periphery,as Europe did before it,South Asia may take its place,Mr Greenspan,by
contrast,thinks America's build-up of foreign debt must slow and eventually be reversed,But he is
confident of a soft landing,market forces will,incrementally defuse” the deficit,The dollar may fall
and bond yields rise,but America is flexible enough to adjust painlessly,
Messrs Dooley,Folkerts-Landau and Garber put their faith in the rigged exchange rates and
regulated capital markets of Asia,Mr Greenspan puts his faith in market forces and the flexibility of
America,None of them thinks America should lose any sleep over its current-account deficit,All of
them caution against protectionism,of which there have recently been unnerving signs,
Most of the discomfort caused by America's deficit will be felt neither in Asia nor in America but in
Europe,European investors may be growing less willing to underwrite American borrowing for
miserable returns,according to Morgan Stanley,they sold $403m-worth of American stocks,bonds
and notes in September after purchasing $28 billion-worth a month between January and August,
Meanwhile,European exporters are losing markets,squeezed out by an appreciating euro,However
much rope East Asia provides,European necks are in the noose,
* www.federalreserve.gov/boarddocs/speeches/2003/20031120/default.htm
,An Essay on the Revived Bretton Woods System”,NBER Working Paper no,9971,September 2003,www.nber.org/papers/w9971
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