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Marshall Loeb: Double deficits and the faith-based dollar
By Marshall Loeb
Friday, November 5, 2004
NEW YORK -- As if President Bush doesn't have enough
economic and investment problems to worry about in his
second term, here's a lollapalooza:
The United States has long been running not just one but
two huge and expanding deficits. First, of course, is the
familiar federal budget deficit. But then there also is the
less well-known current accounts deficit, which comes
from America's exports and imports, its payments from
U.S. investments abroad and foreign investments in the
United States. In brief, we simply buy much more than
we sell abroad.
The United States has been able sit back and calmly
watch these double deficits grow and grow simply
because foreign lenders have been willing bankroll them.
The lenders have accepted U.S. dollars in payment,
mostly U.S. Treasury bills, notes and bonds.
The creditors have been willing to accept this paper
without limit because the dollar is uniquely and
completely convertible -- you can change your
greenbacks into just about any other currency at any
time, in any place. The dollar is also a faith-based
currency; it is not supported by gold.
But the lenders lately have grown impatient with this
game. They have been tiring of the buildup of the double
deficits. They have grown a bit nervous about the U.S.
economy. In consequence, they are less willing than
before to lend money to the United States to cover these
deficits, and take dollars without end.
If these foreign lenders ever stop accepting unlimited
amounts of dollars, it would cause grave economic woes
in the United States, and clobber America's bond and
Already there are some danger signs.
As Harvard economics Professor Jeffrey Frankel points
out, every year for the last four years, foreign private
investors have funded less and less of the U.S. current
accounts deficit, and foreign government investors have
funded more and more of it. Meanwhile, the current
accounts deficit is steadily rising, and now amounts to
about 6 percent of the U.S. gross domestic product.
In the year 2000, government-run foreign central banks
-- notably the People's Bank of China and the Bank of
Japan -- bought $43 billion in Treasury securities, and
thus funded only about one-tenth of that year's $413
billion U.S. current account deficit.
But in 2003 (the latest year for which there are full
statistics), government-run foreign central banks swelled
their purchases to $249 billion in Treasury securities, thus
funding almost half of that year's current accounts deficit
of $531 billion.
What happened? The government bankers presumably
felt they had to step in when private investors showed
some reluctance to buy. The bankers knew that if ever
there were a serious shortfall in demand for Treasury
securities, interest rates in the United States would
shoot up in order to make those securities more
By becoming such a force in the Treasury securities
market, foreign central bankers may gain some leverage
in their economic relations with the United States. Says
Morris Goldstein, a senior fellow at the Institute for
International Economics: quot;In a dispute, you don't know
how they will lean. It's uncomfortable to depend on the
kindness of strangers.quot;
This is a situation that has trouble written all over it, he
adds. Some time in the next three to four years there
will be problems. The only way to escape them, bankers
at home and abroad agree, is to reduce the U.S. budget
deficit and the current accounts deficit.
One way to do the latter would be to reduce the value of
the dollar relative to other major currencies. That would
increase America's exports, and cut its imports.
Another sure way to do that is for China to raise the value
of its currency, the yuan. That would raise the price of
China's goods in global markets, and thus reduce U.S.
demand for those goods.
China's currency is greatly undervalued -- by 20 to 40
percent, according to some estimates. That is because
China's economy has been growing at a breakneck pace
of 8 to 10 percent a year, but Beijing has not raised the
value of its currency relative to the dollar in 10 years.
The Chinese have been reluctant to risk the slowdown in
exports -- and growth -- that a currency revaluation would
But lately the Chinese have concluded that they are
growing too fast and would be willing to slow the pace --
by raising the value of their money. Similarly, several
other Asian currencies are undervalued and should be
So the pieces are in place for some moves soon on the
currency front that would tend to reduce the nagging U.S.
current accounts deficit.
But even so, a daunting part of the problem would remain:
to reduce the U.S. budget deficit, $412.6 billion in fiscal
2004. That will require all the familiar challenging steps:
to reduce government spending, increase savings and
enhance the economy's growth.
Marshall Loeb is the former editor of Fortune magazine
and a columnist for CBSMarketWatch.
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