Analysis: O'Neill's Free Dinner-I

By SAM VAKNIN, UPI Senior Business Correspondent  |  Sept. 30, 2002 at 1:35 PM
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SKOPJE, Macedonia, Sept. 30 (UPI) -- Only four months ago, the IMF revised its global growth figures upward. It has since recanted, but at the time its upbeat Managing Director, Horst Koehler, conceded defeat in a bet he made with the outspoken and ever-exuberant U.S. Treasury Secretary, Paul O'Neill.

He promised to treat him to a free dinner.

Judging by his economic worldview, O'Neill is a great believer in free dinners. Nowhere is this more evident than in his cavalier public utterances regarding the U.S. current account deficit.

As opposed to those of other, smaller countries, U.S. deficits have far-reaching consequences and constitute global, rather than domestic, imbalances. The more integrated in the global marketplace a country is, the harsher the impact of U.S. profligacy on its economy.

In a paper dated October 2001 and titled "The International Dollar Standard and Sustainability of the U.S. Current Account Deficit," Ronald McKinnon of Stanford University concluded: "Because the world is on a dollar standard, the United States is unique in having a virtually unlimited international line of credit which is largely denominated in its own currency, i.e., dollars.

"In contrast, foreign debtor countries must learn to live with currency mismatches where their banks' and other corporate international liabilities are dollar-denominated but their assets are denominated in the domestic currency. As these mismatches cumulate, any foreign country is ultimately forced to repay its debts in order to avoid a run on its currency.

"But however precarious and over-leveraged the financing of individual American borrowers -- including U.S. banks, which intermediate such borrowing internationally -- might be, they are invulnerable to dollar devaluation. In effect, U.S. collective current-account deficits are sustainable indefinitely."

In another paper, with Paul Davidson of the University of Tennessee, the authors went as far as suggesting that the interminable U.S. deficit maintains the liquidity of the international trading system. A reduction in the deficit, by this logic, would lead to a global liquidity crunch.

Others cling to a mirror image of this argument. An assortment of anti-globalizers, non-governmental organizations, think tanks and academics have accused the United States of sucking dry the pools of international savings painstakingly generated by the denizens of mostly developing countries.

Technically, this is true. U.S. Treasury bonds and notes compete for scarce domestic savings with businesses in countries from Japan to Russia and trounce them every time.

Savers -- and governments -- prefer to channel their funds to acquire U.S. government obligations -- dollar bills, T-bills, T-notes, equities, corporate bonds and government bonds -- rather than invest in their precarious domestic private sector.

The current account deficit -- at well over 4 percent of U.S. gross domestic product -- absorbs 6 percent of global gross savings and a whopping three-quarters of the world's non-domestic savings flows. By the end of last year, foreign investors held $1.7 trillion in U.S. stocks and $1.2 trillion each in corporate debt and treasury obligations -- 12 percent, 24 percent and 42 percent of the outstanding amounts of these securities, respectively.

The November 2000 report of the Trade Deficit Review Commission, appointed by Congress in 1998, concluded that America's persistent trade deficit was brought on by -- as the Cato Institute's Daniel Griswold summarizes it -- "high trade barriers abroad, predatory import pricing, declining competitiveness of core U.S. industries and low wages and poor working conditions in less-developed countries (as well as low) levels of national savings, (high rates of) investment, and economic growth -- and exchange rate movements."

Griswold noted, though, that "during years of rising deficits, the growth of real GDP (in the U.S.) averaged 3.5 percent per year, compared to 2.6 percent during years of shrinking deficits ... the unemployment rate has, on average, fallen by 0.4 percent (compared to a similar rise) ... manufacturing output grew an average of 4.6 percent a year ... (compared to an) average growth rate of one percent ... poverty rate fell an average of 0.2 percent from the year before ... (compared to a rise of) an average of 0.3 percent."

A less sanguine Kenneth Rogoff, the IMF's new chief economist, wrote in The Economist in April: "When countries run sustained current-account deficits up in the range of 4 and 5 percent of GDP, they eventually reverse, and the consequences, particularly in terms of the real exchange rate, can be quite significant."

Rogoff alluded to the surreal appreciation of the dollar in the past few years. This realignment of exchange rates rendered imports to the U.S. seductively cheap and led to "unsustainable" trade and current account deficits.

The IMF concluded, in its "World Economic Outlook," published on Sept. 25, that America's deficit serves to offset -- actually, finance -- increased consumption and declining private savings rather than productive investment.

Fed Chairman Alan Greenspan concurred earlier this year in USA Today: "Countries that have gone down this path invariably have run into trouble, and so would we."

An International Finance Discussion Paper released by the Fed in December, 2000 found, as The Economist put it, that "deficits usually began to reverse when they exceeded 5 percent of GDP. And this adjustment was accompanied by an average fall in the nominal exchange rate of 40 percent, along with a sharp slowdown in GDP growth."

Never before has the U.S. current-account deficit continued to expand in a recession. Morgan Stanley predicts an alarming shortfall of 6 percent of GDP by the end of next year. The U.S. is already the world's largest debtor, having been its largest creditor only two decades ago.

Such a swing has been experienced only by Britain during and after the Great War. In five years, U.S. net obligations to the rest of the world will grow from one-eighth of its GDP in 1997 to two-fifths of a much larger product, according to Goldman Sachs. By 2006, a sum of $2 billion per day would be required to cover this yawning shortfall.

Rogoff -- and many other scholars -- foresee a sharp contraction in U.S. growth, consumption and, consequently, imports coupled with a depreciation in the dollar's exchange rate against the currencies of its main trading partners. In the absence of offsetting demand from an anemic Europe and a deflation-struck Japan, a U.S. recession may well translate into a global depression.

Only in 2003, the unwinding of these imbalances is projected by the IMF to shave 3 percentage points off the U.S. growth rate.

But are the budget and current-account deficits the inevitable outcomes of American fiscal dissipation and imports run amok -- or a simple reflection of America's unrivalled attractiveness to investors, traders and businessmen the world over?

Echoing Nigel Lawson, Britain's chancellor of the exchequer in the 1980s, O'Neill is unequivocal. The current deficit is not worrisome. It is due to a "stronger relative level of economic activity in the United States," he insisted in a speech he gave this month to Vanderbilt University's Owen Business School.

Foreigners want to invest in the U.S. more than anywhere else. The current-account deficit -- a mere accounting convention -- simply encapsulates this overwhelming allure.

This is somewhat disingenuous. In the past three years, most of the net inflows of foreign capital into the spendthrift U.S. have been in the form of debt to be repaid. This mounting indebtedness did not increase the stock of income-producing capital. Instead, it was shortsightedly and irresponsibly expended in an orgy of unbridled consumption.

The second part of this analysis will appear Tuesday

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