SKOPJE, Macedonia, Oct. 1 (UPI) -- In 1999, for the first time in a long time, the United States savings rate turned negative.
Americans borrowed at home and abroad to embark on a fervid shopping spree. Even worse, the part of the deficit that was invested rather than consumed largely went to finance the dot-com boom turned bust. Wealth on an unimaginable scale was squandered in this bubble. The much-hyped U.S. productivity growth turned out to have been similar to Europe's over the last decade.
Luckily for the U.S. -- and the rest of the world -- its fiscal stance during the Clinton years was impeccable and far stronger than Europe's, let alone Japan's. The government's positive net savings -- the budget surplus -- nicely balanced the inexorable demand by households and firms for foreign goods and capital. This is why these fiscal years' looming budget deficits -- about $200 billion in the year to Sept. 30, 2002, maybe $300 billion in the year to September 2003 -- provoke such heated debate and anxiety.
Is there a growing reluctance of foreigners to lend to the U.S. and to finance its imports and investment needs? To judge by the dollar's slump in world markets, yes. But a recent spate of bad economic news in Europe and Japan may restore the global appetite for dollar-denominated assets.
This would be a pity and a blessing. On the one hand, only a flagging dollar can narrow the trade deficit by rendering U.S. exports more competitive in world markets -- and imports to the U.S. more expensive than their domestic imperfect substitutes. But, as the late Rudi Dornbusch pointed out in August 2001: "There are two kinds of Treasury secretaries - those like Robert Rubin who understand that a strong dollar helps get low interest rates and that the low rates make for a long and broad boom. And (those) like today's Paul O'Neill. They think too much about competitiveness and know too little about capital markets ... Secretary of the Treasury Paul O'Neill, comes from manufacturing and thinks like a manufacturer (who) have a perspective on the economy that is from the rabbit hole up. They think a weak dollar is good for exports and a hard dollar hurts sales and market share. Hence they wince any time they face a strong dollar and have wishy-washy answers to any dollar policy question."
The truth, as usual, is somewhere in the middle. Until recently, the dollar was too strong -- as strong, in trade-related terms, as it was in the 1980s. Fred Bergsten, head of the Institute for International Economics, calculated in his testimony to the Senate Banking Committee on May 1, that the U.S. trade deficit soars by $10 billion for every percentage rise in the dollar's exchange rate.
American manufacturers shifted production to countries with more competitive terms of trade -- cheaper manpower and local inputs. The mighty currency encouraged additional -- mostly speculative -- capital flows into dollar-denominated assets, exacerbating the current account deficit.
A strong dollar keeps the lid on inflation, mainly by rendering imports cheaper. It thus provides the central bank with more leeway to cut interest rates. Still, the strength of the dollar is only one of numerous inputs -- and far from being the most important one -- in monetary policy. Even a precipitous drop in the dollar is unlikely to re-ignite inflation in an economy characterized by excess capacity, falling prices, and bursting asset bubbles.
A somewhat cheaper dollar, the purported -- but never proven -- "wealth effect" of crumbling stock markets, the aggressive reduction in interest rates, and the wide availability of easy home equity financing should conspire to divert demand from imports to domestic offerings. Market discipline may yet prove to be a sufficient and efficient cure.
But, the market's self-healing powers aside, can anything be done -- can any policy be implemented -- to reverse the deteriorating balance of payments?
In a testimony he gave to the Senate in May, O'Neill proffered one of his inimitable metaphors: "All the interventions that have been modeled would do damage to the U.S. economy if we decided to reduce the size of the current account deficit. And so I don't find it very appealing to say that we are going to cut off our arm because some day we might get a disease in it."
This, again, is dissimulation. This administration -- heated protestations to the contrary notwithstanding -- resorted to blatant trade protectionism in a belated effort to cope with an avalanche of cheap imports. Steel quotas, farm and export subsidies, all manner of trade remedies failed to stem the tide of national red ink.
The dirty secret is that everyone feeds off American abandon. A sharp drop in its imports, or in the value of the dollar, can spell doom for more than one country and more than a couple of industries. The U.S. being the global economy's sink of last resort -- absorbing one quarter of world trade -- other countries have an interest to maintain and encourage American extravagance. Countries with large exports to the U.S. are likely to reacts with tariffs, quotas, and competitive devaluations to any change in the status quo. The IMF couches the awareness of a growing global addiction in its usual cautious terms: "The possibility of an abrupt and disruptive adjustment in the U.S. dollar remains a concern, for both the United States and the rest of the world ... The question is not whether the U.S. deficit will be sustained at present levels forever -- it will not -- but more when and how the eventual adjustment takes place ... While this would likely be manageable in the short term it could adversely affect the sustainability of recovery later on."
Another embarrassing truth is that a strong recovery in Europe or Japan may deplete the pool of foreign capital available to the U.S. German and Japanese investors may prefer to plow their money into a re-emergent Germany, or a re-awakening Japan, especially if the dollar were to plunge. America requires more than $1 billion a day to maintain its current levels of government spending, consumption, and investment.
There is another -- much hushed -- aspect of American indebtedness. It provides other trading blocks and countries -- for example, Japan and the oil producing countries -- with geopolitical leverage over the U. S. and its policies. The U.S., forced to dedicate a growing share of its national income to debt repayment, is "in growing hock" to its large creditors.
Last month, Arab intellectuals and leaders called upon their governments to withdraw their investments in the U.S. This echoed the oil embargo of yore. Ernest Preeg of the Manufacturers Alliance was quoted by the Toronto Star as saying: "China, for example, could blackmail the United States by threatening to dump its vast holdings of U.S. dollars, forcing up U.S. interest rates and undermining the U.S. stock market. Chinese military officials, he claimed, had included this kind of tactic in their studies of non-conventional defense strategies."
These scenarios are disparaged by analysts who point out that America's current account deficit is mostly in private hands. Households and firms should be trusted to act rationally and, in aggregate, repay their debts. Still, it should not be forgotten that the Asian crisis of 1997-98 was brought on by private profligacy. Firms borrowed excessively, spent inanely, and invested unwisely. Governments ran surpluses. As the IMF puts it: "To err is human and this is as true of private sector investors as anyone else."
Sam Vaknin advises governments in their negotiations with the IMF.
Part 1 of this analysis was published Monday. Send your comments to: [email protected].
