The American "twin deficits" have become a popular topic - especially on the currency markets. Every time a new journalist learns something about the basic flows of money in the economy, he or she writes an article. This article is read by other journalists who write their own articles, and so forth. Consequently, there are thousands of articles about the American deficits and all of them look alike.
Don't get me wrong: I think that the US trade gap shows that something is not quite right. It's great that the Americans like almost all other nations in the world, and they buy all of their products - but they're just doing too much of it and others are doing too little of it! :-) The British empire in the 19th century was not only a superpower, but also the world's biggest creditor. (Note that it did not help them too much to remain the number one superpower either.) The budget deficit is also kind of wrong - although this one is more likely to shrink if the economy works well. After 1999, I did not believe for a single minute that the US budget surplus would be a permanent state of affairs and one should "plan how to spend it" - in other words, I believed that it should have been spent to compensate a part of the debt from the previous years and the following years. Yes, of course that I would have also supported tax cuts, but they should come together with cuts in spending.
Although the deficits are not right, my feeling is that some not-terribly-deep ideas are repeated too many times. Also, some unfounded rumors - such as the statement "China is reducing its US dollar reserves" - appear all the time - this one has been officially denied. So let me propose a provoking alternative description of the situation.
The sino-dollar zone
The USA effectively have a monetary union with China because the Chinese government pegs their yuan to the US dollar. The monthly trade gap of the Sino-American union is roughly 40 billion dollars: 50 billion of the US gap and 10 billion of the Chinese surplus: these two numbers also include the internal trade between China and the USA. The deficit is roughly 25 dollars per capita; obviously, the Chinese citizens are treated as people with all of their human rights!
Let me call the monetary union "USAC" - which stands for The United States of America and China. ;-) It's a disconnected country with 50 states on one continent and another, large independent state on another continent which is run by a Communist Party. It has two capitals and nearly 1.6 billion people.
Those 25 dollars of the monthly trade gap per a citizen of USAC is a lot, but it is not so much if compared to other countries. For example, Australia's October trade gap was nearly 2 billion US dollars, which is 100 dollars per capita.
United Kingdom's October trade gap was 8 billion USD, which is 130 USD per capita. Note that even if I split USAC to America and China, the US gap will be "just" 170 USD per capita (about 6 dollars a day) - it's not so terribly different from the UK, and you may explain the difference by a better ability of the USA to grow. The more space & population growth a country has, the more you should expect that it will attract investments to support its growth. It's of course incorrect to imagine that the only sustainable configuration is when all trade deficits vanish.
Why I talk about America and China together? Because every time the dollar loses a cent, the yuan loses, too - which makes China even more competitive. Most people don't appreciate the fact that the depreciating dollar has also depreciated the yuan.
Imagine that yuan becomes a floating currency. Free market is always great, but will it be enough to restore balance in the global trade? I am not so sure. Even if China's currency would double, China would remain an excellent source of cheap labor simply because the salary per hour is just 10% of the salary in America, for example.
(Some people say that the yuan is only undervalued by 40 percent - I don't believe it. The correction would start with 40 percent, but it would continue.)
Although a floating Chinese currency is eventually desirable, it may be inappropriate to make this change in the period when many people believe exaggerated ideas about China which is so "hot".
Such a transition should be done in a predictable environment. By "predictable", I mean predictable by the policymakers, not so much predictable by the speculators! I actually think that China itself should first demand more - e.g. higher taxes - from all the foreign (and domestic) companies that come there and the government should actually do more for their people! They're giving their capital - which is the work of the Chinese people - too cheaply. It probably sounds ridiculous if a pro-free-market advocate like I complains about the Chinese communist government that it is not sufficiently socialist on the economic issues, but well, this is what I do. :-)
When the situation in China is sufficiently cooled down so that the average expectation for the yuan motion is zero, it should become a freely floating currency. Floating the currency in the environment of high expectations helps primarily the speculators who buy the currency in time, but that's probably not the goal.
Let's return to America. OK, what do the deficits depend on?
The budget deficits after 2000 appeared because the US economy slowed down, and the deficits in 2003 and 2004 were affected by things like the war in Iraq. With an improved economy and improving situation in Iraq (hopefully), it may be expected that the budget deficit will decrease in 2005.
What about the trade gap? It is not right to assume that the healthier economy will reduce it too much. A growing economy means that the demand is strong, and the imports are strong as well. However it seems clear that the trade gap is large especially because it's still easy for the Americans to borrow money. As the interest rates grow - and hopefully there won't be anything that stops Greenspan to raise the basic interest rate to 3.5 - 4.0 % next year - they will reduce the consumption paid from the loans. This will naturally limit the trade gap. Higher interest rates may attract more investments, and the currency exchange rates may move closer to those when the US interest rates were high in the late 1990s - although this time, they necessarily won't be that high.
I am skeptical about the eurozone growth next year, and my estimate is 0% while the new members of the EU will have a moderately positive growth. The main reasons why the growth in the eurozone will not be positive are:
- the jobs are gonna be moved to the Eastern Europe, and because most of the new countries will already be seen as comparably expensive, given the reduced quality of the workforce there, the jobs will be moved even more to the East. This will undermine the Western European job market and the domestic demand
- the hedging contracts will evaporate throughout 2005 and the European exporters will see, without too much of the rosy glasses of hedging, what it means to be producing with a currency overvalued by 20-40 percent; we claim that a sustainable EUR/USD rate that allows growth everywhere is about $1.10 per euro
- the inflexibility of the oversocialized European economy will take its toll
- moreover, some new pressures suppressing the growth - such as the Kyoto protocol that will take effect in February - will start to act
OK, let me finish with a judgement about the unbalanced situation on the market. It is mostly a fault of the small interest rates in the U.S. - in this sense, I apologize to Mr. Maestro - it is Alan Greenspan's fault. The very small interest rates have discouraged Americans from saving; the discouraged saving also reduces the intent to export; the small rates encourage them to borrow money and import. All these things support the semi-rational idea that the dollar should fall, and the dollar fall clearly does not solve anything. Americans still buy the same things and pay more for it; the foreign exporters get less for their exports, which makes them less able to import from America. The real inbalance is elsewhere, and the interest rates are a major reason.
There are lots of hedging funds and currency speculators around. These disgusting parasites are small replicas of George Soros who have decided to earn money simply by making bets that the dollar or something else will drop - and so far, the theory that this is the ultimate free lunch has worked for them. There should be no free lunches like that because a free lunch is something that makes economy inefficient - a free lunch is a socialist concept. The hedging pseudo-businessmen are not doing anything useful, and they receive a lot of money for this "work". Instead, they should be cleaning the toilets, for example, to be more useful for the society. They should be awarded for their excellent "work" they have done so far: for example, the Fed should raise the rates more than expected. The dollar would then recover much more rapidly than otherwise, and these stinky anti-dollar hedged bastards - which are worse than loop quantum gravity - should drown in their own blood, much like amoebas in a petri dish after we added acid. ;-)
The market should become much less predictable for the speculators - they should be much less able to predict the outcome. Because they're often able to predict, many people with poor moral standards become speculators, and many speculators around is certainly not good for the society as a whole. You know, in socialist Czechoslovakia, we used to have a lot of "wechselmen" who were buying the German mark from the German tourists for 10 crowns and selling it to the Czechs for 20 crowns while the communists claimed that the German mark was equal to 4 crowns (except that you could not buy it - but 4 crowns is what the Germans got in the bank). These people became pretty rich; in some sense, they were already building the market economy within socialism. That does not change anything about my opinion that these people are immoral, useless, and despicable, and the hedge funds are analogous.
My guess is that America can happily grow with up to 5 percent interest rates. It was only the period after the internet bubble burst when the people were so discouraged that they needed a smaller interest rate. Today, the USA should be able to return to the high interest rates. Greenspan has warned everyone sufficiently many times, and the next thing he should do is to act.