November 2004
Policy Challenges of Global Payment Imbalances
The United States is presently running its largest-ever external current-account deficit. In the absence of appropriate corrective policy measures by the major industrialized countries, this deficit has the potential for hampering the global economic recovery. At a November 4 AEI seminar, experts examined the underlying causes of the large U.S. external payments imbalance, the need for a coordinated policy response by the G7 to this problem, and the reasons why Asian countries are reluctant to allow their currencies to appreciate against the U.S. dollar as part of the global adjustment process.
John Taylor
Under Secretary for International Affairs, U.S. Treasury
Current-account deficits have been a concern since the 1960s. However, today we face a much different system of flexible exchange rates and a significant savings-investment gap. America's present current-account deficit as a percentage of GDP has been growing steadily since the 1990s, and in 2004 it reached 5.75 percent. This trend will persist in the short run, as America remains an attractive place to invest.
Taylor offered several policy remedies to reduce the size of the current-account deficit. Domestically, a policy of reducing the federal budget deficit would increase domestic saving and thereby help lower the current-account deficit. President George W. Bush has stated that he will do this. Also, the government should pursue the creation of other incentives to save like health savings accounts, retirement savings accounts, and personal accounts for Social Security.
Internationally, support for faster global growth will increase demand for U.S. exports and lower the current-account deficit. Initiatives crucial to doing so include America's Partnership for Growth with Japan, the Group for Growth with Brazil, and the Doha Development Round. The G7 needs to continue to reduce market regulations and lower marginal tax rates. Finally, China must be pressured by the G7 to adopt a flexible exchange rate. Overall, there are no reasons to think there will be problems in financing or adjusting the current-account deficit.
John Williamson
Institute for International Economics
The current world expansion is generally balanced with one significant exception: the massive U.S. external current-account deficit, which is the largest the world has ever seen. Williamson presented two forecast models: the first predicts that the deficit will expand to 12 percent of GDP by 2010, while the second predicts that the deficit will expand to 7.6 percent of GDP. Williamson believes this is a problem. As a country's deficit increases, so does the potential for a crisis. He recommends that adjustment policies be implemented immediately.
Fiscal policy is the main domestic instrument for affecting the current-account deficit. Therefore, President Bush should rescind some of his earlier tax cuts, although this may be politically impossible. Internationally, the United States should stop "jawboning" about the strong dollar and encourage a depreciation of about 15 percent to occur. The bulk of adjustment is going to have to occur vis-à-vis the Asian countries' currencies.
Williamson concluded by stating he believes the Treasury erred when it encouraged China to move toward an agenda of free capital movements and a floating exchange rate. It would have been more effective to ask them to institute limited exchange flexibility to allow a modest devaluation of their currency.
David DeRosa
DeRosa-Research and Trading, Inc.
The projected current-account deficit for 2005 is 5.1 percent. Is the U.S. deficit now at an unsustainable level, and if so who decides that it is? DeRosa observed that with floating exchange rates there may not be an adjustment mechanism. He posed two questions to illustrate this point: First, what size deficit equates to what size movement in exchange rates? Second, what is the stopping rule--does adjustment stop when the deficit reaches zero or at some point before this? DeRosa is also skeptical of a significant adjustment occurring because central banks still like to hold reserves denominated in U.S. dollars. The dollar is also still the major exchange medium of international capital.
DeRosa sincerely hopes that the G7 will not get involved with this issue. He quoted Greenspan as saying that anticipating movements in major currencies is rarely possible because almost all relevant information is instantly imbedded in the exchange rates. The present situation can continue for a very long time without a necessary devaluation of the dollar.
Allan H. Meltzer
AEI and Carnegie Mellon University
The present current-account deficit came into existence because people like to invest in America and because of Chinese "market mercantilism." China considers its major problem to be the creation of 200 million domestic jobs and is not primarily concerned with its exchange rate. To achieve their goals the Chinese practice export-led growth, and the cost to them is that they have to buy U.S. assets.
The current situation has four important aspects from an American point of view: First, the United States presently receives valuable goods while giving the world paper, even though this paper is likely to depreciate. Second, the U.S. economic record suggests that a dollar depreciation will occur. Third, we have a World Trade Agreement with the Chinese that will lead to increasing U.S. investment in their country and an increase in the U.S. current-account deficit. Fourth, the likely outcome of all this is incremental steps toward protectionism for domestic firms and possibly a devaluating dollar. It is unlikely that the U.S. savings rate will rise.
Thomas Byrne
Moody's Rating Agency
China and Japan will not play major roles in fixing the U.S. current-account deficit because they have their own internal prerogatives to consider. In China, exports and exports as a percentage of GDP have both doubled since 1998, and the export market is the only source of stable employment. China will not take any drastic action to change the present situation. The government has begun to gradually open up qualified outflows, although this will not necessarily help America's current-account deficit.
Japan will not play a central role until it is sure that its economic recovery is complete. For now they will not allow the yen to appreciate. There are signs of strong economic growth in Japan that may eventually lead to a currency appreciation.
Yusuke Horiguchi
Institute of International Finance
The current-account deficit will continue in the short term for two reasons. There is a persistent growth gap that can be seen in America's high Domestic Demand Index. Also, Asian countries are reluctant to allow their currencies to appreciate. The United States is still running a surplus in the Balance on Investment Income, which means that the current-account deficit need not shrink rapidly.
Eventually an adjustment will occur, so it is better to adopt policies now that will make the adjustment smooth. The Eurozone countries and Japan should adopt a demand-management policy to close the gap between their potential and actual GDP. Emerging countries in Asia should allow a real appreciation of their currencies. The United States should strengthen its fiscal deficit reduction policies. Horiguchi seriously doubts that any of these policies will actually be adopted. The final result will be an inevitable plunge in the dollar that will harm world growth.
AEI intern James Moore prepared this summary.
