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Loss of confidence in US dollar could be as dangerous as this crisis
September 21, 2009, Monday
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AS the global economy appears headed toward recovery, concerns are growing that the United States' addiction to massive fiscal stimulus as an economic panacea could eventually lead to an even bigger crisis - a loss of confidence in the US dollar.
Nobel Prize-winning economist Paul A. Samuelson raised the specter of a "truly global financial panic" if countries funding the US deficit, particularly China, decide their investments in US Treasury securities are no longer safe.
Warren Buffett warned in The New York Times that side-effects of the current fiscal intervention could be as dangerous as the financial crisis recently averted - in the form of inflation eroding the dollar's purchasing power.
Preserving the dollar's strength has importance far beyond protecting American tourists from the shock of paying the equivalent of US$25 for a hamburger in London or Tokyo.
Economic experts are concerned about the dollar's health for a number of reasons. Most importantly, the scale of current trade and spending imbalances puts heavy downward pressure on the dollar's value over the long term.
The US imports far more goods and services than it exports, flooding international markets with dollars and undermining their value.
Trade deficit
The current account deficit - the net balance of trade in goods, services, income and transfers - was US$700 billion in 2008. The US trade deficit remains by far the world's largest, although it declined 35 percent in the first quarter of 2009 as the recession dramatically reduced demand for oil and other imports.
"If we continue to borrow from foreign countries to sustain our spending, eventually there will come a time when asset holders around the world will begin to wonder whether the US is credit worthy," says Wharton finance professor Richard C. Marston.
Reflecting the size of the fiscal stimulus, the federal budget deficit is projected to be US$1.6 trillion in 2009 - the highest level since World War II - amounting to 11 percent of gross domestic product (GDP), a dramatic increase from three percent in 2008.
To fund its deficit spending, the US depends on the willingness of major trading partners, such as China, Japan and (the Republic of) Korea, to purchase and hold Treasury securities paying low interest rates.
The biggest threat to the dollar, however, is the shift from reckless consumer spending during the housing bubble to unprecedented levels of government spending in the US.
While aggressive intervention was initially necessary to prevent a global economic collapse, experts warn of federal deficits that could lead to a long-term decline in the dollar. There are two steps that can help avoid rising inflation and a loss of confidence in the dollar.
Cooler heads
First, reduce the US budget deficit. "I'm optimistic that cooler heads will prevail," Marston says, addressing the consequences of the fiscal stimulus before the deficit spirals out of control.
"Clearly there will be some deterioration in the dollar" over the next several years. But he expects the Obama administration to avoid a dramatic depreciation by adopting debt-reduction policies similar to those of the Clinton administration, which balanced the budget for the first time in 30 years in 1998.
The second step is to support China's gradual shift to a consumer-driven economy. Wharton management professor Marshall Meyer expects China to make the transition to a consumer economy in five to 10 years, a process that will require retraining workers now in repetitive manufacturing and moving them into service jobs requiring higher skills.
There is a growing realization in China, particularly among technocrats, that the export-driven model cannot lead to sustainable growth, he says. By over-investing in fixed assets, such as factories and infrastructure, the current system suppresses household consumption and creates boom-and-bust cycles that undermine stability.
The US should provide "every encouragement" for China's transition, including assistance in retraining the workforce, Meyer suggests.
(Reproduced with permission from Knowledge@Wharton, http://knowledgeatwharton.com.cn. Trustees of the University of Pennsylvania. All rights reserved. Shanghai Daily condensed the article.)
Nobel Prize-winning economist Paul A. Samuelson raised the specter of a "truly global financial panic" if countries funding the US deficit, particularly China, decide their investments in US Treasury securities are no longer safe.
Warren Buffett warned in The New York Times that side-effects of the current fiscal intervention could be as dangerous as the financial crisis recently averted - in the form of inflation eroding the dollar's purchasing power.
Preserving the dollar's strength has importance far beyond protecting American tourists from the shock of paying the equivalent of US$25 for a hamburger in London or Tokyo.
Economic experts are concerned about the dollar's health for a number of reasons. Most importantly, the scale of current trade and spending imbalances puts heavy downward pressure on the dollar's value over the long term.
The US imports far more goods and services than it exports, flooding international markets with dollars and undermining their value.
Trade deficit
The current account deficit - the net balance of trade in goods, services, income and transfers - was US$700 billion in 2008. The US trade deficit remains by far the world's largest, although it declined 35 percent in the first quarter of 2009 as the recession dramatically reduced demand for oil and other imports.
"If we continue to borrow from foreign countries to sustain our spending, eventually there will come a time when asset holders around the world will begin to wonder whether the US is credit worthy," says Wharton finance professor Richard C. Marston.
Reflecting the size of the fiscal stimulus, the federal budget deficit is projected to be US$1.6 trillion in 2009 - the highest level since World War II - amounting to 11 percent of gross domestic product (GDP), a dramatic increase from three percent in 2008.
To fund its deficit spending, the US depends on the willingness of major trading partners, such as China, Japan and (the Republic of) Korea, to purchase and hold Treasury securities paying low interest rates.
The biggest threat to the dollar, however, is the shift from reckless consumer spending during the housing bubble to unprecedented levels of government spending in the US.
While aggressive intervention was initially necessary to prevent a global economic collapse, experts warn of federal deficits that could lead to a long-term decline in the dollar. There are two steps that can help avoid rising inflation and a loss of confidence in the dollar.
Cooler heads
First, reduce the US budget deficit. "I'm optimistic that cooler heads will prevail," Marston says, addressing the consequences of the fiscal stimulus before the deficit spirals out of control.
"Clearly there will be some deterioration in the dollar" over the next several years. But he expects the Obama administration to avoid a dramatic depreciation by adopting debt-reduction policies similar to those of the Clinton administration, which balanced the budget for the first time in 30 years in 1998.
The second step is to support China's gradual shift to a consumer-driven economy. Wharton management professor Marshall Meyer expects China to make the transition to a consumer economy in five to 10 years, a process that will require retraining workers now in repetitive manufacturing and moving them into service jobs requiring higher skills.
There is a growing realization in China, particularly among technocrats, that the export-driven model cannot lead to sustainable growth, he says. By over-investing in fixed assets, such as factories and infrastructure, the current system suppresses household consumption and creates boom-and-bust cycles that undermine stability.
The US should provide "every encouragement" for China's transition, including assistance in retraining the workforce, Meyer suggests.
(Reproduced with permission from Knowledge@Wharton, http://knowledgeatwharton.com.cn. Trustees of the University of Pennsylvania. All rights reserved. Shanghai Daily condensed the article.)
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