Friday, June 16, 2006

The Deficit Is Down, Slightly

On Friday June 16th, America’s Bureau of Economic Analysis released its preliminary balance-of-payments estimates for the first quarter. Although many analysts had been hoping for a small contraction, everyone was surprised by the size of the adjustment. For the first three months of 2006, America’s current-account deficit shrank to $208.7 billion, or about 6.4% of GDP. This is down from 7% in the previous quarter. So, America’s enormous current-account deficit finally is on the mend? Probably not. As it stands, the current deficit is still far too large.
The main reason for such a large gap is because Americans still import much more than they export, which they can do because foreigners are willing to lend them lots of money at attractive interest rates. This once was an agreed upon strategy, however this bred a mentality not unlike the millions of Americans with credit card debt, and not enough rainy-days to pay it all off. To prove my point, in a rare instance of economic consensus, most economists now agree that the current-account balance, which was over $800 billion in the red at the end of last year, is unsustainable.

It is also generally agreed that the most natural way for the deficit to correct itself is with a sizeable drop in the value of the dollar. Such an idea already has many politicians sensing another issue for the fall. Of course, the immediate impact of such an action would make imports more expensive for American shoppers, and make their exports more attractive to others. However, what is more interesting is the fact that, until recently, the dollar has been surprisingly uncooperative. It has fallen from the high levels of early 2002, when a buck bought more than €1.1 and over ¥130. Last year though, its value rose steadily, even though the current-account deficit grew by almost $150 billion. It is only over the past few months that the dollar has begun dropping back towards a more sustainable level.

A weaker dollar should please America’s protectionist congressmen, who increase the volume of their complaints about globalisation every time the local Wal-Mart adds another shelf of cheap Chinese electronics or textiles made in Romania. European and Japanese politicians, fear that a more feeble dollar will depress the exports they are counting on to drive their own still-fragile economic recoveries. Italy, Japan and Germany, economic growth is highly dependant on exports. Domestic demand has not yet recovered to the point where consumers can support robust growth in their own economies, much less take on the burden of reducing the gross trade imbalances between America and the rest of the world. Policymakers are keen to keep import prices high, since it will please both workers in export industries and the broader population who tend to feel it is better to be a net exporter than a net importer.

All this is a mixed bag for America’s economy. The dollar will no doubt continue to fall, but by itself this is unlikely to bring America’s current account back in the black. Tough decisions by Congress are ahead, hopefully politicians will stop long enough in their rush to get (re)elected to take notice.

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