World - US faces a tricky balancing act

Daniel Altman


Before the current financial crisis, the United States carried enormous trade deficits, and investors from other countries gorged themselves on dollar-denominated assets. Those imbalances were already starting to readjust in the past year as the U.S. economy slowed.

A relevant question now is whether the crisis will alter that trend.

The answer will have far-reaching effects. If the United States is required to become more of a saver and less of a consumer, businesses around the world will have to find new markets for their products or sell less. But if U.S. consumers continue to spend rather than save, the U.S. economy will still need overseas investors to fill their portfolios with dollars, leaving the old status quo in place.

Among specialists in the study of international trade and finance, there is little consensus on how the imbalances will change. Charles Engel, a professor of economics at the University of Wisconsin, said the imbalances would shrink gradually as Americans changed their behavior. "It looks like this is going to have a bigger effect on consumption and investment in the United States than in the rest of the world," he said. "It's more likely that we're going to have more saving and less spending in the United States. That will help our imbalance."

The main issue, Engel said, will be a fall in borrowing. "One way to think about what's been happening in the last 10 years is that credit markets have functioned well, probably too well, in letting households and businesses borrow.

"Now they aren't working so well, and almost surely you're going to see households and businesses reduce borrowing. There'll be more reduction in the United States than in other countries, mostly because we've done more borrowing. We're not going to be buying as many consumer durables, and businesses won't be importing as much equipment from overseas."

A different point of view comes from Maurice Obstfeld, a professor of economics at the University of California at Berkeley.

He said the crisis was likely to slow the readjustment of global trade and investment balances, not help it.

"Had the housing collapse within the United States been contained, that would have led to an increase in American saving relative to that in other countries, which is exactly what we need to decrease our imports and increase our exports," he said. "But now we're going to see an increase in saving worldwide, which is going to complicate the process and lead the different exchange rate effects depending on where the downturn is most intense."

Catherine Mann, a professor of international economics at Brandeis University, said the economic future could take one of two routes.

In what she called "the relatively benign scenario," the United States keeps growing because of long-term export contracts, as the rest of the world also manages to move forward because it is less exposed to the destruction of wealth in the stock markets. As foreigners diversify away from dollar-denominated assets, the dollar declines and the trade gaps continue to close.

In Mann's "global downturn scenario," the picture is quite different. Spending by U.S. consumers plunges, which seriously damages growth abroad. To make their exports more competitive, foreign countries start to devalue their currencies against the dollar. Their businesses maintain their export advantage in the U.S. market, the trade deficits stay as big as ever, and foreigners keep piling up dollars.

For ordinary folk, the outlooks offer mixed fortunes. If the dollar continues to fall, U.S. consumers won't be able to afford as many imports. Foreigners will invest less in the United States, and interest rates will probably rise. But U.S. exports will be more competitive, and that effect could create new jobs.

In the rest of the world, a drop in demand from the United States could hamper growth, but stronger currencies could allow households to enjoy a higher standard of living by buying more imported goods and services. If investors' money stays at home, interest rates will fall, and borrowing to buy a house or start a business will become easier.

But if investors keep on believing that the United States is the best place for their money, then the dollar will stay high. Indeed, in recent weeks its value has risen against major currencies. And that would mean the old imbalances are here to stay.

There is one wildcard in this situation: the U.S. government. The direction the global economy takes, Obstfeld said, will depend in large part on how Congress and the new president respond to the recession and handle the government's budget."The United States doesn't enter this crisis with a very favorable public financial situation, both because of the relatively high federal debt and the impending demographic changes," he said. "It's critical for the future of the dollar that we have a strategy for maintaining government budgetary solvency over time."And, according to Engel, the United States will also have to continue working closely with other countries. "This whole thing has really spotlighted the need for some international coordination of financial policies," he said. "For sure, we're going to see more regulation or at least more enforcement of regulation. Hopefully they'll be as creative regulating as they were trying to find their way out of this crisis."