Wednesday, November 18, 2009

Economic Problems in the US

The US is facing many economic problems from unemployment of 10%, to the deepest recession on record. This recession has also aggravated levels of US debt. Usually, recessions solve trade deficits. But, the US has still been left with a hefty trade deficit of approximately $500bn.

1. Trade Deficit

The US trade deficit has recently fallen from a peak of 6.5% of GDP to just under 5% of GDP. However, this decreas is largely because of the sharp fall in US GDP and world trade, and may prove temporary. The great recession caused an unprecedented fall in American consumer spending, which led to lower imports. But, despite a fall in the dollar and lower consumer spending, the deficit is still surprisingly large. The US trade deficit widened between August and September

One reason for the persistent deficit is the Chinese government's policy of keeping the Renminbi undervalued. They are doing this by buying dollar assets such as Treasury bills. It is these capital flows which are financing the US current account deficit and preventing the Renminbi appreciating against the dollar. The Chinese purchase of dollar assets such as Treasury bills have also helped fund the US budget deficit, something the US doesn't really mind.

But, the problem is that the large US trade deficit reflects a persistent economic imbalance.

To rectify the deficit will require:
Further depreciation in the dollar to restore competitiveness. This decline in the dollar will reduce American purchasing power abroad.
A period of lower spending and higher saving rates.

There are some who suggest that we should not worry about trade deficits in an ear of free capital flows and floating exchange rates. If the deficit is too large, the dollar should devalue and this should help solve the problem. As long as people are willing to buy dollar securities, the trade deficit will be financed. (see: Should we worry about Trade deficit?)

But, what happens if the world's appetite for buying dollar assets dries up? The dollar could fall sharply to rectify the trade deficit. The worrying thing is that the financial / economic crisis has still not tackled the underlying economic imbalances that exist in the world economy.


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