Nov 05 2010

US balance of payments deficit prophecies!

Published by at 12:00 pm under Uncategorized

 US balance of payments deficit hits another record – WSWS.org – 16 March 2006

As I was looking for news stories about the balance of payments, which we started studying in AP Economics today, I stumbled upon a story from over two years ago, published on the World Socialist Website, of all places. The reason I am blogging about it today, 25 months later, is that it contains some ominously prophetic messages about what the future (now the past) could hold for the US based on the economic data at the time. Read below to see what I mean:

The extent of the imbalances in the global economy and the fact that normal growth patterns will not correct them has been underlined by the latest US balance of payments deficit. The current account deficit reached $225 billion in the fourth quarter of 2005, up from $185.4 billion in the third. For the year 2005 the deficit was $805 billion, equivalent to 6.4 percent of gross domestic product.The latest figures show that rather than being closed, the payments gap is widening. This was the seventh year out of the last eight in which the deficit hit a new record.

“The bottom line is that a current account deficit of this unparalleled magnitude is unsustainable and there is no hope of it being painlessly resolved through higher exports alone,” Paul Ashworth, an analyst at Capital Economic told the Financial Times.

Total US exports would need to increase by 70 percent to eliminate the payments gap. “This is clearly not going to happen,” Ashworth continued. “Instead it will require a big dollar depreciation alongside much weaker domestic demand for imports.”

In other words,

 

the only way the deficit would start to fall is through a major recession in the US.“a big dollar depreciation” would almost certainly lead to a sharp interest rate rise, as international banks and financial institutions demanded bigger compensation for placing their funds in dollar assets. And a significant interest rate rise would bring a downturn in the economy.On the other hand, On the one hand,

 

“weaker domestic demand for imports” could be achieved only by a severe contraction of the US economy.This is because the very structure of the US economy, in which imports of goods and services are some 59 percent higher than exports, means that normal economic growth automatically increases the deficit.

 

So far almost everything the article has mentioned has actually happened, except for the increase in US interest rates. In fact, the Fed has lowered interest rates as the economy has approached recession, indicating that it considers a slowdown in growth a bigger threat than a weaker dollar and the accompanying inflation. In fact, expansionary monetary policy in the US (i.e. lower interest rates) has accelerated the dollar’s decline as foreign investors have pulled their money out of the US assets as interest rates in Europe and other markets have become more attractive.The article doesn’t hold out much hope for rising exports helping the US out of the predicted recession:

 

The only way the US could export its way out of the crisis would be if economic growth in the rest of the world proceeded at a significantly higher rate than the American economy. But here a vicious circle is in operation because economic growth in the rest of the world is itself highly dependent on an expanding US market. This is especially the case in Asia where economic growth is increasingly being fuelled by exports to China where goods are manufactured for the American market.

Today in class we introduced the determinants of exchange rates. One way Americans have been able to import so much more from China and other countries (remember, the US has trade deficits with 13 of its 15 largest trading partners!!) has been through foreign purchase of financial and real assets in the US, including government bonds:

In fact, the US is becoming increasingly dependent on foreign sources to support its current account and budget deficits. Foreign lenders have been financing 80 percent of the increase in the federal budget deficit, and foreign holdings of treasury securities increased by $108 billion in the last quarter of 2005.As Stephen Roach noted, with a foreign capital inflow of $3 billion every business day—up from $2 billion in 2003—the external dependency of the US “is simply without precedent in the annals of globalization and international finance”.

 

I found it interesting that most of what this article predicted would happen has already transpired, or is in the process of transpiring as we speak. The dollar has depreciated by 18% to the RMB, and even more to other major currencies, the US has entered a recession, raising questions as to the degree to which the economies of Europe and Asia have “de-coupled” from the US economy.Whether the US recession will lead to a significant slowdown in growth among its trading partners has yet to be seen. Uncertainty in global financial market has resulted in an international credit-crunch, meaning lenders have been less willing to extend loans to borrowers, leading to a decline investment and consumption everywhere; but with growth rates still predicted at 8-10% in China, and not too far behind elsewhere in the developing world, it seems plausible that a continued decline of the dollar combined with healthy growth and rising incomes abroad will shift America’s balance of payments away from worsening deficits in 2008.

Discussion Questions:

 

  1. Define “US balance of payments deficit“. What accounts make up a country’s balance of payments?
  2. In what ways would “a big dollar depreciation alongside much weaker domestic demand for imports” help achieve more balanced trade between the US and its trading partners?
  3. Explain the statement: “weaker domestic demand for imports could be achieved only by a severe contraction of the US economy
  4. Which of the determinants of exchange rates that we learned in class (remember “SIPIT”) is referred to in the following claim: “The only way the US could export its way
    out of the crisis would be if economic growth in the rest of the world
    proceeded at a significantly higher rate than the American economy
    “.

16 responses so far

16 Responses to “US balance of payments deficit prophecies!”

  1. Angel Liuon 28 Apr 2008 at 3:28 pm

    1) A country's balance of payments include capital and financial accounts and current account.

    2) A big dollar depreciation encourage US trading partners to import more American goods because the US dollar is relatively cheaper. Before 8rmb is needed to buy $1 of American goods, but now with only 6.99rmb, you can buy $1 of American goods. At the same time, unemployment due to recession limits Americans' purchasing power, and this might discourage Americans to buy relatively more expensive foreign goods or reject imports all together because they can't afford any shopping spree.

    3) Although logically Americans will buy less imports, it is also a known fact that Americans are dependent on MIC imports. In order for the US to decrease import, a major major recession must take place and depreciate the dollar so much that Americans have nill purchasing power.

    4) Economic growth world wide changes the "price-level, and income" in SIPIT. First, economic growth means higher price level and higher income, and in terms of the US recession, there's deflation and lower income. As Americans goods become cheaper and Americans poorer, on the other hand, foreigner goods more expensive and foreigners richer, foreigners will demand more cheaper American exports and Americans demand less imported goods. The result is: decrease import and increase export will theoretically erase trade deficit and pull out aggregate demand!!

  2. Howardlinon 28 Apr 2008 at 3:46 pm

    Responding to "The only way the US could export its way out of the crisis would be if economic growth in the rest of the world proceeded at a significantl higher rate than the American economy." I think perhaps this is saying that like right now, Africa and China and all other developing countries, labor is cheep thats why companys built fatories in those contries which contributes to their GDP, Perhaps one day the rest of the world would be develped and people will have to come to US to produce things. Thats when US will get out of the crisis that it is experiencing.

  3. Jessica Ngon 28 Apr 2008 at 6:40 pm

    1. A country's balance of payments is made up of its current and capital account. Right now, U.S. has a balance of payments deficit in its current account due to a huge trade deficit. This means it has a capital account surplus.

    2. The problem the U.S. is facing right now is its HUGE trade deficit because it imports way more than it exports. Thus, if the dollar depreciates, foreign imports will be more expensive to the U.S., and with a weaker domestic demand for the imports, this leads to a decrease in imports. At the same time, U.S. goods will appear "cheaper" to foreign countries, and thus they will import more from the U.S., leading U.S. to export more, achieving a more balanced trade.

    3. “Weaker domestic demand for imports could be achieved only by a severe contraction of the US economy“ because Americans are so dependent on imports, as evident by the huge trade deficit. Unless America faces a recession, which it is right now, their demand for imports will continue to be high.

    4. “The only way the US could export its way out of the crisis would be if economic growth in the rest of the world proceeded at a significantly higher rate than the American economy“. The determinant of exchange rate here is relative income changes. When growth in the rest of the world occurs at a faster rate, their income increase will occur faster as well, thus increasing the demand for imports from the U.S..

  4. kevinchiuon 28 Apr 2008 at 7:52 pm

    2. The dollar depreciating causes a decrease in imports, as foreign goods appear relatively more expensive, and increase in US exports, as the US goods/services appear cheaper. This causes an increase in the balanced trade.

    3. Americans love imported goods/services, as shown by the trade deficit in the US current account. The only way to really force Americans to not buy imported goods/services is to take away their purchasing power of them, through great depreciation of the US dollar, or create trade-barriers to prevent consumption of them.

  5. judychenon 28 Apr 2008 at 10:53 pm

    Country's balance of payments is made of current and capital account.

    US now is facing a trade deficit, that's because US dollar used to be strong, so Americans buy more exports and other nations' people don't buy imports from US as well. If US dollar depreciates now, imports from US seems to be cheaper, therefore, Americans would buy more domestic good and foreigners prefers US goods as well. Therefore, US would achieve balance trade.

    Because American is known to be dependent on import goods even they are facing a hard time in economies now, unless US really goes recession, they would not stop buying imports.

  6. Margaret Liuon 28 Apr 2008 at 10:56 pm

    1. A balance of payments is defined by a country's current account, capital account, and official reserves account.

    2. Because the US is sitting on a deficit in its current account but a surplus in its capital account, the decrease in imports and increase in exports resulting from a weaker dollar should help to balance its account.

    3. the culture of the US relies too heavily on imports to satisfy their consumption. Because of this, there would need to be a severe contraction of the US economy to be able to decrease imports enough to balance its payments.

    4. If the US exports its way out of its crisis, then that would imply that its currency is relatively cheaper than other currencies. This means that relative income changes, and relative price changesa re involved.

  7. Kevin Yehon 28 Apr 2008 at 10:59 pm

    Having a major imbalance of trade does have its benefits i guess, because with a floating exchange rate, eventually all will be equalized. Of course, this goes along perfectly with Adam Smith's laissez faire principle which states that government should stay out. It corresponds with the self correcting models of macro econ as well. In an open market system, all the models tend to be self-correcting…hm interesting

  8. andyxuon 28 Apr 2008 at 11:20 pm

    This is a nice prophecy. If only we read this two years ago and converted all our US Dollar savings into RMB or Euros ….

    1. Difference in total value between payments into and out of a country over a period

    4. Relative income

  9. kevinmaon 29 Apr 2008 at 5:25 pm

    1.Balance of payments is the current accounts, capital accounts and official reserves accounts.

    2.The US right now is in trade deficit because their imports exceed their exports. Their dollar will depreciate which will allow them to export more because their goods will be cheaper than their competitors because their dollar isn’t worth as much as it used to be. American goods will seem cheaper and more people will buy them and balance their imports and exports.

    3.American people are in serious trade deficit right now because they buy so many imported goods. In order to create weaker, only severe contraction of the US economy could do that.

    4. Relative income change

  10. A.Eon 31 Oct 2009 at 9:38 pm

    A recession would help America get out of their trade deficit. When the dollar becomes weaker, then the domestic products would seem less expensive for the Americans. Therefore, they would start buying domestic products. This would cause the demand for imported goods to decrease and therefore, the prices of the imported goods would increase. If Americans wouls stop buying as much foreign goods, then America would have a greater balance of payments.

  11. Lailaon 09 Nov 2009 at 2:41 am

    Balance of payments is the sum of all transactions such as imports and exports, tourist expenditures, sale and purchase of financial or real assets abroad between residents from different countries. For it to find an equilibrium, the current account and the capital account ( which the balance of payments consists of) have to balance each other; the same amount of money coming into the country should also go out of the country and the buying and selling of assets should be equal. Therefore, a balance of payments deficit refers to an imbalance between the current and capital account. In this case, there is a current account deficit due to a shortage in trade which means there is a capital account surplus.

    As the dollar depreciated, the U.S. will have less purchasing power as products from other countries become more expensive with a stronger currency. There is a shortage in trade because the U.S. will import less than before as it lost its purchasing power and the demand for domestic goods in the U.S. will increase. Also, as the dollar has depreciated, products from the U.S. will appear cheaper to foreign countries so they will purchase more increasing their exports. Therefore, there will be less imports (money going out of the U.S.) than before and more exports( money flowing into the U.S.) which will balance their current account deficit and consequently the balance of payments deficit.

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  13. Theresaon 01 Dec 2009 at 12:07 am

    1.Define “US balance of payments deficit“. What accounts make up a country’s balance of payments?

    If a country spends more on imports than it earns from exports, it is said to have a "current account deficit".

    The US balance of payments account is the record of all transactions between residents of the US and all other countries in the world.

    It consist of the currect account which measures the buying and selling of all physical goods, services and other financial flows and the financial accound which measures the buying and selling of assets.

    2.In what ways would “a big dollar depreciation alongside much weaker domestic demand for imports” help achieve more balanced trade between the US and its trading partners?

    If the dollar depreciates then a given amount of foreign currency will buy more US Dollar than before. In conclusion the exporting sector of the US economy will increase as exports become less expensive. Also imports will become more expensive which will generate this "much weaker demand for imports" and therefore the importing sector will decrease. This will move the balance of payments more towards equlibrium.

    3.Explain the statement: “weaker domestic demand for imports could be achieved only by a severe contraction of the US economy“

    Weaker domestic demand is often generated by expenditure reducing policies such as contractionary fiscal policies. These attempt to reduce the overall expenditure in the economy and therefore shift the aggregate demand to the left. Deflationary fiscal policies such as an increase in direct tax and a reduction in government expenditures are example of these.

    4.Which of the determinants of exchange rates that we learned in class (remember “SIPIT”) is referred to in the following claim: “The only way the US could export its way out of the crisis would be if economic growth in the rest of the world proceeded at a significantly higher rate than the American economy“.

    The article is referring to a rise in incomes in the rest of the world, which would lead to more demand for american exports and an increase in price level. If inflation is high in a country then goods from american countries seem relatively less expensive.

  14. Andrew McLennaghan Bon 20 Apr 2010 at 9:44 pm

    1. The US balance of payments deficit is the countries' current and capital account. The US are in a deficit with China mainly due to the weak RMB. The weak RMB makes Chinese goods more attractive, so

    the US demands more Chinese goods. The US pay in dollars, so the demand for RMB will increase and the supply for dollars will increase (on the forex graphs). This way,

    the Chinese get dollars and the US get their goods. The Chinese can then either invest the dollars back into the American economy (through firms, buying government bonds, etc..)

    or can keep some of the money in the official reserves. The Chinese keep their currency artificially low by putting US dollars in the official reserves

    2. If the US currency depreciates then their would be less foreign imports so therefore the trade deficit would decrease or even give the chance for the US to get back what they have lost

    3. This is Just saying that because of the USA's consumerism is the reason of the USA's large trade deficit

  15. Blair Ton 09 Nov 2010 at 8:15 am

    I also find it interesting that the article could predict things that have occurred. But what I don't get is how come it seems, well maybe this is from my own perspective and I'm still learning and grasping all of these concepts, but how come if we are able to predict our actions, we don't end up with a better economy than we have? I mean it seems logical that if you predict it , we should be able to get it right and be successful.

    1. A balance of payments is something that keeps track of all the monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, and financial capital, and financial transfers. So in this case it would be between the U.S. and the rest of the world, and it would show how much we were spending because we are in a deficit.

    2. A big dollar appreciation would allow an increase in U.S. exports because U.S. items will be cheaper than of that of other countries. Then imports would become more expensive, which would put the emphasis on purchasing U.S. goods. As a result, things would be pushed back into equilibrium, like they should be.

    3. This is showing how we need to change our old habits, which would be buying too many imports, and balance it out more with the increase of exports or the purchase of more domestic products, because it would improve our economy, and put it where it needs to be.

    4. Our relative income would change because our currency is cheaper as a result of more exports. So our income will have to adjust as well as the prices.

  16. Jackie L.on 09 Nov 2010 at 2:19 pm

    I feel as though this whole article just goes to show that we need a drastic change of some sort, or our economy is going to go nowhere. Especially now, when we can look back and realize, oh hey, we should have noticed this huge problem sooner, our policies obviously aren't working.

    One thing I was confused about though was the interest rate. It says that in order for the demand for imports to go down, we would need a drastically higher interest rate, however, that hasn't happened. However it also goes on to say that other countries have begun to pull their assets out and invest them somewhere else. Isn't that what was supposed to happen with the higher interest rate, or am I understanding that part wrong?

    1. A balance of payments is basically a record of every monetary transaction for a country and all the other nations. We currently have a balance of payments deficit because we import significantly more than we export.

    2. The dollar depreciation would increase the world's demand for the dollar, because they can now buy one dollar for less of their own currency, making our products appear cheaper. If the depreciation occurred, everything in the rest of the world would seem more expensive to us, causing us to want to import less. The combination of those two would mean more exports and less imports, helping to decrease the giant gap we currently have between exports and imports.

    3. Unless Americans have a solid reason to, they are not going to suddenly not want to import anything. We want the cool stuff that comes from China, so in order to make Americans want to stop buying from them, they would need to lose their buying power.

    4. Well, I don't know what SIPIT is, but income is referred to, because in order for the rest of the world's economies to increase, there would need to be an increase in their relative incomes.

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