Foreigners call the shots
Copyright The Economist The World in 2001.
In the past couple of years the American economy has increasingly relied on foreign funds to finance its investment and consumption booms. Strong corporate investment coupled with falling personal savings (which reached an all-time low of minus 0.4% in mid-2000) means that America's private-sector financial deficit has been reaching record highs. Earlier in the expansion this was largely covered by improved government finances. Gradually, however, ever more of the private-sector financial deficit is being covered by foreign capital inflows.
Funding even moderate growth in demand will require considerable foreign capital. According to economists at Goldman Sachs, an investment bank, demand growth of 4% in 2001 (compared with 5.7% in 2000) would still imply a private-sector financial deficit of 7% of GDP. If foreigners do not provide this capital, the impact on growth, asset prices and the dollar could well be substantial.
In a paper recently presented to the annual gathering of central bankers at Jackson Hole, Wyoming, Maurice Obstfeld, an economist at the University of California at Berkeley, and Kenneth Rogoff from Harvard University, argued that for the current account quickly to reach balance, the dollar would need to depreciate by more than 24%, perhaps even over 40% in real terms. A gradual adjustment, where the current account returned to balance over a period of three to five years, would demand a real exchange-rate adjustment of 12%.
There are good reasons to expect the more gradual, and favourable, scenario. Foreigners' love affair with American assets has not been speculative, but has consisted in large part of long-term financial flows (including a lot of direct investment), based on productivity improvements that are increasingly evident. These are unlikely to dry up overnight.
Nonetheless, history is full of sudden current-account reversals due to investor panic and exchange-rate crises. Remember East Asia in 1997. Much will depend on policymakers' aptitude. A loose fiscal policy - whether it comes from irresponsible tax cuts or from excessive spending - will increase the need for foreign capital to fund American demand, and could easily spook investors. Monetary policy will have to steer a careful course: keeping the lid on price pressure without precipitating a sudden slowdown. Any mis-step and the Federal Reserve could face the unenviable combination of rising inflation, falling asset prices and a falling dollar. America's economy in 2001 will need good policy and, every bit as important, another dollop of good fortune.
I habe been looking for this chart for quite a while:
Destination America in
theworldin.com |
