Jenna - here is more, another economist.
This is not selve serving, I am long some small caps, heavy cash and T-bills. Just the reality angle of these rate cuts that people are not seeing.
Like Reagan in 1981, Bush takes offices looking to cut taxes, and that will have to be financed primarily by foreign investors, owing to the very low rate of national savings in the US.
However there is an important difference: in 1981, the US was still the world's largest creditor country and ran a current account surplus. Overseas lenders were, for awhile willing to fund Mr. Reagan's initiative. Mr. Bush by contrast inherits an external deficit of almost $500B, one that has been rising by about 50% annually for the last three years, atop a net foriegn debt of that exceeds $1,500B. Foreign investors, which already provide the US with about $2B every working day, may balk at pumping even larger amounts, especially as US growth and equity prices have now dropped sharply.
The imbalance in US trade and current accounts - approaching 5 per cent of GDP have received surprinsingly little attention in the debate over these tax cuts.
Foreigners hold about $10,000B in US assets, much of which could be sold off in short notice. Americans themselves could join any flight from the dollar. Hence the US is already exceedingly vulnerable to a change in attitide to its currency.
Any foreign unwillingness to continue pouring hugh amounts of money into the US, let alone substantial liquidation of existing dollar investments, could severly destabilise the US economy.
If the dollar were to fall 20 to 30%, as it easily might, inflation may rise by 2 to 3 percentage points, since the economy is still running close to full capacity. The federal reserve would be unable to cut interest rates further, indeed, rates would likely rise substantially, as the hugh deficit would still have to be financed and foreign investors would demand higher yields to offset the falling currency. The stock market would then drop again, compounding the negative wealth effects that are already cutting growth. |
