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Is The Trade Gap A Ticking Bomb?

Economic Trends


It could lead to a run on the dollar

Ask economists to identify the most positive element of U.S. public policy in recent years, and a vast majority will cite cutting the federal government's deficit. Yet as Wall Street economic consultant Peter L. Bernstein points out, in a key respect, deficit reduction has failed to deliver what the experts promised: America's chronic trade gap shows no signs of receding.

The notion that the U.S. budget and trade gaps are linked, notes Bernstein, first surfaced in the 1980s, when both deficits exploded. The chain of causation supposedly began with the need to finance the huge budgetary shortfall that emerged in the wake of Reagan-era tax cuts and defense spending. This led to a sharp rise in U.S. interest rates that attracted foreign investors and caused the dollar to take off. And that unleashed a flood of newly cheap imports and lagging U.S. exports.

In basic economic terms, however, the scenario was more simple: The ballooning federal deficit had cut national saving far below the nation's investment needs. As a result, the U.S. had to import capital from overseas, which inevitably resulted in a trade deficit.

By this logic, says Bernstein, the solution to the trade shortfall seemed clear. If the two deficits are truly twins, as many experts insisted, then the U.S. could solve its trade woes by eliminating the federal government's drain on national saving. As it happens, however, while the budget gap has virtually disappeared, the trade gap hasn't budged--and is clearly headed much higher.

Why did the experts' predictions miss so badly? The long answer is that trade flows are influenced by many more variables than the federal budget--by monetary policy and relative interest rates, by the business cycle, by shifting conditions and economic policies abroad.

The short answer, says Bernstein, is that the experts forgot that government savings and private savings often move in opposite directions. Thus, while the public sector's savings performance has improved mightily in recent years, America's household savings rate has plummeted to its lowest level in 39 years--leaving the U.S. still highly dependent on foreign capital.

The upshot is that the dollar has risen by 12% over the past year, and the merchandise trade gap could rise as much as $40 billion in 1998, by some estimates. With the economy currently in overdrive, that doesn't seem to be much of a problem today. Indeed, it should temper U.S. growth and keep inflation at bay over the near term while bolstering our ailing Asian trading partners.

Over the longer run, however, warns Bernstein, the persistence of large trade deficits could cause foreign investors to shift out of dollar assets--perhaps precipitously. "The dollar," he says, "is becoming increasingly over-owned, vulnerable, and exposed. It is an accident waiting to happen."BY GENE KORETZReturn to top

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They're globally competitive after all

The claim that American students are doing far worse than their peers in other nations has become a virtual mantra of educational reformers. An article in the current issue of The American Prospect, however, charges that the experts--and the media--have misread the evidence.

In the article, educational researcher Gerald W. Bracey notes that U.S. students finished second in a major comparative study of reading in 1992 involving 31 nations, surpassed only by Finland. What's more, the top 10%, 5%, and 1% of American students in the study were the best in the world at both ages tested, 9 and 14.

In the 1996 Third International Mathematics & Science Study (TIMSS), American eighth graders finished slightly below average in math, while American fourth graders finished above average, ranking 12th among 26 nations. In science, American fourth graders actually came in third from the top, while eighth graders were above average.

Such results, says Bracey, suggest that American students are "near the top in reading, just below average in math, and just about average in science." Aside from a few Asian nations at the top of the rankings and a half-dozen developing nations at the bottom, most of the nations in the TIMSS study, including the U.S., fell within a narrow range of scores, he reports.

None of this means that U.S. education is out of the woods. Bracey notes that the results of another international study in 1992 suggest that while "the top third of American schools are world class and the next third are O.K., the bottom third are in terrible shape." Most schools can use help, he writes, but such results "argue for a reform effort more focused on those that generally have the least resources and the most difficult social environments."BY GENE KORETZReturn to top

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