The Euro Makes Trade A New Game

Get ready for the protectionist Cassandras to begin shouting their alarms in the months ahead. The trade deficit, because of the Asian crisis, is set to explode. As Asia drops into recession, it may peak out at $300 billion.

There is no cause for panic over this short-term bulge in the U.S. deficit. The American economy is nearly twice as large as it was in 1987, the last time the deficit loomed as a problem. As a percentage of gross domestic product, the deficit, at its worst, will be smaller than a decade ago. U.S. companies are also far more competitive now. Exports were extremely strong before Asia hit the wall and will be stronger still in the future. Exports to Mexico are at record levels, two years after that country's financial crisis. Market openings, and financial reforms mandated by the International Monetary Fund, will produce record U.S. exports to Korea, Thailand, and other Asian countries a year or two down the road.

But there is no room for complacency. Thanks to the dollar's role as reserve currency in world financial markets, the U.S. has been able to do what no other country can--consistently import more goods than it exports. Dollar hegemony has raised America's standard of living beyond what it could otherwise attain. People hold the dollar overseas because it is a good store of value and because there is no alternative. Until now, that is. Soon a competing numeraire, the new euro, will make its appearance. And Europe's single currency could make it much harder for America to continue running current-account deficits. Germany and France fully intend to make the euro a reserve currency. They see it as the financial equivalent of Europe's Airbus Industrie, the only major competitor anywhere to the U.S.'s Boeing Co.

The U.S. owes some $5 trillion to dollar holders abroad, thanks to three decades of trade deficits. This "dollar overhang" hasn't been a problem to date. But by 2001, the first competing store of value to the dollar since the days of a strong pound sterling will be here. No one knows what will happen. But though the impending surge in the trade deficit poses no immediate threat, America should ponder getting its trade house in order. The euro could change everything.

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