Uncle Sam's Debt to the World

The greenback is down, but the trade gap keeps growing -- as it will until the U.S. increases savings

By David Wyss

Despite the 50% drop in the dollar against the euro since early 2002 and a slowdown in U.S. demand this year, the trade gap continues to hit new records -- $666 billion in 2004. It took 0.6 percentage points from gross domestic product growth last year and shaved off 1.5 percentage points in the first quarter.

If the trade gap had just held constant, first-quarter growth would have been 4.6%. But don't look for the deficit to peak until 2006, when it's expected to reach $865 billion.


  The trade gap remains the major threat to the continuation of the current economic expansion in both the U.S. and other industrial countries, as well as the stability of world financial markets.

Like everyone else, I am disappointed by the lack of response of the trade deficit to the weaker dollar. The greenback declined sharply in 2002 and 2003, but has been roughly stable since then. The drop was predominantly against European currencies and the Canadian dollar.

While the exchange rate against the yen has fallen slightly, against most other Asian currencies it has remained flat since 2002. This lack of movement doesn't reflect market forces, but rather continued central bank intervention to contravene market forces.


  Unfortunately, the U.S. tends to import from Asia and export to Europe and Canada. Europe and Canada together accounted for 49% of our exports, but only 39% of imports during the first two months of 2005. Non-Japan Asia accounted for 17% of exports in early 2005, but 24% of imports.

Exports to Europe and Japan are not rising, despite the weaker dollar, because these economies remain basically flat. Japan's economy grew only 2.6% last year and will advance barely above 1% this year. Eurozone GDP rose 1.8% last year. We expect growth of only 1.3% this year.

Even though the U.S. is more competitive against the European producers, the lack of growth in demand from the Continent means few opportunities to expand sales. The recent decline of the euro triggered by French and Dutch voters' rejection of the new European Union constitution is also convincing investors that America is safer than Europe -- further weakening the euro and delaying correction in the trade deficit.


  On the other hand, imports continue to flood in from Asia because of strong U.S. demand and the fact that the dollar hasn't moved against most Asian currencies. The trade gap with China is at a record high, accounting for 28% of the U.S. trade deficit for the first two months of 2005.

The dollar is being supported by the massive intervention of Asia's major central banks, which last year financed more than 60% of the U.S. current account deficit, and this year have financed 75% of federal borrowing. This huge inflow is helping to keep U.S. interest rates low and investment strong, but we are selling off bits of the country (or at least promises to pay in the future) for growth now.

The Asian banks are intervening because they want the stimulus of exports to the U.S. We are allowing it because we need the money to finance the shortfall in U.S. savings, including the need to fund the federal deficit. The cure on their part has to be a cutback in intervention and a realization that they will have to give up their trade surpluses to allow us to eliminate the trade deficit. The cure on our part has to be to raise the national savings rate, most simply by eliminating the budget deficit.


  Weak growth abroad remains a large part of the problem. Most of the growth in the world is being supplied by the U.S. and non-Japan Asia, as Japan and Europe continue to depress the world economy. In 2004, world real GDP rose a strong 5.1%, according to IMF purchasing power basis. In 2005, growth is expected to slow to 4.4%, still a strong number.

The changing pattern of world growth is much clearer if we look at GDP measured by purchasing power parity (PPP), rather than official exchange rates. Using the IMF measure of PPP, the advanced economies now account for 54.6% of world GDP, vs. 45.4% for developing nations.

The euro zone is only 15.3%. China is now the second-largest world economy, producing 13.2% of global GDP, compared with 7.1% for Japan. India, at 5.9% of world output, is now fourth, behind Japan.


  Emerging countries are growing faster -- up 7.2% last year (led by China's 9.5%), compared to 3.4% in advanced economies (with the U.S. at 4.4%). The result is that developed nations last year accounted for only 37% of world growth.

China was the largest contributor at 24%, and the U.S. was second at 18%. Both Eastern Europe and India contributed more to world growth than the euro zone.

The shift in world economic power is accelerating, as China and India grow in relative size. Their impact on world trade in both manufactured goods and commodities is increasing rapidly and will continue to dominate trade discussions. The economic future is in Asia, not Europe.

Wyss is chief economist for Standard & Poor's

Edited by Patricia O'Connell

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