3/22/2005

The Deficit: The Sky may not be Falling

According to an article from BusinessWeek Online, on March 16 the Commerce Dept announced the current account deficit to be 665.9 billion last year. Because this number hit a record there is some concern that the US has become so dependent on foreign money that sooner or later the dollar will crash. However, a number of Federal Reserve officials say this is not true. Fed Governor Ben S Bernanke has a theory called the “global saving glut” that says, the glut is holding down interest rates in the US, freeing the federal government to run big budget deficits and allowing debt-laden consumers to spend more. If Bernanke is right, fears that foreign funds will dry up and lead to the collapse of the dollar are significantly exaggerated.

These federal officials believe the US will be okay because of the Retiree Effect and the War Chest Factor. In short, the Retiree Effect says that global saving surplus comes from the rapidly aging societies of Japan and Europe. Workers there need to build up savings for retirement but because of their countries slow growth, they are investing money abroad and much of it is in US Treasury Securities. The War Chest Factor says that China, South Korea, Taiwan, Thailand, and Brazil have increased their holding of Treasuries to insulate themselves against the vagaries of international capital market flows, and some countries like China, are even linking their currencies to the dollar.

If these Fed optimists are right, then there is no big rush in cutting the current account deficit. The deficit will some day fall, not with a bang of a dollar crash but slowly, as the rest of the world gathers the rewards of the savings it invested in America. Do you agree with these Federal optimists?

2 comments:

Diane said...

Yes, deficit spending is good to a point. It does help keep inflation in check. But the republicans are spending like there is no tomorrow and cutting taxes. It's a recipe for disaster. Europe is worried about our excess spending. Many foreigners have invested in our debt. Many American have too by buying bonds.

The government shouldn't continue this gluttonous spending. I've been wondering if I should write to our state senators pleading with them to do something.

Dr. Tufte said...

What does this have to do with ManEc?

Even among macroeconomists, Ben Bernanke is someone that we listen to and trust as being thoughtful and level-headed. So, he's a good name for students to stick in the back of your head - he may even be Greenspan's successor.

In this case, I agree with Bernanke more than I usually do (which is a lot). I think he pretty much hit the nail on the head.

Not being in a public office though, I would add one more effect. I'll call it the "our-country-is-run-by-idiots effect". The citizenry of just about every country on the planet invests more readily in the U.S. than U.S. citizens invest in reverse. The reason is that most of those foreign investors feel that there is a better chance of making and keeping a return on their investment in the U.S. than in their own country. That says really awful things about the faith that most people with money to invest have about their local surroundings.