Eva Cheng
The re-emergence of concurrent deficits in the external current account and the federal budget of the United States — dubbed the "twin deficits" — and the likelihood of them continuing to grow for a long time, has reignited a debate among economic analysts on whether they are sustainable.
Except for a small surplus in 1991, the US has been running an external current account deficit (CAD) since 1982. Between 1995 and 2002, the CAD nearly quadrupled from US$105.2 billion to $480.8 billion. The CAD for 2003, announced on March 12, was a record $541.8 billion.
After enjoying four years of surplus between fiscal years 1998 (beginning October 1, 1997) and 2001 that included a sizable surplus of $236.4 billion in FY2000, the US federal budget sharply deteriorated thereafter — running up a deficits of $157.8 billion in FY2002 and $375.3 billion in FY2003. The budget deficit is officially projected to reach $520.7 billion for FY2004 and to stay in the red for many more years after that.
Huge amounts of borrowing from abroad will be needed to cover both the CAD and the federal budget deficit. Massive external borrowing in the early 1980s helped turn the US from being the world's biggest net creditor nation from the beginning of the 20th century into the biggest debtor nation — with a foreign debt that now exceeds the entire foreign debt of the Third World.
Warnings
The re-emergence of the twin deficits has prompted warnings from high-profile capitalist institutions and individuals.
In a joint statement in September 2003, the Washington-based Committee for Economic Development (CED), Concord Coalition (CC) and Center on Budget and Policy Priorities (CBPP) said: "Instead of expressing alarm, many in Washington now argue that escalating deficits do not really matter, that they are self-correcting, that they are unrelated to interest rates or future economic well-being, and that tax cuts will pay for themselves later by spurring economic growth. It would be wonderful if this were true. It is not."
On January 4, in a joint presentation with economists Peter Orszag and Allen Sinai, former US treasury secretary Robert Rubin (now a director of two of the world's largest corporations — Citigroup and the Ford Motor Company) warned: "The US federal budget is on an unsustainable path. The scale of the nation's projected budgetary imbalances is now so large that the risk of severe adverse consequences must be taken very seriously, although it is impossible to predict when such consequences may occur."
Three days later, the Washington-based International Monetary Fund (IMF) issued an extensive report, US Fiscal Priorities and Priorities for Long-Run Sustainability, which stated: "The United States is on course to increase its net external liabilities to around 40% of GDP within the next few years — an unprecedented level of external debt for a large industrial country. This trend is likely to continue to put pressure on the US dollar."
The US dollar has already declined 15-25% against the other major currencies — the euro, the yen and the British pound — since early 2002.
Many questions have been thrown up in the unfolding debate about the twin deficits. Some of the key ones are: Is US federal budget deficit avoidable and is it a problem? What caused the US to run CADs for such a long time and are they a problem? Are the two deficits connected? Are they sustainable? Why has the US, despite being the world's dominant capitalist power become a huge capital importer for more than two decades? What are the implications of this for rest of the world?
While temporary budget deficits can help stimulate a capitalist economy, US President George Bush's administration has taken on, as the FY2004 budget itself projects, a strategy of sustained and deepening deficits. Even the Congressional Budget Office's (CBO) highly optimistic projection expects the budget deficits between FY2004 and FY2013 to total $1400 billion. The CED/CC/CBPP expects the accumulated shortfall over the same period to reach $5000 billion, Decision Economics' calculation is $5400 billion and Goldman Sachs' estimate is $5500 billion.
The January 7 IMF report attributed a quarter of the FY2002-03 "fiscal turnaround" to Bush's increases in military spending related to the "war on terror", another quarter to major tax cuts (for the super-rich), and the remainder to the reduced tax income and increased social spending related to the 2001 recession.
The tax handouts are highly controversial. The projected 75-year cost of the tax cuts endorsed by the FY2004 budget is more than three times the projected 75-year actuarial deficit in social security and medical payments. Over "an infinite horizon", the IMF estimates such unfunded US social program liabilities to be as high as $47,000 billion, or nearly 500% of the current US GDP.
Trade balances
Cross-border trade balances account for the bulk of most countries' current accounts, but the latter also include investment income and payments, and unilateral transfers such as aid and remittances. This also applies to the US. The US goods trade deficit of $36.4 billion in 1982 is decisive in the CAD of $5.5 billion for that year. Its goods trade deficit rose to $482.8 billion in 2002, pushing its CAD to $480.8 billion.
The higher profit rate in Third World manufacturing compared with US manufacturing has prompted substantial amounts of US capital to shift to other more profitable US industries or to manufacturing overseas. This has produced a relative decline in US goods exports. But this has little bearing on US economic dominance within the world capitalist economy. US capitalists still hold monopolies over critical technologies in strategic industries.
The US runs a trade deficit with most countries, and the threat to close or restrict access to its market has been a powerful and consciously used lever by Washington to exert influence on other capitalist governments.
The CADs need to be financed, but US public and private savings have been declining. According to Rubin, Orszag and Sinai, a number of "reasonable estimates" suggest that about one-third of the savings decline has been offset by capital inflows from abroad. "That introduces", their study says, "a direct connection between budget deficits and current account deficits."
The study also points out that budget deficits tend to put upward pressure on interest rates, and the latter tend to depress domestic investment and interest-sensitive consumption, and encourage borrowing from abroad.
In testimony before the US House of Representatives' committee on financial services, Federal Reserve chairperson Alan Greenspan said on February 11 that the twin deficits are related "because large federal dissaving represented by the budget deficit, together with relatively low rates of US private saving, implies a need to attract saving from abroad to finance domestic private investment spending".
A December 2003 CBO study, The Budget and Economic Outlook, adds: "Taken to the extreme, such a path [an unsustainable fiscal policy] could result in an economic crisis — economic problems in the United States could spill over to the rest of the world. A policy of higher inflation could reduce the real value of the government's debt. If the government continued to print money to finance the deficit, the situation could eventually lead to hyperinflation."
The net international liabilities of the US at the end of 2002 were 23% of the country's GDP. According to Greenspan on January 13, they had increased to 25% of GDP by the end of 2003.
Role of US dollar
Such an external liability level would have sent red lights flashing in most countries. But because of the US dollar's critical role as the dominant currency for international transactions and reserves, Washington can "print money" at will to supply global trade and central banks with enough "liquidity" to keep the system going smoothly.
Under the dollar-based system, most countries, especially the underdeveloped countries, operate under the constant fear of a speculative attack against their currencies. The export- dependent countries are particularly keen to intervene in the currency market to minimise fluctuations of their currencies relative to the US dollar, or their export competitiveness will be hurt. They need a sizable reserve, mostly of dollar-denominated instruments, to back those interventions. It's little wonder then that foreigners owned about 40% of US treasury securities at the end of 2003.
Even Japan has to rely on this strategy. In 2003, it used a record amount — equivalent to 20,060 billion yen — for such interventions. The Japanese central bank's foreign exchange reserves rose by $203.8 billion over 12 months to $673.5 billion in December 2003.
The central banks of China, Taiwan, Hong Kong, South Korea and Singapore are the next biggest foreign exchange reserve holders and frequently engage in similar interventions into the currency market to keep their currencies stable with the US dollar. In May 2002, these five countries' foreign exchange reserves totalled $680.5 billion.
Such central banks aren't just a substantial source of demand for "high quality" dollar-denominated assets such as US treasury securities, they are also relatively stable holders. Other US dollar holders, especially the hedge funds and other speculators, are ready to dump the dollar any time for a quick profit.
This prompted the January 7 IMF report to warn that the "global risks of a disorderly exchange rate adjustment [of the dollar]" can't be ignored. It added: "Episodes of rapid dollar adjustments failed to inflict significant damage in the past, but with US net external debt at record levels, an abrupt weakening of investor sentiments vis-a-vis the dollar could possibly lead to adverse consequences both domestically and abroad."
The paper of Rubin, Orszag and Sinai sounds a similar warning: "The adverse consequences of sustained large budget deficits may well be far larger and occur more suddenly. Substantial deficits projected far into the future can cause a fundamental shift in market expectations and a related loss of confidence can generate a self-reinforcing negative cycle."
From 91×ÔÅÄÂÛ̳ Weekly, March 17, 2004.
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