Home >>

Increasing Trade Deficits and the US Economy
Published By V Kumar on 2012-02-25 42 Views

The significance of the US trade deficits in the recent economic crisis has been largely overshadowed by the allegations of greed pinned on financial executives drawing astronomical salaries, and their unaccountability. Yet, even a cursory analysis of events will make it clear that it all began with the unsustainable trade deficits. If the situation continues, history may repeat itself.

The Trade Deficits of United States in Twenty-first Century

Increasing trade deficit of the US economy had been baffling economic experts the world over before 2008. The way it was rising unabatedly was a phenomenon that seemed impossible to explain. This trade deficit of United States neither caused inflation nor an economic downturn till late 2007, creating questions about its sustainability, as well as raising questions over our understanding of modern economic phenomena. Finally, when the economic downturn did arrive, it is still not perceived as an outcome of unsustainable US trade deficit, as the primary blame for it has been cornered by the over-enthusiastic sub-prime housing credit market and financial agencies that made it possible.

Two Major Blind Spots

The first decade of the twentieth century will always be remembered for the awareness it created about two major blind spots in our vision and understanding of economic processes. The first is the sustainability of constantly rising trade imbalances, reflected by surplus of China and OPEC and deficit of United States. The second is the puzzle of asset pricing during phases of bubble formation and its aftermath, as evidenced throughout the global economy in the booming asset bubbles till late 2007 and their subsequent bursting with a resultant global crisis.

Link between trade Deficits and Subprime Crisis

Many people still do not see the link between US trade deficit and the subprime crisis. Some see it, but are not willing to agree, while others see it, understand it and are ready to agree provided there is sufficient evidence. Empirical evidence is scarce primary because of the overemphasis of current economists in mathematical modeling of human behavior, and the inability of such models to properly cover the 'human' decision making that is behind speculative investing and sub-prime housing investments.

During the period from 2003 onwards till end of 2007, US Economy witnessed a rising US trade deficit that was closing towards the US $ one trillion mark. During the same time, China had achieved the impossible by keeping its currency fixed, behaving like an open economy and taking its forex reserves to a mind boggling figure of over two trillion. The OPEC countries were reaping the benefits of crude prices which had inflated over 300% in a short duration. The puzzle was that in spite of this mammoth deficit, the US dollar was not weakening, nor was any other adverse impact observed in US or global economy.

The Answer to this Economic Puzzle

The answer to this puzzle lies in the balancing of the US current account deficit by its capital account surplus that was a result of investments in treasury bills flowing from China, other parts of Asia and Oil exporting countries. Their surpluses found a safe haven in US dollar, and the resulting demand of dollar prevented its slide. The excess inflow of capital was entering in to US economy not for the purpose of consumption, but as investment and that too not in the real sector, only the monetary and financial sector. It served to balance the currency demand and supply, but it created havoc on the demand of assets. As treasury prices rose, their yields fell, as did the interest rates in the initial years, before Fed intervened and began to raise the rates.

In the meantime, while the economists the world over were pondering as to when that thin line between sustainability and unsustainability will be breached, the excess of financial capital supply created by capital inflow of close to a trillion dollars per annum was having an impact on the asset prices. US stock markets and other economic indicators have become the strongest signals for the whole speculation industry of this planet, so the asset prices of other countries followed their tail. The resulting asset price boom also has a feel good factor. People around the globe, as also in United States, begin to spend more because of the dramatic increase in price of their assets, their equity portfolio and real estate. Some were spending in anticipation, others by taking mortgage loans against their property. The result was more demand, more supply and more incomes. Everything looked just perfect.

Just as all good things have to come to an end, asset prices can also not rise forever. When the yield of treasury bonds started to fall below a level that would attract investors, investments shifted to more risky options. As prices of stocks, precious metals, commodities including oil and even real estate rose to yet higher levels, and as the economy was running on all fours, financial institutions especially non banking ones, lead by the liberalization of the last decade, began taking more risks. Thus came along the sub-prime chapter of credits, which were distributed but never returned, once the asset bubble burst. As the news of bankruptcies and disasters started flowing, the dream was over. Assets became bad investment, and suddenly there was a crisis that engulfed the world.

Things May be Improving ... Or Are They?

After around two years, things finally seem to be improving. In these two years, the trade deficit of US economy has also moderated as the anxiety of recession made people adopt a more conservative and less consumerist approach. One fears that as the economy returns to normal, this conservatism will again be replaced by another wave of spending, which may push US deficit back to its earlier levels.

If that happens, it will create another challenge for the economists the challenge of forecasting how long the situation will remain sustainable!

Post Comment Comments (0) Report This

More Articles Specially Recommended for You:

Endangering the Great Lakes of North America : Will we learn to respect the nature?

The Great lakes of North America are being endangered progressively by unremitting human intervention. While the Governments are also stepping i

Written By : V Kumar
Can rationing prevent environmental crisis ?

Rationing is an unpopular way of controlling wastage, but it can still reduce environmnetal damage and need to be considered as a possible polic

Written By : V Kumar
Should schools provide cash rewards to best performing students ?

Creating strong and effective incentives is the best way to promote a particular behavior. There is no reason why it will not work in education.

Written By : V Kumar
Expectations rule our existence

Most aspects of our daily life depend on what we expect to happen. It affects our happiness, our relationships and our behavior. Expectations ar

Written By : V Kumar
Freedom is not free from limitations

Our literatures, our media, our education, our aspirations – even our minds, are in the habit of talking so much about freedom. While free

Written By : V Kumar
Urban Exploration: trespassing or adventure - the stuff you really should know before you urbex

What is Urban Exploration? Urban Exploration or 'Urbexing' is, put simply, an interest in deserted, abandoned and derelict

Written By :10prestoncourt
Sourcing Raffle Prizes and Auction Lots

Holding a raffle or auction is a great way to raise funds for your cause. However, you need to go about it in the right way. Who t

Written By :10prestoncourt
Event Publicity – tried and tested ways to reach the right audience

You don't need to spend lots of money to publicize your event, you just need to follow some tried and tested methods. Establish

Written By :10prestoncourt
How to create eye-catching event flyers

In a world where we are bombarded with information everywhere we go, it is very easy to overlook a neatly typed up event poster. 

Written By :10prestoncourt
Howtoee Review

Howtoee is a new revenue sharing site. It currently pays $5 per article and gives 100% revenue from Google Adsense. The site looks clean but I a

Written By :11tatic


LogIn or SignUp! now to post your comments on this article.