Is Uncle Sam Dragging The World Into Economic Meltdown?, The Global Economy Teeters... Options

[Guest_Jox_*]

Is Uncle Sam dragging the World into economic melt-down?

Economists are, for the public safety, locked in padded cells between crises. This is only prudent: firstly, why fix something if it isn’t broken? and, secondly, many economists are very scary beings - often bearded, academic-looking and with a penchant for inappropriate sexual excitement when they see a widening trade gap.

But, one-by-one, economists are now being re-released into the community after doing quite a long time in well-deserved clink. You will find one at a tv news station or newspaper near you. So what is happening to merit such a dangerous policy of releases?

Oh, yes, and why are shares falling in value fast?

Quite simply, Uncle Sam is obese. He is gobbling far more than he can produce - and being bank-rolled by Asia, so he can keep buying. His government is no better: it is spending like a gambler trying to chance his way out of debt.

Let’s consider a couple of figures: (Source: BBCi)

(A) The US Trade deficit is a shade under $750 billion. ($750,000,000,000) (7% of the US economy).
(B) The US (Government) budget deficit $400 billion.

So what (with B)? - As the US economy is currently buoyant, this is bad. During good economic times (like the ones we may just be leaving behind) a government usually expects to recover its over-spending from lean times. (Because more taxes flow in and fewer benefits flow out). If the US Government is over spending now, how can it possibly reduce that in worse times? And if it did, it would badly damage a weakened US economy (precisely what led to the Great Depression).

So what? (with A)

Firstly, other countries (the UK included) have trade deficits - but the USA is by far the World’s largest economy, so what happens there affects everyone.

Secondly, though countries can act financially in many ways that an individual cannot, in the end, they still have to pay their way. The US is not doing this. By continually over-spending on trade (importing more than it is exporting in money terms) it is effectively running-up a debt - which must be repaid.

With the flow of funds from the US to the far east (where the US - and Europe - are buying staggering quantities of goods) those far east companies and countries have bought US Government debt (IOUs issued by the US Government). This, effectively, means the far east is not only selling its goods to the USA but is financing their purchase. Good for the US? No, because one day those IOUs may be presented for repayment - and, in the meantime, interest payments from the US are flowing out to the far east - more draining of funds in that direction. Another problem is that, because the US has paid for much of its imports in $US there are a lot of green bills sloshing around the World (though mostly virtual, electronic ones nowadays). What happens when there is a surplus of anything? Its price falls. And such is so with the value of the $US - it is dangerously plummeting (though maybe not quite in free-fall yet).

OK, a falling dollar. Is that good or bad? Well both. (Another reason economists are locked away - to stop self-harm by too much fence-sitting).

The falling $US is good because it is a way in which markets adjust. A falling $US means that Americans cannot afford to buy as many Asian goods for each $1 as before - hence reducing their imports and, therefore, trade deficit. Better still, foreigners (to the US) can obtain more goods for their currency (because US firms expect to be paid in $US and, as the $US fell against far eastern currencies, so far eastern consumers - via their importing firms - can obtain more US goods for each unit of their own currency spent.) This will help the US to import less and export more - plus US consumers will find US products more competitive and will switch some import-purchases to purchases of domestically-produced goods and services.

But! A falling $US is also bad. It will, as we have just seen, cause the price of imports to the US to rise. This will fuel cost-push inflation. In turn, that pushes US firms’ costs up - i.e. because they may need to import goods and because their workers may demand higher pay to off-set their higher-cost imports. Moreover, US consumers will find their consumption choices more limited and their real incomes fall.

Now, remember that the US economy is vast. Despite the massive trade deficit, they do buy huge amounts of imports. If the dollar has fallen, then they cannot buy as many imports (as we just saw). But this will have a knock-on effect both in Asia and Europe. Many exporters - especially in those two continents - will be hit. Also, as the $US is cheaper, the US may export more and undermine various domestic markets. But it is the crash in US demand which economists really fear.

Share prices fall because people feel that companies will face reduced demand in the future.

Economists like stability - a small and steady growth in living standards and no shocks to the system. What they fear is a US in economic free-fall - the $US plummeting and US consumers not being able to buy globally-produced goods. The knock-on effect of that would be to hit Asia and European economies - which, in turn, would reduce global demand still further and hit the USA’s output. Potentially a spiral could be unleashed - such as the Great depression of the 20thC. Then again, such a severe global cock-up only happened once and we have learnt much.

But, if history teaches us anything, it is that people often do not learn from history.

Copyright TC 14/06/06.