[OPE-L:7559] [OPE-L:1104] Re: Re: Re: Re: Re: Re: Is anyone there

Fred B. Moseley (fmoseley@mtholyoke.edu)
Fri, 3 Sep 1999 15:18:03 -0400 (EDT)

This is a reply to Rakesh. Thanks again for your comments.

On Sun, 29 Aug 1999, Rakesh Bhandari wrote:

> Dear Fred,
> I do remain skeptical of imminent and massive dollar devaluation..
> Previously I noted that the inflow of European capital into the US for
> purposes of high tech acquistion should put a bottom on any dollar
> devaluation.

You are probably right that foreign acquisitions of US high-tech companies
are significant and increasing. However, this is still only a small
percentage of total foreign investment. This type of acquisitions is
called "direct foreign investment" in the balance of payments accounts
(purchase of greater than 10% of the stock of a foreign company). Foreign
direct investment in the US as a percentage of the total foreign
investment has fluctuated in recent decades between 10% and 20%. I
haven't had a chance to check the latest data, but I will do so next week
and will get back to you. But it would have to be increasing very rapidly
in order to keep up with the increasing current account deficit. And the
majority of foreign investment is the shorter-term "portfolio" investment,
which is vulnerable to capital flight if the pressure on the dollar

> The main reason for this optimism is that they think
> >that the Asian-global crisis is over (as has been proclaimed by the IMF
> >and many others) and hence that the demand for US exports will soon start
> >to increase again.
> Yet net exports have fallen mainly due to a rise in imports (?), not
> collapsing demand for US exports.

Net exports have declined because of an increase of imports (about 5% in
1998) and because exports stopped increasing and even declined slightly
(about 1% in 1998). Exports to Asia declined about 20% in 1998. Without
a revival of exports to Asia, I don't think there is much hope of reducing
the current account deficit.

> Moreover, an Asian rebound would put
> upward pressure on commodity prices and thus remove an important prop for
> the US boom. So I would think that a belief that the Asian crisis is over
> would make investors pessismistic about US economic possibilities.

There has been a beneficial effect of lower inflation, but I think on
balance investors would be less optimistic about the US is they thought
the Asian crisis would continue and therefore the US current account
deficit would continue to worsen.

> > But I think that the Asian-global crisis is far from
> >over, which would mean that the US current account deficit will continue
> >to worsen. Also, a factor which many people may not recognize is that
> >there has been a $50b negative swing in the "investment income / payments"
> >line item on the current account in the last 15 years: what used to be a
> >$30b surplus is now a $20b deficit and growing every year for the
> >foreseeable future, due to the increasing foreign indebtedness of the US
> >since 1982. This growing negative item will make it all the more
> >difficult to reduce the deficit on current account in the years ahead...
> But
> >one important historical comparison is with the US in 1985. The deficit
> >on current account as a percentage of GDP in 1995 was approximately the
> >same in 1999 (about 3.5%), and the dollar declined over the next two years
> >about 40%. So I think that at least this much devaluation will be
> >required this time around.
> >
> I don't see why this on the face of it is such a problem. Imbalances are
> now more easily financed by flows of private capital esp for the reserve
> center.

I agree that the "reserve center" can run a balance of payments deficit
longer than other countries. But even the "reserve center" cannot run an
increasing balance of payments deficit forever, as the US found out in the
early 1970s and the mid-1980s.

> And the dollar
> appreciated in the early 80s as the current account deficit rose then too
> (one could argue as well that Reagan accepted devaluation as a political,
> not economic, manuver against protectionist legislation then coming through
> Congress--see Barry Eichengreen). Moreover, the US has been in continuous
> current account deficit throughout the 80s and 90s. The dollar has
> fluctuated, but the exchange rate movements have bore little relation to
> current account deficit.

In 1980-85, the US current account deficit increased, largely as a result
of the increasing dollar. However, in 1985-87, the increasing current
account deficit led to a 40% devaluation of the dollar. I think a similar
devaluation will happen again within the next year or two, and that this
devaluation will have much more negative effects on the US economy this
time around, for reasons discussed in my last post.

It is true that the 40% devaluation of the dollar in the mid-80s had
surprisingly little effect on the current account deficit - it was
reduced, but remained substantial. One reason for this was that the US
net investment income from abroad was getting smaller and smaller due to
the increasing foreign debt. This problem is worse today because the US
is now making net PAYMENTS on foreign investments, rather than receiving
net INCOME (because the foreign debt has continued to increase).

And then, from 1995 to the present, the dollar has risen again, which
along with the Asian crisis, has increased the current account deficit
still further, so that this year it will be at least as high as the record
level in 1987 (3.7% of GDP) and will continue to increase unless the
dollar falls or there is a US recession.

I am not saying that there will necessarily be a significant devaluation
of the dollar, which will cause a recession. But I am saying that, one
way or another, a recession is highly likely within the next year or two.
Another possible cause of recession is increasing inflation which leads to
tighter monetary policy. Or disappointing profits (i.e. the expected huge
increase of profits does not materialize) leads to a reduction of
investment and a stock market decline, etc.

But I don't think the US economy can maintain a 3% rate of growth for very
long. In order for the economy to continue to grow at 3%, the current
account deficit would continue to increase beyond its already record
levels and US foreign debt along with it. And consumer spending would
have continue to grow faster than income, so that the savings rate would
become more and more negative and household debt would continue to
increase from its already record level of 100% of disposable income. I
don't think this can go on for much longer.

Finally, if a recession were to occur, I think it will be a bad one,
because households will have to reduce their consumer spending sharply in
order to meet their very high debt obligations.

I look forward to further discussion.