Untangling the US Deficit

Untangling the US Deficit

Evaluating Causes, Cures and Global Imbalances

Richard A. IIey and Mervyn K. Lewis

As the US current account deficit has expanded to a record level of $811 billion in 2006, debate about the deficit’s causes and consequences has also grown. Is the deficit a product of American profligacy or a ‘glut of savings’ in the rest of the world? Is it a serious problem or essentially benign? Untangling the US Deficit charts a course between the competing explanations in a systematic and rigorous approach, incorporating the latest academic research and market data. Particular attention is given to the China–United States trade imbalance and to the special role of the US dollar and US capital markets in global finance.

Chapter 4: The International Perspective

Richard A. IIey and Mervyn K. Lewis

Subjects: economics and finance, financial economics and regulation, money and banking


THE AGENDA The title of this chapter may seem to be misplaced, for any discussion about the US external deficit necessarily must have an international dimension. It is not possible for the United States to have a current account deficit unless some other countries, and all other countries in combination, have a current account surplus. Rather, what we mean by the distinction between domestic and international is whether the increase in the US current account deficit primarily reflects economic policies and other economic developments within the United States (the domestic explanation) or whether the deficit is primarily responding to economic policies and economic developments that originate outside of the United States (the international or Nth currency perspective). For example, from a domestic viewpoint the trade imbalance might be seen to be a consequence of trade-related factors such as variations in the quality or composition of US and foreign-made products (and there have been large changes in the latter), to changes in trade policy, or to unfair foreign competition (lack of intellectual property rights protection, currency manipulation), factors widely discussed in business circles, labour unions and in Congress. Most economists, however, have tended to offer explanations based on macroeconomic variables which, from a US domestic perspective, revolve around excess absorption (spending running in excess of output), fuelled by the fiscal deficit, or a savings– investment imbalance due to the collapse of national savings. Finally, the attractions of the domestic productivity boom and the housing...

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