Us Deficit06

Final Project: The US Current Account Deficit
Group 7: Ahmed Fakih, Chafik Jabrane, Teth Phan & Signe S. Hansen
Agenda
1. Overview of Historic Data 2. Reducing the Budget Deficit 3. Is the U.S. Deficit Sustainable? 4. The Role of the US Major Trade Partners
Fakih, Hansen, Jabrane & Phan
Overview of Historic Data

U.S. net trade has been in deficit for more than 20 years being the main cause of the increasing current account deficit. What has the evolvement in key economic indicators been? And what has the effect of this evolvement been?
The Current Account 1980-2007

1.00% 0.00% -1.00% -2.00% -3.00% -4.00% -5.00% -800,000 -6.00% -7.00% -8.00% -1,000,000 -1,200,000 -400,000 -600,000 200,000 0 -200,000
19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06
Year
CA as percent of GDP Current account balance
4
US$ millions

Key economic indicators: Private savings and consumption Government savings and expenditures GDP growth and U.S labor productivity Unemployment and minimum wage Government debt to GDP
Private Savings and Consumption

10000 9000
Value in US$ billions
8000 7000 6000 5000 4000 3000 2000 1000 0
19 90
19 92
20 02
Year
Net Private Savings Personal consumption expenditures
6
20 04
19 96
19 86
19 80
19 82
19 94
20 00
19 88
19 84
19 98
Government Savings and Expenditures

3000
Value in US$ billions
2500 2000 1500 1000 500 0
19 96
19 98
-1000
Year
Net Government Savings Government consumption expenditures and gross investment National defense
Fakih, Hansen, Jabrane & Phan 7
20 04
19 90
19 92
19 94
20 00
20 02
19 80
19 82
19 84
19 86
19 88
-500

Development in savings and consumption: Both private and government consumption/expenditure show a clear trend: increasing. Private savings are pretty steady. Government savings are generally negative, but positive 1998-2002 and starting to decrease more rapidly from 2002 and onwards. Expenditures for national defense are increasing with a steeper increase from 2002 and on.
GDP Growth and Labor Productivity

8.0 7.0 6.0 45.0 40.0 35.0 30.0
US$
Growth Rate in %
5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0
25.0 20.0 15.0 10.0 5.0 0.0
19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04
Year
Annual Growth Rate in % Labor Productivity in US$
9

Trends in GDP growth and labor productivity: Steady growing labor productivity through the past 20 years from mid 90es the slope starts to get steeper. Changes in GDP growth are more volatile but generally positive. From 2001 to 2002 there is a big decrease in the growth rate and then a fast increasing growth rate from 2002 to 2005.
U.S. Minimum Wage and Unemployment

8.00 7.00 10.0 6.00 12.0
Real US$ per hour
8.0 5.00 4.00 3.00 4.0 2.00 2.0 1.00 0.00 0.0 6.0 %
19 80
19 84
19 96
19 98
19 86
19 88
19 94
20 00
20 02
19 92
19 82
Year
Minimum wage Unemployment rate
20 04
19 90
11

Unemployment and minimum wage 1980-2005: Altogether, there is a fall in the unemployment rate from 7.1% in 1980 to 5.1% in 2005. Similarly, the minimum wage (in real terms) is decreasing through this period.
12
General Government debt

7,000,000 6,000,000 5,000,000 70 60 50 40 30 20 10 0 % 3,000,000 2,000,000 1,000,000 0
US$ billions
4,000,000
19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06
Year
Net debt Net debt as a percentage of GDP
13

Development in government debt: Generally, U.S. government debt has been increasing the debt in 2005 is 6.8 times the debt in 1980. From 2001 to 2005 the debt has increased by almost 50% reaching an all time high (in these 25 years) in 2005. The debt to GDP ratio is about 60% in 1993-1994 but only 46% in 2005. Again, we see that 2001-2002 is a turning point in the data of our economic indicators

What has the effect on other factors in the U.S. economy been: Consumer Price Index U.S. Investments Interest Rates Exchange Rates
15
Consumer Price Index, 1982-1984 = 100

250.0
200.0
150.0
CPI
100.0 50.0 0.0
19 82
19 88
19 96
19 98
19 90
20 00
19 92
19 94
Year Fakih, Hansen, Jabrane & Phan 16
20 04
19 80
19 84
19 86
20 02

Inflationary pressure? The graph depicts an on average 5.5% increase in CPI every year. The trend in the graph mirrors the trend in consumption. Inflation shows a steady growth with no particular fluctuations.
US Investment
2000 1500
US$ billions
1000 500 0 -500
-1000
19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04
Year
US owned assets abroad Foreign owned assets in the US
18

Increasing investments in the U.S.: One explanation to the widening U.S. current account deficit is the increased foreign investment an investment boom. The increased investment is partly due to the accelerating growth of U.S. workers compared with that of workers in other countries and general U.S. growth. The US negative net international investment position points to an increased vulnerability to rising interest rates. Rising interest rates will widen the U.S. current account further.
Date
0
FED Funds O/N Rates, 1990-2006
18- 12 -1990 08- 03 -1991 13- 09 -1991 06- 12 -19 02- 07 91 -1992 22- 03 -1994 16- 08 -19 06- 07 94 -1995 25- 03 -1997 17- 11 -1998 16- 11 -1999 16- 05 -2000 20- 03 -2001 27- 06 -2001 02- 10 -20 06- 11 01 -2002 10- 08 -2005 14- 12 -20 03- 05 04 -2005 20- 09 -2005 31- 01 -2006 29- 06 -2006
1 2
Interest Rate in %
20
US Yield Curve, dec. 7th 2006

5.6 5.4
Interest Rate in %
5.2 5 4.8 4.6 4.4 4.2 4
O/ N
1Y ea r
5Y ea r
2Y ea r
Ye ar 10
on th
on th
6M
Maturity
30
Ye ar

Since 2002 the FEDs O/N interest rate has been raised 17 times. In the short term the U.S. yield curve is now negative. The O/N interest rate mirrors the evolvement in exchange rates: in the beginning of 2000 and on the dollar experienced an appreciation, but 2002 and is a turning point and the dollar starts to depreciate against most of the U.S. major trade partners.
23

US Imports by Country 2005 1 2 3 4 5 6 7 8 9 10 Canada China Mexico Japan Germany United Kingdom Korea, South Taiwan Venezuela France 290.4 243.5 170.1 138.0 84.8 51.0 43.8 34.8 34.0 33.8 US Exports by Country 2005 1 2 3 4 5 6 7 8 9 10 Canada Mexico Japan China United Kingdom Germany Korea, South Netherlands France Taiwan 211.9 120.4 55.5 41.9 38.6 34.2 27.8 26.5 22.4 22.1
In US$ billions. Not seasonally adjusted.
In US$ billions. Not seasonally adjusted.
24

U.S. Trade: Pre-2002 U.S. exports were hurt by dollar appreciation. Post 2002 the dollar has depreciated against all major trade partners except for Mexico and China. Why has this depreciation not resulted in an increase in exports and a decrease in imports?

Imports still increasing: Have U.S. import prices become less responsive to exchange rate changes?
The New York FED finds that there has been a 10% decline in exchange rate pass-through. This result is, however, not statistically significant and is most likely due to a change in the collection of data.
Have the relative price elasticities of imports changed?

The commodity and country composition of trade has changed over the past 25 years particularly for imports.

In conclusion: The deterioration of net trade in consumer goods comes from very strong U.S. consumer demand growth. The deterioration of net trade in capital goods comes from robust U.S. investment and relatively slower investment growth abroad. The trade deficit of 6.35% of GDP falls outside the oft-quoted range of 4-5% after which, research on industrial countries suggests economic forces tend to narrow the imbalance. The U.S. is experiencing increased vulnerability to rising interest rate due to the government debt. Few suggest that the trajectories of the U.S. imbalances are sustainable.
Reducing the Budget Deficit

Many different explanations of the cause of the deficit have been offered, and to varying degrees we believe that all may have played a role in the evolution of the deficit.
28
GUESS!!!!!!!
29
30
31

Fiscal policy: Fiscal policy can have important long run effects on the health of the economy through impact on: National saving Growth of productivity
Reducing private saving shrinking less capital to invest Future productivity growth are lower
Savings Rate
Personal Savings as a Percentage of Disposable Personal Income
5,0% 4,0% 3,0% 2,0% 1,0% 0,0% -1,0% -2,0% -3,0% -4,0%
Aug. 2006: -0.5%
A S O N D J F M A M J J A S O N D J F M A M J J A 2004 2005 2006

Source: Commerce Department, Bureau of Economic Analysis

The faster the productivity increases overtime, the more rapidly living standards increase. If the economy is more productive this will ease the financing of social security and medical benefits for future retirees.
34
35
36
37
38
39
40

US should worry about:
High energy costs Cost of Natural disaster Unfunded pension liabilities Iraq, now Iran New terrorist attacks--higher security costs Rising levels of corporate and consumer debt Large and growing budget and trade deficits Social Security and Medicare shortfalls Higher interest rates
Is the U.S. deficit sustainable?

YES
1. The $ is playing a major role within the monetary and financial international system: The dollar is used in 90% of international interbank transactions. Principal word trade currency 73% of OECD reserve; 64% developing countries 1.
NO
Empirical studies showed that a deficit can not be sustainable over 5% of GDP (need for a devaluation of about 15 to 20%) Composition of the deficits financing is very risky ( -85% decrease in LT debt since 2000) high volatility Capital can be moved easily to other countries
2.
42
2. 3. 4.
Many countries are reluctant 3. to any float of their currency with the $ (a depreciation of the dollar will lead to increase local inflation) Central banks have their 4. reserves in dollar avoid that their reserve value decrease High Word demand of the $ with low elasticity US CA deficit almost unlimited US can pay their debts in their local currency Low inflation since the 90s American transnational firms role
Political sustainability : CA deficit Strengthen dollar Price competitiveness Unemployment. Risk of Losing Industrialization Word economy is living many CA disequilibrium of most of developed countries even with smooth adjustments between countries, the effects on exports and exchange rates could be considerable + macroeconomic disequilibrium
43
How to shrink U.S. deficit

Adjustment Long run adjustment Exchange rate adjustment Public Budget Exchange rate adjustment Public Budget
Impact
Growth moderately sustained Growth moderately affected Growth highly stimulated the first year
Short run adjustment
Growth highly decreased the first year

44
How to shrink U.S. deficit

Fiscal Policy
Low rate net of net domestic saving tax reductions, removal of the tax deductibility of mortgage interest payments Good managing of demand and supply
Monetary policy
With the rest of the world
How far is the rest of the world implicated in US adjustment
45
Global actions for the U.S. Current Account deficit

U.S. Current Account deficit needs to be curbed
US fiscal deficit needs to be cut Dollar needs to depreciate substantially
It is not anymore a home issue but a global issue Exchange rate Intervention policies:
Plaza Agreement
46

Plaza Agreement (1985): On September 22nd: meeting of the finance ministers of the 5 largest industrial countries (G5) at Plaza Hotel in New York. Carried out exchange rate intervention policies to reduce the value of the dollar.

Plaza Agreement (1985) (cont.): On the 1st day after the announcement of the agreement, dollar fell an average of 4.3% against other major currencies:
German mark appreciated 13% against dollar Japanese yen had risen 18.3%
(IMF, International Financial Statistics)
48

Plaza II: Today there is a need for an initiative comparable to the Plaza Agreement, probably by the G-20 group. Tiers of countries:
First tier: currencies that appropriately would rise some 40% or more against the dollar. Second tier: currencies that appropriately would rise 15 to 40% against the dollar. Third tier: there would be no specific initiative unless the currency began to fall against the dollar.
Desirable Exchange Rate Realignment

Real appreciation against the dollar from 2002 level (percent) Country/region Russia Australia Korea Euro area United Kingdom Switzerland India China Taiwan Singapore Japan Hong Kong a. To November 15, 2005 Sources: Cline (2005) International Financial Statistic, IMF, and Central Bank of China (Taiwan) Fakih, Hansen, Jabrane & Phan 50 Optimal 55.6 44.2 45.6 44.4 42.2 55.7 44.5 45.9 47.7 87.5 53.3 55.9 Actuala 46.7 31.9 22.1 19.7 13.5 10.0 9.9 1.8 -2.2 -2.4 -5.6 -10.7 Remaining 6.1 9.3 19.2 20.6 25.3 41.6 31.5 43.3 51.1 92.1 62.4 74.5
Counterarguments
A nations current account balance thus is essentially a market phenomenon that is not readily subject to rebalance by targeting one or more policy variables such as the exchange rate stated by Retiring Federal Reserve Chairman Alan Greenspan in November 2005. A major US fiscal correction and decline in the dollar would impose a severe recessionary shock on the rest of the worlds economy.
Sources:
The International Monetary Fund: www.imf.org Bureau of Economic Analysis: www.bea.gov Institute for International Economics: www.iie.com Organisation for Economic Co-operation and Development: www.oecd.org Board of Governors of the Federal Reserve System, Washington D.C.: www.federalreserve.gov Federal Reserve Bank of New York: www.newyorkfed.org Federal Reserve Bank of Chicago: www.chicagifed.org Federal Reserve Bank of Kansas: www.kansasfed.org
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Articles:
Have the U.S. Import prices Become Less Responsive to Changes in the Dollar?, R. Hellerstein, D. Daly & C. Marsh, N.Y. FED, Current Issues, Vol. 12, No. 6, Sept. 2006 Breaking Up Is Hard To Do: Global Co-Dependency, Collective Action, And the Challenges of Global Adjustment, Catherine L. Mann, IIE The Case for a New Plaza Agreement, William R. Cline, IIE Is The Large U.S. Current Account Deficit Sustainable?, Jill A. Holman, Kansas FED How worrisome is the U.S. net foreign debt position?, Michael Kouparitsas, Chicago FED Letter, May 2004, No. 202 The U.S. Trade Deficit: A Disaggregated Perspective, Catherine L. Mann & Katharina Plck, IIE

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Final Project: The US Current Account Deficit

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

Fakih, Hansen, Jabrane & Phan

The Current Account 1980-2007

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

Fakih, Hansen, Jabrane & Phan

Private Savings and Consumption

Value in US$ billions

8000 7000 6000 5000 4000 3000 2000 1000 0

Fakih, Hansen, Jabrane & Phan

Government Savings and Expenditures

Value in US$ billions

2500 2000 1500 1000 500 0

Overview of Historic Data

GDP Growth and Labor Productivity

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0

25.0 20.0 15.0 10.0 5.0 0.0

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

U.S. Minimum Wage and Unemployment

Real US$ per hour

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

Fakih, Hansen, Jabrane & Phan

General Government debt

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

Overview of Historic Data

Fakih, Hansen, Jabrane & Phan

Consumer Price Index, 1982-1984 = 100

Year Fakih, Hansen, Jabrane & Phan 16

Overview of Historic Data

1000 500 0 -500

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

FED Funds O/N Rates, 1990-2006

Fakih, Hansen, Jabrane & Phan

US Yield Curve, dec. 7th 2006

5.2 5 4.8 4.6 4.4 4.2 4

Overview of Historic Data

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

In US$ billions. Not seasonally adjusted.

In US$ billions. Not seasonally adjusted.

Fakih, Hansen, Jabrane & Phan

Overview of Historic Data

Overview of Historic Data

Have the relative price elasticities of imports changed?

Overview of Historic Data

Reducing the Budget Deficit

Fakih, Hansen, Jabrane & Phan

Fakih, Hansen, Jabrane & Phan

Fakih, Hansen, Jabrane & Phan

Fakih, Hansen, Jabrane & Phan

Reducing the Budget Deficit

Aug. 2006: -0.5%

A S O N D J F M A M J J A S O N D J F M A M J J A 2004 2005 2006

Source: Commerce Department, Bureau of Economic Analysis

Reducing the Budget Deficit

Fakih, Hansen, Jabrane & Phan

Reducing the Budget Deficit