Posted on Sustainabilitank.info on July 25th, 2008
by Pincas Jawetz (PJ@SustainabiliTank.com)
Saturday, July 26, 2008, japantimes.co.jp
What is the greenback’s sustainable value? How much further will the dollar fall? Or has it already fallen so far that it will now start to move back to a higher level?
By MARTIN FELDSTEIN, Harvard University, CAMBRIDGE, Mass.
For travelers to the United States from Europe or Asia, U.S. prices are dramatically lower than at home. A hotel room or dinner in New York seems a bargain when compared to prices in London, Paris, or Tokyo. And shoppers from abroad are loading up on a wide range of products before heading home.
But, despite this very tangible evidence, it would be wrong to conclude that U.S. goods are now so cheap at the existing exchange rate that the dollar must rise from its current level. Although the goods and services that travelers buy may cost less in the U.S. than abroad, the overall price of American products is still too high to erase the enormous trade imbalance between the U.S. and the rest of the world.
To be sure, the falling dollar over the past few years has made American products more competitive and has caused the real value of U.S. exports to rise sharply — by more than 25 percent over the past three years. But the trade deficit in 2007 nevertheless remained at more than $700 billion, or 5 percent of GDP. The large trade deficit and equally large current account deficit (which includes net investment income) implies that foreign investors must add $700 billion of U.S. securities to their portfolios. It is their unwillingness to do so at the existing exchange rate that causes the dollar to fall relative to other currencies. In falling, the dollar lowers the value of the dollar securities in foreign portfolios when valued in euros or other home currencies, shrinking the share of dollars in investors’ portfolios. The weaker dollar also reduces the risk of future dollar decline, because it means that the dollar has to fall less in the future to shift the trade balance to a sustainable level.
But what is that sustainable level of the trade balance and of the dollar? While experts try to work this out in terms of portfolio balances, a more fundamental starting point is the fact that a U.S. trade deficit means that Americans receive more goods and services from the rest of the world than they send back — $700 billion more last year. The difference was financed by transferring stocks and bonds worth $700 billion. The interest and dividends on those securities will be paid by sending more “pieces of paper.” And when those securities mature, they will be refinanced with new stocks and bonds.
It is unthinkable that the global economic system will continue indefinitely to allow the U.S. to import more goods and services than it exports. At some point, the U.S. will need to start repaying the enormous amount that it has received from the rest of the world. To do so, the U.S. will need a trade surplus.
So the key determinant of the dollar’s long-term value is that it must decline enough to shift the U.S. trade balance from today’s deficit to a surplus. That won’t happen anytime soon, but it is the direction in which the trade balance must continue to move. And that means further depreciation of the dollar.
An important factor in this process will be the future price of oil and the extent of U.S. dependence on oil imports. In each of the past four years, the U.S. imported 3.6 billion barrels of oil. At the current price of more than $140 a barrel, that implies an import cost of more than $500 billion. The higher the cost of oil, the lower the dollar has to be to achieve any given reduction in the size of the trade deficit. So a rising oil price as measured in euros or yen implies a greater dollar fall, and therefore an even higher oil price when stated in dollars.
There is one further important consideration in thinking about the future value of the dollar: relative inflation rates in the U.S. and abroad. The U.S. trade deficit depends on the real value of the dollar — that is, the value of the dollar adjusted for differences in price levels in the U.S. and abroad.
If the U.S. experiences higher inflation than our trading partners, the dollar’s nominal value must fall even further just to maintain the same real value.
The inflation differential between the dollar and the euro is now relatively small — only about one percentage point a year — but is greater relative to the yen and lower relative to the renminbi and other high-inflation currencies.
Over the longer run, however, inflation differentials could be a more significant force in determining the dollar’s path.
Martin Feldstein, a professor of economics at Harvard, was formerly chairman of President Ronald Reagan’s Council of Economic Advisers and president of the National Bureau for Economic Research
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Posted in Policy Lessons from Mad Cow Disease, Reporting from Washington DC, Canada, Real World's News, European Union, Archives, Japan, The US States
July 26th, 2008 at 8:50 am
Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth - its preeminent industrial power - into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It’s a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today’s recession may be just a preview of what’s to come.
Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.
Clearly, there is something amiss with “free trade.” The concept of free trade is rooted in Ricardo’s principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn’t consider?
At this point, I should introduce myself. I am author of a book titled Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America. To make a long story short, my theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.
This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density - rising unemployment and poverty - are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.
One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!
Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China’s. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world’s population.
Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.
If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It’s also available at Amazon.com.)
Please forgive me for the somewhat “spammish” nature of the previous paragraph, but I don’t know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.
Pete Murphy
Author, Five Short Blasts