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Alan Greenspan and the US current account deficit
Gerard Jackson
I have written before about the Fed’s scandalously loose monetary policy, referring, as an example, to its effects on the current account deficit. Well the latest figures merely confirmed my worst fears, with the US current account deficit hitting nearly 7 per cent of GDP.
But what else should one expect given the monetary boom that Greenspan unleashed. Now the actual US current account deficit figure does not really matter — what matters is the trend and the reason for it. The reason has already been established and is now monetary history.
What should concern us are the international consequences of America’s monetary-fuelled US current account deficit. Greenspan has already warned that excessive domestic demand cannot continue to absorb increasing quantities of imports. This is a clear admission that his slack monetary policy is the villain. Even so, the Treasury Department has argued strongly, as have so many supply-siders, that imports help to hold down inflation.
The import/inflation argument brings us to the heart of this matter. I have stressed in previous articles that loose monetary policies create malinvestments (what Greenspan calls imbalances) that eventually emerge as ‘excess investment’ and rising unemployment. Unfortunately this fact is scarcely understood and rarely discussed in public. If it were then the reasoning would be readily extended to imports.
When the US economy generates ‘excess demand", i.e., implements an inflationary policy, the US current account deficit eventually starts to deteriorate as the economy starts sucking in more imports. But imports do not come from Santa’s workshop. They are produced by foreign firms that have responded to increased US demand for imports by directing production away from domestic demand.
The longer the US persists with an inflationary policy that directs foreign production toward satisfying US demand the greater will be foreign malinvestments. As these firms and industries become more dependent on exporting to the US they will absorb more and more capital and labour, directing them away from domestic use. America’s record US current account deficit makes this an indisputable fact.
But this analysis leads to the conclusion that rather than holding inflation in check, rising imports really indicate that the US is exporting its inflation to its trading partners. So even if these exporting countries do not allow dollar imports to expand their money supplies, as was the case with Eurodollars, they will still accumulate malinvestments. When the monetary brakes are finally applied American industries will not be the only ones to suffer.
It’s impossible to say to what extent exporting countries will suffer or even which countries will suffer the most. But we can say that any country with a poor history of political stability (China, perhaps?) will be sorely tested if a significant number of its industries have come to depend on US demand for their prosperity. Such countries cannot afford to have hundreds of thousands put out of work, which could happen if America’s demand for imports were to plunge.
Naturally, that government intervention in the market place in the form of a criminally loose monetary policy is the real destabilising factor behind crises in international trade is not something that is generally recognised — thanks to Keynesian thinking. Just as naturally, when the next crisis finally emerges it will be capitalism, not meddling governments, that will get the blame.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 4 July 2005