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(05/1999 - Prestowitz) Is America's Large And Growing Trade Deficit Economically Sustainable?

Is America's Large And Growing Trade Deficit Economically Sustainable?
 
Samuel Brittan;Martin Feldstein;Gary Hufbauer;Clyde Prestowitz;et al;

May/Jun 1999;
The International Economy; Washington;
Volume: 13
Issue: 3
Start Page: 10-17
ISSN: 08984336
Subject Terms: Trade deficit, Trade policy, Economic impact, Economic forecasts
Copyright International Economy Publications, Incorporated
May/Jun 1999


Abstract:
Some analysts argue that while the trade deficit is large, it can be sustained indefinitely. Brittan believes Americans should sit back and enjoy it.


[Headnote]
BACKGROUND: Some analysts argue that while the trade deficit is large, it can be sustained indefinitely: Capital inflows are going into private investments leading to a continued expansion in industrial capacity, even though labor markets are tight. Do you agree? How should the period in the 1980s of the so-called "evil twin deficits" be distinguished from the present period of rising budget surpluses and growing current account deficits?

SAMUEL BRITTAN

Principal Economic Commentator, Financial Times, London.

Two and a half centuries ago the Scottish philosopher and economist, David Hume, wrote of the absurdity of statesmen lying awake worrying about the balance of trade in their countries. First, the trade balance takes care of itself. Second, Hume noticed that the same people felt perfectly at ease about imbalances between different parts of Great Britain -- maybe because regional trade statistics were not available then (and fortunately they are not now either).

Under a fixed exchange rate, there is no need for a country's current account to be in the balance. Such imbalances reflect an excess of savings in some countries relative to others; and both the world and individual states are better off if these differences can be offset by international borrowing and lending.

Under a floating exchange rate, worries about trade imbalances are even more misplaced. The exchange moves to balance all flows across the exchanges: current and capital, visible and invisible, goods and investment, short-term and long-term.

Of course this balance is not always ideal. Maybe the U.S. should save more and Japan should save less. But who knows whether this conventional wisdom is correct? The statesman or economist who can devise an ideal savings and investment flows plan for the globe (and corresponding current account balances) has not yet been born.

As a practical matter, nearly every proposed solution for addressing the U.S. current account deficit would make matters worse, not only for the rest of the world but for the U.S. itself. If actions are taken on the trade front, as naive Congressmen advocate, the entire post-war movement toward trade liberalization would be put at risk. At a time of widespread recessionary pressures outside the U.S., many producer groups would feel threatened and seek to retaliate. In any case, trade controls would not rectify the U.S. current imbalance since they do not act directly on the savings and investment balance.

Trade controls would only even seem to work if accompanied by very restrictive monetary policies involving much higher U.S. interest rates. And they would work mainly by dealing a body blow to U.S. domestic investment. If they boosted savings, it would be by bringing the Wall Street boom to a halt and making American consumers feel much poorer.

The world needs such action as much as it needs a hole in the head. For the first time since the 1930s, there is the genuine danger of international deflation. The U.S. is the one major country with vigorous non-inflationary growth. If it were to join the many other countries now flirting with recession, a world slump could be triggered.

The U.S. current deficit, which at the moment enables Americans to consume more than they produce, is not a burden but a bonus. Americans should sit back and enjoy it, leaving the Fed to concentrate on sound internal policy.

MARTIN FELDSTEIN

President and CEO, National Bureau of Economic Research and Professor of Economics at Harvard University.

The large and increasing U.S. current account deficit is not sustainable because the rest of the world will not continue to make what is effectively a massive gift to the United States. At some point, they will require that we provide real goods and services to compensate for all they have already given us.

The United States has run a trade deficit every year since 1976. Because of these trade deficits, the value of foreign assets in the United States are now about $1.5 trillion more than the value of U.S. assets abroad. This year's current account deficit will raise that total by another $250 billion.

Although foreigners who finance our current account deficits receive bonds, stocks, and other claims to real assets, they are ultimately giving us their current output in exchange for the promise that they will receive American-made goods somewhere down the road. If they never do, it would end up constituting a remarkably generous gift to the United States. That seems improbable.

The inevitable shift to a U.S. trade surplus does not imply that a current account surplus will also ensue. Whether the trade surplus will be large enough to result in a current account surplus will depend on the asset preferences of wealth owners in the United States and abroad. Because of our net asset imbalance with the rest of the world, a continual flow of capital to the U.S. is both possible and consistent with a future U.S. trade surplus.

The use of the capital inflows to support investment rather than consumption is ambiguous at best in an economy in which consumers now spend more than their disposable incomes. But the use of the capital inflows is also essentially irrelevant for the United States. We have the capacity to produce enough exportable goods to have a trade surplus, and an exchange rate could undoubtedly be established at which our trade balance would shift from deficit to surplus.

GARY HUFBAUER

Reginald Jones Senior Fellow, Institute for International Economics and former U.S. Treasury official.

High on the list of America's non-problems is the trade deficit. The United States in 1999 is not Mexico in 1994, nor Thailand in 1997. Instead, the U.S. economy is the envy of the world. The trade deficit is really an investment surplus: it reflects strength, not weakness.

Some quick numbers: The U.S. trade deficit during 1999 (more accurately the current account deficit) will run about $300 billion, about 3.4 percent of an $8.8 trillion GDP. Every dollar of trade deficit translates into a dollar of new investment in the U.S. economy by foreigners. Foreigners, like Americans, have made a lot of money on their holdings of U.S. stocks, bonds, and real estate. At the end of 1999, therefore, foreigners will own about $7.5 trillion of U.S. assets, while Americans will own about $5.5 trillion of foreign assets. Is the $2 trillion difference something to worry about? Not really. U.S. households and nonprofit organizations own about $36 trillion of assets. If financial crisis strikes the U.S. economy, it won't come from foreigners suddenly dumping their U.S. assets. It's far more likely to come from Americans deciding that they would rather hold cash than stocks, bonds, or real estate. What could cause that? Well, bad economic policy in Washington could be one source.

Over the past decade, "unsustainable" trade deficits have averaged about $110 billion per year. If we were told in 1988 that this "bad twin" would survive ten years after Reagan's departure from the White House, pundits would have forecast gloom and doom in the 1990s. Yet the troubles have not been in the United States but in Japan, Europe, and emerging Asia. What does that tell us? The United States has been a great place to invest.

Every distinguished economist should be permitted one economic fallacy. Martin Feldstein's great contribution was the "twin deficit." Budget deficits were never the twin of trade deficits. But more important, the budget deficits of the 1980s were a policy problem worthy of attack. The trade deficits of the 1990s are not.

CLYDE PRESTOWITZ

President, Economic Strategy Institute.

The rising U.S. current account deficit is a short-term necessity and a long-term liability that is sustainable at the moment. The deficit is all that stands between the world economy and economic disaster as America provides the consumption so desperately needed by the global market.

But because the United States consumes more than it produces, its consumption binge can only continue as long as other countries are willing to lend it money. At some point - who knows when - they will most likely become less willing to do so. Such a shift will result in higher interest rates and slower U.S. economic growth.

Moreover, the need to finance a large and rapidly growing current account deficit will increasingly create a drag on long-term U.S. growth potential.

It is important, therefore, that the world use the window of opportunity provided by the U.S. trade deficit to restart the global economy before the U.S. engine begins to sputter.

LOUIS BACON

Chairman and C.E.O., of Moore Capital Management, a multi-- asset investment firm.

The questions in my mind worth asking are, to what extent is there a trade deficit, and is it large? The Commerce Department, which reports the trade numbers, estimated in a recent study* that exports of goods alone could be understated by as much as $70 billion, a full 10 percent of goods exports. Service exports are more difficult to count. But if undercounted by the same percentage, another $23 billion would be lopped off the trade deficit, leaving it at $76 billion, less than 1 percent of an $8.5 trillion economy. Even the overstated $169 billion figure amounts to just 2 percent of the U.S. economy, down from 3 percent in the mid-eighties. And as a percentage of world trade, the misreported trade deficit has dropped from 6.5 percent in the mid-eighties to 4 percent today.

The second point regards imports. The Commerce Department estimates that 85 percent are denominated in dollars. Although foreign exporters do not have to hold dollars, almost two-thirds of our trade deficit is with dollar-linked countries, that is, those countries who usually need more dollars for exchange reserves and targeting purposes. Certainly the dollar can withstand the trade deficit -- whatever it is - because these dollar-linked trading partners have constantly had to devalue against the dollar. If the trade deficit were problematic, the dollar would have devalued against them.

Perhaps the question should be, could the present U.S. economic expansion be sustained without the trade deficit? The pressure foreign goods put on prices has kept both inflation and interest rates low in the U.S. while keeping productivity high. As a result, the U.S. has been the buyer of last resort for those countries whose domestic demand has collapsed, alleviating the world financial crisis and thereby aiding our own economy.

RENATO RUGGIERO

Director-General, World Trade Organization, May 1995 to April 1999.

In recent months the U.S. trade deficit has been a key factor in maintaining global economic demand and stability. But concerns about its size and continued expansion have grown. How much should we worry about the deficit? If it is true, as some analysts argue, that the trade deficit is investment driven, there is no reason to worry. The income generated by investment will provide the wherewithal to service the related foreign debt. Other analysts suggest that the burgeoning trade deficit results from strong private consumption and declining household savings. In this case, high consumption and growing indebtedness could imply a potentially painful adjustment over time.

The reality doubtless lies somewhere in the middle. U.S. consumption has grown strongly in recent years but so has investment. Foreign debt has grown, but high investment productivity has also increased the ability to service it. If some correction of household behavior is desirable, the key question is, what would be the right policy response?

Let me start with what the wrong response would be. The worst possible reaction would be to look at the growing trade deficit and conclude that import restrictions were the way to correct it. Contrary to what some people like to argue, protection will not reduce the trade deficit. The deficit is a macroeconomic phenomenon-the result of excess demand for consumption and investment goods in relation to available domestic resources. If demand in the economy continues to be strong, the trade deficit will persist. The right way to deal with it, if a policy response becomes necessary, is through macroeconomic instruments, be they monetary or fiscal. Trade restrictions, while perhaps politically tempting, would merely shift imports to less protected sectors, the exchange rate would appreciate, and exports would decline.

What trade protection does achieve, however, is an increase in the profits of protected industries. So calls for trade measures to address trade deficits must be seen for what they are - subterfuge or simple wrong-headedness. It is as well to remember, moreover, that protectionist profits only come at the expense of economic efficiency and jobs elsewhere. And protection can trigger trade wars and undermine investor confidence, jeopardizing economic and political stability.

HORST SIEBERT

President, Kiel Institute of World Economics and member of the German Council of Economic Advisors.

As an economic principle, a large current account deficit is not sustainable forever because the intertemporal mechanics of debt accumulation is "hammering in the basement" as John Hicks once noted for autonomous investment. Absorption cannot be higher than production indefinitely. At some point, the impact of high foreign debt shows up.

However, we have no explicit criteria for determining how long a current account deficit can continue. The behavior of market participants may abruptly change, and at any moment foreigners may become unwilling to finance the U.S. current account deficit.

How quickly the corrections occur depends on economic dynamics in the U.S. relative to the world economy. If the U.S. economy continues to generate a high growth rate, Japan continues to totter, and Europe remains stunted by both high unemployment and welfare state costs, a correction is less likely. In the meantime, Lafontaine's retreat has made it clear that international coordination and a demand-side approach cannot be Europe's answer to globalization. And continental Europe remains bent on a redistributive strategy. All of this helps the U.S. to attract capital to finance its current account deficit.

Corrections may occur abruptly or smoothly; there are two mechanisms of adjustment: First, asset prices in the U.S. could fall and the ensuing wealth effect would reduce consumption and, thus, absorption (not unlike the Japanese bubble). Capital inflows would then be weaker. Second, monetary policy could cautiously reduce the increase in asset prices by slowing the expansion of the money supply and raising the interest rate. The U.S. dollar would then be weaker because the profitability of investment would be reduced. In this scenario, the lower profitability would dominate the higher interest rate, and the United States' attractiveness to international capital would dim.

With respect to policy measures, the government should not use tax policy to reduce absorption and to stimulate savings in the private sector. Moreover, the experience of the 1980s shows that international coordination and asking others overseas to play the demand locomotive does not solve the problem.

RICHARD N. COOPER

Boas Professor of International Economics, Harvard University.

The current account deficit of the United States - all imports of goods and services, less America's exports will almost certainly exceed $300 billion by the end of the year, nearly 3.5 percent of GDP. It has, of course, been enlarged by the economic slowdown in East Asia, including Japan: Their imports have stalled, while they export aggressively in order to restore growth.

Foreigners do not give their goods to Americans. Indeed, the U.S. current account is as high as it is, and growing, because foreigners want to invest in America - in stocks, bonds, real estate, industrial plants, and other assets. Investing in America is viewed favorably around the world, and for good reason: The U.S. economy is a good, steady performer, less sluggish than Europe and Japan and less volatile than emerging markets. Inflows of investment funds push up the dollar and make foreign goods more competitive.

As always, a number of investments will go bad and foreigners will lose their money, as some did on real estate purchased in the 1980s. But, on balance, the claims will generate future income, especially for aging Japanese and Europeans. When they withdraw their accumulated savings, U.S. exports will be stimulated by a weaker dollar. Until then, American obligations to the rest of the world will grow.

Investment by foreigners in the United States is good for them. It is also good for Americans, so long as we use their funds well, that is, invest in improved productive capacity and innovation in the U.S. economy. If the investments yield 10 to 15 percent, and U.S. obligations to foreigners yield 5 to 10 percent, as many of them do, all will benefit.

In the meantime, however, some American businesses will find themselves under severe competitive pressure from foreign goods not fully offset by foreign demand for U.S. exports. That could result in political pressures for increased protection, particularly as we move into a presidential election year. Americans should realize their advantage in producing attractive paper claims to future income, and continue to be willing to share those claims with the rest of the world.

CLAUDE BARFIELD

Resident Scholar, American Enterprise Institute.

Some years ago, Herbert Stein said, "The U.S. has a trade deficit because people in the rest of the world invest their savings here...(and therefore) the stock of productive capital...is higher than it would otherwise have been. The inflow of capital has been mainly of benefit to American workers who as a result of it work with larger capital stock and have higher productivity and higher incomes." Stein's explanation remains valid today.

The United States has been operating at full employment and, until recently, full production. Given these circumstances, imports - and that means the trade deficit have acted as a safety valve by tamping down inflation while allowing greater consumption. And because 40 percent of U.S. imports represent intrafirm transactions, much of it intermediate goods, lower-priced imports allow U.S. companies to pass on savings to U.S. consumers or to compete more effectively with foreign companies when the final goods are re-exported. On the other side of the equation, import of capital has allowed the United States to achieve record levels of investment: Fixed private investment has grown over 50 percent since 1991.

The U.S. trade deficit also has positive benefits for the rest of the world. With Asia in recession and Europe almost stagnant, the U.S. economy is the main engine of growth. While Europe and Japan should be pressured to jump-start their own economies again, it is important for the United States to continue accepting Asia's intermediate and final products. This will generate the economic activity and income growth necessary for renewed economic expansion, which in turn will revive a demand for U.S. goods and services and allow U.S. firms to repatriate their earnings for investment here and abroad.

JAGDISH BHAGWATI

Arthur Lehman Professor of Economics and Professor of Political Science, Columbia University.

America today is an oasis of prosperity. By contrast, the fearsome tigers of Asia appear more like sheared sheep. Japan is in recession so that our 1980s mind-set that Japan was Superman and Lex Luthor rolled into one has given way to a mocking perception of a pathetic and paralyzed nation, a ship of fools.

We are also currently at the end of a sustained expansion that seems to defy all our business cycle experience in the post-war period and has made many think that the good times will not end. Unemployment levels are at a historic low and yet inflation, surprisingly, remains subdued. Equally paradoxically, the President's poll figures have risen even as his misdeeds have been bared for all to see. And finally, Wall Street's "exuberance," whether rational or irrational, doesn't seem to end.

I suspect that the trade deficit is driven directly by our relative and absolute prosperity: it tends to pull imports in (this being the "income effect" of the economist). But it may also be an "accomodating" flip side of our attracting funds, both as a safe haven and as a buoyant financial market.

It has no significance, therefore, in making us worry about its overall "employment" effects here and now. Down the road, continuing deficits reflecting our strength may lead to a reversal of confidence as others acquire dollars and related assets, as we witnessed when we had to abandon convertibility of dollars into gold. But that is not inevitable; and when we get there, it is incorrect to think that we will not have options for dealing adequately with the phenomenon.

So, you would expect our leadership from President Clinton on down to be refuting the alarmist preoccupation with the trade deficit and educating the public and the Congress like proper statesmen. Instead, they feed the illiteracy and the hysteria. Secretary Daley and Ambassador Barshefsky would have us believe that we are the "importers of last resort," fueling our protectionism. So, like Saddam and Milosevic who have invited our bombing by their own actions and inactions, our retribution and protectionism are the Clinton Administration's fault. Really!

ULRICH RAMM

Chief Economist, Commenbank AG, Frankfurt, Germany.

Economic history teaches us that nothing lasts forever. One only has to think of the Japanese boom or the South East Asian miracle to realize that over-extended economies cannot expand indefinitely. Certainly this also applies to the United States. During the recent period of international market turmoil the U.S. has clearly been the world's importer of last resort, and this has led to a rise in the external deficit. This deficit has been covered by capital inflows, and while it is true that direct investment into the U.S. has been on an upward trend in recent years, in net terms the U.S. still invests more abroad than foreigners do in the U.S. The bulk of the external deficit is therefore covered by inflows into financial securities, which have produced very generous returns on bonds and equities due to the strength of the domestic economy. Much of the capital which has recently flowed into the U.S. could flow out again if investors decide more generous returns can be made elsewhere. This could occur if the U.S. economy slows sharply or if emerging markets regain momentum.

Thus the recent combination of a widening external deficit and a stable dollar appears to be unsustainable, as when the deteriorating current account position in the mid1980s was followed by a sharp dollar correction (albeit with a little help from the Plaza Accord). But in contrast to the 1980s, the U.S. no longer has a large government deficit and the twin deficits problem. Instead, the presence of a public sector surplus suggests that, today, the current account deficit is a private sector problem. The root of this problem can be found in the dramatically low level of savings - particularly in the household sector, where the savings ratio is at its lowest since the 1930s. To put it crudely, the U.S. either needs more savings or less investment. Since the latter option is probably not desirable, the United States clearly needs higher private savings. Otherwise, the sustainability of the U.S. expansion and its ability to finance the external deficit could be put in jeopardy.

ISAIAH FRANK

William L. Clayton Professor of International Economics, Johns Hopkins University's Nitze School of Advanced International Studies.

We were right to worry about the large U.S. trade deficits in the late 1980s, but today's deficits are no cause for alarm.

The trade deficit is the main component of the U.S. balance of payments on current account, but the current account (which also includes investment income and unilateral transfers) is the more significant indicator of the United States' external economic position. Today's U.S. current account deficits, although comparable in absolute size to those of the late 1980s, are a smaller percentage of U.S. GDP: 2.1 percent in 1997 and 2.7 percent in 1998, compared to 3.5 percent in 1987.

Moreover, the recent rise in the U.S. trade deficit is largely due to cyclical factors: increased imports (associated with exceptionally strong U.S. economic growth) combined with sluggish exports (resulting from slow growth in much of the rest of the world, including Europe, Japan and developing countries affected by the Asian financial crisis).

The domestic counterpart of a nation's external deficit is an excess of aggregate expenditure over output. The difference is financed by an inflow of capital from abroad. In the 1980s, the excess of U.S. domestic expenditure was mainly concentrated in the public sector, where it was manifested in ballooning federal budget deficits and high interest rates that attracted foreign capital. By contrast, the current situation is noteworthy for the surplus in the federal budget.

Today's capital inflows are attracted by the strong U.S. economy, and are helping to finance a higher level of private domestic investment than would be possible on the basis of domestic saving alone. Between 1992 and 1997, gross U.S. private investment increased from 12.7 percent to 15.5 percent of GDP. The increased investment has in turn contributed to improved U.S. productivity, faster economic growth, and greater capacity to service the foreign debt resulting from accumulated external deficits. And despite the large trade deficit, unemployment in the U.S. is the lowest in recent decades.

One final point. There is a big difference between the foreign debt of developing countries recently hit by financial crises and the external debt of the United States. Not only have the developing nations' debts been larger in relation to the size of their economies, much of the debt has been denominated in dollars or other foreign currencies. When the crises struck, their central banks only had a limited quantity of foreign currency that could be lent to troubled banks. By contrast, the capital inflows to the U.S. are invested in dollar-denominated assets. In a crisis, the Federal Reserve, as lender of last resort, would face no comparable lending limit.

DANIEL T. GRISWOLD

Associate Director, Center for Trade Policy Studies, Cato Institute and co-editor of Economic Casualties: How U.S. Foreign Policy Undermines Trade, Growth, and Liberty (Cato, March 1999).

America's big current account deficit is not a cause of trouble, but a sign of prosperity. It reflects the glow of an economy flush with disposable income and ripe with investment opportunity.

Running a trade deficit is how we accommodate a net inflow of foreign investment. Without a deficit, Americans would have to fund all domestic investment through domestic savings. Until we figure out how to save more, a "balanced" current account would mean higher interest rates, less investment, and a weaker economy in the long run.

The rising trade deficits of the 1990s have created breathing space for a surge of domestic investment. Since the current record expansion began in 1991, real annual fixed business investment has increased by 75 percent, from $547 billion to $962 billion. Investment in computers and peripheral equipment alone has jumped from $32 billion a year to an annual rate of more than $400 billion.

Claims that the deficit is a drag on growth and job creation do not square with experience. In the last two decades, the American economy grew about 50 percent faster in those years the current account deficit expanded as compared to those years it shrank. The reason is simple: The same growth that creates jobs and rising incomes acts as a magnet for imports and foreign investment.

The only sense in which the trade deficit is a problem is its effect on politicians. As the deficit expands, so do misguided and self-defeating threats of trade retaliation.

If politicians are determined to cut the trade deficit, I suggest two possible solutions: We find a way to encourage Americans to save more (for example, by allowing individuals to invest their Social Security taxes in personal accounts). Or, we could reduce investment. A sharp recession would do the trick.

Then again, we could stop worrying about the trade deficit and just be happy with our prosperity.

SUSAN AARONSON

Institute of Public Policy, George Mason University and author of forthcoming Redefining the Terms of Trade, Johns Hopkins Press, 2000.

The trade deficit is less of an economic problem than a political problem. The great sucking sound of NAFTA is a whisper compared to the great sucking sound of imports and capital pulled in by the growth of the U.S. economy. As the trade deficit grows, those of us inside the beltway will spend a lot of time obsessing about it. We should include our counterparts on Main Street.

Commentator Pat Buchanan hopes to ride the deficit to the White House. While he describes it as "a cancer that will kill America," Federal Reserve Chairman Alan Greenspan regards the deficit as having curative propensities. It has helped stimulate stalled economic growth in Asia and Latin America. And it helps maintain U.S. prosperity by preventing U.S. producers from raising prices.

Whether the trade deficit is an economic disease, cure, or a placebo, it is the statistic Americans use when they talk about trade. America's trade deficit in goods and services rose to a record $168.6 billion in 1998; a 53 percent increase over the 1997 trade figure of $110 billion. The 1998 merchandise trade deficit (goods alone) was $248 billion, a 25 percent increase over the 1997 figure of $198 billion. Although these deficits are huge, they are clearly sustainable economically because they comprise a small segment of the U.S. economy. The merchandise trade deficit was less than 3 percent of gross domestic product, while the goods and services deficit was only 1.5 percent.

But the trade deficit may not be politically sustainable. As jobs are lost to imports, public support for the Pat Buchanan cancer treatment, protection, may increase. We have seen this in the steel and agricultural sectors. The first step in discussing the deficit is to acknowledge that, as Pogo says, we have seen the enemy and he is us. Although the United States is a production powerhouse, American producers, consumers, and citizens have a wide range of reasons to import. And importing per se is not bad for the United States. It is high time that policymakers and business leaders make this case.

CHARLES P. KINDLEBERGER

Professor Emeritus, M.I. T.

Parsimonious economists would attribute the deficit in the U.S. current account to a limited number of the following: growth of the money supply; low personal (if high governmental) savings; high interest rates attracting foreign capital; a fall in world commodity prices; an overvalued dollar; a flight to quality (the dollar) by foreign individuals and companies, especially in finance; and sustained economic growth despite widespread forecasts of slowdown. Those of us who believe in complexity suggest most or all of the above in tangled ways that econometrics seems to have difficulty sorting out.

One wild card is the euro, which began less than auspiciously on the first of the year. Views on its impact on the dollar are still evolving. Initially it was thought that central and commercial banks would shift portions of their reserves from dollars to euros and that merchants would build working balances in it, leading to increased demand for euros and the dollar's depreciation. Next it was thought that the wider and deeper capital market in the European Monetary Union would lead the outside world to borrow euros, adding to the supply. Finally, it has been believed that the new capital market will encourage outside investors to buy more European equities and debt. The changes in the capital market are still awaited, but the net of forces defies forecasting.

What can be forecast (with a degree of uncertainty) is that the "overvalued" New York stock market will recede at some future date, cutting consumption, stimulating personal savings (but reducing governmental), and leading to withdrawals of foreign capital - all of which will begin pushing the deficit down. Depreciation of the dollar in terms of euros would help.

I am unwilling to bet the farm on this outcome. Especially of interest is whether the reduction would be drawn out over time, or occur in collapse as in 1893, 1907, and 1929. I plead the Fifth. Too complex.

[Footnote]
* Foreign Trade Division, U.S. Department of Commerce, "The Understatement of Export Merchandise Trade Data," January 1997.

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