The Twin Deficits in the Economy of the United States Essay Example

a surplus. Since Bush came into power the economy of the United States has owe money dramatically.

In 2000, the US debt was about $5 trillion; in 2007 it was about $9 trillion. The problem is not only that the deficit is at record high, but that the government is taking to long to find a solution for the debt. Date Dollar Amount 09/30/2007 9,007,653,372,262. 48 09/30/2006 8,506,973,899,215. 23 09/30/2005 7,932,709,661,723. 50 09/30/2004 7,379,052,696,330.

32 09/30/2003 6,783,231,062,743. 62 09/30/2002 6,228,235,965,597. 16 09/30/2001 5,807,463,412,200. 06 09/30/2000 5,674,178,209,886. 86Policies to reduce the twin US deficits typically involve an “adjustment in the external value of the US dollar and in US fiscal stance” (Miller 4).

During the Administration of President Reagan, the twin US deficits were at a record high. What Reagan’s administration proposed was a “devaluation of the dollar with combined with fiscal contradiction” (2). The devaluation of the dollar was supposed to put the US back in the world markets and restore external balance. The fiscal contraction, which means to lower the fiscal budget spending, is intended to prevent from upsetting the internal balance.The way to attain fiscal contraction is by taking into action non inflationary strategies.

However, in today’s US economy the government problem is that the US is lacking in private savings. The US economy “net of depreciation, private saving rate of households and businesses, combined, stood at just 4. 5% of national income in 2003; that’s only a little more than half the 8. 3% average recorded in the mid 1980s” (1). The deficiency in private savings is putting tremendous tension in the financial markets and in the economy, which was not the case

in the 1980s.

The current account deficit is equal to a nation’s current investment and saving. The current account deficit is the sum of the trade balance, the balance on investment income, the balance on labor income and unilateral transfers. In the US, current account deficit means that private investors and government are investing more than they save. Following a small surplus around 1990, in the middle 1990s the current account deficit recorded a deficit of 1% of GDP.

With a huge private investment boom in the mid 1990s, the current account deficit deteriorated sharply.As private investment boom ended, “government saving in the US decreased from about 3% of GDP in 1999 to about -4% in GDP in 2003 and 2004” (Stuchney 4). Therefore, the current account deficit matches the federal budget deficit. If private individuals and government have did not invest more money that save, the current account deficit would have not been this shocking. But, the whole world is not running a deficit, for the same reason as the US has a deficit in some other part of the world there are countries with large balance of surpluses.Japan, Germany, China and other nations have been financing the US deficit.

Japans current surpluses amounted to “3. 5% of its GDP in 2004 and Germany’s to 3. 3% of its GDP” (5). A nation can finance its own deficit by selling a variety of financial assets to foreign nations.

The US has been selling private equity, private debt and government debt. It is amazing that the US is now an importer of private equity securities. It is more striking that the current account deficit is the

US is being financed by Central Banks of Asian countries.Economists say that the Asian Central Banks have paid over 80% of the current account deficit in 2003. In many nations dollars reserve have increased dramatically by 2004: “Dollar reserves increased by 150 billion in China and Japan each, and by 200 billion in the rest of the world” (Stuchtey 5). The Japanese government believes that the growth in exports has kept their economy afloat.

The intervention to support the dollar was necessary for the exchange rate to stay at the level where it is, which will not increase the prices of products being exported to the US.As the dollar continued to depreciate against the yen during 2003 and the first months of 2004, “the Ministry of Finance acquired foreign exchange reserves totaling $650 billion dollars” (Crawford and Young 1). Besides, the Japanese businesses are moving their production sites to important economy markets. Therefore, products can be produced in other markets and countries that have no production expenses base on the dollar, and in which the final product will be priced in dollars.

With the help of business going outsource, Japan is not required “a foreign exchange transaction and it has minimized its foreign exchange risk” (1).The federal government is facing difficult decisions about its finances, with a growing national debt and long term fiscal problems, the US prosperity could be in danger. With the federal budget deficit being at a record level and the soon retirement of the baby boomers, the economy of the US is about to go through a catastrophe. Economists believe that if nothing is done quickly, “by 2040, there will be

little money for anything else other than Social Security, Medicare and interest on the debt” (Public Agenda 1).

There is a famous saying, to govern is to choose.Creating the federal budget is to make choices that we believe are the best choices, even if sometimes will make a dramatic impact on individual Americans. Even in a federal budget of $3 trillion, there isn't enough money for everything. And choices made now can have implications for years to come.

What happens to the federal budget can determine how much you salary is going to be, “whether you can get a college loan or a home mortgage and how secure your retirement will be, not to mention the indirect impact on the quality of your local schools, roads and police” (Truman 2).The current account deficits and the federal budget deficit are our own fault. In 2000, “the federal budget surplus, adjusted to remove business-cycle effects, was nearly 1 percent of GDP. By 2004, it had swung to a negative 5 percent; this is a dramatic shift in the fiscal stance of six percentage points”(Chinn 7). Even though, the Bush Administration came into power with a surplus, the government decided to spend more money than what they had by financing two rounds of tax cuts, two wars and being un able to say no to spending.

The resulting deficits affected the current account deficit: Tax cuts and government spending made Americans consume more and because of that more imports came into the country. For this reason, the demand for credit increased, so it made the interests go up. This cause for American products to be less competitive in the

world markets and made it difficult for US industries to compete with imported goods. Also, the US is a dependent oil country.

Couple years ago, when the oil price was low Americans decided to buy cars that are gasoline intensive vehicles.Today, with the oil price almost hitting $100 and with Americans having to depend on their gasoline intensive cars that they bought couple years ago, it is clearly that Americans are dependent on oil, which is not cheap. The oil price movements not only affect the economy, but the current account has become sensitive to such movements as well. For example, “forty percent of the $350 billion increase in the trade deficit from the end of 2001 until the first quarter of 2005 is accounted for by increases in oil imports” (Chinn 8). Also, since the oil prices are in dollars, the weakening of the dollar has no effect on the price of oil.This means that a larger exchange rate change is necessary for a reduction such as this one.

According to the twin deficit theory, a federal budget deficit should be accompanied by the current account deficit. For example, when a government cuts taxes, the people spend that money instead of saving it and that causes for a decline in savings. The decline in saving requires the country to borrow money from foreign nations or to reduce its foreign lending, unless people decide to invest less money inside the country, which will offset the saving loss. However, the current deficit and the federal budget deficit do not always act as twins.

In the late 1990s, the US had a current account deficit accompanied by a

federal budget surplus. The two economic factors that are in charge of the twin deficit relation are fiscal policies and savings. Savings tend to fall by about “35 cents in response to each extra dollar of fiscal deficit, down from the decline of 40 to 50 cents that researchers have reported for earlier periods” (Bartolini and Lahiri 6). In addition, as the savings decrease the current account also decreases. Current account deficit “rises by 30 cents for each extra dollar of fiscal deficit” (Bartolini and Lahiri 7).

In January 7, 2008, the IMF presented an article in which they presented opinions from different economist and world leaders about the twin US deficits. The IMF declared that the “American current account deficit—which it deemed an unprecedented level of external debt for a large industrial country—represents a clear and present danger to the world economy” (Frankel 1). The IMF reported interviews and opinions from Warren Buffet, Robert Rubin and Alan Greenspan. Warren Buffett said in Fortune that “America’s growing trade deficit is selling the nation out from under us” (1).

Robert Rubin said that “America’s deficits were now so large that conventional models—which predict a slow accumulation of the costs of adjustment—no longer suffice”( 2), and that the social and economic consequences of the deficits could be rapid and brutal. Even the pro Bush editorial page of the Wall Street Journal lambasted Bush government for leading the U. S. into a “fiscal train wreck” (2). Alan Greenspan opinion was a more positive opinion toward the deficits.

Greenspan believes that the economy is not going to go through a recession.He “expressed confidence that the international financial system—whose sophistication and flexibility

have grown since previous financial bubbles—could readily accommodate the U. S deficits” (3). Greenspan believes that the market by itself by adjust the current account deficit. The history of the total public debt of the United States has been increasing dramatically in the last ten years. As I said, many economists believe it is deteriorating the economy of the US.

Economists believe that a current account deficit indicate economic problems and tells the government figures to change their economic policies.Current account deficits are the result of people investing money in the country, whi ch is being financed by other countries. At other times, current account deficits are the result of people not saving enough money. The reasons why people do not save money are: confidence in the market, tax cuts or changes in the fiscal policy. In the other hand, the US government should be worried about the federal budget.

The federal budget deficit means that a country is spending more money than what they have. Right now, the United States is debt for more than 9 trillion dollars.Japan, China and oil countries are getting tired of financing the US deficits. All these countries are getting nervous and irritated when they see their dollar holdings, whether it is the treasuries they buy to finance the deficit every month or the dollar reserve holdings they own, which are depreciating on a daily basis. The truth is that American people should be worried because the way I look at it, it seems like the economy is not going to improve, unless the government makes some changes in their economic policies.

For the Americans, the deficits mean “invisible

inflation and asset deflation” (Grespi 1).If the countries that are financing our deficits stop buying the government treasuries, the US government will find itself in a very rough situation. Economists believe that if that happens, the government will have two choices: find the money some other way and people know that raising taxes will be the way, or finance the budget in a different way, and as we know the government has not done a good job in that area. People always say that the dollar depreciation is good for the products that the US exports. But the truth is that most of those products are made in other countries.

An American columnist and reporter by the name of Ron Grespi says, "Nike and Reebok products are made in China, Ralph Lauren and The GAP, ditto. Oh yeah, the same thing goes for computers” (Grespi 1). He also talks about people saying that Ford cars are being sold in Europe, it is true, but they are being made in Spain. The truth is that a lot US companies are moving their production to foreign countries and that is not helping the US economy in any way, besides making a huge profit for the shareholders and owners of those companies. The truth is that government has come up with a rapid economic policy to pay off the federal budget deficit.If they wait, and they do not do it soon, by 2040 the government will only have money to cover Mediacare, Social Security and interest in the debt.

I believe in the US and n its hegemony, but the american people should take the deficits as a lesson

that way it would not happen again. Work Cited Bartolini, Leonardo, and Amartya Lahiri. ”Twin Deficits, Twenty Years Later”. Federal Reserve Bank of New York. Oct. 2006.

17 Mar. 2008 http://www. newyorkfed. org/research/current_issues/ci12-7. pdf Chinn, Menzie D. Getting Serious About the Twin Deficits.

Council of Foreign Relations.New York: The Bernard and Irene Schwartz Series, 2005. 1-38. 4 Mar.

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Crawford, Peggy, and Terry Young. "A Looming Crisis? " Graziadio Business Report. 2004. Pepperdine University. 4 Mar. 2008 <http://gbr.

pepperdine. edu/042/deficits. html>. Frankel, Jeffrey.

"Could the Twin Deficits Jeopardize the US Hegemony? " Journal of Policy Modeling os (2006): 1-14. 4 Mar. 2008 <http://ksghome. harvard. edu/~jfrankel/SalvatoreDeficitsHegemonJan26Jul+.

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4 Mar. 2008 <http://links. jstor. org/sici? sici=0317-0861(198902)15%3CS58%3APTSTPO%3E2. 0. CO%3B2-Y>.

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