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Thursday, June 22, 2006

In the Bad Old Summer's Time?

Larry Summers says the economists who worried about growing global imbalances and predicted tough times ahead that have since rescinded their predictions in favor of milder scenarios may have thrown in the towel too early:

Summers Sees Account Deficit as Global Threat, by John M. Berry, Commentary, Bloomberg: Former Treasury Secretary Lawrence H. Summers said last week that the $800 billion U.S. current account deficit represents a risk to the global economy and that if its decline isn't carefully managed, it could lead to a world recession. ... In contrast, several of the other conference speakers, including ... Richard N. Cooper and ... Peter Garber..., portrayed the deficits as relatively benign.

And a large majority of the roughly 75 economists and academics present indicated by a show of hands that they expect the current account deficit eventually to shrink smoothly to a sustainable level. ... [T]here was also broad agreement that the big short-fall in transactions with the rest of the world may continue unabated for years to come.

Summers was skeptical... In recent years, numerous economists have predicted the foreign investors and central banks whose purchases of U.S. stocks and bonds, direct investments in companies and bank loans have financed the current account deficits would become reluctant to continue doing so. That could have forced up interest rates and caused the deficits to decline.

That hasn't occurred, of course, and now some of those economists are wondering if it ever will. Summers labeled that thinking the ''throw in the towel theory.'' ''Since the conventional view hasn't been right, that's evidence that view is wrong,'' or so that argument goes, Summers said. To the contrary, there's ''more risk now'' than previously that a crisis could erupt...

On June 15, the Boston Federal Reserve Bank's president, Cathy E. Minehan, asked how many of the participants expected a smooth correction of the deficits at some point. So many hands went up that she didn't ask who disagreed. ...

Either way, smooth or rough, American households are going to feel a lot of pain when the adjustment does occur. ... For the current account deficit to shrink, U.S. savings have to rise and consumption will have to fall. Summers derided as an ''enduring fallacy'' the notion that a country can decide to save more, have its current account deficit improve and maintain good economic growth while nothing else happens.

''If the current account deficit falls, something else has to change,'' Summers said. Exports have to rise, or imports will have to fall, and if U.S. savings were increasing, ''there would be a decline in global aggregate demand'' unless growth increased elsewhere in the world, he said. ...

Several papers presented at the conference provided convincing evidence that the U.S. current account deficit isn't just the product of over-consumption by Americans. Economic circumstances and government policies in many other parts of the world have played a major role as well.

The extraordinarily high savings rate in China and a number of other countries has provided a huge amount of capital to be invested elsewhere. By keeping its currency peg at a relatively low value to the U.S. dollar, the People's Bank of China, its central bank, has accumulated an enormous amount of dollars, much of which it has used to purchase U.S. Treasury securities.

Several other East Asian countries also maintain currency pegs that have required them to accumulate dollars. And with oil priced in dollars, so have many of the oil exporting nations. ...

Were the U.S. current account deficit to begin to shrink, the surpluses in other countries ... would have to shrink as well. As Summers put it, ''What happens in the rest of the world is probably more important in the resolution of this than what happens in the U.S.''

No one at the conference had a clue as to what might happen to cause the deficit to begin to shrink, which is another reason to wonder whether it may be a financial crisis. In the meantime, the deficit is still headed higher.

I'll add that this could be reducing economic activity to some extent already due to uncertainty about future economic conditions. Whether a hard landing actually occurs or not, the chance that it will has to be taken seriously by consumers, financial markets, and policy makers as they formulate plans for the future.

Is a Wile E. Coyote moment coming?

    Posted by on Thursday, June 22, 2006 at 02:15 AM in Economics, International Finance, International Trade | Permalink  TrackBack (1)  Comments (4)


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