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Hang On US: This Won't Hurt - Much
A double dip for the United States economy? Or at least a couple of flat-line years? It sounds a grim prospect. But setting aside for a moment the impact on families and on social cohesion in the US, could it be what the US economy and the world need more than an unsustainable bounce fed by cheap money and underwritten by Asian creditors?
From the perspective of Asia, the creditor half of the world, the long, if not deep, US recession has resolved few of the fundamental imbalances in the global economy. The US financial sector may be partly restored to health and the real estate market may have half adjusted to its long-term trend. But the deficit in the current account of the balance of payments is already heading back towards levels which cast doubt on the country's ability to meet accumulated net foreign liabilities now totaling US$2.7 trillion.
The current account deficit – the sum of exports and imports of goods, services, transfers and investment income -- fell from a peak of US$856 billion or 6 percent of gross domestic product in 2006 to 3 percent in 2009 but is already 4 percent of GDP again and rising. A continuation of the US recovery without a significant change in other factors affecting global imbalances will return us to the situation prior to the pre-2008 crisis era of US current accounts deficits averaging 5 percent of GDP. The consequent flood of dollars helped generate speculative surges in commodity and other asset prices.
The current account deficit may not get quite that bad because domestic demand in the developing world should generate demand for more US exports and more profits for US companies overseas. But a pickup in US as well as global growth would likely push up the price of US imports, notably oil, and make it ever harder for the US to reduce its external deficit and stabilize its foreign liabilities.
Viewed from Asia, where prices of commodities and labor are rising and will be reflected in export prices, the threat of deflation in the US is exaggerated. If so there will be scant excuse for the Federal Reserve to keep rates well below inflation or to boost money supply by buying more treasury bonds. However interest rates should lag those in Asia and keep the dollar weak.
Talk of a double dip has actually led to the dollar rallying. This is counter-intuitive as one would normally expect US weakness and thus the prospect of a prolonged era of very low interest rates to weaken the US currency. But markets may be sensing that a weak US means a smaller external deficit and fewer dollars for the world to play with.
A stronger dollar is however the last thing the US needs if its deficit, which threatens the long-term role of the currency, is to be addressed. The last thing the world needs for longer term financial stability and free trade is a yuan which remains massively undervalued and is, to varying degrees, making other east Asian surplus nations reluctant to see their currencies appreciate.
A number of things need to happen. Firstly, zero growth in US imports would bring the current deficit down to a sustainable 2 percent of GDP. How painful this will be depends of how far there can be a shift in US demand from import-intensive consumption to infrastructure and services. That would be influenced by import prices, particularly those of Asian manufactures.
In turn that means currency and demand adjustments in Asia which seem only likely to be come about as a result of both domestic carrots and foreign sticks. The carrots will be the need for demand stimulus to offset flagging exports to a static US economy. China's massive 2009 domestic economic stimulus to offset the impact global recession was such a response, but there is now a danger that Beijing will overdo current tightening measures.
As for the yuan, a stick seems likely to be needed to get any meaningful adjustment. The liberalization of policy announced in June has so far led to some daily fluctuation but no sustained rise. Meanwhile the Chinese trade surplus – and that of most of its Asian neighbors -- has bounced back to levels which are incompatible with longer term global equilibrium.
In sum, a double dip would both enable the US to complete the adjustments needed to offset the pre-2008 profligacy – an adjustment partially thwarted by excessive leniency towards the financial and housing sectors. And it would make east Asia recognize in practice as well as theory that the era of growth via external demand and weak currencies is over. The US recession may have already been long but it has not been deep enough to induce sufficient change in either US or Asian mindsets.