United States of America Deficits
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The U.S is the most powerful and greatest on the face of earth. It is also found to be the greatest debtor based on a report by the former Treasury Secretary Lawrence Summers. From the report, we get the facts on why it experienced large debts and how to make money for itself as a government. In addition, we find the mechanisms of which will actually improve on the U.S exchange rates, interest rates and goods prices of which would change during this restoration process and to what level they would change.
According to the National Income Identity (Y=C+I+G+CAB), the cause of the U.S current account deficits since 1975 included the excessive dependence on foreign capital and growing foreign debts. This made the U.S. economy rest on an unsustainable accumulation of foreign debts.
Having being fuelled by government profligacy and low private savings rates, the current account deficit brought about some difference between what the U.S. residents spend abroad and what they earn abroad in a year. At that particular time, this stood at almost six percent of the GDP and total net foreign liabilities were approaching a quarter of GDP. This led to the current account deficit in the 1975.
There was also the sudden unwillingness by investors abroad to continue adding to their already large dollar assets to the economy of the U.S due to its large deficit. In this scenario, it would set off panic, causing the dollar to lose value, interest rates to go higher than expected in the market and U.S. economy to descend into crisis thus dragging the rest of the world down with it (Brown and Levey, 2005).
The U.S also rests on an economy that is continually extending its lead in the innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. This actually depends on more resources that are not enough to sustain the U.S economy. The U.S also grows faster than its trading collaborates and spends a disproportionate share of its growing income on imported goods and services.
The last figure represents a whopping 74 percent of the U.S GDP on a statistic that would seem to give ample cause for alarm. However, considering foreign ownership of the U.S financial assets as a percentage of GDP are less enlightening than comparing it to the total available stock of U.S Financial assets (Brown and Levey, 2005).
At the start of the year 2004, the total of U.S. securities amounted to $33.4 trillion (some 50 percent of the world total). Foreign investors held more than 38 percent of the $4 trillion in U.S. Treasury bonds, but only 11 percent of the $6.1 trillion in agency bonds (such as those issued by Fannie Mae and Freddie Mac); 23 percent of the $6.5 trillion in corporate bonds; and 11 percent of the $15.5 trillion in equities outstanding. These foreign liabilities are the result of a string of current account deficits that have grown from 1.5 percent of GDP in the mid-1990s to an estimated 5.7 percent of GDP about $650 billion in 2004.
According to Brown and Levey (2005), a country with huge government budget deficits and trade deficits like the current U.S can finance itself. This can be by the simple virtue of spending on knowledge creating activities such as on the job training, new-product development and testing, design and blue print experimentation. It can also be through managerial time spent on workplace organization because most of its citizens would eventually know how to make income and eventually contribute to the greater growth of economy through payment of taxes.
In addition, the U.S economy remains on the frontier of global technological innovation and can therefore attract foreign capital as well as immigrant labor with its rapid growth and the high returns it generates for investors. Through these, it will eventually create income or finances for itself.
Until 1989, the United States was a creditor to the rest of the world and the net international investment position (NIIP) peaked at almost 13 percent of GDP in 1980. If such practices would also be undertaken currently, it would enable the government finance its self. The government can also avoid imposing capital losses on domestic holders of dollar assets, and reduce the risk of an economic slowdown that could lead to a deflationary spiral.
There are market forces in goods, money and foreign exchange markets that can bring about a restoration of U.S. balance of payments equilibrium. For instance, Unpacking of the net international investment position (NIIP), which gives a better sense of the risk it actually poses. It has its own components, which include direct investment, the value of domestic operations directly controlled by a foreign company and financial liabilities, the value of stocks, bonds, and bank deposits held overseas.
It is possible to have U.S. exchange rates, interest rates and goods prices change during this restoration process. Dollar will appreciate against the Euro and the Yen in which will keep the (NIIP) raise despite the large current account deficits. The same result is likely for the future. Although the (NIIP) will continue to grow for many years to come, its increase will be far more than economists would expect. Interest rates would also improve and goods prices will be manageable to the government and its citizens.
In an open economy, governments cannot raise taxes and cut spending in isolation. Raising taxes would not have the same impact as cutting government spending on restoring current account balance. Since by raising the taxes then the government would eventually lead to the current account balance since it would not be operating on debts. This is opposed to when the government reduces or cut the spending cost, which means the government may not have enough to sustain the economy without the source, which is TAX. The difference is that the Taxes affect the government spending as opposed to spending in isolation, which does not involve much of the tax.