A balancing act that defies belief

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The Independent Online

American dominance of the world economy is taken for granted. At the start of the new millennium its leadership of the hi-tech industries has become one of the clichés of business life. America's apparent destiny to be supreme in the technologies of the future has been celebrated by the surge in the prices of computer and internet stocks, with the Nasdaq index up by over 80 per cent in 1999.

American dominance of the world economy is taken for granted. At the start of the new millennium its leadership of the hi-tech industries has become one of the clichés of business life. America's apparent destiny to be supreme in the technologies of the future has been celebrated by the surge in the prices of computer and internet stocks, with the Nasdaq index up by over 80 per cent in 1999.

Yet something is wrong. In 1991 the US enjoyed virtual balance on its international payments. But, apart from one or two quarters in 1995, the US's imports continually rose faster than its exports in the following eight years. In 1999 the balance of payments deficit approached $350bn (£230bn), by far the largest-ever in money terms. If American companies really do dominate world markets, why is the foreign competition so successful selling in their backyard?

The increase in the US's indebtedness to the rest of the world is at present greater than the value of all the goods and services made in a significant European economy.

Does it matter? A number of American economists have argued that the external deficit is a positive development. Professor Gary Hufbauer of the Washington-based Institute for International Economics claimed last spring that the American economy was "the envy of the world" and attracted heavy foreign investment. This investment flow financed the deficit on trade in goods and services. Professor Hufbauer said the trade deficit should be understood as "really an investment surplus" and was a sign of "strength, not weakness".

This sounds odd, but in some circumstances it could be correct. A developing country with outstanding prospects for export growth can run a large payments deficit for several years, as foreign investors build the factories that will eventually sell products around the world, and so transform the deficit into a surplus - as did Singapore.

But to claim that the US is in the same situation is preposterous. As it already has one of the world's most advanced industrial bases and represents over a fifth of the world economy, it is most unlikely that its exports can grow much faster than those of other industrial economies.

American-made car production has increased strongly in recent years, but cars made by American companies (General Motors, Ford and the half-German Chrysler,) continue to lose ground both to imports and to cars made in the US by foreign companies.

For over eight years US imports have been growing faster than its exports. The US has become the world's largest debtor nation. If imports keep on increasing more rapidly than exports, the situation would be intolerable. But what would happen if exports, imports and national output grow at the same rate?

At first sight that would be sustainable. The trade gap would stabilise relative to national output. In the past few quarters foreign investors have shown a willingness to buy American assets on a scale sufficient to finance a gap of this size. If so, why should there be any special problem in the future?

It would indeed be an improvement if the US could halt the trends of the 1990s and prevent the trade gap widening further. But the stabilisation of the trade gap would not stop foreigners increasing their assets in the US at a faster rate than American national output. The US's deficit on international investment income - and so its deficit on the current account of the balance of payments as a whole - would keep on increasing. But that cannot be allowed to happen. It is a mechanical exercise to show that the stabilisation of the trade gap in 2000 would not prevent the US sliding further into the red. On plausible assumptions, net foreign ownership of its assets would reach half of the US output by 2008.

The current boom is totally unsustainable. At next week's meeting of the Federal Reserve's Open Market Committee a small rise in interest rates is expected, to counter potential inflation risks. But in the medium term, Alan Greenspan, chairman of the Federal Reserve, and his colleagues will also have to turn their thoughts to the dangers posed by the vast imbalance in the US's external payments.

* Professor Tim Congdon is managing director of Lombard Street Research. This article is based on a research paper in Lombard Street Research's 'Monthly Economic Review'.

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