International Finance in USA - Assignment Example

International Finance I. Introduction In an interview with USA Today, President George W. Bush said, “the best way to deal with the trade defect is to make sure that America is…the best place in the world to do business.” The wisdom of the President’s statement had been the subject of discussion in different sectors. There are those who think that American economy with its ballooning deficit is heading for a crash down. However, there are also those who think that this not a thing to worry since this is just a kind of anomaly and that the economy is bound to correct itself. Is there a need to panic is this just another minor obstacle? In order to understand the situation better, let us look into the facts. Last March 9, 2006, the US Census Bureau/US Bureau of Economic Analysis issued a press release outlining the state of the country’s economy. It announces that total January exports of $114.4Billion and imports of 182.9 billion resulted in a goods and services deficit of $68.5 billion, which is $ 3.4 billion, more than the 65.1 billion in December. January exports were 2.8 billion more than December exports of 111.6 billion. January imports were 62.2 billion more than December imports of 176.6 billion. (U.S. Department of Commerce, March 9, 2006). To get a clear picture of the effect of these figures in our economy, let us view this in the context of balance of payment. II. Balance of Payments The balance of payments (or BOP) is a measur upon which a country traces how much money flows into or out of a given country or countries1. Factors involved in the determination of balance of payment is the country’s export2 and import3 of goods, services and financial capital4, including financial transfers. The need for some balance of payments tatistics can be traced back to the Fourteenth centruy when the Bullionist Doctrine5 was developed in England which lead to the prohibition of export of bullion. This is the early form of Mercantilism which seeks to achieve an equilibrium between value of expoets and imports (Soderstien 1980). The later part of the Mercantilist period observed that there are also transactions which stems from trade relations outside of the country and should be taken into considerations in order to establish a state of economic equilibrium. From its inception in the Fourteenth century until its application in the present times, balance of payment plays a vital role in economic analysis. How does the analysis of balanceo of payment work? The principle of balance of payment gives us an idea of how much money or wealth ins flowing and how much is flowing out of the county. If the amount of wealth flowing out of the country is more than the amount flowing into such country, we have a negative balance of payment or a deficit. In the same manner, where more wealth enters into the country than that which flows out, then we have a positive balance which we refer to as surplus. For instance, having a trade surplus gives us a idea that our country’s export is higher than out import signified by the positive net flow of money from outside sources. On the other hand, a trade deficit, give us a picture that the countrys imports exceed its exports thereby presenting a net outflow of money. Is there such thing as a zero balance of payments? In order to have a zero balance of payments, current acount dificts must be balanced by capital account surplus. A country must balance the scale to reach an equilibrium point and attain a semblance of stability in its economly. Since the 1990’s, the United States have been carrying a negative current balance. This is a debt which is currently financed by issuing securities. As a rule of thumb, the only ay to buy more you sell is to borrow, which is what the United States is doing at the present. III. Interpreting the Current U.S. Dificit Laurence H. Summers interpreted the currently difit in the U.S. as asign of incipient problem. According to him, althought “there is standard set of things that the finance ministers of countries with significant current deficits say, suggesting thac deficits are somehow a a sign of economic strength, … it is natural to look at the U.S. current account deficit and ask whether its level and its deterioration is better atrributed ti increased investment or reduced savings.” Summers was quick to point out that, “ a substnatial deterioration over the last five years’ have happened. The rate in these last five years “represents the lowest net national savings rate in American history, and I believe, that of any major country.” To what degree should we be worrying? Is the current deficit enough to bring down the economy? Businessweek reports that to “many businesspeople and politicians, the trade deficit shows the U.S. is living beyonfd its means and stealing from the living stnadnards of the furute generations. They worry that foreign creditiors, by propping up the dollar and allowing Americans to overconsume, are giving the U.S. the rope to hang itself. They fear that an abrupt plunge of th dollar could boost inflation, devastate the stock market, and force the Federal Reserve to jack up interst rates to defend the currecy.”6 On the government side, Roger Ferguson of the Federal Reserves Department is quite relaxed on the ussue. According to him, “My sense is that the implications fo current-accout adjustments for US economic gwoth and inflation will most likely be benign.” However, Morgan Stanley (MWD Chief Economist Stephen Roach strongly disagree. According to him, “We’re guilty of taking excess consumption to an entirely different plateau than any leading modern economy has ever seen.”7 Like Summers, Roach is very critical with the governments’s stand on the issue of defict and accused the Federal governments of “attempting to rewrite conventional macroeconomics” with “revisionist theories” that shift attention from the real problem. IV. The President’s Solution President Bush’s suggestion that we should not overreact on the problem of trade deficit is founded on the belief that America is still the “best place in th world to do business.” His idea is promote prosperity at home and make the U.S. a magnet for the world’s capital. “Given its strong growth prospects, investors from other nations want to own American stocks, facotries, real estate and the like. The inflow of foreign money, in turn, enables Americans to purchase foreign goods.”8 The argument continues that since the U.S. have been investing is foreign countries, the drop of the dollar will have a postive impact on the economy since assets located overseas will suddenly have higher values. To this end, the economy will find a counter-balance thus attaining sustainability. However, Gian Maria Miles-Ferretti9, calculates that between the year 2002 and 2004, more than 75% increase in the U.S. foreign debt was offset by the sudden change in vale of the country’s overseas assets. This shift was believed to be brought about by the drop of the dollar value in international market (Lane & Milesi-Ferretti IMF Working Paper 05/3) . A strong argument in the drop to the dollar value to counter the current deficit is that cheaper dollar accordingly, would help reduce America’s imbalance by shifting economic production towards exports. This is based on the fact that the economy is already near full employment. However, experts believe that this can only hold true if domestic demand is reduced such as in the case of bedget cuts and tightening. Otherwise, econmist see that a cheap dollar would cause the economy to overheat and interst rate to rise: that would either stall the econmoy or limit the decline in the dollar and rebalancing of th current account.”(Truman 2004). V. Conclusion Many are the conflicting ideas regarding the statement of president Bush. Some are reactions are benign and often times adopt the wait and see attittude while others reacted strongly. Judging by the manifold statements and issues presented in different sector, I would agree with those who agree with the President’s statement. Over the years, the international community witness how countries incur huge deficits. Given this scenario, the U.S. is in a favorable position to recover since it is currently ahead in terms of technology advance compared to its other contemporary nations. To qoute businessweek magazine, “Over the years, we have witnessed how the U.S. has shifted toward the production of knowledge-oriented goods and services, from biotech to movies, while relying on other countries to supply manufactured products. Yes, the U.S. buys a lot from overseas, but it can afford to -- as long as the rate of return on investments in the U.S. remains high enough to continue attracting foreign capital.”10 As long as capital investments keep coming into the country, we can sustain the present near full employment status and eventually achieve price stability. The balance of payments and price sttablility equilibrium can be regarded as secondady importance, next to high economic growth and full employment. Experience tells us that a countries having moderate rate of inflation like the U.S. can still achieve high growth and almost full employment creation. We should not commit the mistake of taking balance of payments as the overriding objective of our economic policies since there is no clear and urgent need why a country should always maintain a balance of payments equilibrium. It is not an imperative that our improts and exports should always be balanced. In my opinion, deficits on the balance of payments equation are not downright harmful as long as it will be offset at the later stage, although I do not negate the fact that having achieved such equilibrium will greatly help a country achieve stability in terms of prices and employment. Furthermore, I do not propose an ida that balance of payment should be considered negligible as it is a good tool in looking into economic possibilities and how government policies could be formulated to avert economic dissasters. Bibliography 1. businessweek report available online at http://www.businessweek.com/magazine/content/05_05/b3918068_mz011.htm last accessed March 17, 2006 2. Lane & Milesi-Ferretti IMF Working Paper (05/3) Financial Globalization and Exchange Rate. 3. Gordon, R. (2003), Exploding Productivity Growth: Context, Causes, and Implications, Brookings Papers on Economic Activity, 2 4. Gordon, R. (2002), Technology and Economic Performance in the American Economy, Center for Economic Policy Research Discussion Paper No. 3213. 5. Erceg, C. J., L. Guerrieri and C. Gust (2002) Productivity Growth and the Trade Balance in the 1990s: The Role of Evolving Perceptions, Board of Governors of the Federal Reserve System, Washington, DC. 6. http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-2362.2005.00164.x 7. Erceg, C. J., L. Guerrieri and C. Gust (2005), Expansionary Fiscal Shocks and the US Trade Deficit, International Finance, 8(3). 8. Jane E. Ihrig; Mario Marazzi; Alexander D. Rothenberg January 2006) Exchange-Rate Pass-Through in the G-7 Countries 2006-851   9. Christopher J. Erceg, Luca Guerrieri and Christopher Gust (2005) Expansionary Fiscal Shocks and the US Trade Deficit* online available http://www.blackwell-synergy.com/doi/ref/10.1111/j.1468-2362.2005.00165.x 10. U.S. Department of Commerce, March 9, 2006. Press Release 11. Summers L. (2005) The U.S. Current Account Deficit and the Global Economy 12. Sodestien B.O. (1980) international Economic. London. Macmillan 13. Truman E.(June 2004) Budget and External Deficit: Not Twins but the Same Family. Federal Reserve Bank Boston Annual Research Conference 14. Kamin B. and Sylvain Leduc. (February 2005) Federal Reserve International Finance Discussion paper No. 827 Read More