What to do about the US deficits?
Published by The Straits Times, Singapore on 2004-10-15
PRESIDENT George W. Bush of the United States and his Democratic challenger, Senator John F. Kerry of Massachusetts, have accused each other during their three televised debates - including the last one on Wednesday evening in Tempe, Arizona - of intemperately tossing around figures on federal expenditures that would damage the US$12 trillion American economy, which is still recovering from a lingering recession.
At the heart of their economic arguments was the budget deficit, the amount that represents the difference between the US$2 trillion that federal government spends each year and what it recovers, mainly through taxes and investments. The nonpartisan Congressional Budget Office says that the Bush administration racked up a record deficit of US$375 billion in the fiscal year 2003; the CBO also estimates a deficit of $415 billion for the 2004 fiscal year, which ended 14 days ago.
In addition to these deficits - incurred mostly because of Mr Bush's generous tax cuts, increased defence expenditures, and the war in Iraq and on terrorism - there's the US current account deficit, which is expected to rise beyond US$600 billion this year, or more than five percent of the US gross domestic product. (In 2000, the last year of President Bill Clinton's term, the federal treasury enjoyed a 1.3 percent surplus, or more than US$200 billion.)
"What we're seeing is unsustainable," Mr Steve Brice, Standard Chartered's Chief Economist in Singapore told The Straits Times yesterday. "Any time that current account deficits move above three percent, economists tend to start worrying."
The central question, which neither Mr Bush nor Mr Kerry has satisfactorily addressed during the presidential campaign, is: How will these deficits be corrected?
The short answer is: They cannot, at least not in the short term.
For the current account deficit to come down, global growth outside the US needs to pick up sharply - and that's unlikely to happen. The US economy, long the engine of growth for the international economy, is registering an annualised growth rate of between 3.5 percent and 4 percent, and it may slow down further; Japan and Europe are showing sustainable growth of about 2 percent. But there are those who also argue that the US economy growing too fast relative to its major partners - such as Japan and Europe - and that this can be corrected either by slower US growth or stronger external growth, the latter being unlikely.
The value of the US dollar, which has lost 25 percent of its value against the euro over the last 18 months, therefore needs to fall to increase the US's competitiveness. The uncompetitiveness of the US economy at current exchange rates can be helped by a weaker US dollar, but that's not about to happen either.
Borrowing from foreigners typically finances trade deficits: Japan, for example, holds nearly 17 percent of US Treasury bonds, although it's buying less of late.
But now these overseas investors are worried, and some of them have already begun selling US assets and putting their cash into the euro or in Asian currencies. Asian central banks presently hold over US$2 trillion in US currency assets in reserves. Asian countries have long been supporters of the US dollar, and Asian central banks have kept their currencies weak in an effort to maintain competitiveness, hindering the US dollar's required decline.
President Bush refuses to even acknowledge that these deficits constitute a significant problem; indeed, he has pledged to reduce taxes even further if he's re-elected. In his view, tax cuts offer a fiscal stimulus - which is to say, the more money people have in their pockets, the more they will spend on consumer durables, and the more investments manufacturers will make in their factories, thereby creating jobs. The fact that this hasn't quite happened hasn't deterred Mr Bush; on his watch, some 1.7 million jobs have been lost.
An analysis by the Concord Coalition, a Washington-based nonpartisan group that advocates deficit reduction, shows that Mr. Bush would cut taxes by $1.2 trillion in the coming decade, while Mr. Kerry's tax proposals, taken together, would reduce projected revenues by $498 billion. The Coalition also points out that new spending proposed by Senator Kerry would total $771 billion in the next decade, vastly higher than the $82 billion that Mr. Bush has proposed. This means that both Mr Bush and Mr Kerry would spend an additional US$1.3 trillion each year over the next 10 years.
For the trade deficit to go down, Americans need to consume less, which they're not about to do. The rise in the price of crude oil to beyond US$52 a barrel - up 60 percent so far this year - has also cast everyone's calculus into confusion. The price rise, in fact, was the highest since future contracts in oil were created 21 years ago. Higher energy costs can hurt company earnings; they could depress stock markets, and also curtail consumer spending. Analysts usually expect every $10-a-barrel increase in oil prices to shave growth in the gross domestic product by 0.3 to 0.5 percentage points.
Rising oil prices will most certainly increase the US trade deficit, already expected to exceed US$600 billion in 2004, That trade deficit, plus the US national budgetary deficit - the difference between the US$2 trillion that the government spends annually and what it gets through taxes and investment income - means that the total US national debt will soar beyond US$7.3 trillion this year, 40 percent of which is held by countries such as China, Japan, Taiwan, as well as by foreign individuals and institutions. That debt figure is more than twice the amount of debt of the rest of the UN's 191 member nations put together, and almost a fifth of the total annual global trade of US$31 trillion. The US spends US$320 billion of its revenues in servicing debt-interest payments each year.
For his part, Mr Kerry cannot afford to push the deficit issue too aggressively either because of the impact his comments will surely have on financial markets. Any further volatility would almost guarantee that he would lose the November 2 election. No wonder he has committed himself not to raise taxes for those earning under US$200,000 a year.
Why should the deficit issue matter to Asians and others outside the US? The obvious reason is that the US economy is still the world's biggest, and any sharp slowdown in its growth will trigger another worldwide recession. The US, for example, continues to be Singapore's major export market - and any further threats to the American economy will most certain have repercussions here. America's ability to keep its markets open to the rest of the world - particularly the 135 nations of the Third World - will also affect global growth.
"They are presenting very, very different agendas. But they arrive at roughly the same place relative to the deficit," Mr Robert Bixby, executive director of the Concord Coalition, said on Wednesday. He reckons both men's initiatives would increase the government's red ink by at least $1.2 trillion through 2014.
But Mr Bush and Mr Kerry each declare they would cut the annual deficit in half within five years. Mr Kerry favors budget restrictions that go further than Bush, like requiring savings to pay for tax cuts, and has said he would trim his priorities if deficits worsen, according to the New York Times.
That won praise from the investment bank Goldman, Sachs & Co., which wrote in a newsletter this month, "On the budget, Senator Kerry is more credible" than Bush.
But, said Mr Bixby of the Concord Coalition, "Given the size of the deficit and the likely explosion of expenses after five years, we need to be looking at a longer time frame and a more ambitious goal.''
And Standard Chartered's Mr Brice added: "This year is about as good as it's going to get for global growth."
Both a weaker US dollar and US economy seem the only ways to reduce the deficit to sustainable levels. Not terribly optimistic scenarios. Little wonder that Mr Bush and Mr Kerry talk about everything else but this matter.
Senior Writer and Global-Affairs Columnist