The Future of the American Economy Series:
The Dollar and Destiny
February 22, 2005

Robert Z. Aliber, Wilson Center Fellow and a Professor of International Economics and Finance at the Graduate School of Business, University of Chicago (emeritus)

Paul Blustein, International Economics and Trade Reporter, The Washington Post

As part of its continuing series on The Future of the American Economy, the Program on Science, Technology, America, and the Global Economy (STAGE) recently hosted a discussion with Robert Z. Aliber, Wilson Center Fellow and a Professor of International Economics and Finance at the Graduate School of Business, University of Chicago (emeritus).

The discussion with Aliber focused on the causes and potential consequences of the large U.S. current account and trade deficits. While standard theories emphasize the low U.S. saving rate (including the large U.S. fiscal deficit), Aliber stresses the impact of high savings, relatively low consumption, and export orientation of other economies – especially those located in Asia.

Aliber introduced to the audience a Warhol theory of economic growth. Instead of the fifteen minutes of fame that pop artist Andy Warhol promised everyone, Aliber pointed to fifteen or twenty years or more of very rapid growth in the Asian economies. After the growth spurt, investment fell but saving rates remained very high.

One response to the excess of savings over investment in Japan and other Asian countries is that the purchases of U.S. dollar securities and U.S. real assets have increased. The result is the large trade and current account deficits. As America's paper wealth increased, consumption rose and the personal saving rate declined. Capital flows also drove up the value of the dollar with the predictable result that U.S. exports declined while imports rose.

In 2005, Aliber noted that the current account deficit was approaching both $700 billion and six percent of Gross Domestic Product (GDP). If current trends were to continue, the deficit could reach eight or even ten percent of GDP. The United States is already in historically unprecedented territory. The risk is that a sudden decline in purchases of U.S. dollars could drive interest rates sharply higher in the United States and tip much of the world economy into recession. Protectionist pressures at home would increase.

In the post-World War II era, the United States has responded to international economic imbalances in two ways. President Nixon shut the U.S. Treasury's gold window, ended the system of fixed exchange rates, and imposed a temporary surcharge on most imports in 1971. When a large trade deficit again emerged in the 1980s, President Reagan's Secretary of the Treasury James Baker met with the ministers of finance from France, Germany, Japan and the United Kingdom at the Plaza Hotel in New York in September, 1987. The five ministers reached an agreement to gradually bring down the value of the dollar and reduce the size of America's trade deficit.

While Aliber did not propose specific strategies to deal with the imbalance, he raised two questions that demand immediate and careful analysis. First, central bankers should be preparing for the possibility of sudden, sharp turns in global finance. Second, the United States needs to think about how the real economy can move to a level of production that is consistent with a sustainable U.S. trade and current account deficit.

Many economists believe that a sustainable level of deficit would be around $200 billion. The existing current account deficit of $650 billion suggests an additional $450 billion (more or less) of added domestic production of goods and services. Aliber doubted the United States has the capacity to meet that goal and wondered if it requires considerable expansion of domestic capacity, perhaps even the reentry into industries that had been lost to overseas production?

Instead of the usual mantra that the U.S. current account deficit is the product of America's glutinous appetite for imports, Aliber stresses the global origins of the trade and current account deficits. In recent years, export dependent and high saving Asian economies have induced the American deficits by buying large amounts of Treasury bonds and other dollar denominated securities. If we are to have the favored 'soft landing', the United States, Asia and other countries will need to unwind these unsustainable economic challenges together.