Sunday, March 06, 2005
The Overstretch Myth
Foreign Affairs (access required) has a very interesting article on why the US current acount defecit is not a threat to it's global economic hegemony.
Read the whole thing, but here's a section that explains that even a rapid flight from US dollars would be mitigated by man factors and would not lead to a US economic collapse:
The conclusion explains what the real threat to US economic hegemony for the long forseable future is, a sentiment that I wholeheartedly agree with:
Read the whole thing, but here's a section that explains that even a rapid flight from US dollars would be mitigated by man factors and would not lead to a US economic collapse:
Whichever perspective on the current account one favors, the United States cannot escape a growing external debt. The "hegemony skeptics" fear such debt will lead to a collapse of the U.S. dollar triggered by a precipitous unloading of U.S. assets. Such a selloff could result -- as in emerging-market crises -- if investors suddenly conclude that U.S. foreign debt has become unsustainably large. A panicky "capital flight" would ensue, as investors raced for the exits to avoid the falling dollar and plunging stock and bond prices.
But even if such a sharp break occurs -- which is less likely than a gradual adjustment of exchange rates and interest rates -- market-based adjustments will mitigate the consequences. Responding to a relative price decline in U.S. assets and likely Federal Reserve action to raise interest rates, U.S. investors (arguably accompanied by bargain-hunting foreign investors) would repatriate some of their $4 trillion in foreign holdings in order to buy (now undervalued) assets, tempering the price decline for domestic stocks and bonds. A significant repatriation of funds would thus slow the pace of the dollar decline and the rise in rates. The ensuing recession, combined with the cheaper dollar, would eventually combine to improve the trade balance. Although the period of global rebalancing would be painful for U.S. consumers and workers, it would be even harder on the European and Japanese economies, with their propensity for deflation and stagnation. Such a transitory adjustment would be unpleasant, but it would not undermine the economic foundations of U.S. hegemony.
The conclusion explains what the real threat to US economic hegemony for the long forseable future is, a sentiment that I wholeheartedly agree with:
Only one development could upset this optimistic prognosis: an end to the technological dynamism, openness to trade, and flexibility that have powered the U.S. economy. The biggest threat to U.S. hegemony, accordingly, stems not from the sentiments of foreign investors, but from protectionism and isolationism at home.
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