2002 October 20 Sunday
A US Dollar Decline Would Cause Recession

Irwin Stelzer puts his finger on how the US economy could go into recession: a dollar decline would have many negative follow-on consequences:

It is that sustained spending that is a two-edged sword. It has kept the economy moving forward in spite of a massive slowdown in business investment. But American’s appetite for imported cars, television sets, trainers, and T-shirts has created a current account deficit that is now approaching 5 percent of GDP. Most economists think that an imbalance of that magnitude between imports and exports inevitably leads to a run on the currency of the importing—some would say profligate—nation.

So far, the United States has avoided more than a minor decline in the dollar by attracting sufficient inward investment to offset the massive outflow of dollars. Europeans’ withdrawal of funds has been matched by increased inflows from Asia. But if share prices continue to fall, foreigners may tire of holding dollar assets. If they do so suddenly and in a major way, the dollar may fall so far and so fast as to force the Federal Reserve Board to jack up interest rates to increase returns on dollar assets. That would, of course, abort the halting economic recovery now underway.

Consumer spending creates another problem—record borrowing. Haskel points out in a memorandum to me that the cost of servicing private debt is now running at about 14 percent of disposable income, the top end of the historic range. Should interest rates rise, the cost of carrying that massive pile of debt—now equal to more than 100 percent of disposable income, compared with about 75 percent in 1990—will soar, forcing consumers to rein in spending.

The debt load and the trade deficit have both got cause a day of reckoning for the economy sooner or later. Americans can't continue to live beyond their means indefinitely.

Share |      By Randall Parker at 2002 October 20 02:53 PM 


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