Cause for Concern: Serious imbalances in the US economy
Paul Volcker, former chairman of the Federal Reserve (1979 - 1987), in his February 2005 address to the Stanford Institute for Economic Policy Research, highlighted serious imbalances in the US economy:
- personal savings have almost completely disappeared;
- consumers are buying housing at ever increasing prices;
- and using equity in their homes to fund rising levels of personal debt;
- the only positive is that businesses are re-building their reserves;
- but this is more than offset by the huge federal deficit.
In effect, the nation is consuming and investing 6% more than it produces. This is unsustainable in the long term.
How does the country balance its books? The deficit is funded by a huge
influx of capital from offshore investors; to the tune of $2billion per working
day. The US is seen as a safe haven and the dollar is the closest there is to an
international currency. Lately there has been a disturbing shift with central
banks, especially China and Japan, replacing private capital. It is in the
interest of these economies that the US market remain buoyant, as they are to
some extent dependant on their exports to the US.
The problem, as Volcker points out, is that there is a lack of willingness to tackle these issues: "What can be left till later usually is -- and then alas, it's too late".
How can the problem be solved?
- Persuade China and other major Asian economies to permit a substantial appreciation of their currencies against the dollar;
- Encourage Japan and Europe to deal with structural obstacles to domestic growth and to stimulate their domestic markets; and
- Introduce measures to forcibly increase the rate of personal savings, thereby reducing demand for imported goods.
The former Fed chairman called for a strong sense of monetary and fiscal discipline. If the imbalances are not tackled in good time the government will sooner or later be forced to face them during a financial crisis. Confidence in US capital markets may fade or offshore investors and central banks may decide that they have had their fill of the dollar. In either case the economy is ill-equipped to deal with unforeseen events.