August 1, 2004 ECONOMIC VIEW Does the Economy Have Cement Shoes? By EDUARDO PORTER THE economy is a major electoral battleground, and President Bush and Senator John Kerry have been jousting over everything from budgetary policy to the unemployment rate.
Yet even as the candidates unfurl their clashing economic philosophies, some experts say the next president will not easily turn the American economic ship. Like never before, economic policy will be constrained by the nation's foreign debt. The debt load mounted when the nation's current account deficit started to bloat in the late 1990's. That deficit - the broad measure of America's balance of trade and interest payments with the rest of the world - grew despite the recession of 2001, and now amounts to about 5 percent of the nation's total output. The growing foreign debt led to one of the most radical turnarounds in modern financial history. Until the late 1980's, the rest of the world owed the United States more than it owed the world. At the beginning of 2004, though, the balance between the United States' foreign assets and its liabilities was in the red by an amount equivalent to nearly 30 percent of gross domestic product. "The United States is hurtling into debt," said Wynne Godley, a professor of economics at Cambridge University and a researcher at the Levy Economics Institute at Bard College in New York. No one knows how high this debt can go. "We're in new territory," said James W. Paulsen, chief investment strategist at Wells Capital Management. "It can scare the jeebies out of a lot of people." Still, Professor Godley and two colleagues - Alex Izurieta of Cambridge and Gennaro Zezza at the University of Cassino in Italy - made some projections on how the rising foreign debt load would limit economic growth. They assumed that the dollar would stay at current levels after declining 9 percent since 2002, and that the economy in the rest of the world would grow by 4 percent, on average, over the next four years. Then they factored in the propensities of Americans to import and export, and the impact of rising interest rates on the servicing of foreign debt. What they found wasn't pretty. Under these conditions, for the United States' economy to grow by 3.2 percent per year, on average, over the course of the next administration, the American current account deficit would have to surge to an unprecedented 7.5 percent of G.D.P. over the next four years. The nation's net financial deficit with the world would widen to more than 50 percent of G.D.P. These precarious finances could limit action on the budget deficit, despite the claims of the two candidates. President Bush says the deficit will pretty much take care of itself, mainly through faster economic growth that will increase government revenues and reduce entitlement spending. Senator Kerry says he can cut the deficit painlessly by scrapping some of Mr. Bush's tax cuts and reducing corporate subsidies and tax loopholes. Neither of these options is a slam-dunk. As things stand now, it is questionable whether the United States can sustain brisk growth. But Mr. Kerry's plan would further reduce growth as higher taxes and lower spending cut into aggregate demand. And while lower budget deficits tend to reduce long-term interest rates and stimulate private spending, the over-indebted American consumer is unlikely to pick up the slack. In fact, using the same assumptions as before on the dollar and foreign economic growth, Professor Godley and his colleagues found that if the next administration cut the overall government budget deficit by around 2 percentage points of gross domestic product, this could reduce annual G.D.P. growth by about 2 percent. There is an alternative to this bleak outlook, but it will not be easy to achieve: let the dollar fall much further. This would improve the United States' net trade balance by increasing exports, reducing imports and putting a lid on the current account deficit. It would also improve the country's net financial position by increasing the dollar value of the country's foreign assets. If the dollar fell by 5 percent a year from now until the end of the next administration, for a total decline of about 23 percent, the economy would grow 3.2 percent a year, according to Professor Godley's calculations. At the same time, the current account deficit would shrink to less than 3 percent of G.D.P. and the nation's net external financial deficit would halve to some 15 percent of G.D.P. This would also allow for a significant cut in the budget deficit, because slowing imports and rising exports would transfer the pain of reduced domestic demand onto the rest of the world. IT'S possible that this will happen naturally, and the dollar will simply decline in value, Mr. Paulsen said. Foreign purchases of American stocks and bonds have been falling in the last several months, and if this trend continues, it could push the dollar lower. But it is unlikely that the dollar will be allowed to fall substantially. Pacific rim countries like Japan and China have resisted letting their currencies appreciate by intervening in currency markets. And Europe might oppose a further slide in the value of the dollar against the euro. Indeed, while a fall in the dollar would help the United States economy, it would hurt the rest of the world. And the rest of the world might not like that. Copyright 2004 The New York Times Company
