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C. FRED BERGSTEN is Director of the Peter G. Peterson Institute for International Economics. He was Assistant Secretary of the Treasury for International Affairs from1977 to 1981 and Assistant for International Economic Affairs to the National SecurityCouncil from 1969 to 1971. Copyright 2009, Peterson Institute for International Economics.
Even as efforts to recover from the current crisis go forward, the United States shouldlaunch new policies to avoid large external deficits, balance the budget, and adapt to aglobal currency system less centered on the dollar. Although it will take a number of years to fully implement these measures, they should be initiated promptly both to bolsterconfidence in the recovery and to build the foundation for a sustainable U.S. economyover the long haul. This is not just an economic imperative but a foreign policy andnational security one as well.A first step is to recognize the dangers of standing pat. For example, the United States'trade and current account deficits have declined sharply over the last three years, butabsent new policy action, they are likely to start climbing again, rising to record levelsand far beyond. Or take the dollar. Its role as the dominant international currency hasmade it much easier for the United States to finance, and thus run up, large trade andcurrent account deficits with the rest of the world over the past 30 years. These hugeinflows of foreign capital, however, turned out to be an important cause of the currenteconomic crisis, because they contributed to the low interest rates, excessive liquidity,and loose monetary policies that -- in combination with lax financial supervision --brought on the overleveraging and underpricing of risk that produced the meltdown.It has long been known that large external deficits pose substantial risks to the U.S.economy because foreign investors might at some point refuse to finance these deficits onterms compatible with U.S. prosperity. Any sudden stop in lending to the United Stateswould drive the dollar down, push inflation and interest rates up, and perhaps bring on ahard landing for the United States -- and the world economy at large. But it is nowevident that it can be equally or even more damaging if foreign investors do finance largeU.S. deficits for prolonged periods.U.S. policymakers, therefore, must recognize that large external deficits, the dominanceof the dollar, and the large capital inflows that necessarily accompany deficits andcurrency dominance are no longer in the United States' national interest. Washingtonshould welcome initiatives put forward over the past year by China and others to begin aserious discussion of reforming the international monetary system.To a large extent, the U.S. external deficit has an internal counterpart: the budget deficit.Higher budget deficits generally increase domestic demand for foreign goods and foreigncapital and thus promote larger current account deficits. But the two deficits are not"twin" in any mechanistic sense, and they have moved in opposite directions at times,including at present. The latest projections by the Obama administration and theCongressional Budget Office (CBO) suggest that both in the short run, as a result of thecrisis, and over the next decade or so, as baby boomers age, the U.S. budget deficit will
 
exceed all previous records by considerable margins. The Peterson Institute forInternational Economics projects that the international economic position of the UnitedStates is likely to deteriorate enormously as a result, with the current account deficitrising from a previous record of six percent of GDP to over 15 percent (more than $5trillion annually) by 2030 and net debt climbing from $3.5 trillion today to $50 trillion(the equivalent of 140 percent of GDP and more than 700 percent of exports) by 2030.The United States would then be transferring a full seven percent ($2.5 trillion) of itsentire economic output to foreigners every year in order to service its external debt.This untenable scenario highlights a grave triple threat for the United States. If the rest of the world again finances the United States' large external deficits, the conditions thatbrought on the current crisis will be replicated and the risk of calamity renewed. At thesame time, increasing U.S. demands on foreign investors would probably becomeunsustainable and produce a severe drop in the value of the dollar well before 2030,possibly bringing on a hard landing. And even if the United States were lucky enough toavoid future crises, the steadily rising transfer of U.S. income to the rest of the world toservice foreign debt would seriously erode Americans' standards of living.Hence, new record levels of trade and current account deficits would likely levy veryheavy costs on the United States whether or not the rest of the world was willing tofinance these deficits at prices compatible with U.S. prosperity. Washington should seek to sharply limit these external deficits in the future -- and it is encouraging that theObama administration has indicated its intention to move in that direction, opting forfuture U.S. growth that is export-oriented, rather than consumption-oriented, andrejecting the role of the United States as the world's consumer of last resort.Balancing the budget is the only reliable policy instrument for preventing such a buildupof foreign deficits and debt for the United States. As soon as the U.S. economy recoversfrom the current crisis, it is imperative that U.S. policymakers restore a budget that isbalanced over the economic cycle and, in fact, runs surpluses during boom years.Measures that could be adopted now and phased in as growth is restored includecontaining the cost of medical care, reforming Social Security, and enacting new taxes onconsumption.The U.S. government's continued failure to responsibly address the fiscal future of theUnited States will imperil its global position as well as its future prosperity. The country'sfate is already largely in the hands of its foreign creditors, starting with China but alsoincluding Japan, Russia, and a number of oil-exporting countries. Unless the UnitedStates quickly achieves and maintains a sustainable economic position, its ability topursue autonomous economic and foreign policies will become increasinglycompromised.THE DOLLAR'S LONG SHADOWInside the United States, the international prominence of the dollar is widely seen asserving the country's national interests. Because of this global role and the foreign money
 
it attracts to the United States, the dollar allows Americans to live beyond their means, asexemplified by the cheap Chinese goods at Wal-Mart, affordable vacations on the FrenchRiviera, and U.S. budget deficits financed by Middle Eastern countries.Many foreigners share the view expressed by French officials in the 1960s that thedominance of the dollar confers an "exorbitant privilege" on the United States. Theyargue that this automatic financing of U.S. external deficits -- since most internationaltransactions are financed in dollars -- means that the United States has little need to takeglobal considerations into account in formulating its economic policies. These foreignvoices note the financial instability caused by wide fluctuations in the value of the dollar,such as its seesawing by 30-50 percent against the euro over the past decade. Periodicsizable declines in its exchange rate have reduced -- sometimes sharply -- the value of thedollar holdings of both private investors and monetary authorities around the world.Hence, many international voices believe that the dollar-based monetary system is not intheir interest, and they are increasingly calling for reform.Both sides are wrong. Other countries gain from the convenience of a worldwidecurrency (as they do from having English as a worldwide language) and the subsequentreduction in transaction costs. Whatever their complaints, most governments are happywith the trade surpluses and the jobs created by the U.S. deficits that their dollarfinancing allows. In fact, if the United States stopped running large trade deficits andacting as the consumer of last resort, many countries would be forced to rebalance theirgrowth strategies to expand domestic demand instead of relying on exports. Othercountries should be careful what they wish for when they propose dethroning the dollar.That said, the United States itself would benefit from a reduction in the international roleof the dollar. The deficits enabled by the dollar's prominence are indeed attractive in theshort run -- as are credit cards that allow deferred payments. U.S. politicians lookingtoward reelection are thus understandably reluctant to jeopardize the dollar's status, not tomention afraid of being called "un-American" for not defending the national currency.After all, the deficits were not very damaging while they remained modest, as they didthroughout the postwar period until the 1980s, during which time there were no plausibleinternational alternatives to the dollar anyway.The current crisis, however, starkly reveals the folly of blithely funding increasing U.S.deficits. To be sure, China and other large foreign investors in the dollar did not forceU.S. financial institutions to make stupid subprime loans and ignore traditional creditstandards. Nor did they force the U.S. government and U.S. financial regulators toconduct policies that were lax to the point of indifference. But the huge inflows of foreigncapital to the United States -- which rose steadily from the mid-1990s and reached recordlevels for several consecutive years until 2006 -- depressed interest rates by at least 100and perhaps by as many as 200 basis points. They facilitated, if not overtly induced, theoverleveraging and underpricing of risk. Meanwhile, U.S. regulatory authorities werelulled into complacency. Even when the U.S. Federal Reserve raised short-term interestrates in 2005, the influx of foreign funds kept long-term rates down and prevented theintended tightening of the money supply.
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