Thrift is a foreign concept

Jan 14th 2005
From The Economist Global Agenda

The falling dollar has failed to narrow America’s trade deficit, which set another record in November. The world’s largest economy is looking increasingly like the mirror image of its third largest, Germany

TRADE deficits are as American as apple pie. But the deficit announced on Wednesday January 12th still caught many by surprise. Despite falling oil prices and a falling dollar, America’s exports of goods and services fell short of its imports by $60.3 billion in November. It was a record, the second in a row, and marked a widening of almost $10 billion in the trade gap since September.

On the import side of the ledger, America’s petrol bill increased. Though the price of oil had eased, America imported more of it. In the other column, the country’s exports slipped by 2.3%, with sales of capital goods, such as machinery and equipment, falling particularly hard. Economists thus lowered their sights for fourth-quarter growth. J.P. Morgan, which had expected the American economy to maintain an annual pace of growth of 4% in the fourth quarter, now envisages growth of 3.5%.

In theory, the falling dollar should be narrowing the trade deficit. Other things being equal, a cheaper dollar should make America’s exports more competitive and its imports dearer. Since May 2004, the dollar has fallen by 8.2% in trade-weighted terms. But the deficit has only widened in that time.

Of course, some $16.6 billion of America’s November deficit was in trade with China alone, and a dollar depreciation provides little help for American exporters against Chinese rivals because China—like several other Asian countries—pegs its currency to the dollar. But falls in the dollar also do surprisingly little to deter imports. By one estimate, if the dollar depreciates by 10%, the prices of American imports rise by just 2%.

So, the dollar does not drive the trade figures; instead, the trade numbers seem to drive the dollar. Deficits must be financed. And as America’s deficit sets new records, foreign investors ask themselves anew whether it is sustainable, and, more to the point, whether they want to be the ones left sustaining it. On Wednesday, some decided not. The dollar lost much of the ground it had gained in the past three weeks.

A European pastime

Living within your means by importing no more than you export has, it seems, become an un-American activity. It is the sort of thing they do in “old” Europe. Over the past 12 months, Germany’s exports surged by 8.2%, the federal statistics office said on Thursday. Europe’s largest economy is running a sizeable trade surplus, which accounted for about 70% of its economic growth last year. (Yes, there was some.)

Foreigners are keen to buy German goods, but Germans themselves are more hesitant. Domestic demand fell in 2004 for the second year in three. The reasons are not hard to discern. In Germany, unlike America, unemployment has risen: the ranks of the jobless reached 4.48m in December. The country’s shops are open at the retailers’, not the shoppers’, convenience. And the Germans are, by American standards, a financially repressed people. They are not free to overborrow against overvalued homes.

Some at America’s central bank, the Federal Reserve, think a little repression is now needed in the United States. In the minutes of its December meeting, concerns were voiced about “potentially excessive risk-taking in financial markets” and “speculative demands…in the markets for single-family homes and condominiums”. Americans are tempted to live beyond their means because they blithely assume that gains in the value of the assets they hold—those houses and flats—will make up the difference.

At that meeting, the Fed raised interest rates to 2.25%, taking them above those in the euro area for the first time since 2001. On Thursday, the president of the Federal Reserve Bank of St Louis, William Poole, said that the Fed’s measured pace of rate hikes may accelerate in the coming months. The markets have priced in a federal funds rate of 3.5% by the end of this year. The European Central Bank, by contrast, again kept interest rates steady at 2% on Thursday. It may keep things on hold for the whole of this year and next, reckons Capital Economics, a London-based consultancy.

This transatlantic gap in interest rates, and the prospect that it will grow, will tempt some to keep faith with dollar assets, attracted by the better yields they offer. Indeed, the dollar strengthened a little on Thursday after Mr Poole’s comments. But returns on these investments are only worth as much as the dollars in which they are denominated. As Capital Economics points out, a single day of panic in the currency markets can easily wipe out months of accumulated yields. Until thrift becomes an all-American virtue once again, the prudent will stay away.

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