US spending makes others look goodLoving America’s over-indulgence [Archives:2005/810/Opinion]

By Kenneth Rogoff
With the weak dollar hanging like the sword of Damocles over the global economy, almost everyone laments America's spendthrift habits. But did it ever occur to anybody how hard Americans must work to make everyone else look good?

Thanks to America's gaping trade deficits, the biggest headache of every developing country finance minister nowadays is trying to keep his or her country's currency from going up too fast against the dollar. When was the last time that happened? Chronic debt-crisis countries from Mexico to Russia to South Korea are all fighting off capital inflows from investors looking for an exit as the dollar collapses.

Ordinarily, as the world comes out of a downturn and global interest rates rise, at least one or two emerging market countries suffers a spectacular blowup. Not likely this time, at least for the next year.

True, policy in some countries has improved markedly. Brazil and Turkey, for example, have each instituted market-friendly policies that have made their economies more flexible and growth more durable. But can the same be said for Mexico, where reform has stalled, or for Russia, where reforms have been reversed? America's reckless deficit spending is making all their currencies look like good investments for 2005.

So non-Americans should be more appreciative of America's deficits. Do people think it is easy for a 12-trillion-dollar economy to spend beyond its means year after year just to prop up other countries' reputations for stability? It isn't. Going deep into debt when you have that much money to spend takes a lot of hard work.

Start with the American consumer, who consumes everything on earth (helping the United States eat up 25% of world oil production) but saves essentially nothing. Thanks to America's gold-plated financial system, its consumers can buy fancy cars with almost no down payment. They can borrow more and more each year against the value of their homes, and spend every cent. They can retire earlier and earlier on their smaller and smaller savings. It takes nerve and energy to live like that.

Of course, the US government does it share, too, and more. When President George W. Bush took office in 2001, he was staring at giant budget surpluses as far as the eye could see. It was hard work engineering a five-trillion-dollar deterioration in America's fiscal position.

Cutting taxes was easy, but hiking spending on virtually every program involves a lot of legislation. Sure, the decision to invade Iraq was a big help in pushing the country's finances off a cliff, but that is far from the whole story. So why is the world so ungrateful?

Maybe some Europeans and Japanese are upset that they have consistently earned such poor returns on their US investments. Part of the problem has been the sinking dollar, which makes dollar investments look bad when translated into yen or euro.

Part of the blame also lies with bad market timing. Many Europeans bought into the US stock market at its peak in 1999 and 2000, only to find themselves selling at steep discounts after the collapse of 2001.

The same happened to the Japanese in real estate. Japanese financiers bought up pricey trophy properties like Rockefeller Center in New York and the Pebble Beach Golf Club in California, and then had to sell later at rock-bottom prices. These investment failures have been great for Americans, who owe a lot less to foreigners than they would otherwise.

Unfortunately, this cannot go on forever. Foreigners are either going to start earning much better returns in the US, pushing American debt levels into unsustainable territory, or else they will pull back and invest elsewhere. Either way, the dollar collapse has to continue.

So how low can the dollar sink? By my calculations, the dollar still needs to go down another 15% if the US trade deficit it to go back towards balance. Ideally, Asian currencies would rise much more than 15% while European currencies would rise less.

Unfortunately, there is a real danger that we may see the opposite, with the euro going to $1.50 or beyond. Governments may try to resist the fall of the dollar, but in today's world of deep and fluid capital markets, they will not succeed indefinitely, even in Asia.

Moreover, although US policy is making everyone else look good for now, things might not be so comfortable if the dollar collapse leads to skyrocketing interest rates and a sustained global slowdown. Some of the countries that look so strong today may suddenly experience the kind of financial crises that they thought they had left behind.

Even if countries avoid the immediate blow of a dollar collapse, they still have to watch for a boomerang effect. Exchange rates have a nasty habit of overshooting their equilibrium values, then knifing back on countries, especially those who have been spending too much based on inflated income valuations.

OK, so maybe it is too soon for the world to start toasting America's insane consumption patterns. Even so, isn't it generous of the Americans to make everyone else look so sober and frugal, if only for the moment?

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.
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