Economic Reporting Review
October 4, 1999
By Dean Baker
Trade Deficit & the Dollar | Social Security & the Budget | Race & Housing | Europe | Russia | Outstanding
Stories
TRADE DEFICIT & THE DOLLAR
"Ballooning Deficit Poses Risk to Economy"
John M. Berry
Washington Post, September 25, 1999, page E1
"Japan Gives Hint That It Will Act to Halt Yen's Rise"
David E. Sanger
New York Times, September 27, 1999, A1
Both of these articles discuss aspects of the U.S. trade deficit and its impact on the dollar. The
Post article discusses the potential economic implications of the large trade deficit being run by
the United States. While the article quotes several economists who point out that the deficit is
not sustainable, it does not point out that the deficit was the predictable outcome of the
high-dollar policy pursued by the Clinton administration. A highly valued dollar will cause a
trade deficit because it reduces the price of imports, causing people in the United States to buy
more foreign goods and services, while it increases the price of U.S. exports, leading foreigners
to buy less from the United States.
As the article notes, a high dollar provides a short-term economic benefit in the form of
cheaper imports, which have the effect of reducing inflation and raising living standards.
However, a large trade deficit cannot be maintained indefinitely. At some point, the dollar must
fall to the point where the deficit is brought down to a manageable level. The decline in the
dollar will raise the price of imports and will increase inflationary pressures in the United States.
In this sense, the high-dollar policy can be seen as policy that leads to short-term benefits, but
which potentially has significant long-term costs.
At one point, the article quotes an economist who notes that both the over-valuation of the
stock market and the dollar could be corrected quickly by plunges in the financial markets
which would lead to a recession, adding, "we are sure no one wants to see the gap closed in
such a disorderly fashion." Although the article presents no differing views, there are economic
reasons why a rapid adjustment could be desirable.
By historic measures, the stock market is over-valued by between 50 to 75 percent relative to
current and projected future profits. This means that people who buy stock at present are
paying far too much for it. The over-valued stock market leads to an enormous generational
transfer, since the people who are net sellers of stock are mostly older people facing
retirement, while the biggest net buyers are workers in their prime earning years. Those who
are concerned about generational equity should find the over-valuation of the stock market
very alarming, since it is the equivalent of an enormous tax on younger workers.
This point can be illustrated with a simple example. Suppose that the stock market is
over-valued by 50 percent. If a middle-income worker earning $40,000 a year puts $3,200 a
year into a stock-based mutual fund, then the eventual correction would effectively tax this
worker's savings at the rate of $1,600 per year. This is the equivalent of a 4.0 percentage point
increase in the Social Security payroll tax. Anyone who was concerned about generational
equity should find a transfer from young to old of this magnitude quite disturbing. For this
reason someone might want to see the stock market correct very quickly.
It is also worth noting that articles in both the Post and Times have often presented the
argument that nations should be willing to endure short-term pain in exchange for long-term
benefits. For example, last December a Washington Post article asserted that many
economists felt that Japan should deliberately induce an economic collapse: "The nation has
two choices. The first, the course advocated by many international economists, is to close
unneeded factories, allow inefficient companies to go bankrupt, deregulate the economy, and
hope that out of the ashes of this collapse will spring new business." (See "Excess Capacity
Slowing Japan's Recovery," by Sandra Sugawara, Washington Post, 12/25/98, page B9;
ERR, 1/4/99.)
More recent articles have presented the argument for the merits of painful transitions in
Germany (e.g. see "Another Crushing Defeat for Schroder in a State Vote," by Roger Cohen,
New York Times, 9/20/99, page A8) and East Asia (e.g. see "Trying to Keep Recovery
Going," by John Burgess, Washington Post, 9/23/99, page E14; "Asian Rebound Derails
Reform as Many Suffer," by David E. Sanger and Mark Landler, New York Times, 7/12/99,
page A1; and "Skepticism Over Korean Reform," by Stephanie Strom, New York Times,
7/30/99, page C1; see also ERR, 7/19/99, 8/2/99, 9/27/99.) Presumably the economists and
policy analysts who believe that quick painful transitions are the most desirable route for these
other nations would apply the same logic to the over-valuation of the stock market and the
dollar.
The article concludes by wrongly asserting that the United States might be forced to raise
interest rates to finance its current account deficit. A nation with a freely floating currency, like
the United States, never has to raise interest rates to finance a current account deficit. If
insufficient money is flowing into the United States to cover the deficit, then the value of the
dollar will decline. The dollar will continue to fall until enough people are willing to hold it at the
market price. At this level, whatever current account deficit still exists (the deficit will shrink as
the dollar falls, because a lower dollar increases exports and reduces imports) will be fully
financed by foreign investors. While the Federal Reserve Board may opt to raise interest rates
to limit the fall of the dollar, this is a policy choice. The Federal Reserve Board will never be
forced to raise interest rates simply to finance a current account deficit.
The Times article comments on efforts to weaken the yen relative to the dollar. The article
discusses concerns that a rapid rise in the yen may reduce Japanese exports by raising their
price. A reduction in exports could in turn put an end to Japan's recovery. The article, noting
the large U.S. trade deficit with Japan, comments that "unless Japan recovers, the thinking
goes, that deficit will not be reduced by much."
Actually, Japan's recovery is unlikely, on its own, to greatly affect the size of the trade deficit.
Currently Japan is importing from the United States at a $54 billion annual rate. It is exporting
to the U.S. at a $126 billion annual rate, yielding a $72 billion annual trade deficit. If its
economy grew by 10 percent, and this led to a 20 percent increase in imports (both very
generous assumptions), this would only increase Japan's imports to $65 billion, still leaving a
$61 billion deficit.
[Top]
SOCIAL SECURITY & THE BUDGET
"A Fiscal Deadline Could Force GOP to Break a Pledge"
Tim Weiner
New York Times, September 26, 1999, Section 1 page 1
"Noble Talk of Saving Social Security Is Muted by Political Gamesmanship"
Richard W. Stevenson
New York Times, September 29, 1999, page A20
"GOP Spending Bills Tap Social Security Surplus"
Eric Pianin and Juliet Epstein
Washington Post, September 30, 1999, page A1
"Republican Plan Would Delay Tax Credit for Working Families"
Tim Weiner
New York Times, September 30, 1999, page A1
These articles report on Republican efforts to pass appropriations bills for the next fiscal year,
and the likelihood that they will not be able to avoid spending a portion of the surplus
generated by the Social Security program. The article written by Stevenson correctly points out
that the finances of the Social Security program will not be affected at all by whether the
government spends a portion of the surplus it generates. The Social Security program will be
issued exactly the same quantity of government bonds regardless of how, or whether, the
federal government spends its surplus. This fact was also correctly pointed out in a recent
Washington Post editorial ("False Debate," 9/23/99; A28). All the other articles use terms
like "raid" or "siphoning" to refer to spending money from the Social Security surplus, leading
readers with the impression that such spending will actually take money away from the Social
Security program.
The Stevenson article describes the debate over restructuring Social Security as an effort "to
insure the long-term viability of the system." Actually, the long-term viability of the system is
already largely insured, and there is very little this Congress can do to affect it. According to
the most recent Social Security trustees report, the system can pay all benefits through 2034
even if nothing is done. It can pay all scheduled benefits through its 75-year planning horizon
with a tax increase that is less than 1.0 percent of GDP.
The article suggests that paying down the debt will help insure the long-term viability of the
system by lowering interest rates and stimulating more investment. In reality, the economic
impact of paying down the debt would be so small that they would barely affect the long-term
projections. (See ERR, 9/27/99.)
It is worth noting that the first Times article characterizes the current budget debate as a battle
over whether to use the projected surplus "to cut taxes, expand government programs, or pay
down the federal debt." No one in the debate is proposing to expand government programs as
a whole. President Clinton has proposed expanding certain areas of government spending, but
under his budget proposal most areas of government spending, when adjusted for inflation,
would decline over the next decade. The decline is even larger when measured relative to the
size of the economy.
[Top]
RACE & HOUSING
"Fannie Mae Eases Credit to Aid Mortgage Lending"
Steven A. Holmes
New York Times, September 30, 1999, page C2
This article reports on plans by the Fannie Mae Corporation, the nation's largest mortgage
underwriter, to ease its credit standards. Since most banks will follow the standards set by
Fannie Mae, this could significantly increase the availability of mortgages to moderate income
families.
At one point the article discusses the growth of home ownership among minorities, commenting
"home ownership has, in fact, exploded among minorities during the economic boom of the
'90s." It then reports on a study which found that the number of mortgages extended to
Hispanics, African-Americans and Asian-Americans rose by 87.2, 71.9 and 46.3 percent,
respectively, between 1993 and 1998.
This comparison is extremely misleading. In 1993, the economy was just beginning to recover
from the recession. Housing is extremely cyclical, so a comparison from a point near the trough
of a recession and a business cycle peak will mostly just reflect the expected movement over a
business cycle. It would have been more appropriate to compare the number of mortgages
issued in 1998 with the number from 1989, the peak of the last business cycle.
To evaluate the growth of home ownership among minorities, it would have been most
appropriate to examine the percentage of home owners in each demographic group. This has
risen far by less than is implied in this article. For example, in the most recent data, the home
ownership rate for African-Americans was 45.8 percent. While this is up from 42.0 percent in
1993, it is virtually the same as the 45.6 percent figure at the previous peak in 1983. (See "In
Home Ownership Data, a Hidden Generation Gap," by Louis Uchitelle, New York Times,
9/26/99, Section 3 page 4.)
[Top]
EUROPE
"In Europe's Economic Boom, Finding Work Is a Bust"
Anne Swardson
Washington Post, September 28, 1999, page A1
This article discusses the fact that recent economic growth in Europe appears to be creating
very few jobs. The article presents an extremely confused analysis of this phenomenon. The
fact that the same amount of economic growth leads to fewer jobs in Europe than in the U.S.
logically implies that Europe has more rapid productivity growth. Economists generally view
productivity growth as the primary measure of an economy's dynamism.
In fact, data from the Bureau of Labor Statistics (BLS) and the OECD show that most
European nations have consistently enjoyed productivity growth of approximately 2.0 percent
annually. By contrast, in the United States, productivity growth has averaged just over 1.1
percent for the last 25 years, although it has been somewhat higher since 1996. (The article
cites a study showing that Toys R Us stores in France employ 30 percent fewer workers than
comparably sized stores in the U.S., apparently failing to recognize that this implies that the
workers in the French stores are 30 percent more productive.)
Almost without exception, economists view productivity growth as being good, since it is the
main long-run determinant of living standards. According to data from the BLS, several
European countries already enjoy levels of productivity that are comparable to the level in the
United States. If these nations maintain an annual productivity growth rate that is near 2.0
percent, while the growth rate in United States remains on its 1.1 percent trend, by 2030 living
standard across western Europe will be more than 30 percent higher than in the United States.
The fact that Europe's unemployment remains so high is attributable to the fact that its economy
is not growing as fast as it could. Contrary to the assertion in the article's headline, there has
been no European "boom," as growth there has averaged less than 2.0 percent over the last
year. The most obvious explanation for the slow growth is the contractionary monetary policy
being pursued by the European central bank. Even though Europe has an unemployment rate
over 9 percent and almost no inflation, the European central bank is still keeping the real short
term interest close to 2.0 percent. By contrast, Alan Greenspan allowed the real interest to fall
to zero in the United States in 1992, as the economy was recovering from the last recession.
[Top]
RUSSIA
"Clinton Widens Plan for Poor Debtor Nations"
David E. Sanger
New York Times, September 30, 1999, A12
This article reports on an announcement by President Clinton that the United States would
cancel the entire debt of poor nations that adhered to an I.M.F. structural adjustment program.
At one point, the article presents the comments of Michel Camdessus, the director of the IMF,
that Russia has had seven years of "real progress." The article does not point out that Russia's
economy has actually contracted by nearly 50 percent over this seven-year period. Nor does it
point out that its health care system has virtually collapsed, leading to a decline in life
expectancy of more than six years. (See "A Letter From Russia," by Francis C. Norzon et al.,
Journal of the American Medical Association, 3/11/98, pp. 793-800.)
[Top]
OUTSTANDING STORIES OF THE WEEK
"In Home Ownership Data, a Hidden Generation Gap"
Louis Uchitelle
New York Times, September 26, 1999, Section 3 page 4
This article examines patterns of homeownerships among different demographic groups. It
notes, that while homeownership rates for the population as a whole are at record level, this is
primarily the result of an aging population. Within most demographic groups, the rate of
homeownership is actually lower than its previous peak in 1982.
"Extensive Effort Seeks to Clarify Medicare Maze"
Robin Toner
New York Times, September 27, 1999, page A1
This article reports on the difficulty that the Health Care Financing Administration is
encountering in trying to educate Medicare beneficiaries about the choices between alternative
Medicare plans. The article points out that many it can be quite difficult to determine the exact
nature of a plan's benefits and costs. People suffering from problems often associated with
aging, such as poor eyesight or senility, may find it especially hard to make an informed choice
among competing plans.
"Wary of the Internet? Just Try to Avoid It"
Gretchen Morgenson
New York Times, September 26, 1999, Section 3 page 1
This article reports on an analysis done by Prudential Securities, which found that most of the
major market indexes contained a large percentage of Internet companies. For example, the
analysis showed that 25.9 percent of the value of the S&P 500 is attributable to Internet
companies. This means that individuals or institutions that view such indexes as safe investments
are still very vulnerable to a collapse of Internet share prices.
[Top]
Dean Baker is a senior research fellow at the Preamble Center and at the Century Foundation.
Recent articles can be found on the websites of the New York Times and Washington Post.
You can sign up to receive ERR via email every week at
www.preamble.org/columns/subbaker.htm. ERR is archived at www.fair.org/err/.
FAIR | Economic Reporting Review | Last Week | Next Week | Latest | Search | Mail/Suggest