OP-EDS

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October 24, 2004

Budget deficit shouldn't be the only concern: Trade deficit anyone?

With John Kerry and George Bush trading spars about the economy and the cover of the Economist screaming titles such as "Scares ahead for the world economy," you might be wondering why you can't just stay in college forever and avoid real life. Sorry, even that plan won't allow you to escape the forces of what looks to be one of the most difficult economic situations in recent history. So what are some of the economic challenges we are facing and what do they really mean for us?

The real economic challenge for the next president is dealing with "the twin deficits," the budget deficit and the trade deficit. While most of us are familiar with the budget deficit from the news media, the trade deficit has been little talked about in this election cycle. Typically in a recession, consumers buy less and save more, so the trade deficit shrinks; but in this latest downturn, abnormally low borrowing rates have allowed consumers to keep on buying by using credit, and the trade deficit has swelled.

Adding to this problem has been the movement of the dollar. In a typical recession, the dollar would decline and the economy would work out its problems through foreigners buying more of our relatively cheap consumer goods. But this recession has been unique: Even with the large trade deficit and deficits, the dollar has not fallen to the degree it should have. That is because right now, Asian central banks, mostly the Japanese and Chinese, are buying up dollar denominated assets in an effort to slow its decline and keep their goods selling at cheap prices in our stores. By preventing the dollar from falling, the Chinese and Japanese are helping stall our recovery; if the current scenario continues for any length of time, it will end with the Chinese and the Japanese owning most of our debt, leaving Americans with a large collection of used consumer goods. Even credit card companies have the sense not to let you keeping buying until your only worldly assets are a bunch of used consumer goods.

So what do the two candidates have to say about the twin deficit problem? They've both been talking vaguely about halving the budget deficit over the next presidential term, but almost every publication I read wants to know how they are going to accomplish this with their respective spending plans. President Bush wants to explore some kind of fundamental rewrite of U.S. tax policy, which based on his record would suggest further cuts of some sort. Senator Kerry has adamantly professed his desire to repeal the Bush tax cuts for those earning more than $200,000 per year, but to keep them in place for everyone else; however, this plan will only cover a small portion of the budget deficit as it stands now. What really calls into question the candidates' pledges to halve the budget deficit are their new, giant sized spending plans: Senator Kerry wants the federal government to cover the "high-burden" illnesses that cost hundreds of billions of dollars, while President Bush is continuing to talk about Social Security reform, with his current plan projected to cost $2 trillion over a ten year transition period. I think most of the mathematics concentrators will agree with me when I say the math just doesn't work. The reality is that until both parties in Washington D.C. reign in their schemes and come up with a real plan to end the red ink, the uncertainty over America's fiscal strength will linger and the economy will continue to stagnate.

For those of us who believe in free trade, the candidates' current views on the trade deficit are even more worrying: President Bush campaigned in his first election on being a free-trader, but his term in office has been marked by protectionist trade sentiments; Senator Kerry has a long-standing record of being pro-trade but now seems to be appealing to the manufacturing sector as some form of proto-protectionist. Both seem to be ignoring the larger issue with respect to the trade deficit: The future president is going to have to convince Beijing, Seoul, and Tokyo to allow the dollar to depreciate so that Asian goods are more expensive in American stores and American goods cheaper in Asia. Only when US manufactured goods are relatively cheaper than their counterparts will the trade deficit shrink naturally. The trade protectionism that President Bush and Senator Kerry seem to have ascribed to will only put a temporary patch on the economy, as the trade protectionist schemes of the 1930s proved. It's time to remind both of the candidates that while dealing with the trade deficit properly may not be politically beneficial in the short-term, sound long-term trade policy could mean a lock on the White House for decades.

So you are probably asking yourself what this really means for you. Yes, we as students care about getting jobs when we eventually graduate, but jobs are subject to a larger financial markets phenomenon. No company is going to invest in new employees or equipment until it is more confident of the long-term business outlook. The financial markets see the twin deficits problem, along with other issues such as higher commodity prices, uncertainty about Iraq, and the threat of another terrorist attack as one giant series of risks. Until we address these risks properly, the financial markets are only going to move sideways: Stocks will trade in a range that doesn't really allow many individuals to make money and companies will defer hiring until they are more confident about long-term business prospects. In short, until the "winner" of the presidential election realistically addresses these problems, the election will have little effect on the financial markets and business confidence.