U.S. Trade and Budget Deficit Thesis

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U.S. Trade & Budget Deficit

Twin deficits, a growing budget deficit along with a growing current account deficit began in 2002. In effect, the United States is borrowing from foreigners in exchange for foreign imports. Some economists like to present this as a fairly benign problem. For instance, Cooper (2005) states that our deficits are just a drop in the bucket compared to the magnitude of money in the larger world financial markets. Therefore, he concludes that our foreign investors will continue to finance our budget deficit indefinitely. Yet, others explain America's current-account deficit as the inevitable consequence of a savings glut in the rest of the world and believe that conditions in the United States don't have too much to do with foreign lending (The Economist: Danger time for America, 2006). However, for a number of reasons, the United States is responsible for the twin deficits phenomenon which is a very dangerous situation with potentially devastating consequences.

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Many economists dispute the savings glut theory as the reason for the dramatic increase in foreign lending to the U.S. And believe that the party won't last forever. United States' policies are in large part directly accountable for the twin deficit and the pursuit of foreign money. Federal government policies have allowed growth in domestic demand to outstrip supply for more than ten years (The Economist: danger time for America, 2006). Thus, America has decided to borrow from the future for current prosperity. The real question is when foreigners will stop financing the current-account deficit. Already, the Chinese government is expressing interest in diversifying China's foreign-exchange reserves (The Economist: danger time for America, 2006). According to this same source, if this happens, the dollar is likely to fall and bond yields rise as investors demand higher compensation for risk. Less access to foreign money could also result in: a) higher interests rates if the government borrows domestically; b) increased inflation if the Federal Reserve monetizes the debt; c) tax hikes; or all of the above in some combination (Garrison, 2003).

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Still, the government will continue to try to sell debt abroad.… [END OF PREVIEW] . . . READ MORE

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