The following are the key reasons analyzed by our team , as part of our group assignment in macro-economics and also followed by suitable remedies to solve the global imbalances.A timed assignment this was,and more importantly ,the conditions were, google free and limited number of words ( no long stories),and,boy,we did score pretty high.
The major reasons for CA deficit of US are:
- Foreign funds financed the difference between
- Value of dollar decreased vis-a-vis Euro but Asian countries prevented their currencies from rising.
- Slowdown in the economy during 2001-02 leads to decline in CA deficit because of slowing imports.
- Slowdown of economies of major trading partners.
Reasons for high Forex reserves with Developing countries, Japan and the EU
- Exports driver of economic growth
- FII and FDI
- Local demand catered to by local industries
- Depreciation of US$ temporarily arrested by growing forex reserves of developing countries who invested heavily in US T-bills.
Effects of high current account surplus of Non-US countries:
- Inflation due to increased money supply
- Increase in real estate prices leading to possible burst.
- Low return on investments in US Treasury bonds.
USD : the global currency
- USD is the choice currency of international trade , deriving its strength from economic and political clout of US.
US Debt:
- The external debt of the
- This will continue to grow with higher interest payments, even if the trade stabilizes.
Emerging Euro:
- Euro is fast emerging as a long term potential substitute to USD.
- However strength of Euro will depend on the stability and growth of EU.
- ECB follows similar policies as US – Fed. i.e a flexible exchange rate mechanims.But ECB is not agaisnt the idea of defending Euro.
Recovering
- Japanese economy is showing signs of recovery after slump over the last 5 years.
- JPY is maintained at a flexible market determined rate,however Japanese central bank has interfered in the past ,in 2003, to maintain competitiveness of Japanese exports.
- But
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SUGGESTIONS / GUIDELINES
Recommendations for India and China:
- Diversify trading partners – will minimize risk associated with US as main trade partner. Eg: EU, Australia
- Also expand forex baskets – Maintain reserves in a diverse range of complementary currencies to reduce dollar associated risks.
- Regional treaties and understandings to increase regional trade relationships – promote regional co-operation and development and trade.
- Reduce purchases of dollars and deregulate exchange rate – allow depreciation of US$ by encouraging trade with other strong currency blocks.
- This will help them free of burden of large reserves.
- Greater freedom in monetary policy .
- Allowing more imports into their countries, resulting in a more balanced global economy.
Recommendations for USA:
- US on its part should avoid a narrow focus on exchange rate as the sole reason for trade imbalance.
- US should make an attempt to reduce the cost of doing business and educate and retrian its workers to move into other roles up the value chain.
- US should move towards a gradual increase in interest rate.
- Reduce Fiscal and Current account deficit – by reduced spending
- Increase taxes – reverse the tax breaks.
- Increase interest rates to combat inflation. This will counterbalance depreciation of US currency, and inflationary tendencies in the US economy.
- For reducing the current account deficit the US exports (major EU and Japan) should increase at a faster pace than their import.
- The tight monetary policy of European central bank and restrictive labor and trade regulation in EU are not allowing US exports to grow.
- Permitting more immigration of skilled population will reduce the dependency ratio of the population which will curtail transfers and increase revenues.
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