The Deficit and Devaluation Dilemma


The American economy has been hailed as the sturdiest of all; a giant defined as too huge to plummet. While many sage minds of the financial world wither at testing the veracity of this claim, the cracks in the supposedly unshakable economy are starting to appear; even as the rebound is faster than many originally predicted in the pre-covid period. However, the fallacies were starting to ebb away much before the pandemic struck the world haywire. 

The stronger US dollar might appeal to the layman; a stronger currency casting an image of a sturdy economy. However, an overvalued US dollar creates problems in the economic operation of the country. Being overvalued results in US imports being cheaper relative to the domestic produce. Similarly, US exports are perceived as relatively expensive by foreigners. This causes a trade deficit in the current account, that is, the imports exceed the exports causing a net monetary leakage from the economy. This is the rudimentary reality that has been steadily gripping the United States over multiple decades. Due to the consistent overvaluation of the US dollar, the running trade deficit has bloated by 3-fold as a percentage of the total GDP since the 1990s. 

With a currency being highly expensive, fundamentals of economics dictate the demand to shift to cheaper alternatives. This has been the main reason lacing the outpour of core manufacturing to middle-income countries. Foreign companies reap the advantage of the demand rising from the US while the US continues to lose jobs in manufacturing despite being one of the most competitive sectors of the US economy. Due to the ease of import in the manufacturing sector, it has been the prime target of heated competition from foreign companies. More than 5 million jobs were lost in the manufacturing sector in 2011 alone while the trade deficit bloomed at an unrelenting rate.

High currency valuation has been an intricate issue in the political arenas as well. Significant job losses and unstable foreign debt levels concerned the bipartisan house and the senate combined. Largely due to the fact that the fed resents any viscous debt that is hard to sell to foreign entities, managing trade deficit has continued to streamline the agendas of government and fed alike. President Donald Trump addressed the blooming trade deficit boldly. However, instead of taking the overvaluation of the US dollar into account, he resorted to adopting an offensive strategy to impose tariffs on key imports. The ineffectiveness of the strategy cleared any haze remaining since the trade deficit continued to exacerbate in his governance as well despite the extensive tariffs imposed on Vietnam on the account of favored currency devaluation as a subsidy offering by the Vietnamese regime to its companies. While the subsidized nature of the imports was cited as an unfair practice to outcompete the US counterparts, the imposition of tariffs only channeled the funds to other imports; the import bill continuing to expand and widening the hole of the trade deficit.

The nature of the trade deficit has been questionable and often contested by experienced economists around the world. Some have asserted the merits of a growing trade deficit on the basis of a consumption-driven economy. They argue that the United States is denominated by the young workforce expending on consumption goods at a voracious rate; contrary to the likes of Japan which incline towards a net surplus largely due to their relatively elder population and its higher propensity to save. However, this Blasé narrative is debunked by seasoned economists advocating a stable current account balance; even with a deficit but controlled in nature. According to the forecasts, even with the United States’ natural appetite to consume taken into consideration, the trade deficit should have been valued at 0.7% of the $21 trillion GDP of the United States in 2019. Instead, the figure stood at almost 3 times the predicted value: 2% of the total US economy, making up hundreds of billions of dollars in debt.

The appropriate strategy would be an active intervention by the fed to devalue the US dollar by 15% to 20%; cited as a legitimate valuation of the currency in the global market. However, it is easier said than done. While the federal reserve could actively buy out foreign currency by expending its dollar reserves, a swift devaluation might take the industrial sectors by surprise. Similar to the imposition of the tariffs in the Trump regime, a drastic devaluation of 20% would immediately drive up the import prices of many manufacturing essentials. This could hike up the production bill amidst a time span when the US is dealing with record unemployment rates. With unemployment pushing down demand for consumption and dollar devaluation pushing up the production costs carrying forward in prices, a manufacturing disaster could damage the US economy beyond repair.

Moreover, the fed could also tax foreign investment in the US assets. This strategy would likely discourage the excessive demand for US currency by foreign investors that would ultimately transition into a controlled devaluation of the US dollar over time. However, while the taxation would drive up the federal tax revenues, the investment institutions would most likely retaliate with a re-evaluation of their portfolios. An economic rebound after a catastrophic year, the US could hardly afford a fallout in investments that holds a prospect of an interest rate hike and a subsequent stock market decline following the quench in lenders to the US government.

The United States has historically flagged the narrative of ‘Let the market decide the exchange rate’, a policy that has been hailed as the true nature of a capitalist economy. The US has notoriously accused China of currency devaluation to compete in the global markets. A shift in the strategy, therefore, is not a pill swallowed easily. However, with a new economic advisory with President Joe Bidden, a renewed approach could be on cards. Now with the whopping $1.9 trillion stimulus package narrowly passing the senate and awaiting the final vote of the house, the propensity of consumption is expected to return to the lower- and middle-income households. With the $300 weekly allowance, rent relief and exemption of taxation for the first $10,200, and an effective vaccine rollout, manufacturing is spreading wings to outshine again. The policy and the strategy to channel the strong demand and supply without hurting other sectors or the sentiments of the investors: that’s the true challenge facing the Democrat administration.

Syed Zain Abbas Rizvi
Syed Zain Abbas Rizvi
The author is a political and economic analyst. He focuses on geopolitical policymaking and international affairs. Syed has written extensively on fintech economy, foreign policy, and economic decision making of the Indo-Pacific and Asian region.


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