Small Business Blog from Atlantic Canada

I am "CA" Atreya (PMP, MBA), the author of this blog. I help businesses in Atlantic Canada achieve their BHAG successfully. You may subscribe to this blog using a feed reader (RSS).

For all those in the US who were shouting themselves hoarse about the evils of globalization, there’s some good news. The manufacturing jobs that were lost to the countries in Asia may just return. No, I am not kidding. I think we are just past that bend where companies might evaluate moving manufacturing & other outsourced services back to US. That’s the good news. The not so good news is it will not happen overnight. It will take some time. Ceteris paribus, I expect it to see the first trickle in the reverse direction in 7 to 10 years. Here’s why I think so.

Current account deficit

But first let’s see if we understand current account deficit. What does this term mean? Simply put,
Current Account Surplus = net of private sector savings - net of government deficit
It follows from the above equation that if the private sector savings in not greater than the government spending, you have a deficit rather than a surplus. In plain words, it means the US is importing (goods) more than it is exporting AND the government is also spending money like crazy. Taking the analogy of your personal finances, what this means is you are depending on lenders to finance your expenditure.

The US is running a deficit with every trading partner and what a deficit it is! The US now owes $2.7 trillion. The current account deficit currently is about 5-6% of its GDP. If current trends continue, the current account deficit will reach 9% of its GDP in the next five years. The US needs lenders & investors who can finance close to $1 trillion in a year because that will be the current account deficit in the next five years. In other words lenders and investors must lend the US close to $4 billion every day.

Any other country would be staring at a financial crisis about now. Europe’s ERM crisis in 92-93, Mexican crisis in 94-95 and Asian crisis in 97 all had similar beginnings - a large and seemingly unsustainable current account deficit. During the 1997 Asian crisis, currencies were hammered even when the current account deficits was a mere 4-5%. Of course there is no significant statistical relationship between a crisis and current account deficit percentage - but it helps to keep that in mind. However, the US is different. The US dollar still retains the title of the vehicle currency; i.e. it is the currency in which most of the world trade takes place. If countries shift their holdings to another vehicle currency, then the US dollar is in trouble.

That puts things in perspective, doesn’t it? Now, why would lenders and investors give the money to the US? What would they get in return? Higher investment rates, for one. But the turmoil in the stock markets is not helping its cause. Even accounting for these short term fluctuations, investors have been able to earn higher returns outside of the US. The US market must provide sufficiently higher return to be able to attract investors. Traditionally, short term interest rates would also rise (and long term interest rates would fall) to attract debt investors, but with the focus on yields, I am not sure how much of an interest rate increase we will see soon.

[Update] With the current volatility in the stock markets & the sub-prime mess, it is certain that that we are not going to see any increase in short term interest rates until this crisis abates.

Getting $4 billion per day is unsustainable by any stretch of imagination. The trade surplus countries may be willing to invest in the US, but the US assets may now be foreign owned. Also, the US must compete with all other countries for the investment dollars.

Depreciation

Export growth on its own will not be sufficient to wipe out the deficit. There is another tool in the policy makers arsenal - depreciation. The Canadian loonie is threatening to be at par with the US dollar. Why? The US dollar is depreciating, albeit gradually. By devaluing its currency, the US is targeting to make its imports more expensive and its exports more affordable for foreign consumption. But the depreciation will have to be very large to wipe out the deficit.

Impact

What does this mean? Will the customer become the competitor? What will Canadian businesses do? We will look at these and other scenarios in my next post.

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