The US trade deficit

When speaking of a trade deficit, we refer to a negative balance of trade. The balance of trade forms part of the current account of a country; this is why we notice that a deficit also decreases the net international asset position.
When we speak in numbers, the US is facing a total balance of trade deficit of over $ 800 billion in 2007, while 40 years ago in 1967 they had a surplus of $ 2 billion.

But how do the Americans finance this deficit? What impact does it have on the value of the US $? Is it good or bad for them?



The US obviously had to find a way in order to finance this huge deficit. Back in 2006 Warren Buffet came up with the idea of using a tool called Import Certificates as a solution to the problem.
Basically Import Certificates refers to a governmental economic intervention used to fix a country’s trade deficit. Creating a market for import certificates that would represent the right to a certain dollar amount of goods into the US from other countries does this. These certificates would be issued to US exporters in equal amount to the sum of the dollar of the goods they export, and can be sold to importers, who must purchase them in order to be allowed to import goods.
The price of an import certificate is set by free-market forces, and therefore is dependent on the balance between imported and exported goods through supply and demand.

They believe that proceeds from sale of import certificates would encourage exporters, as they’d gain extra-money out of it, while on the other hand importers would be discouraged as they’ll have to pay the additional cost.
Basically it refers to creating tariffs on imports to the US, kept at the exact level in order to promote trade balance.


But this wasn’t the only idea; also Americans tried to push foreigners to invest in American multinationals, going into the stock market or let them take part in the economy of the US of any other way.
Basically it was all about finding foreign countries that are investing in $, and this is exactly what makes this currency so special. It is the only currency that doesn’t have a change in value linked to trade deficit or surplus.

Imports to the US are somehow “free”. While other countries have to find a way in order to refinance themselves, the US has the power of printing money as long as they need more. This is due to the fact that meanwhile they’re paying for their imports, they know that they can spend as much as they want, as the money will return to them.
Obviously they take the risk of loosing people’s confidence in the $, but they are protected from foreigners, such as the EU and China, as they’re aware that if the $ is loosing in value, they all loose.



To conclude, I believe that even though the amount of the US’ trade deficit is incredible, they have enough power, not having to worry about refinancing all their debts.
This is obviously due to the fact that if the US economy is in depression because of its trade deficits, the whole world will be affected, and this is why, the US basically isn’t fighting against it on its own, but has other economic forces behind them, working on the stability of the American economy.

Protectionism

When speaking of protectionism we usually refer to the economic policy of restraining trade between nations. This is mostly done through methods such as tariffs on imported goods, restrictive quotas, and a variety of other restrictive government regulations designed in order to discourage imports. When we speak to criticizers of protectionism, they’re very likely to define is at anti-globalization as it contrasts with free trade.



As we all know, the Presidential elections in the US are a very deeply discussed issue nowadays, as the Americans are basically left to choose, either Mc Cain, fighting for globalization or Obama, promoting protectionism.
We’ll focus on Mr. Obama’s view, considering what sort of measures he might take in order to protect the US economy from foreign trade.

Nowadays, the US remains the greatest economic power worldwide, but it is facing strong competition from overseas as well as internal difficulties. When the US economy was built up, they focused on venturing abroad in order to promote trade and set up special production sites in other countries. Whatsoever, the US has reached so far, that their local industry starts to be eroded.

Furthermore the US achieved something far more important than anything else: the Dollar became the world’s currency. This means that all the main decisions on the amount of cash in circulation are made within national borders. This gives the US an exorbitant privilege as it guarantees a maximum degree of national independence. Still, by becoming the world’s currency, existing in huge amounts the dollar also became the most threatened money, as it can be bought to collapse by external forces.

However the US is far from being in a good state nowadays, private, public and corporate debt far exceeds any known dimensions, millions of households are constantly borrowing huge amounts of money so that in the end the future they’re looking forward to, doesn’t seem to be the one they expected.

We do believe in Change -

But is it going to affect the US and the whole world in a positive way?

If Mr. Obama gets elected president of the United States, he’s believed to set up stricter regulations, in order to protect his country and promote employment. I believe that to start with he’s going to set up price-control objectives in order to protect the US-Dollar, which is steadily losing in value.
As for this, he might set some specific restrictions as well on exports as on imports. The export restrictions may include raising costs of smuggling prevention, the importance of keeping domestic prices down by increasing domestic supply or also to shift foreign production and sales. Considering the restrictions that Obama’s administration might put on imports, they may include the prevention of having exports priced below national prices and finding a way of having foreign producers lower their prices.
I believe that by “protecting America from foreign trade”, Obama believes he found a way of “saving the middle-class” by restricting imports in order to promote the production of local consumption goods and services that formerly were imported.

As we all know, Obama keeps on praising that he wants to “save the middle-class”, but I truly believe that by enforcing the protectionist level of the US, he’s not going to reach his objective. Obviously he will create new jobs and promote employment, but is this truly Americas main aim??
The US is facing such an incredible amount of debts nowadays, they’re not likely to pay it back any time soon, so is it a good idea to set up new facilities (as they outsourced many branches of production) and pay a higher amount of labour-cost? Is it actually promoting the American economy?
Well I don’t think so. To the contrary, by setting up restrictions, the EU, China and many other developed countries won’t hesitate and follow him, and the whole system of globalization will be facing a breakdown. And the US, who’s obviously going to be “in charge”, won’t be able to do anything about it as the value of their money is decreasing while their amount of debts is increasing.

To end up with I believe that the main problem nowadays is that the world is suchlike interlinked, that his willingness of promoting protectionism came to late. All the countries depend on each other to a certain limit and if one of them starts proving “selfishness”, I believe, it’ll end up in a complete economic desaster.

NAFTA vs. EU - Why is the EU more successful?

Both the NAFTA and the EU are perfect examples for prescriptive trade theories, which means that they are concerned with government interference in the free movement of goods and services.

The North American Agreement Free Trade Agreement, NAFTA, was created by the governments of the US, Canada and Mexico. Basically it is a trilateral trade bloc, which first came into effect on January 1, 1994.
Thanks to the NAFTA, all non-tariff barriers to agricultural trade between the US and Mexico were eliminated, and in addition to that many other tariffs were eliminated. Since than, even more have been phased out, which allowed for an orderly adjustment to free trade with Mexico, with full implementation beginning January 1, 2008.
Since entering into effect in 1989, the agricultural provisions of the US – Canada Free Trade Agreement, they simply got incorporated into the NAFTA in 1994.
Anyhow Mexico and Canada reached a separate bilateral NAFTA agreement on market access for agricultural products, most of the tariffs have been eliminated but still a few remain.




The European Union, EU is an economic and political union, which was established by the Treaty of Maastricht in 1993. It counts twenty-seven member states, mainly located in Europe.
The main power of the EU is that its members have been able to create a single market through a standardized systems of laws which apply in all member states, guaranteeing the freedom of movement of people, goods, services and capital. Due to its common Trade policy and many other agreements the EU is nowadays the biggest free trade block in the world.

But was does the EU have, the NAFTA doesn’t?

Basically, in order to find an answer, we have to concentrate ourselves on the different theories of trade.

Obviously, in both the NAFTA and the EU, we live in the principle of comparative advantage, defined by David Ricardo, which believes that in order to promote productivity it is essential to specialize in what your best at. Even though richer countries are better at everything, by leaving some work to developing countries they become even more successful, and both countries are highly benefiting.
Basically a country is said to have comparative advantage in the production of a good if it’s able to produce that good with a lower opportunity cost than all the other countries.

Above we have an example of comparative advantage, based on Germany and Italy.

However, the theory of comparative advantage is not the reason why the EU is more successful than the NAFTA, in order to answer this we have to refer to a Swedish economist, Steffan Linder, who developed the Country Similarity Theory. It basically states that the more similar countries are (mostly measured per capita income), the greater is the chance of forming a strong trade connection.


And here we got the answer, the EU consists of twenty-seven different members, which are all more or less on the same economic basis or have at least some countries they’re equal to, which, when relating to the country similarity theory, makes it easy to build up a strong trade connection.
On the other hand, the NAFTA is compiled of Canada, the US and Mexico; while it is obvious that the US have the strongest economy, Canada also proves strong economic performances. However, Mexico is still developing and as such “drags” down the possible efficiency, the NAFTA could have if Mexico was as strong as the others.

GLOBAL ECONOMICS - Blog 1 Globalisation

When speaking of globalization we refer to the phenomenon we’re living in today, to a society, which works together on a social, cultural, economic and political basis.

Globalization became popular after the industrial revolution, in the early 1990’s, its concepts basically refer to a strategic economic planning, which promotes integration, growth and boosts free trade. Promoting free trade might have been the most important issue this process had to deal with, as by eliminating all the barriers between countries, we finally were given the opportunity to build up a flow of goods and services, which was unhindered by government-imposed restrictions.
The drop of these barriers were very cost effective on one hand but also promoted great INTERDEPENDENCE between different countries. Nowadays, the world’s economy wouldn’t survive without free trade.

With globalization constantly growing technology became more and more important in order to reduce costs (as we saw in the example of free trade), be more effective and be able to push the phenomenon to the point we’ve reached today – Globalization controlling the world.


But was Globalization profitable to the whole world? Did it promote solely well? Who benefited from it? Who didn’t?

When we refer to economic theories of comparative advantage, we can clearly see that free trade suggests that all the countries involved in the trade are somehow benefiting. This is due to the fact as in general it leads to lower prices, lower unemployment rates, higher standards of living and higher outputs.

This obviously is true to a certain point, but still the difference lays on how much they profit and the gap, which grows between the winners and the losers.

If we have a look at the graph shown below, we can clearly see that the US has a main impact on the International Trade. But if we had the same graph showing us the importance Africa has on the International Trade Exposure, we would barely see the line climbing above null.





As such we can tell that the winners of Globalization clearly are the US, Europe and the BRIC’s, which somehow made their way through and outsourced the whole process to a maximum and have nowadays a very important place in the international economy.



In contradiction to that Africa and South America are the losers of the whole process, as when globalization started to overcome the world at once, those countries weren’t developed enough to compete with the others and were always trying to keep up with them. Still, this didn’t work out as while the others kept on growing more year by year, getting more and more interdependent, they were left besides and haven’t had the possibility to interact.

If we take an example of trade between developed and developing countries: poorer countries mainly export agricultural goods and it is very hard for them to compete with stronger countries which are more likely to subsidize their own farmers as they are willing to save their national markets.
However this leads us to the fact that as the poorer farmers cannot compete, they have no other way than to sell their crops at extremely low price, which are far inferior than what the market is paying.


Anyhow the main issue nowadays basically is this incredible gap, which build itself up during the last decade. If globalization is keeping up steadily growing that way neither Africa nor South America are very likely to reach the level of the benefiting countries any time soon.

What did the ECB decide to do?

While the FED was clear about stabilizing the crisis with lowering interests rates dramatically, the European Central Bank (ECB), which first was expected to stimulate its rates, decided to keep its interest rates in the Eurozone on hold at 4%.

The ECB was even expected to raise rates in a bid to stem rising inflation, after the BNP Paribas freezed three investment funds with connections to American asset backed securities (BNPQY, News, People) earlier this year.
Somehow though, expectation went completely wrong as the ECB decided to do whatever it’d take to preserve price stability, and as such pay huge amounts of money in order to prevent inflation.





In August 2007 the ECB offered to loan more cash to banks to help ease the troubled market. By then its attempt to add more liquidity to money markets has seen the ECB lend over 253 billion euros.
Furthermore the ECB indicated afterwards, that they were willing to inject much more liquidity into the markets as they’d do whatever it’d take in order to contribute to orderly conditions. This statement made analysts believe that unchanged interest rates were confirmed, given the ongoing financial market turmoil, July's sharp fall in consumer price inflation, and the current major uncertainties about the inflation and growth outlooks.

By December 2007, the ECB was one of five central banks that had injected billions in emergency cash into money markets, with the aim of cutting the cost of lending between retail and commercial banks.
At this time the hope was that lower interbank rates would mean that banks would be able to make funds available at cheaper rates to companies and individuals. By cutting short-term lending rates, the two-week euro Libor rate fell sharply and the ECB succeeded, however the rate still remained above the 4% ECB refinancing rate.

Anyhow, the main aim of the ECB, while boosting liquidity into the banking sector, was to ensure banks kept offering credits to businesses, as those banks feared that they might need any spare cash in order to cover their losses and stopped lending.

Until today, the ECB has not followed the Fed's lead in lowering official interest rates and the Bank of England has also proved more reluctant to ease policy.
Analysts believe that the BoE should not follow the Fed's example with big interest rate cuts and said central banks were taking similar action to ease lending conditions by providing additional funds as required.

To end up with, we can underline the fact, that even though the ECB is making a huge amount of debts, its strategy helps easing the crisis a lot, as even though the ECB keeps on boosting liquidity into the market, the strong held of its interest rates assures price stability.

What did the US government and the Federal Reserve decide to do?

With the US economy now clearly in recession, the latest -- and potentially most dangerous -- phase of the global financial crisis is under way.
When the credit crunch had heavily affected all the parts of the US economy, it was absolutely indispensable for the US government to find a way of stopping the constant growth of the amount of market liquidity.
This is why in early 2008 the US central banking system, the Federal Reserve, in partnership with central banks around the world, has taken several steps to address the crisis. At this stage it was important to put all the efforts into pursuing all the macroeconomic objectives while always considering the monetary policy and taking into to account the support of market liquidity and its functioning.
All in all the Fed has been working to pump billions of dollars into the banking system to aid an economy rocked by the subprime mortgage crisis and the severe tightening of credit.



To start with the FED lowered the discount rate, which is the interest rate charged to commercial banks and other depository institutions on loans they receive from the FED, in August — 50 basis points. That was followed by another 50-point cut in September ... a 25-point cut in October ... another 25 in December ... a whopper 75-point cut on January 22 ... then another 50 eight days later.
During that same time period, the federal funds rate was slashed from 5.25% to the current 3%. And by all indications, we'll see another 50-point or 75-point cut into the 2s at the Fed's March 18 gathering.


Furthermore the FED conducted open market operations to ensure member banks have access to funds.
All this was primarily done to stabilize the financial system and stop the constant creation of extra money, which the US doesn’t have. These available funds stimulate the commercial paper market as well as general economic activity.




Basically the FED was using the TAF, Term Auction Facility, fro the first time, to provide liquidity to banks, in order to enhance the ability of financial institutions to sell mortgage-backed and other debt.
When all this didn’t seem to suffice, the FED had to use the TSLF, Term Securities Lending Facility, which allows major firms to swap their less-liquid, somewhat impaired mortgage-backed securities for highly liquid, rock-solid US treasuries. They hope that this will help ease pressure on balance sheets and help reduce mortgae rates in a fast and effective way.

Moreover regulators and legislators are considering action regarding lending practices, bankruptcy protection, affordable housing, tax policies, the licensing and qualifications of lenders… These regulations can influence the transparency required for all the legal entities and securities involved in these transactions.
They concluded that in order to stabilize the crisis as well as to prevent it from growing even further a nationwide licensing of mortgage brokers, as well as credit rating firms (which are supposed to update their rating scales in order to distinguish between structures products and traditional bonds) had to be implemented.

Even though the US is trying hard, trying a way of cleaning up the mess produced so far, there is no certainty about when the downward spiral will come to an end.

The spread of the credit crisis

When the “housing bubble” proved constant growth, it was only a matter of time until the crisis would spread and other parts of the economy would be affected.

Since September 2007 the housing prices remained stagnant or fell. This basically means that the longer the situation remains this way, the greater will be the penalty to our future economic growth. In order to stop the Spread, Countries, Banks and other Companies, pass legislations, funding in order to support the mortgage counselling and help homeowners refinancing during this difficult period.

In December 2007, sales volume of new homes dropped by nearly 30%, compared to the previous year, this is why at the start of 2008, and the inventory of unsold new homes was at its highest level since 1981, counting nearly 10 %!
Anyhow, prices are expected to keep on declining until this excess of supply is reduced. Prices have to be stabilized in order to stop the crisis from keeping on spreading.




To start with, we have to underline the fact that if the decline of new home construction as well as the demand of housing products won’t come to an end in the nearest future, we’ll face an enormous risk of recession and stagnation if not even a fall in GDP growth.
What is important now is to focus on the re-balance concerning supply and demand of the housing market.

Moreover, financial institutions suffer a lot, as they’re primary affected by the spiralling mortgage and credit crises; banks face bankruptcy and incredibly increasing debts. In addition to this the entire financial system was threat to collapse due to a lack of transparency on parts of the market.
In order to illustrate this we could take the example of NetBank, a pioneer in Internet banking, filed for bankruptcy protection after the savings-and-loan became failed at the end of 2007. The filing in U.S. Bankruptcy Court by NetBank Inc. listed assets of $87.2 million and debts as high as $42.4 million. Federal law prohibited the savings-and-loan subsidiary from filing for bankruptcy protection from creditors like its.
This is basically why federally chartered banks cannot be reorganized and must be liquidated by the FDIC.
The bank's failure in 2007 was the result of margin compression from an inverted yields curve, fewer mortgage originations and demands to repurchase delinquent loans.
But not only banks, mortgage lenders, real estate investment trusts (REIT), and hedge funds suffered significant losses as a result of mortgage payment defaults or mortgage asset devaluation, also did stock markets and insurance companies.

Furthermore, the economy and the financial markets need to be very careful in order to prevent the liquidity crunch from spreading even further. The expansion of the crisis made the demand for MBS decline and risk premiums increase, which now led to reimprovement concerning self-regulations as well as litigation.

But not only companies are affected, the ones who suffer most are the home owners themselves, as they took large credits, and all they’ve left now is an incredible amount of debts. Additionally to the social and personal disappointment, the increasing mortgage is the main reason why homeowners are now confronted to foreclosure.

To end up with, what we can say is that this incredible bursting of the housing bubble has set in motion such a large number of economic forces, that could bring a recession in the world economy as a whole.

The causes of the credit crisis

In fall 2006, the United States were facing an extremely sharp rise in home foreclosures. The problems related to this finally resulted in a global financial crisis in 2007 and are known as the Subprime Mortgage Crisis. But what caused that crunch?

It all started in the last decade when an economic bubble was created through constant rising housing prices. The term “economic bubble” is used to characterize trade in high volumes at prices that are considerably at variance from contained value, this specific one is known as the housing bubble.
Furthermore high default rates on Subprime and many other mortgage loans, convinced many people to take higher risks. Three primary risks were involved in this crisis: the credit risk, the Asset risk and the liquidity risk. The combination of these three factors made it pretty much impossible to pay back the debts created by the declining home-prices.
Looking back, we can nowadays say that the increase in prices of housings was completely unrealistic.
As already said, investors believed in the possibility of future re-finance as the price growth seemed constant and decided to take more important credits, to purchase greater accommodations.
But not only the investors found themselves mouse trapped, also did the lenders. These were prompt to offer these riskier loans, as they believed in the continuous rise in housing value.



These graphs illustrate how the crisis evoluated since 1998, and finally became global in 2007. In 2007 neither home buyers, nor the lenders could afford to pay the incredibly high prices anymore and the money-flow broke down (see graph 1).
Basically too much loans were given, but none of the money was returned. That is when the housing crunch became a global financial crisis, which now threats to affect the whole economy. The widespread dispersion had a main impact on everyone involved. Investors as well as lenders are facing debts and bankruptcy.

The government’s role now, is to do whatever it takes in order to stop the crisis, by saving peoples homes, but mainly prevent them from an eviction from those.