The US' twin worries — fiscal and trade deficits — if left to mend themselves, have the potential to de-stabilise not just the US but the whole world.

Before dwelling on the number one shock/risk, it is in order to dispense with the other nine as those potentially impinging on the international value of the dollar relatively directly. The reason why the rest of the world watches the US economy and is concerned about the twin deficits and the dollar's standing is that the US has the highest share in global GDP. In 2004, for instance, its share was 21 per cent, despite a mere 10 per cent share in world exports and less than 5 per cent share in world population (all data from the IMF's latest World Economic Outlook).

A quick review of the recent economic performance (see Table) shows that, whatever his personal problems, Mr Bill Clinton's second term in office saw high and consistent rates of economic growth, boosted by relatively high and almost record investment growth rates. Significant was the impact of both on employment growth. The unemployment rate was a record low in 2000. Inflation was moderate and the fiscal balance positive for the most part. The modest savings-investment gap and the current account deficit in relation to GDP were justified amply by the record of investment and employment. Countries are never judged solely on the twin deficit indicators.

If they have been moderate and have delivered jobs, productive investments and growth in incomes, one need not unduly worry about them. Enter George Bush Jr era and the tables turn for worse. The savings-investment gap and current account balance shot up; yet, they did not contribute to any spectacular rates of economic growth. The fiscal deficit, too, did not help create more jobs, and the situation led to pointing of fingers at some low-wage economies, as if they had stolen the jobs from the US. It is perhaps no exaggeration to say that it is the US government's spending patterns that need to be scrutinised for loss of jobs.

Who is helping Mr Bush cover the fiscal and current account deficits? Why is the dollar not crashing yet? How come US interest rates are still soft? Countries enjoying massive export surpluses with the US are transferring the dollars back to the US. The central banks of such countries as Japan and China, as well as Thailand, Korea and Singapore, have been purchasing US Treasury Bills. This helps those countries ward off possible currency appreciation and loss of export competitiveness.

And it `helps' the US companies to try and cut costs by any means possible, including moving operations to low-cost locations. Textbook theories state that the dollar should weaken enough to cut the trade and current account deficits. The faith is that a weak dollar would stimulate exports and discourage imports. Quantitative evidence, however, seems to indicate that US imports are not quite sensitive to relatively minor changes in the exchange rates.

What the nation needs is a currency depreciation that would be high enough to have a lasting impact via fundamental structural changes. That will not happen as long as the dollar is worshipped by the central banks of the world, with limited options to invest their surpluses in.

How will the situation change? The European Union, China and India could hold the key, by becoming important economic powers and having currencies that are strong and stable so that countries are no longer shy of diversifying investments away from the dollar tothe euro, the yuan or the rupee.

Since there is no prospect of such a shift happening anywhere near the horizon, it is safe to conclude that the US can carry on with its twin deficits, moderating them only if the next President were to care about domestic economic prosperity and not about waging wars abroad.

(The author, formerly with the National University of Singapore and the World Bank, is Professor Emeritus, GITAM Institute of Foreign Trade, Visakhapatnam. He can be reached at bhanoji@gmail.com)

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