The United States economy is undoubtedly the world’s largest and most influential with an estimated Gross Domestic Product (GDP) of $ 13.84 trillion according to CIA world fact book in the year 2008. This figure represents a triple of the second largest economy GDP, Japan approximated at $ 4.4 trillion. However, despite its strong position as the world’s leading economy, the United States economy is facing unprecedented and a serious economic downturn and recession. These problems have exposed fundamental economic weaknesses which would have otherwise been avoided (R. Pettinger, para1).
Underlying problems of the United States economy
National dept and Budget deficit
National dept has been an issue of concern across the United States. It is estimated that the Federal Reserve dept index as at the beginning of 2008 was $9.2 trillion. This is approximately 67 percent of the gross domestic product representing $79,000 per individual American taxpayer amounting to slightly over 117 million American population. Comparisons of the national debt figures during Clinton and Bush administration reveals a sharp rise in the national debt in the latter case. The national dept as a percent of the GDP as stated by WhiteHouse.Gov indicates arise of 40% between 1980 and 1990 during Bush senior and Reagan administration. Contrary, the period between 1990 to 2000 witnessed a significant fall in national debt index of up to 15%. This was the period during Clinton’s administration. Beyond this period the national debt has been on the rise and is projected to rise until 2010.The high national dept level has necessitated the increase in the cost of interest rates and consequently limited the possibility of future tax relief and government spending ability. The problems of national dept become even more pronounced when the public sector government pension liabilities are factored in. The increase in national debt has been brought about by a number of factors.
These factors are tax cuts which have failed to increase consumer spending proportionate to the cut, military invasion of Iraq have increased government expenditure, increased welfare spending as a result of the increase in ageing population. An increase in the government deficit is as a result of increased expenditure due to tax cuts for the rich. The budget deficit wields immerse demand on interest rates which comprises investment as a result of increased consumption. These effects later roll back compelling people to pay high interest rates. During the Bush administration, the budget deficit continued to increase. This deficit neither rekindled demand nor increased investment to control recession. The fiscal policy administered in 2001 by cutting taxes for the rich never stimulated the economy. Increased military spending also increased the government deficit. As a result of these factors, the United States now experience recession because of the limited capacity of these fiscal policies. The current government now faces the enormous task of reducing budget deficit that has proliferated for close to a decade. Solving the problem of national debt and budget deficit will therefore require measures aimed at increasing taxes and lowering expenditure. This becomes an obstacle for future economic growth (R. Pettinger, para4).
Current Account Deficit and External Dept
The United States economy has been driven by has resulted into imbalance between imports and export. This is because increases in imports have not been reflected by the same magnitude of increase in exports. The current US account deficit stands at 6.5 percent of the GDP. Majority of the United States foreign debts are held by Asian investors mostly from Japan and China because the account deficit has been financed by securities purchased by these investors. However, the current account deficit has slowed down capital flow and therefore devaluing the dollar. The problem of account deficit has exposed underlying differences between domestic production and consumption and remains as a major obstacle to future economic growth. The United States current account deficit has been on the downturn from 1990, particularly because of the recession experienced in late 1990 and 2001as indicated by the US Department of Commerce in 2007. During 1990, the national debt level stood at a positive figure of about $50 billion. However, the figure currently stands at close to -$1,000 billion (T. Pettinger, para9).
The recent slump in the United States housing market has resulted in economic slowdown. The US mortgage market has had unprecedented price booms in the past. This was brought about by several factors which led to overvaluation. These factors include lack of regulation of mortgages. This simply means the mortgages were sold without taking into consideration the capability of paying them back. Other parts of the world such as Europe have regulations to protect against these trends. The irresponsibility of the government and the mortgage industry contributed to this anomaly. Low interest rate of 2001 as a result of rate cuts is another factor. People ran into buying mortgages because of their affordability not knowing that they would increase. The last factor which led to the bubble in the housing industry is adjustable mortgages. The US has no measures to control the instability in the mortgage industry. In most European countries, there are measures to ensure that mortgage rates are fixed and long term. This isolates incidences of induced interest rates as a result of market volatility and thereby maintaining market stability. However, mortgage prices are tremendously falling with statistics showing that there has been a fall of close to 10 percent in the last one year as shown in the following graph. As prices fall, the ability of consumers to spend is reduced as their assets are diminished. This has slowed economic growth and therefore slipping the economy into recession. The national housing price index had been relatively constant for decades ranging from highs of +8% to +10% between 1950s to early 1990s. However, these prices began to rise after adjusting to the inflation of late 1990s. Currently, with homeowners facing difficulties in paying their mortgages, the prices are projected to fall tremendously below -3% mark. (R. Pettinger, para10).
The United States economy has faced tremendous increase in inequality since 1980s. Both income growth and tax cuts have resolved around high income earners. In the contrary, minimum wages have struggled to match with the pace at which the real income has grown. In addition, most people have resorted to part time, unskilled and low income earning jobs which do not invite tax cuts. This has created a labor market with two different tiers, one tier comprising high income earners with guaranteed job security and the other tier comprising low income earners with limited job security. This scenario has resulted into a large fraction of the population with casual and lowly paid jobs. The problem however lies with the government’s reluctance in reducing poverty levels. As revealed by economic policy institute, from 1973-2005, income for those in the 90th percentages grew by over 30percent. This growth is concentrated at the top where most people are college or degree holders. This group comprises of high salary earners like sports and entertainment celebrities, CEOs, among others. However, the 50th percentage range and below comprises of people with diplomas, where wages grew by 5-10 percent (T. Pettinger, para12).
The fall in the dollar has continued to rise. Compared to the Euro, the dollar has reached as low as $1.39 and $2.03 against the pound. Study conducted by Bloomberg indicates that the exchange rate of the dollar against the Euro stood at around $1.2 in the late 1999. However, the rate stood at around $1.4 in 2007. This trend has caused the value of the dollar to fall tremendously. Reduced capital flows have devalued the dollar as a result of loss of confidence by investors in the United States economy. This devaluation has been mirrored on the changes in trade trends such as dwindling potential of economic growth and dropping of interest rates which have made trading in the dollar less lucrative. This decline in the dollar is partly as a result structural loopholes in money and fiscal policies of the United States economy making the dollar lose its competitive advantage over its partners (R. Pettinger, para11).
Solutions to the United States economic problems
This involves government intervention by cutting the rates of taxes to increase the aggregate demand. As tax rates are reduced, more disposable income become available to consumers and therefore increasing their consumption rate and as a result increasing economic growth. A government can also intervene by increasing its expenditure using expansionary fiscal policy which results in increased budget deficit. However, the effectiveness of this policy depends on several factors. Tax cuts will at times lead to increased spending. For instance, cutting taxes for high income earners who have a high ability to save, expenditure will only increase a little. It also depends on the level of consumer confidence. If there are uncertainties about the future, consumers will tend to save the additional disposal income rather than spend it according to Keyne’s thrift principle. The success of this policy also depends on the national dept. High national dept levels reduces the ability of expansionary policy because any further borrowing exerts pressure on interest payment rates. Finally, crowding out is another concern in administering this policy. This occurs when increase in government spending results in reduction in private sector expenditure as a result of purchasing government bonds and therefore reducing their ability to spend (Gadrey, pp45).
This policy encourages lending institutions to cut interest rates so that it becomes cheaper for consumers to borrow and thereby encouraging investment and increased consumption. However, this policy becomes conflicting when inflation resulting from high prices of energy and food forces banks to stop reducing their interest rates. This policy also has a great impact on the stock exchange market. Further interest rate cuts may lead to prolonged devaluation of the dollar (Andrews, pp15).
Housing industry is an important economic force in any economy. The government should therefore strive to maintain stability in this industry because cutting interest rates has proved insufficient in boosting the economy (R. Pettinger, para14).
There are international monetary policy challenges across the world. Most countries trading in the dollar have the tendency of diversifying in foreign currencies. However, most dollar handling counties are not willing to accept these flows. This has made countries from Asia such as China to heavily diversity their currency and consequently making it rise. Any additional out of dollar shifts might push above equilibrium these floating currencies. There are proposals to solve this impasse by creating an account with International Monetary Fund (IMF) called a substitution account where floating dollars could be held. This proposal would stabilize global currencies. Conversion of currencies from one currency to the other has the effect of slowing down the former and consolidating the latter. Instead of conversion, these floating dollars could be deposited in the substitution account which would be used to finance future budget deficits and national debt making the asset fully liquid. This intervention would help the US by reducing the rate of inflation and interest rates and a further slump of the dollar (Bergsten, para7).
International intervention through the creation of a substitution account proves to be a better solution because the United States economic problems have taken a global trend and therefore needs a global intervention. However, the United States dollar should be allowed to decline even further in order to return to its equilibrium and to restore its global status. This would allow Asian counties to experience sharp rise in their currencies for sometime. The implementation of this account would otherwise minimize the current imbalances experienced with exchange rates and give rise global monetary policy based both on the euro and the dollar
As once stated by former United States president J.F. Kennedy, “The security of the dollar is security to all”, the United States government should endeavor to come up with long term measures to protect the dollar against further slip. As observed throughout this paper, the problems facing the United States are as a result of policy failures. The government should therefore implement policies which encourage stability in the housing sector, reduce the inequality gap between high income earners and low income earners by improving education as a recipe for reducing this gap, and reduce government spending on military operation in countries like Iraq in order to reduce the national dept. such policies would ensure that the economy is restored to its global status and improve the livelihood of American citizens.
Andrews, Marcellus. “Beyond the Abyss: America’s Economic Future after the
Financial Crisis.” Dissent Magazine. October 16, 2008. Retrieved March 4th,
2009 from http://www.dissentmagazine.org/online.php?id=152
Bergsten, Fred. “How to Solve the Problem of the Dollar.” Financial Times. December
11, 2007. Retrieved March 4th, 2009 from http://www.petersoninstitute.org/publications/opeds/oped.cfm?ResearchID=854
Gadrey, Jean. New Economy, New Myth. Routledge, 2003.
Pettinger, Richard. Problems Facing American Economy. 2008. Retrieved March 4th,
2009 from http://ezinearticles.com/?Problems-Facing-American-Economy;id=965725
Pettinger, T. What Went Wrong With the US Economy? 2008. Retrieved March 4th,
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