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Tuesday, November 07, 2006

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Lafayette

There is only one good reason for a current account deficit. It is in response to economic lethargy that provokes a climbing unemployment figure. It should be sharp and as short as possible in circumstances that are particular.

The European experiment (for lack of a better word presently to describe it) acknowledges the possibility for a deficit as long as it is not chronic. Otherwise, it is limited to 3% of GNP and for good reason. Beyond that threshold there is every reason to believe that it kindles inflation.

The impact on European countries, where taxation represents between 40 and as much as 52% of GDP, this rule is particularly difficult for countries that continue to think, as they have over decades, that the best way for politicians to get reelected is to spend before elections.

But the EU is not the USA, and in fact, the states are free to spend as they see fit - whether it adds to the total deficit or not. Is there any state in the union, in fact, that has legislation to forbid deficits?

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Savings Accounts

There are two main forces behind the large U.S. current account deficits. First, an increase in the U.S. demand for foreign goods. Second, an increase in the foreign demand for U.S. assets.

Both forces have contributed to steadily increasing current account deficits since the mid-1990s. This increase has been accompanied by a real dollar appreciation until late 2001, and a real depreciation since. The depreciation accelerated in late 2004, raising the questions of whether and how much more is to come, and if so, against which currencies, the euro, the yen, or the renminbi.

Our purpose in this paper is to explore these issues. Our theoretical contribution is to develop a simple model of exchange rate and current account determination based on imperfect substitutability in both goods and asset markets, and to use it to interpret the past and explore alternative scenarios for the future. Our practical conclusions are that substantially more depreciation is to come, surely against the yen and the renminbi, and probably against the euro.
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@Jackson
Savings Accounts

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  • This is a personal web site, produced in my own time and solely reflecting my personal opinions. Statements on this site do not represent the views or policies of my employer, past or present, or any other organisation with which I may be affiliated. The information on this site is provided for discussion purposes only, and are not investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities.