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Collegiate
Case
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How can U.S. stay on top of


the world?
Global Economics
As the U.S. and global economies continue to grow at strong rates, economists and
By Antoine van Agtmael financial analysts are increasingly concerned about a number of underlying factors
...............................................................................5-6 that could pose substantial risk to the global economy. The U.S. current deficit has
set historical highs since 2000, and the U.S. savings rate is stagnant. Internationally,
investors in U.S. equities have been lured by stability, and rising interest rates, but
not at high enough levels to finance deficits indefinitely. Resurgent protectionism
Some would like to build a and job insecurity coupled with instability in emerging and energy markets create
additional potential to undermine global economic growth. This case study
wall around U.S. economy explores the financial and monetary policy causes and effects of recent global eco-
By David J. Lynch nomic trends and examines prospects for ongoing stability.
................................................................................7-9

World economy expanding, but


Tensions push Congress
faces dangerous balancing act
By David J. Lynch
............................................................................10-13
to get even with China
By David J. Lynch
USA TODAY
Trade imbalance keeps
After years of inconclusive
growing, so lawmakers
Critical inquiry skirmishing, trade tensions are getting in on the fight
Discussion and future implications between the United States and
.........................................................................................14 China are about to intensify. The
escalation comes as both
countries' domestic political
calendars are complicating
prospects for the compromises
USA TODAY Snapshots® needed to call off this high-stakes
game of financial chicken.
U.K. considered the top economic ally
Which country will have the most positive
effect on the future of the U.S. economy? On Capitol Hill, lawmakers from
both par ties are drafting
United
Kingdom 47% legislation designed to punish
China for trade practices they say
Japan 40%
violate the Asian giant's
European international commitments and
Union 29%
leave American companies at a
China 23%
profound competitive
India 15% disadvantage. A bilateral trade
13% deficit that yawns wider with
Russia every year is fueling the push for
Note: Multiple responses allowed.
Source: Harris Interactive online survey of 1,833 adults age 18 and older.
action. By Bob Laird, USA TODAY
Margin of error: ±2 percentage points.

By Jae Yang and Karl Gelles, USA TODAY

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reset global currencies.


China’s economic muscle But today, the target of U.S. ire isn't a
China’s foreign exchange reserves are U.S. trade deficit with China shows democratic ally ultimately dependent
now the world’s largest: no signs of shrinking: upon the American militar y for its
(in billions) security. It's a prickly, one-party state
$1.2 trillion 0
with deep memories of humiliation by
foreigners and aspirations for recognition
$1.0 trillion as a global power. Where Japan was
-$50 prepared to absorb some U.S. criticism,
$800 billion China's patience is likely to prove more
-$100 limited.
$600 -$56.9
Relationship out of balance
-$150 billion
$400
Still, there's no question that the Sino-
$28.6 billion U.S. trade relationship is out of balance.
$200 -$200
The debate is over why and what to do
-$232.5 about it.
0 -$250 billion
’90 ’071 ’98 ’06
Last year, the USA sold $55.2 billion
1 – as of March; Source: People’s Bank of China
worth of goods to China. Only three
By Adrienne Lewis, USA TODAY other countries — Mexico, Canada and
Japan — bought more U.S.-made
products than China did.
"We're competing not only with a world's largest and its fastest-growing
country with low wages but with very economies "the biggest risk to the global "Our companies do not want to see a
high and heavy subsidies and a rigging of economy." trade war with the Chinese. Our
their currency. Essentially, you have companies want to expand trade
China with a very clear-cut economic Imposing duties on Chinese imports relations. It's a very, very good market for
plan in terms of exports and (the U.S.) would result in "a direct hit on the the U.S.," says Cal Cohen, president of the
saying ... it will work out or we'll talk. But American consumer" as prices of Emergency Committee for American
that hasn't worked," says Rep. Sander products such as clothing, furniture, Trade, which represents companies such
Levin, D-Mich., chairman of the House computers and appliances rose. If China as Cargill, IBM, Boeing and McGraw-Hill.
trade subcommittee. retaliated by curtailing purchases of U.S. But those impressive expor ts were
government securities, long-term dwarfed by imports from China of $287.7
A bipartisan quartet of influential interest rates would rise and the value of billion, resulting in a $232.5 billion
senators today is scheduled to unveil a the dollar sink. The effect of this action- bilateral trade deficit, the USA's largest
measure to pressure China into reaction cycle on an already fragile single-nation shortfall.
accelerating its evolution to a market economy, as the USA enters the
economy, while Sen. Chris Dodd, D- presidential election year of 2008, could Under U.S. pressure, China over the
Conn., chairman of the Senate Banking be enough to tip it into recession, Roach past two years has allowed its currency,
Committee, readies a separate bill that warns. The Shanghai newspaper Jiefang the yuan, to rise in value about 8%.
would target China's currency policy. Ribao agrees: "Once a trade war breaks Despite that increase — which makes
House Ways and Means Committee out, it will be devastating for China and Chinese products more expensive in
action on a competing trade proposal the United States." dollar terms and thus presumably less
will occur in the next few weeks, attractive to buyers — the trade gap this
according to Levin. The U.S. has been here before. In the year is running ahead of last year's pace.
1980s, as surging imports of Japanese Through the first four months of 2007,
But even as the mood in Congress autos and electronics seemed to the $76.3 billion deficit was 18.5% greater
hardens, some economists are warning highlight American industrial decline, the than during the same period in 2006.
that the likely congressional action could U.S. won "voluntary" import limits from
backfire. Stephen Roach, Asia chairman Tokyo. Fears that a weak yen gave Critics blame the runaway deficit on
for investment bank Morgan Stanley, calls Japanese exporters an unfair edge led to Chinese policies that keep the yuan
the prospect of a trade war between the 1985's landmark "Plaza Accord," which ar tificially depressed and provide

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exporters with generous subsidies. On the eve of high-level In an interview, Levin said Wu described the U.S. and Chinese
talks in Washington last month, China announced it would economies as "complementary," saying China shipped shoes
begin allowing the yuan to fluctuate more on a daily basis, the and clothing to the USA while American companies sent high-
latest sign of its gradual move toward allowing the market to tech products to China.
determine the currency's value. But lawmakers such as Sen.
Charles Schumer, D-N.Y., one of the authors of the forthcoming But citing Census Bureau data showing the U.S. running a
Senate bill, derided the move as too little, too late. deficit even in trade of advanced technology goods, Levin
disagreed.
The Chinese currency remains as much as 40% below its fair
market value, says economist Morris Goldstein of the Peterson "That's just not true," said Levin. "What she said is just
Institute for International Economics in Washington. Chinese wrong."
exporters, many partially owned by the government, also
enjoy a range of benefits, including financing by state banks. Indeed, through April, the USA imported $20.5 billion more
in high-tech products from China than it shipped there.
Treasur y Secretar y Henr y Paulson, however, says the
unbalanced Sino-U.S. trade is not a result of Chinese cheating. “Our companies do not want to see a trade
Real improvement in the trade statistics depends upon ongoing
"structural" reforms to reduce China's reliance upon exports war with the Chinese. Our companies want to
and increase consumption by Chinese consumers, he says. The expand trade relations. It’s a very, very good
administration opposes legislation designed to crack down on
China. But lawmakers hope to assemble a veto-proof majority. market for the U.S.”
U.S. firms in a bind — Cal Cohen, president of the Emergency Committee
for American Trade
In markets from apparel to electronics, American companies
that compete with Chinese rivals are struggling to keep pace. In
Cary, Ill., northwest of Chicago, Bartlett Manufacturing has seen A complex relationship
sales of its printed circuit boards sag from $20million in 1999 to
about $9million today, according to Douglas Bartlett, the But reflecting the complexity of the Sino-U.S. trade
company chairman. relationship, of the 10 categories of high-tech products tracked
by the Census Bureau, the USA enjoys a trade surplus with
Bartlett, 50, says longtime customers tell him they can buy China in eight. The two categories that account for the overall
Chinese circuit boards for a fraction of his price, often for no high-tech deficit are mostly consumer electronics, largely
more than the cost of materials. Example: Bartlett sells a circuit laptop computers, DVD players and CD players. And more than
board used in the turn signal on a Japanese car for 39 cents 90% of those products are produced not by domestic Chinese
each. He's about to lose an order to a Chinese maker that sells companies but in the factories of multinational corporations in
the same product for 20 cents. China, according to Nicholas Lardy, a Peterson Institute
specialist on the Chinese economy.
"That's not (because of) labor prices alone. It's currency and
export subsidies. … It's not free trade now; it's unfair trade," The prominent role of multinationals in exports from China is
Bartlett says. one indication of the difficulty of fashioning effective trade
sanctions. Some products that appear in trade accounts as
Manufacturers have been airing similar complaints for years. "Chinese" emerge from factories owned by Taiwanese,
But they've been getting a more sympathetic hearing since Japanese or even U.S. corporations.
November, when Democrats took control of Congress.
Another question is how China will react when the U.S. acts.
Chinese officials felt the new mood last month during Like the U.S., China is in the midst of an intensely political
meetings timed to coincide with the Cabinet-level Strategic season. This fall, a critical Communist Party Congress, which
Economic Dialogue held in Washington. The unusual Capitol occurs only every five years and determines the individual
Hill sessions, which brought together Chinese Vice Premier Wu career prospects of thousands of officials, is scheduled for
Yi and key lawmakers, was aimed at promoting mutual Beijing. Party officials at all levels typically are preoccupied
understanding. But at least in Levin's case, the meeting with internal jockeying for influence for months before such
appeared to do just the opposite. conclaves. This year, such concerns are especially intense
because the eventual successor to Party General Secretary Hu

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Jintao is expected to be determined, potentially reshuffling the Commerce Department, triggering an administrative process
landscape of Chinese politics. that can take over a year before duties are imposed.

"Domestic issues trump international issues in every political In only about half the cases does the department find that
system in the world, and China's no exception," says Susan unfair foreign competition injured the complaining American
Shirk, author of China: Fragile Superpower. industry, a necessary judgment for duties to be approved, says
Reinsch, an ex-Commerce official. "At the end of the day, the
Shirk, a former National Security Council aide during the number of Chinese producers affected by what we do is a lot
Clinton administration, says the Chinese government is divided smaller than you'd think."
between those who want to continue integrating China into the
global economy and economic nationalists who favor Nonetheless, if Congress passes, and the president signs,
cultivating home-grown commercial stars while curbing legislation opening the door to duties on Chinese imports,
international ties. In the run-up to the party congress, officials China will respond, Shirk says. Beijing could impose tariffs on
will be enormously reluctant to offer the sort of concessions to U.S. products, restrict additional foreign investment
the U.S. that could defuse trade tensions. opportunities, or purchase fewer dollars and more euros or yen,
says Morgan Stanley's Roach.
"It's not a time for bold initiatives," she says.
On Capitol Hill, meanwhile, China's critics are out of patience.
Still, if there's to be a trade war, it will be a slow-motion Levin makes it clear he doesn't take seriously the notion that
conflict. The measures now under consideration, designed to domestic Chinese politics might limit Beijing's freedom to
comply with World Trade Organization rules, would expand the maneuver and he waves away "trade war" talk.
remedies U.S. companies affected by Chinese competition could
seek, says Bill Reinsch, president of the National Foreign Trade "I hate the term 'trade war' because it's always used when
Council, a business lobbying group. But even if Congress acts, you try to get a fair break. ... People don't like it when you push
duties wouldn't automatically be applied. Individual U.S. back," he says. "Sometimes pressure works."
industries or companies would first have to petition the

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How can U.S. stay on top of the world?


We're no longer the economic center of the
universe, as the global landscape has shifted
to former Third World countries. What to
do? Remain competitive through innovation,
not protectionism.
By Antoine Van Agtmael

South Korean car maker Hyundai recently had to deny


newspaper reports that it is a leading candidate to take over
Chrysler. True or not, it already has a $1.1 billion plant in
Alabama and now beats Toyota in performance quality,
according to the J.D. Power survey. Less than five years ago it
was the joke of a Jay Leno show.

Hyundai is just one of the many profitable firms in emerging


markets that produce just about everything consumers
consume. Within hours of Apple CEO Steve Jobs' recent
unveiling of the stylish new iPhone, shares in Taiwanese
electronics giant Hon Hai Precision Industry shot up. Founded
in 1974 as a marginal manufacturer of TV-set-tuning knobs,
Hon Hai today produces PCs for Hewlett-Packard and Dell,
PlayStation game consoles for Sony, motherboards for Intel,
cellphone handsets for Nokia and Motorola, and now Apple's
new iPhone. Other examples can be found everywhere.

While our attention was focused on the "new economy" a


few years ago, "new economies" quietly stole the show. We are
in the midst of the greatest shift in the global economy since
the Industrial Revolution. This time, the economic epicenter is
shifting away from the developed world to emerging markets
in Asia, Eastern Europe, the Middle East and Latin America.

Market scare
By Web Bryant, USA TODAY
Sharp moves in the Dow Jones used to scare or exhilarate
investors worldwide. Last week's 416-point drop in the U.S. produced in the former Third World? One thing is that America
stock market, together with a sudden reversal in markets (but also Europe and Japan) will need to get used to the idea
around the globe, was the first time that a sell-off in China that we are no longer the center of the economic and political
triggered such a major loss in market values — one that was far universe. Even more important, we should resist the knee-jerk
larger than the entire Chinese market. It was not only an reaction of protectionism that would likely stifle innovation.
overdue reminder that investors get scared from time to time
— usually after periods of over-enthusiasm — but also Yet, in the USA, we have been slow to accept this new reality.
demonstrated the dramatic and growing impact of what I call Countries such as Mexico, South Korea and Russia are no longer
the "Emerging Markets Century." basket cases in need of rescue. Emerging markets now own
three-quarters of the world's foreign exchange reserves, and
What are we in the USA and the rest of the developed world their purchases influence U.S. mortgage rates. The brain drain is
to make of the fact that so much of what we consume is reversing just as budget and current account deficits (the

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broadest measure of a nation's trade gap) have crossed over new breed of companies. And our universities should focus
into the developed world. more on creative problem solving and integrate study and work
experience abroad if we want students to be comfortable with
The world is not flat; it is tilting, with the USA rapidly moving foreign languages and cultures.
from unquestioned dominance to greater dependence. And
this is only the beginning. Twenty-five years from now, When we look at history, a creative response has often
emerging markets will make up more than half of the global succeeded where protectionism has failed. President Kennedy's
economy (up from 21% today) as the General Electrics and inspiring call to put a man on the moon when Russia seemed to
Microsofts of the future will increasingly hail from these new be "winning" provided the United States decades of
economies. technological superiority. Today, leading U.S. universities remain
the best, while creative companies such as Google and Apple
More than ever, the global economy is not a zero-sum game. are more than competitive.
More handsets, refrigerators and beer are sold in emerging
markets than in mature markets. U.S. exports to emerging As a nation, we need a "National Competitiveness" campaign
markets have increased 338% over the past 20 years, much that sets ambitious goals such as developing a successor to the
faster than domestic demand. One billion new consumers and internal-combustion engine, but also tackles legacy issues (high
investors will turn many emerging markets into middle-class cost of health and pension benefits for current, older and
economies. Smart American corporations are already seeking retired workers), places more emphasis on creativity in
their growth in emerging markets. GE plans to double its sales education and gives infrastructure a much-needed face lift. The
in emerging markets from 15% to 30% by 2010. Goldman Sachs choice between protectionism and a creative response to the
built an important franchise in China. Dell and GM increasingly tectonic shift in the global economy (and global power) could
produce in India and China for the local markets. well become one of the key issues in the next presidential
campaign. Instead of complaining and agonizing about this new
Maintaining our edge competitive threat, our focus should be on turning it into an
exciting opportunity.
But that is clearly not enough to keep our competitive edge.
Many more corporations should develop a clear emerging- Antoine van Agtmael is chairman and CEO of Emerging
markets strategy, embed their young managers with local Markets Management, LLC. He recently published The
families (as Procter & Gamble already does), build crucial local Emerging Markets Century: How A New Breed of World-Class
relationships, establish international focus groups to tailor Companies is Overtaking the World.
products to local tastes, and form business alliances with this

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Some would like to build a wall


around U.S. economy
Protectionism makes a
big comeback grounded
in growing fear, distrust
Schumer, D-N.Y., reacting to the surging U.S. trade deficit, has
proposed imposing a blanket 27.5% tariff on Chinese imports if
Beijing doesn't allow its currency to appreciate.

"Today, it's the Middle East. Last summer … it was China. Next
it could be Russia," frets Nouriel Roubini, an economist who
operates the rgemonitor.com global economy website.

A combustible mix of security and economic dangers has left


Americans increasingly unsettled about their engagement with
the rest of the world. Color-coded terror alerts and the
persistence of the global al-Qaeda network mean danger is a
fact of daily life. Compounding public unease is the relentless
economic rise of China and India, which seems to imperil many
Americans' financial futures.
By Sam Ward and Julie Snider, USA TODAY

From 1994 until last year, a solid plurality of Americans saw


By David J. Lynch foreign trade as an opportunity rather than a threat, according
USA TODAY to USA TODAY polling. In May 2000, for example, trade was
backed 56% to 36%. But in a June 2005 survey, by a 48% to 44%
Can the United States run a war and an open economy at the margin, more respondents judged it a threat.
same time?
"Globalization creates vulnerabilities. There's no question
In the wake of the Dubai ports imbroglio, some lawmakers about it," says Mira Wilkins, an expert on foreign investment at
are saying the U.S. needs to rethink its openness. Rep. Duncan Florida International University in Miami.
Hunter, R-Calif., chairman of the House Armed Services
Committee, for example, is demanding that all of the USA's The USA isn't alone in getting cold feet over globalization.
"critical infrastructure" be owned and managed by American Europe, too, is witnessing a renewed concern. In France, Spain
citizens. and Poland, governments are blocking foreign firms from
acquiring companies even in seemingly benign consumer
While there is no across-the-board move to erect walls industries.
around the U.S. economy yet, some analysts worry that the
combination of national security and industr y-specific Global ties grow
economic fears could spiral.
If the concerns suddenly seem acute, it may be because in
Hunter's legislation would require foreign companies that recent years the globalization era that began with the collapse
own anything deemed "critical" to national security, economic of communism in 1989 has intensified dramatically. Example:
security or public health to sell within five years. Sen. Charles Cross-border mergers and acquisitions totaled a staggering $3.2

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International trade
The U.S. economy has become more dependent on foreign trade over the past 35 years. Imports as percentage of GDP:
16%
14%
12% 16.2%
10%
8%
6%
4%
5.4%
2%
0
1970 1980 1990 2000 2005
Source: Bureau of Economic Analysis

By Marcy E. Mullins, USA TODAY

trillion last year, almost three times the level just five years The ports furor catalyzed the debate over security and
earlier, according to the Bank for International Settlements in globalization, though the immediate prospect of an Arab
Basel, Switzerland. company operating terminals at several U.S. ports appears to
have faded. On March 9, Dubai Ports World announced it
The U.S. certainly is much more intertwined with other would spin off its newly acquired American operations so long
economies than ever. In 1971, when President Nixon cut the as it could do so without losing money.
link between the dollar and gold, U.S. imports were equivalent
to 5.5% of the economy. Last year, they hit 16.2%. More complicated times

The furor over the DP World ports takeover may have This isn't the first time the U.S. has faced the issue. An earlier
surprised the White House. But it didn't come out of nowhere. age of global economic integration in the decades before World
Last summer, it took enormous political arm-twisting to get a War I ended with the guns of August 1914. After the war, trade
very modest Central American trade deal through Congress. recovered in fits and starts. But then the 1930 Smoot-Hawley
Then, in the fall, a Chinese enterprise was forced to abandon its Tariff triggered a protectionist frenzy that by 1934 had slashed
planned acquisition of Unocal, a second-tier American oil international trade by two-thirds.
company, after Congress heatedly objected. And now an Arab
firm has been told it can't be trusted to operate cargo terminals During the Cold War, the relationship between national
at American ports. security and commerce seemed clear. Buttressing the
economies of Western Europe helped knit together an anti-
"I think we're riding a wave of xenophobia," says William Soviet alliance. There was no question about who the enemy
Reinsch, president of the National Foreign Trade Council, a pro- was and no question of trading with him. Today, life isn't so
trade group. simple. Instead of a government like the Soviet Union, the
enemy in the war on terror is a stateless network of Islamic
Still, the reaction to date against foreign investment — extremists.
whether for national security or economic reasons — has been
limited. Both the ports controversy and last year's Unocal dust- "We're now in an era where the national security interests of
up involved foreign companies that were government- the United States are a lot more ambiguous, and there's more
controlled. Moves to limit Chinese imports have been confined disagreement about them," says Jeffry Frieden of Harvard
to specific industries, notably textiles and apparel. University. "Even if there's agreement on fighting terrorism, it's
not clear what the economic implications of that are."
"It's not competitive concerns like the 1980s. GM and Ford
are in rough shape, but there's not much sympathy for helping Those who argue for changing the rules of the game target
them" with import limits, says Todd Malan, president of the the inter-agency Committee on Foreign Investment in the
Organization for International Investment. United States (CFIUS), which approved the ill-fated ports deal.

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The committee gathers representatives of 12 agencies to Edward Graham of the Institute for International Economics,
balance foreign investments' gains against potential security author of a forthcoming book on national security and foreign
threats. investment, says CFIUS has been more effective than the
statistics suggest. Although the panel formally rejected only
Hunter, who helped kill the ports deal, wants to tighten the one deal, it effectively blocked 20 others, he says. Many others
government's method of reviewing proposed foreign were modified by compelling the foreign acquirer to accept
acquisitions of U.S. companies. Currently, "Economic or changes in how it would operate the American asset.
commercial implications apparently supersede national
security considerations," the lawmaker wrote in a March 6 "What major security failure has happened in the U.S.? None
letter to colleagues. that we know of," Graham says.

A Government Accountability Office investigation last year U.S. dependent on foreign investment
also concluded that the panel "narrowly defines what
constitutes a threat to national security." Since 1988, CFIUS has As Congress rethinks foreign investment, Clyde Prestowitz,
rejected only one of more than 1,500 proposed foreign president of the Economic Strategy Institute, thinks the new
acquisitions of U.S. companies: China National Aero-Technology focus on security ignores the U.S. economy's dependence upon
Import & Export's 1990 attempt to acquire a Seattle aircraft foreign investment. The USA requires about $3 billion in foreign
parts maker. capital every working day to finance the huge gap between its
consumption of foreign goods and its exports. The country just
Among those approved was a deal that left another Chinese doesn't have the luxury of walling itself off, Prestowitz says:
firm producing 80% of the magnets used in the Pentagon's "We're shooting ourselves in the foot here. People don't realize
"smart bombs," according to Sen. Evan Bayh, D-Ind. this, but our economy is on life support from foreign lenders
and investors."
If any security worries are found in the panel's standard 30-
day review, an additional 45-day probe can be launched. But Questions over foreign investment aren't going away. Next
the GAO report said that the committee, which is chaired by month, Chinese President Hu Jintao is scheduled to meet with
the Treasur y Depar tment, is reluctant to order such President Bush at the White House even as the Treasury
investigations for fear of discouraging foreign investment. Of Department nears a decision on formally stating that China
470 proposed deals from 1997 to 2004, CFIUS initiated only manipulates its currency for trade advantage.
eight investigations, the report said.
Likewise, thanks to high oil prices, the Dubai Ports deal won't
Hunter's proposed legislation would mandate 45-day probes be the last Arab investment here. Since 1998, members of the
for "transactions that may have national security implications." OPEC oil cartel have earned $1.3 trillion in petrodollars,
Treasury Secretary John Snow on Tuesday backed increased according to the Bank for International Settlements. Much of it
scrutiny for deals involving state-owned foreign companies but is staying home, helping fuel enormous increases in regional
warned against "isolationist" moves. stock markets. But tens of billions of petrodollars have surged
into U.S. corporate bonds, equities and direct investment. And
Others say the criticisms are overstated. Phillip Swagel, who more are probably coming.
was chief of staff for the White House Council of Economic
Advisers in President Bush's first term, says the Pentagon "Foreigners have a whole pile of dollars," says Reinsch. "I
representatives on the panel had a myopic focus on security. don't know what we expect them to do with them."
"They just didn't understand the value of foreign investment in
the United States," says Swagel, now a fellow at the American
Enterprise Institute. "They'd rather foreigners not be here
at all."

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World economy expanding, but


faces dangerous balancing act
Vulnerable emerging economist for Morgan Stanley
markets, volatile oil in New York.

prices bear watching Terror attacks. A trade war


with China. Even a historic
By David J. Lynch epidemic of potentially lethal
USA TODAY "bird flu." There's no end to the
list of potential economic
If things go according to plan, the catastrophes that could arise
world economy will chug along this year.
nicely through the new year.
But three dangers —
That would be comforting news if mushrooming global
things ever did go according to plan. imbalances, vulnerable
emerging markets and volatile
Actually, 2006 could see plenty of oil prices — seem especially
nasty surprises. For one thing, the noteworthy.
world economy, though expanding, is
dangerously imbalanced. The Too much red ink
resulting U.S. current account deficit
— reflecting the gap between the To many economists, the
nation's ravenous appetite for swollen U.S. current account
imports and its anemic savings — is deficit looms as the biggest
now at levels that many experts fear Healthy growth forecast potential hazard. In a nutshell,
could trigger a run on the dollar, The global economy looks set to continue expanding in
2006. Will it? Percentage change from previous year in real
the United States spends too
soaring interest rates and global
GDP global growth:
4.0%
3.8%
much and saves too little, and
economic pain. 3.4% 3.5%
3.0%
3.2% Asia saves too much and
2.5% 3.2% spends too little. (Moribund
2.1%
Meanwhile, investment is pouring 1.7% Europe doesn't do enough of
1.4%
into risky emerging markets as if the either.)
past decade's turmoil in Argentina,
Turkey, Thailand and Russia never 1996 1997 1998 1999 2000 2001 2002 2003 2004 20051 20061 No one knows for certain
happened.
1 – Projection Source: World Bank By Sam Ward and Julie Snider, USA TODAY
when the day of reckoning will
come. But Roach, and many
And all that stands between a If prognosticators seem sanguine, others, say the USA and the
barrel of oil and a triple-digit price tag is a perhaps it's because many of the same world cannot go on like this indefinitely.
strike in Nigeria, unrest in Venezuela or warning signals flashed red one year ago,
revolution in Saudi Arabia. and yet, the economy still barreled ahead, "There are significant downside risks to
even overcoming epic natural disasters. the global economy … financial markets
For all that, both the International right now are not pricing in any of these
Monetary Fund and the World Bank "2005 was a year that has lulled a lot of risks," warns Nouriel Roubini, a former
expect solid global growth of 3.2% this year, investors, policymakers and government White House economist in the Clinton
about the same as in 2005. officials into a dangerous and false sense of administration who runs the influential
complacency," says Stephen Roach, chief www.rgemonitor.com website.

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AS SEEN IN USA TODAY’S MONEY SECTION JANUARY 12, 2006

Last year, the U.S. financed its excessive spending by selling Emerging market risks
almost $800 billion worth of Treasury securities to foreign central
banks and investors. Another danger might be brewing in the so-called emerging
markets. Capital flows this year into developing nations in Latin
At 6.4% of total economic output, that's an unprecedented level America, Asia and Central Europe are expected to hit a record
for a major economy. The U.S. is able to get away with such $345.2 billion, according to the Institute of International Finance.
profligacy largely because the dollar plays a uniquely central role in That surpasses the previous high set in 1996, just before the Asian
global commerce. financial crisis, and is up 62% in the past two years.

But here's how a crisis could unfold: If foreigners conclude the Emerging markets enthusiasts shrug off reminders of the
dollar was headed for a fall because of the enormous U.S. deficit, euphoria-and-collapse cycles that hit Thailand in 1997, Russia in
they would cut back on purchases of U.S. debt. To entice them to 1998, and Argentina in 2000. It's different this time, say firms such
buy, the Federal Reserve would have to raise interest rates, perhaps as JPMorgan. Countries, particularly in Latin America, have built up
significantly. Higher interest rates could choke off economic foreign-exchange reserves that should allow them to ride out any
growth, even as the falling dollar ignited inflation by boosting the financial crisis and have introduced economic reforms that give
prices of imported goods. their economies greater stability. Rather than depend on private
capital flows from rich countries as they did in the 1990s,
In 2005, the dollar defied predictions of an inevitable decline. But developing nations now rely on strong export industries.
it is unlikely to keep doing so, according to Roubini.
Bond hoders are so impressed that they regard emerging market
The greenback benefited last year from a one-time change in U.S. securities as little riskier than U.S. Treasuries, according to the
tax law that encouraged companies to repatriate foreign profits JPMorgan Emerging Markets Bond Index Global (EMBIG). In late
and from the Fed's rate increases. 2002, investors demanded an additional 91/2 percentage points of
yield as compensation for the risk involved in holding emerging
The tax provision has expired, and the Fed is believed to be near markets bonds compared with U.S. Treasuries. Today, the spread on
the end of its monetary tightening. the EMBIG is down to little more than 2 percentage points.

"Our ability to finance ourselves depends upon the willingness of But emerging markets also have had the economic winds at their
foreign central banks to hold dollars. That willingness is going to be back for the past couple of years. Strong global demand boosted
shrinking (this) year," Roubini says. commodity prices, a major help for soybean exporters such as
Argentina and oil producers such as Venezuela. And U.S. interest
Even under optimistic assumptions, once the crisis hits, the rates were so low, yield-hungry investors — including normally
economic pain in the USA could be like nothing the country has cautious pension funds — were drawn into countries such as Brazil
suffered in decades. or Hungary.

An abrupt end to the USA's ability to obtain sufficient foreign Now, global growth is slowing, and U.S. rates are higher. "There's
financing could send the dollar into free fall, cutting 21% to 28% a lot to worry about," says Desmond Lachman of the American
from its value, according to research by Sebastian Edwards, a Enterprise Institute, who was among the first to warn of problems
professor at UCLA's Anderson School of Management. That would in Argentina before its historic default.
increase the price of a $21,000 foreign-made sedan to almost
$27,000, unless dealers opted to absorb the blow. While no one is predicting a repeat of the problems that rocked
half a dozen countries in the 1990s, emerging markets remain
In the first year, 3.6% to 5% would be slashed from per capita vulnerable to sharp changes in the global environment. If the dollar
economic growth. That would almost certainly push the USA into tanks, their surging exports would stall. Higher oil prices could deal
recession, perhaps for several years, according to Edwards, who them a double whammy, inflating their energy costs while
presented his findings at last summer's annual Federal Reserve depressing the economies of major customers.
conference in Jackson Hole, Wyo.
Any unexpected mishap could cause the spreads between
"Never in the history of modern economics has a large industrial emerging market debt and U.S. securities to balloon, making it
country run persistent current account deficits of the magnitude more expensive for corporations in developing countries to finance
posted by the U.S. since 2000." their operations, Lachman says.

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AS SEEN IN USA TODAY’S MONEY SECTION JANUARY 12, 2006

Trouble spots could derail global economy gains


Though the outlook is good, it isn’t hard to imagine what could go wrong.

USA: Unprecedented Venezuela: Charismatic Brazil: One of nine European Hungary: Runaway Saudi Arabia: China: Epidemic of
current account deficit leftist leader fomenting Latin American Union: Little sign finances suggest this Al-Qaeda would localized protests could
threatens financial anti-American alliance. countries scheduled that sluggish emerging market love to disrupt get out of hand or escalate
meltdown. to hold elections, economies are could stumble. the kingdom’s oil trade tensions with USA.
unsettling markets. getting in gear. industry.

U.S. current account deficit deepens Capital flows to emerging markets Emerging market spread Oil prices rise
The U.S. current account deficit, reflecting Shrugging off memories of recent cri- Bond holders are now asking only a With little spare capacity, oil prices
the nation’s reliance upon foreign bor- ses in Asia, Latin America and Russia, small premium to buy securities from could continue their climb. In dol-
rowing to finance today’s consumption, yield-hungry investors are shoveling developing nations. The spread is less lars per barrel:
is now history’s largest. Annual deficits: cash at developing nations. than 2.5 percentage points over the
(in billions) return on U.S. 10-year Treasuries. $63.94
(in billions) $317.9 (percentage point premium)
$44.08
$323.9 7.51 $60
0
$300
-$200 8.00
$40
$200
-$400 -$124.9 2.37
4.00 $20
-$600 $100
-$668.1
-$800 -$800.0 0 0 0
’96 ’98 ’00 ’02 ’04 ’051 ’96 ’051’061 12/99 ’00 ’01 ’02 ’03 ’04 12/05 1/7/05 Wed.
1 – projection 1 – projections; Source: Institute of Sources: World Bank, JPMorgan Source: Energy Information Administration
Source: Bureau of Economic Statistics International Finance

Reporting by David Lynch and George Petras, USA TODAY; graphic by Adrienne Lewis, USA TODAY

Reprinted with permission. All rights reser ved. Page 12


AS SEEN IN USA TODAY’S MONEY SECTION JANUARY 12, 2006

Politics also might complicate the economic outlook, especially How likely is such a price spike? Goldman Sachs oil analyst Arjun
in Latin America. Elections are scheduled in eight countries this Murti spooked markets in March with a forecast of a "super spike"
year, including presidential and legislative contests in Brazil and taking oil prices as high as $105 per barrel. On Dec. 12, he
Mexico. The voting takes place amid a clear drift away from the reiterated that view in a note to clients, adding that "non-existent
free-market policies favored by the United States. spare capacity" supported the prediction.

So far, little of this seems to be making an impression. "The John Kingston, global director of oil for Platts, is more optimistic.
markets seem to be pricing in close to zero probability of He expects prices to ease this year with new producing wells in
something going wrong," Barclays Capital wrote in a Dec. 8 note to the Gulf of Mexico, Russia and Nigeria boosting the market's
clients. cushion.

Energy 'super spike' Still, he frets that continued Iraqi turmoil could pinch. Daily
exports there of 1.4 million barrels remain below prewar levels,
One year ago, no one predicted twin hurricanes would wreck according to Platts. Anti-U.S. insurgents last year mounted 96
much of the U.S. Gulf Coast oil infrastructure, sparking gas attacks on the country's aging network of pipelines and
shortages and soaring pump prices. But today, with oil prices at production facilities, or one every four days. There is little reason to
about $64 per barrel, it doesn't take much imagination to conjure expect quick improvement.
up fresh scenarios of price jumps.
"The spot that concerns me the most is Iraq, and not so much
Spare oil supplies amount to 1.9 million barrels per day, down the insurgents," he says. "The oil industry there has been held
from more than 6 million a day three years ago. Any event that together by spit and bailing wire. … It's antiquated and needs
idles significant output for a prolonged period -- political turmoil in massive capital investment."
Venezuela, revolution in Saudi Arabia, a general strike in Nigeria —
would threaten the world economy. To those such as Roach, who are inclined to emphasize the risks
that things won't go exactly as expected, the links between
"With spare production capacity so low, the market is potential problems are the most worrisome element. The USA's fat
particularly vulnerable to a supply shock," the World Bank said in current account deficit could sink the dollar. As it plummets,
its 2006 economic forecast. emerging markets' exports dry up and oil prices, which are
denominated in dollars, rise. In no time, what starts as one
If oil supplies were cut by 2 million barrels per day, prices would country's difficulty becomes a global contagion.
hit $90 a barrel this year and remain at $70 next year, according to
the World Bank. The price spike would add 2.6 percentage points "This is what we signed up for when we bought into
to the inflation rate, which is 2.1% now, and cut global growth in globalization," Roach says. "The next global adjustment or
half. downturn most likely will reverberate very quickly around the
world with a speed we haven't seen before."

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CRITICAL INQUIRY

1. Based on the article Tensions push Congress to get even with China, describe China’s economic policy. Cite specific
information from the article in your explanation. Is China a threat to the USA’s economy or economic stability? Why or
why not?

2. How long do you think that the current model of low saving and high spending can continue to serve as a driving force
of the U.S. economy? How you think your generation’s spending and savings habits will affect the U.S. economy?

3. Besides the temporary measures passed in 2005 regarding repatriation of corporate profits and the slight monetary
tightening of the Fed, what tools do policymakers have at their disposal to boost the value of U.S. equities? Over what
time period are these sustainable? Which of the options are most viable?

4. Given the fact that 35% of the U.S. economy currently depends on global trade, how do you view prospects for resur-
gent protectionism? Survey your peers and ask them whether they think the U.S. economy will be more open. less
open, or be about the same as it currently is 10 years from now. Debate divergent opinions.

FUTURE IMPLICATIONS

1. Each of the articles highlights several factors that can or may contribute to the decline of the dollar. In pairs, list all the
factors you can garner from each article. Then, from your list, put an asterisk by the three factors most likely to con-
tribute to a decline in the value of the dollar. Then, put an “x” by the one factor that is least probable. Finally, write a
four-minute reflection paper explaining your top and bottom picks.

2. In groups of three or four, list some of the factors that could contribute to foreign investors’ decline in interest in U.S.
securities, and then rank them in order of importance.

3. Develop a checklist of at least 8 recommendations for U.S. policymakers seeking to shore up the U.S. savings rate.
Which of these are politically viable, and why? Which are less so, and why? In a two-minute talk, defend your top poli-
cy choice to a classmate. Then, give your classmate two-minutes to defend his/her top choice.

ADDITIONAL RESOURCES

v Institute for International Economics v USA TODAY Commodities Report


http://www.iie.com/ http://markets.usatoday.com

v Roubini Global Economics Monitor v Oil & Gas Journal


www.rgemonitor.com http://www.ogj.com/index.cfm

For more information, log on to www.usatodaycollege.com Page 14

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