The balance of trade, not payments, is true measure of a deficit’s effects

Copyright 2005 The Financial Times Limited (London, England)
Wednesday, February 15, 2006; Financial Times; USA Edition; Letters to the Editor

Sir, Balance of payments deficits often cause concern because they may result in financing difficulties and, possibly, a disorderly depreciation of the currency.

The U.K. payments deficit would seem to be too small, at present, to worry about. But it is the balance of trade, not payments, that measures the direct effect of a deficit on the demand for domestically produced goods and services.

The trade deficit of the US is now about 6.5 per cent of gross domestic product while that of the U.K. is about 4.5 per cent. In both countries domestic demand in total has so far been held up by budget deficits as well as by personal expenditure (on consumption and investment combined) far in excess of disposable income, and this has perforce been financed by unusually high borrowing leading to rapidly rising personal indebtedness.

In other words, the growing subtractions from demand caused by trade deficits, which now seem to be structural, have so far been made good by injections of demand which are essentially temporary.

The unusual size of the deficits, both in the US and in the U.K., has introduced a novel element into economic prospects viewed strategically because if (or when) personal borrowing and expenditure slows down, neither government has any obvious politically feasible policy instrument to avert a prolonged deficiency in total demand.

Cuts in interest rates might conceivably reignite the housing booms for a time but could not provide permanent motors for growth.

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