Meeting Asia's demandHONG KONG The theory of the Federal Reserve chairman, Ben Bernanke, that excess savings by Asians is a major cause of the monstrous U.S. trade deficit will be sorely tested in 2006 - and most likely found wanting.
The key test will be provided by Japan, where even skeptics mostly now agree that domestic demand will continue to rise. The recent announcement of a 5.5 percent fourth-quarter growth does not look like a fluke. Consumer sentiment is rising and wages are likely to get a boost that reflects big gains in productivity and in returns on capital employed.
The 3.5 percent growth in gross domestic product that Japan can expect this year may not seem startling but it will add as much as China's 8 percent growth to global demand. It will also probably shrink Japan's current account surplus - the outward sign of "excess savings" - to a modest 2.5 percent of GDP. That is good for the world and Asia in particular. But will it solve the U.S. deficit?
According to the Bernanke theory, Asian demand should help feed a big drop in the U.S. current account deficit, now nearing 7 percent of GDP. But the evidence of recent years suggests big hurdles. Japan's economy has in fact become increasingly open, as low-price consumer imports have replaced local products. But the gains have been largely achieved by Asian neighbors, particularly China, whose import share is now 22 percent.
The U.S. share of Japanese imports has halved to 13 percent since 1999. Of these, about 20 percent are food and agricultural products with low growth potential. What U.S. products could reverse this trend and close a two-to-one imbalance in Japan's favor as Japan saves less and imports more?
Bernanke may seem to have a stronger case with China, whose current account surplus doubled last year to $125 billion. It does have excess savings - 40 percent of GDP. But China's problem is not so much the low investment of which Bernanke complains but too much investment and too little consumption.
There is much that China could and should do via fiscal policy and the exchange rate to change its growth mix toward consumer demand. But such measures seem likely to have as great an impact on China's demand for raw materials and semimanufactured goods as on imports from the United States. These have been rising faster than its exports in percentage terms, but as they only one fifth of U.S. imports from China, the dollar gap continues to widen.
Among the medium-sized Asian economies there are limited signs of savings excess. Current account surpluses are around 2 percent of GDP for South Korea and Taiwan, while Thailand is only now coming back into balance after a year of deficit. Only oil-rich Malaysia and the city economies of Hong Kong and Singapore have excess savings on a noteworthy scale. All these Asian economies are showing modest to strong growth but little of their rising import demand is being directed at the United States.
As for India, its savings rate is modest by Asian standards and its GDP growth rate is already stretching its current account deficit to levels that may not be sustainable if international liquidity becomes less abundant.
In sum, a 2006 of buoyant Asian import demand growth looks set to do very little to reduce U.S. borrowing requirements. Bernanke's theory had always seemed dubious in Asia, given that the dollar's reserve currency position provides the United States with a mechanism for creating international credit and that other countries have few alternatives to absorbing the deluge of greenbacks the Fed creates, which become their "savings."
More relevant to the U.S. deficit is the level of the Chinese yuan, of which Bernanke complained in recent testimony. But blaming China for its currency policy makes no sense in isolation. It is just part of the undervaluation of the interlinked East Asian currencies. South Korea's is the only one to have seen a significant rise against the dollar.
If they all rise by 25 percent - probably the minimum required to make much difference to trade - the first effect will be a further rise in the U.S. deficit as cheaper sources of supply are hard to find. Only when steeply rising prices of imported goods slash consumer demand will the deficit retreat to a sustainable level.
Forget stories of Asian excess savings. The only way out of the U.S. external bind lies in some mix of three ingredients: major devaluation against Asian currencies, consumer retrenchment and lower energy prices. Watch this space.