PostHeaderIcon Trade Deficit - Reason For The Present Global Economic Crisis

Susmit Kumar, Ph.D.

One common factor for all Western countries in crisis is that they had significant trade deficits during the last ten years. These countries have two type of deficits - budget and trade deficits. Until 6-7 years ago, all Euro countries had similar budget deficits. But in last 6-7 years, the countries in crisis are facing trade deficits as well as significant budget deficits. Domestic and foreign banks operating in these countries invested heavily in non-productive sectors. These banks invest to get maximum return and get it in risky markets -- trading, finance, and real estate. Following such types of investments the economies of these countries boomed, keeping budget deficits in check. After the 2008 Great Recession nearly all the Western countries suffered from the effects of the collapse in real estate which caused an increase in budget deficits, but the countries in crisis (for an example, US and PIIGS in Europe) are affected the most (due to losses of jobs and of revenue collection). Due to pressure from the IMF, countries are now being forced to pay foreign investors who made loans to private sector operators and this is causing a further increase in budget deficits.


Although India never had the problem of budget deficit, it has been devaluating its currency at the rate of 10 percent over the last 20 years in order to pay for its trade deficits. Last year the Indian rupee depreciated nearly 20 percent. Like all other countries, except the US, India is not in a position to print its currency to fund its trade deficit. The US on the other hand, taking advantage of its currency being the global currency, has printed its currency for the last 30 years to fund its budget and trade deficits. Despite generating significant trade deficits the US has seen its dollar go up against all currencies, except against Chinese and Western currencies. Had the US dollar not been the global currency, the US economy would have faced the current economic crisis 20 years ago resulting in a crash of the US dollar.

The present economic crises in the Western countries is mainly due to flight of jobs overseas -- "outsourcing". One important difference between the European countries not in crisis (like Germany, Finland etc.) and those in crisis is that the latter are plagued by significant trade deficits for last several years whereas the former do not have significant trade deficits.

Until 4-5 years ago both categories of countries had similar budget deficits but the crisis group had significant trade deficits as well which the second group did not have. Now the effect of trade deficits has spilled into higher budget deficits in the first group. India never had budget deficit problem but its ongoing currency crash results in inflation causing an increase in both trade and budget deficits. India imports nearly 75% of its petrol consumption. Hence an escalating crash of the Indian currency will cause petrol price to skyrocket, resulting in an avalanche of price rises accross the consumer board due to higher transportation costs.

If and when Greece gets out of the Euro it will have to devalue its new currency drastically in order to pay for the debts, which will result in inflation.


Wednesday, 27 August 2014
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