Monday, October 15, 2007

Game Plan - II

As trade deficit mounts, basic economic instrument is to increase interest rates, which would promote savings and cut down on expenses/borrowings. But when dealing with USA, there has to be a different approach. Since, with rising interest rates more than Americans, who have forgotten to save and limit themselves, its Foreign govts./funds/investors coming and parking their money in the form of bonds. This temporary influx of money strengthens dollar and offsets effect of higher interest rates on borrowing. And thus the cheap foreign goods keep flowing in. Over the years, virtually strong dollar has had its toll on the country's manufacturing and service industry.

Hence this time, despite of mounting trade deficit, the US govt. decided to lower the central bank rates and encouraged weakening of dollar. And now we are seeing a cascading effect on breaking dollar. Financial institutions/funds and govts., in order to take the advantage of strong third world currencies, are now parking their money in the emerging markets, thereby taking advantage of currency rates along with growth. US govt. feel that breaking dollar will make indigenous products competitive in foreign and domestic markets. Thereby, giving push to exports and discouraging imports.

But how far this plan would succeed, I have my reservations. Since, US producers will not enjoy the discount on expensive raw materials, which their counterparts would, on account of stronger paper. Weak currency will also reduce buying power of their population in general. Though it may help bridge some trade gap (more on the demand side) but its toll on moral of the common man is to be seen/analysed.

I believe, it calls for a great deal of character and discipline on part of each unit of the population of a country going through such lean and mean phase. The USA will need a Team of Ramboes to help good old, fragile and pale uncle Sam to get back on to his legs. As for emerging economies, these are the testing times. Investment flowing in today is definitely going to move out in search of Greener pasture one day. Hope these neo ant-hills keep something for the rainy days, a Game Plan -II.