USA TODAY Collegiate Case Study: Global Economics

8/9/2019 USA TODAY Collegiate Case Study: Global Economics

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Collegiate

Case

Study

THE NATIONS NEWSPAPER

How can U.S. stay on top ofthe world?By Antoine van Agtmael

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Some would like to build awall around U.S. economyBy David J. Lynch

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World economy expanding, butfaces dangerous balancing actBy David J. Lynch

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Critical inquiryDiscussion and future implications

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www.usatodaycollege.com

Copyright 2007 USA TODAY, a division of Gannett Co., Inc. All rights reserved.

Japan

China

India

Russia

UnitedKingdom

U.K. considered the top economic allyWhich country will have the most positiveeffect on the future of the U.S. economy?

USA TODAY Snapshots

Note: Multiple responses allowed.

By Jae Yang and Karl Gelles, USA TODAY

47%

40%

29%

23%

15%

13%

EuropeanUnion

Source: Harris Interactive online survey of 1,833 adults age 18 and older.Margin of error: 2 percentage points.

As the U.S. and global economies continue to grow at strong rates, economists andfinancial analysts are increasingly concerned about a number of underlying factorsthat could pose substantial risk to the global economy. The U.S. current deficit hasset 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, butnot at high enough levels to finance deficits indefinitely. Resurgent protectionismand job insecurity coupled with instability in emerging and energy markets createadditional potential to undermine global economic growth. This case study

explores the financial and monetary policy causes and effects of recent global eco-nomic trends and examines prospects for ongoing stability.

Global Economics

Tensions push Congressto get even with China

Trade imbalance keeps

growing, so lawmakersare getting in on the fight

By David J. LynchUSA TODAY

After years of inconclusiveskirmishing, trade tensionsbetween the United States andChina are about to intensify. Theescalation comes as bothcountries' domestic politicalcalendars are complicatingprospects for the compromisesneeded to call off this high-stakesgame of financial chicken.

On Capitol Hill, lawmakers fromboth parties are drafting

legislation designed to punishChina for trade practices they sayviolate the Asian giant'sinternational commitments andleave American companies at aprofound competitivedisadvantage. A bilateral tradedeficit that yawns wider withevery year is fueling the push foraction. By Bob Laird, USATODAY


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Reprinted with permission. All rights reserved.

exporters with generous subsidies. On the eve of high-leveltalks in Washington last month, China announced it would

begin allowing the yuan to fluctuate more on a daily basis, thelatest sign of its gradual move toward allowing the market todetermine the currency's value. But lawmakers such as Sen.Charles Schumer, D-N.Y., one of the authors of the forthcomingSenate bill, derided the move as too little, too late.

The Chinese currency remains as much as 40% below its fairmarket value, says economist Morris Goldstein of the PetersonInstitute for International Economics in Washington. Chineseexporters, many partially owned by the government, alsoenjoy a range of benefits, including financing by state banks.

Treasury Secretary Henry Paulson, however, says theunbalanced Sino-U.S. trade is not a result of Chinese cheating.

Real improvement in the trade statistics depends upon ongoing"structural" reforms to reduce China's reliance upon exportsand increase consumption by Chinese consumers, he says. Theadministration opposes legislation designed to crack down onChina. But lawmakers hope to assemble a veto-proof majority.

U.S. firms in a bind

In markets from apparel to electronics, American companiesthat compete with Chinese rivals are struggling to keep pace. InCary, Ill., northwest of Chicago, Bartlett Manufacturing has seensales of its printed circuit boards sag from $20million in 1999 toabout $9million today, according to Douglas Bartlett, thecompany chairman.

Bartlett, 50, says longtime customers tell him they can buyChinese circuit boards for a fraction of his price, often for nomore than the cost of materials. Example: Bartlett sells a circuitboard used in the turn signal on a Japanese car for 39 centseach. He's about to lose an order to a Chinese maker that sellsthe same product for 20 cents.

"That's not (because of) labor prices alone. It's currency andexport subsidies. It's not free trade now; it's unfair trade,"Bartlett says.

Manufacturers have been airing similar complaints for years.But they've been getting a more sympathetic hearing since

November, when Democrats took control of Congress.Chinese officials felt the new mood last month during

meetings timed to coincide with the Cabinet-level StrategicEconomic Dialogue held in Washington. The unusual CapitolHill sessions, which brought together Chinese Vice Premier WuYi and key lawmakers, was aimed at promoting mutualunderstanding. But at least in Levin's case, the meetingappeared to do just the opposite.

In an interview, Levin said Wu described the U.S. and Chineseeconomies as "complementary," saying China shipped shoes

and clothing to the USA while American companies sent high-tech products to China.

But citing Census Bureau data showing the U.S. running adeficit even in trade of advanced technology goods, Levindisagreed.

"That's just not true," said Levin. "What she said is justwrong."

Indeed, through April, the USA imported $20.5 billion morein high-tech products from China than it shipped there.

A complex relationship

But reflecting the complexity of the Sino-U.S. traderelationship, of the 10 categories of high-tech products tracked

by the Census Bureau, the USA enjoys a trade surplus withChina in eight. The two categories that account for the overallhigh-tech deficit are mostly consumer electronics, largelylaptop computers, DVD players and CD players. And more than90% of those products are produced not by domestic Chinesecompanies but in the factories of multinational corporations inChina, according to Nicholas L ardy, a Peterson Institutespecialist on the Chinese economy.

The prominent role of multinationals in exports from China isone indication of the difficulty of fashioning effective tradesanctions. Some products that appear in trade accounts as"Chinese" emerge from factories owned by Taiwanese,

Japanese or even U.S. corporations.

Another question is how China will react when the U.S. acts.Like the U.S., China is in the midst of an intensely politicalseason. This fall, a critical Communist Party Congress, whichoccurs only every five years and determines the individualcareer prospects of thousands of officials, is scheduled forBeijing. Party officials at all levels typically are preoccupiedwith internal jockeying for influence for months before suchconclaves. This year, such concerns are especially intensebecause the eventual successor to Party General Secretary Hu

Our companies do not want to see a tradewar with the Chinese. Our companies want toexpand trade relations. Its a very, very goodmarket for the U.S.

Cal Cohen, president of the Emergency Committeefor American Trade


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Jintao is expected to be determined, potentially reshuffling thelandscape of Chinese politics.

"Domestic issues trump international issues in every politicalsystem in the world, and China's no exception," says SusanShirk, author of China: Fragile Superpower.

Shirk, a former National Security Council aide during theClinton administration, says the Chinese government is dividedbetween those who want to continue integrating China into theglobal economy and economic nationalists who favorcultivating home-grown commercial stars while curbinginternational ties. In the run-up to the party congress, officialswill be enormously reluctant to offer the sort of concessions tothe U.S. that could defuse trade tensions.

"It's not a time for bold initiatives," she says.

Still, if there's to be a trade war, it will be a slow-motionconflict. The measures now under consideration, designed tocomply with World Trade Organization rules, would expand theremedies U.S. companies affected by Chinese competition couldseek, says Bill Reinsch, president of the National Foreign TradeCouncil, a business lobbying group. But even if Congress acts,duties wouldn't automatically be applied. Individual U.S.industries or companies would first have to petition the

Commerce Department, triggering an administrative processthat can take over a year before duties are imposed.

In only about half the cases does the department find thatunfair foreign competition injured the complaining Americanindustry, a necessary judgment for duties to be approved, saysReinsch, an ex-Commerce official. "At the end of the day, thenumber of Chinese producers affected by what we do is a lotsmaller than you'd think."

Nonetheless, if Congress passes, and the president signslegislation opening the door to duties on Chinese importsChina will respond, Shirk says. Beijing could impose tariffs onU.S. products, restrict additional foreign investmentopportunities, or purchase fewer dollars and more euros or yen,says Morgan Stanley's Roach.

On Capitol Hill, meanwhile, China's critics are out of patience.Levin makes it clear he doesn't take seriously the notion thatdomestic Chinese politics might limit Beijing's freedom tomaneuver and he waves away "trade war" talk.

"I hate the term 'trade war' because it's always used whenyou try to get a fair break. ... People don't like it when you pushback," he says. "Sometimes pressure works."


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By Antoine Van Agtmael

South Korean car maker Hyundai recently had to deny

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

Hyundai is just one of the many profitable firms in emergingmarkets that produce just about everything consumersconsume. Within hours of Apple CEO Steve Jobs' recentunveiling of the stylish new iPhone, shares in Taiwaneseelectronics giant Hon Hai Precision Industry shot up. Foundedin 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'snew iPhone. Other examples can be found everywhere.

While our attention was focused on the "new economy" afew years ago, "new economies" quietly stole the show. We arein the midst of the greatest shift in the global economy sincethe Industrial Revolution. This time, the economic epicenter isshifting away from the developed world to emerging marketsin Asia, Eastern Europe, the Middle East and Latin America.

Market scare

Sharp moves in the Dow Jones used to scare or exhilarateinvestors worldwide. Last week's 416-point drop in the U.S.

stock market, together with a sudden reversal in marketsaround the globe, was the first time that a sell-off in Chinatriggered such a major loss in market values one that was farlarger than the entire Chinese market. It was not only anoverdue reminder that investors get scared from time to time usually after periods of over-enthusiasm but alsodemonstrated the dramatic and growing impact of what I callthe "Emerging Markets Century."

What are we in the USA and the rest of the developed worldto make of the fact that so much of what we consume is

produced in the former Third World? One thing is that America

(but also Europe and Japan) will need to get used to the ideathat we are no longer the center of the economic and politicaluniverse. Even more important, we should resist the knee-jerkreaction of protectionism that would likely stifle innovation.

Yet, in the USA, we have been slow to accept this new reality.Countries such as Mexico, South Korea and Russia are no longerbasket cases in need of rescue. Emerging markets now ownthree-quarters of the world's foreign exchange reserves, andtheir purchases influence U.S. mortgage rates. The brain drain isreversing just as budget and current account deficits (the

We're no longer the economic center of theuniverse, as the global landscape has shiftedto former Third World countries. What todo? Remain competitive through innovation,not protectionism.

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

By Web Bryant, USA TODAY


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broadest measure of a nation's trade gap) have crossed overinto the developed world.

The world is not flat; it is tilting, with the USA rapidly movingfrom unquestioned dominance to greater dependence. Andthis is only the beginning. Twenty-five years from now,emerging markets will make up more than half of the globaleconomy (up from 21% today) as the General Electrics andMicrosofts of the future will increasingly hail from these neweconomies.

More than ever, the global economy is not a zero-sum game.More handsets, refrigerators and beer are sold in emergingmarkets than in mature markets. U.S. exports to emergingmarkets have increased 338% over the past 20 years, muchfaster than domestic demand. One billion new consumers and

investors will turn many emerging markets into middle-classeconomies. Smart American corporations are already seekingtheir growth in emerging markets. GE plans to double its salesin emerging markets from 15% to 30% by 2010. Goldman Sachsbuilt an important franchise in China. Dell and GM increasinglyproduce in India and China for the local markets.

Maintaining our edge

But that is clearly not enough to keep our competitive edge.Many more corporations should develop a clear emerging-markets strategy, embed their young managers with localfamilies (as Procter & Gamble already does), build crucial localrelationships, establish international focus groups to tailorproducts to local tastes, and form business alliances with this

new breed of companies. And our universities should focusmore on creative problem solving and integrate study and work

experience abroad if we want students to be comfortable withforeign languages and cultures.

When we look at history, a creative response has oftensucceeded where protectionism has failed. President Kennedy'sinspiring call to put a man on the moon when Russia seemed tobe "winning" provided the United States decades oftechnological superiority. Today, leading U.S. universities remainthe best, while creative companies such as Google and Appleare more than competitive.

As a nation, we need a "National Competitiveness" campaignthat sets ambitious goals such as developing a successor to theinternal-combustion engine, but also tackles legacy issues (high

cost of health and pension benefits for current, older andretired workers), places more emphasis on creativity ineducation and gives infrastructure a much-needed face lift. Thechoice between protectionism and a creative response to thetectonic shift in the global economy (and global power) couldwell become one of the key issues in the next presidentialcampaign. Instead of complaining and agonizing about this newcompetitive threat, our focus should be on turning it into anexciting opportunity.

Antoine van Agtmael is chairman and CEO of EmergingMarkets Management, LLC. He recently published Th eEmerging Markets Century: How A New Breed of World-ClassCompanies is Overtaking the World.


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AS SEEN IN USA TODAYS MONEY SECTION, MARCH 15, 2006

By David J. LynchUSA TODAY

Can the United States run a war and an open economy at thesame time?

In the wake of the Dubai ports imbroglio, some lawmakersare saying the U.S. needs to rethink its openness. Rep. DuncanHunter, R-Calif., chairman of the House Armed ServicesCommittee, for example, is demanding that all of the USA's"critical infrastructure" be owned and managed by Americancitizens.

While there is no across-the-board move to erect wallsaround the U.S. economy yet, some analysts worry that thecombination of national security and industry-specificeconomic fears could spiral.

Hunter's legislation would require foreign companies thatown anything deemed "critical" to national security, economicsecurity or public health to sell within five years. Sen. Charles

Schumer, D-N.Y., reacting to the surging U.S. trade deficit, hasproposed imposing a blanket 27.5% tariff on Chinese imports ifBeijing doesn't allow its currency to appreciate.

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

A combustible mix of security and economic dangers has leftAmericans increasingly unsettled about their engagement withthe rest of the world. Color-coded terror alerts and thepersistence of the global al-Qaeda network mean danger is afact of daily life. Compounding public unease is the relentlesseconomic rise of China and India, which seems to imperil manyAmericans' financial futures.

From 1994 until last year, a solid plurality of Americans sawforeign trade as an opportunity rather than a threat, accordingto USA TODAY polling. In May 2000, for example, trade wasbacked 56% to 36%. But in a June 2005 survey, by a 48% to 44%margin, more respondents judged it a threat.

"Globalization creates vulnerabilities. There's no questionabout it," says Mira Wilkins, an expert on foreign investment atFlorida International University in Miami.

The USA isn't alone in getting cold feet over globalizationEurope, too, is witnessing a renewed concern. In France, Spainand Poland, governments are blocking foreign firms fromacquiring companies even in seemingly benign consumerindustries.

Global ties grow

If the concerns suddenly seem acute, it may be because inrecent years the globalization era that began with the collapseof communism in 1989 has intensified dramatically. Example:Cross-border mergers and acquisitions totaled a staggering $3.2

Protectionism makes abig comeback groundedin growing fear, distrust

By Sam Ward and Julie Snider, USA TODAY

Some would like to build a wallaround U.S. economy


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Page 8Reprinted with permission. All rights reserved.


trillion last year, almost three times the level just five yearsearlier, according to the Bank for International Settlements inBasel, Switzerland.

The U.S. certainly is much more intertwined with othereconomies than ever. In 1971, when President Nixon cut thelink between the dollar and gold, U.S. imports were equivalentto 5.5% of the economy. Last year, they hit 16.2%.

The furor over the DP World ports takeover may havesurprised the White House. But it didn't come out of nowhere.Last summer, it took enormous political arm-twisting to get avery modest Central American trade deal through Congress.Then, in the fall, a Chinese enterprise was forced to abandon itsplanned acquisition of Unocal, a second-tier American oilcompany, after Congress heatedly objected. And now an Arabfirm has been told it can't be trusted to operate cargo terminalsat American ports.

"I think we're riding a wave of xenophobia," says WilliamReinsch, president of the National Foreign Trade Council, a pro-trade group.

Still, the reaction to date against foreign investment whether for national security or economic reasons has beenlimited. Both the ports controversy and last year's Unocal dust-up involved foreign companies that were government-controlled. Moves to limit Chinese imports have been confinedto specific industries, notably textiles and apparel.

"It's not competitive concerns like the 1980s. GM and Fordare in rough shape, but there's not much sympathy for helpingthem" with import limits, says Todd Malan, president of theOrganization for International Investment.

The ports furor catalyzed the debate over security andglobalization, though the immediate prospect of an Arabcompany operating terminals at several U.S. ports appears tohave faded. On March 9, Dubai Ports World announced itwould spin off its newly acquired American operations so longas it could do so without losing money.

More complicated times

This isn't the first time the U.S. has faced the issue. An earlierage of global economic integration in the decades before WorldWar I ended with the guns of August 1914. After the war, traderecovered in fits and starts. But then the 1930 Smoot-HawleyTariff triggered a protectionist frenzy that by 1934 had slashedinternational trade by two-thirds.

During the Cold War, the relationship between nationalsecurity and commerce seemed clear. Buttressing theeconomies of Western Europe helped knit together an anti-Soviet alliance. There was no question about who the enemywas and no question of trading with him. Today, life isn't sosimple. Instead of a government like the Soviet Union, theenemy in the war on terror is a stateless network of Islamic

extremists.

"We're now in an era where the national security interests ofthe United States are a lot more ambiguous, and there's moredisagreement about them," says Jeffry Frieden of HarvardUniversity. "Even if there's agreement on fighting terrorism, it'snot clear what the economic implications of that are."

Those who argue for changing the rules of the game targetthe inter-agency Committee on Foreign Investment in theUnited States (CFIUS), which approved the ill-fated ports deal

International tradeThe U.S. economy has become more dependent on foreign trade over the past 35 years. Imports as percentage of GDP:

By Marcy E. Mullins, USA TODAY

Source: Bureau of Economic Analysis

1970 2005

16%

14%

12%

10%

8%

6%

4%

2%

0

5.4%

16.2%

1980 1990 2000


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Page 9Reprinted with permission. All rights reserved.


The committee gathers representatives of 12 agencies tobalance foreign investments' gains against potential security

threats.

Hunter, who helped kill the ports deal, wants to tighten thegovernment's method of reviewing proposed foreignacquisitions of U.S. companies. Currently, "Economic orcommercial implications apparently supersede nationalsecurity considerations," the lawmaker wrote in a March 6letter to colleagues.

A Government Accountability Office investigation last yearalso concluded that the panel "narrowly defines whatconstitutes a threat to national security." Since 1988, CFIUS hasrejected only one of more than 1,500 proposed foreignacquisitions of U.S. companies: China National Aero-Technology

Import & Export's 1990 attempt to acquire a Seattle aircraftparts maker.

Among those approved was a deal that left another Chinesefirm producing 80% of the magnets used in the Pentagon's"smart bombs," according to Sen. Evan Bayh, D-Ind.

If any security worries are found in the panel's standard 30-day review, an additional 45-day probe can be launched. Butthe GAO report said that the committee, which is chaired bythe Treasury Department, is reluctant to order suchinvestigations for fear of discouraging foreign investment. Of470 proposed deals from 1997 to 2004, CFIUS initiated onlyeight investigations, the report said.

Hunter's proposed legislation would mandate 45-day probesfor "transactions that may have national security implications."Treasury Secretary John Snow on Tuesday backed increasedscrutiny for deals involving state-owned foreign companies butwarned against "isolationist" moves.

Others say the criticisms are overstated. Phillip Swagel, whowas chief of staff for the White House Council of EconomicAdvisers in President Bush's first term, says the Pentagonrepresentatives on the panel had a myopic focus on security."They just didn't understand the value of foreign investment inthe United States," says Swagel, now a fellow at the AmericanEnterprise Institute. "They'd rather foreigners not be hereat all."

Edward Graham of the Institute for International Economics,author of a forthcoming book on national security and foreign

investment, says CFIUS has been more effective than thestatistics suggest. Although the panel formally rejected onlyone deal, it effectively blocked 20 others, he says. Many otherswere modified by compelling the foreign acquirer to acceptchanges in how it would operate the American asset.

"What major security failure has happened in the U.S.? Nonethat we know of," Graham says.

U.S. dependent on foreign investment

As Congress rethinks foreign investment, Clyde Prestowitzpresident of the Economic Strategy Institute, thinks the newfocus on security ignores the U.S. economy's dependence upon

foreign investment. The USA requires about $3 billion in foreigncapital every working day to finance the huge gap between itsconsumption of foreign goods and its exports. The country justdoesn't have the luxury of walling itself off, Prestowitz says:"We're shooting ourselves in the foot here. People don't realizethis, but our economy is on life support from foreign lendersand investors."

Questions over foreign investment aren't going away. Nextmonth, Chinese President Hu Jintao is scheduled to meet withPresident Bush at the White House even as the TreasuryDepartment nears a decision on formally stating that Chinamanipulates its currency for trade advantage.

Likewise, thanks to high oil prices, the Dubai Ports deal won'tbe the last Arab investment here. Since 1998, members of theOPEC oil cartel have earned $1.3 trillion in petrodollarsaccording to the Bank for International Settlements. Much of itis staying home, helping fuel enormous increases in regionalstock markets. But tens of billions of petrodollars have surgedinto U.S. corporate bonds, equities and direct investment. Andmore are probably coming.

"Foreigners have a whole pile of dollars," says Reinsch. "Idon't know what we expect them to do with them."


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AS SEEN IN USA TODAYS MONEY SECTION JANUARY 12, 2006

Reprinted with permission. All rights reserved. Page 10

World economy expanding, butfaces dangerous balancing act

By David J. Lynch

USA TODAY

If things go according to plan, theworld economy will chug alongnicely through the new year.

That would be comforting news ifthings ever did go according to plan.

Actually, 2006 could see plenty ofnasty surprises. For one thing, theworld economy, though expanding, isdangerously imbalanced. Theresulting U.S. current account deficit

reflecting the gap between thenation's ravenous appetite forimports and its anemic savings isnow at levels that many experts fearcould trigger a run on the dollar,soaring interest rates and globaleconomic pain.

Meanwhile, investment is pouringinto risky emerging markets as if thepast decade's turmoil in Argentina,Turkey, Thailand and Russia neverhappened.

And all that stands between abarrel of oil and a triple-digit price tag is astrike in Nigeria, unrest in Venezuela orrevolution in Saudi Arabia.

For all that, both the InternationalMonetary Fund and the World Bankexpect solid global growth of 3.2% this year,about the same as in 2005.

If prognosticators seem sanguine,perhaps it's because many of the samewarning signals flashed red one year ago,and yet, the economy still barreled ahead,even overcoming epic natural disasters.

"2005 was a year that has lulled a lot ofinvestors, policymakers and governmentofficials into a dangerous and false sense ofcomplacency," says Stephen Roach, chief

economist for Morgan Stanleyin New York.

Terror attacks. A trade warwith China. Even a historicepidemic of potentially lethal

"bird flu." There's no end to thelist of potential economiccatastrophes that could arisethis year.

But three dangers mushrooming globalimbalances, vulnerableemerging markets and volatileoil prices seem especiallynoteworthy.

Too much red ink

To many economists, theswollen U.S. current accountdeficit looms as the biggestpotential hazard. In a nutshellthe United States spends toomuch and saves too little, andAsia saves too much andspends too little. (MoribundEurope doesn't do enough ofeither.)

No one knows for certainwhen the day of reckoning willcome. But Roach, and manyothers, say the USA and the

world cannot go on like this indefinitely.

"There are significant downside risks tothe global economy financial marketsright now are not pricing in any of theserisks," warns Nouriel Roubini, a formerWhite House economist in the Clintonadministration who runs the influentialwww.rgemonitor.com website.

Healthy growth forecasthe global economy looks set to continue expanding in

2006. Will it? Percentage change from previous year in realDP global growth:

Source: Worl d B ank By S am Ward a nd J uli e S ni der, USA TODAY

3.4% 3.5%

2.1%

3.0%

4.0%

1.4%1.7%

2.5%

3.8%

3.2%

3.2%

1996 1997 1998 1999 2000 2001 2002 2003 2004 20051 20061

1 Projection

Vulnerable emergingmarkets, volatile oilprices bear watching


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Last year, the U.S. financed its excessive spending by sellingalmost $800 billion worth of Treasury securities to foreign central

banks and investors.

At 6.4% of total economic output, that's an unprecedented levelfor a major economy. The U.S. is able to get away with suchprofligacy largely because the dollar plays a uniquely central role inglobal commerce.

But here's how a crisis could unfold: If foreigners conclude thedollar was headed for a fall because of the enormous U.S. deficit,they would cut back on purchases of U.S. debt. To entice them tobuy, the Federal Reserve would have to raise interest rates, perhapssignificantly. Higher interest rates could choke off economicgrowth, even as the falling dollar ignited inflation by boosting theprices of imported goods.

In 2005, the dollar defied predictions of an inevitable decline. Butit is unlikely to keep doing so, according to Roubini.

The greenback benefited last year from a one-time change in U.S.tax law that encouraged companies to repatriate foreign profitsand from the Fed's rate increases.

The tax provision has expired, and the Fed is believed to be nearthe end of its monetary tightening.

"Our ability to finance ourselves depends upon the willingness offoreign central banks to hold dollars. That willingness is going to beshrinking (this) year," Roubini says.

Even under optimistic assumptions, once the crisis hits, theeconomic pain in the USA could be like nothing the country hassuffered in decades.

An abrupt end to the USA's ability to obtain sufficient foreignfinancing could send the dollar into free fall, cutting 21% to 28%from its value, according to research by Sebastian Edwards, aprofessor at UCLA's Anderson School of Management. That wouldincrease the price of a $21,000 foreign-made sedan to almost$27,000, unless dealers opted to absorb the blow.

In the first year, 3.6% to 5% would be slashed from per capitaeconomic growth. That would almost certainly push the USA intorecession, perhaps for several years, according to Edwards, whopresented his findings at last summer's annual Federal Reserveconference in Jackson Hole, Wyo.

"Never in the history of modern economics has a large industrialcountry run persistent current account deficits of the magnitudeposted by the U.S. since 2000."

Emerging market risks

Another danger might be brewing in the so-called emergingmarkets. Capital flows this year into developing nations in LatinAmerica, Asia and Central Europe are expected to hit a record$345.2 billion, according to the Institute of International Finance.That surpasses the previous high set in 1996, just before the Asianfinancial crisis, and is up 62% in the past two years.

Emerging markets enthusiasts shrug off reminders of theeuphoria-and-collapse cycles that hit Thailand in 1997, Russia in1998, and Argentina in 2000. It's different this time, say firms suchas JPMorgan. Countries, particularly in Latin America, have built upforeign-exchange reserves that should allow them to ride out anyfinancial crisis and have introduced economic reforms that givetheir economies greater stability. Rather than depend on private

capital flows from rich countries as they did in the 1990s,developing nations now rely on strong export industries.

Bond hoders are so impressed that they regard emerging marketsecurities as little riskier than U.S. Treasuries, according to the

JPMorgan Emerging Markets Bond Index Global (EMBIG). In late2002, investors demanded an additional 91/2 percentage points ofyield as compensation for the risk involved in holding emergingmarkets bonds compared with U.S. Treasuries. Today, the spread onthe EMBIG is down to little more than 2 percentage points.

But emerging markets also have had the economic winds at theirback for the past couple of years. Strong global demand boostedcommodity prices, a major help for soybean exporters such as

Argentina and oil producers such as Venezuela. And U.S. interestrates were so low, yield-hungry investors including normallycautious pension funds were drawn into countries such as Brazior Hungary.

Now, global growth is slowing, and U.S. rates are higher. "There'sa lot to worry about," says Desmond Lachman of the AmericanEnterprise Institute, who was among the first to warn of problemsin Argentina before its historic default.

While no one is predicting a repeat of the problems that rockedhalf a dozen countries in the 1990s, emerging markets remainvulnerable to sharp changes in the global environment. If the dollartanks, their surging exports would stall. Higher oil prices could dealthem a double whammy, inflating their energy costs whiledepressing the economies of major customers.

Any unexpected mishap could cause the spreads betweenemerging market debt and U.S. securities to balloon, making itmore expensive for corporations in developing countries to financetheir operations, Lachman says.


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USA: Unprecedentedcurrent account deficitthreatens financialmeltdown.

Venezuela:Charismaticleftist leader fomentinganti-American alliance.

Saudi Arabia:Al-Qaeda wouldlove to disruptthe kingdoms oilindustry.

China: Epidemic oflocalized protests couldget out of hand or escalatetrade tensions with USA.

Hungary: Runawayfinances suggest thisemerging marketcould stumble.

Brazil: One of nineLatin Americancountries scheduledto hold elections,unsettling markets.

EuropeanUnion: Little signthat sluggisheconomies aregetting in gear.

U.S. current account deficit deepens

The U.S. current account deficit, reflectingthe nations reliance upon foreign bor-rowing to finance todays consumption,is now historys largest. Annual deficits:

96 98 00 02 051

(in billions)

0

-$200

-$400

-$600

-$800

04

Trouble spots could derail global economy gainsThough the outlook is good, it isnt hard to imagine what could go wrong.

Oil prices rise

With little spare capacity, oil pricescould continue their climb. In dol-lars per barrel:

$63.94

Source: Energy Information Administration

$44.08

0

$20

$40

$60

Wed.1/7/05

Capital flows to emerging markets

Shrugging off memories of recent cri-ses in Asia, Latin America and Russia,yield-hungry investors are shovelingcash at developing nations.(in billions)

$317.9

$100

$200

$300

0

96 061051

$323.9

1 projections; Source: Institute ofInternational Finance

(percentage point premium)

Sources: World Bank, JPMorgan

Emerging market spread

Bond holders are now asking only asmall premium to buy securities fromdeveloping nations. The spread is lessthan 2.5 percentage points over thereturn on U.S. 10-year Treasuries.

12/0512/99 00 01 02 03 04

7.51

2.37

0

4.00

8.00

-$124.9

-$800.0

Source: Bureau of Economic Statistics

1 projection

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

-$668.1


13/14



Politics also might complicate the economic outlook, especiallyin Latin America. Elections are scheduled in eight countries this

year, including presidential and legislative contests in Brazil andMexico. The voting takes place amid a clear drift away from thefree-market policies favored by the United States.

So far, little of this seems to be making an impression. "Themarkets seem to be pricing in close to zero probability ofsomething going wrong," Barclays Capital wrote in a Dec. 8 note toclients.

Energy 'super spike'

One year ago, no one predicted twin hurricanes would wreckmuch of the U.S. Gulf Coast oil infrastructure, sparking gasshortages and soaring pump prices. But today, with oil prices at

about $64 per barrel, it doesn't take much imagination to conjureup fresh scenarios of price jumps.

Spare oil supplies amount to 1.9 million barrels per day, downfrom more than 6 million a day three years ago. Any event thatidles significant output for a prolonged period -- political turmoil inVenezuela, revolution in Saudi Arabia, a general strike in Nigeria would threaten the world economy.

"With spare production capacity so low, the market isparticularly vulnerable to a supply shock," the World Bank said inits 2006 economic forecast.

If oil supplies were cut by 2 million barrels per day, prices would

hit $90 a barrel this year and remain at $70 next year, according tothe World Bank. The price spike would add 2.6 percentage pointsto the inflation rate, which is 2.1% now, and cut global growth inhalf.

How likely is such a price spike? Goldman Sachs oil analyst ArjunMurti spooked markets in March with a forecast of a "super spike"

taking oil prices as high as $105 per barrel. On Dec. 12, hereiterated that view in a note to clients, adding that "non-existentspare capacity" supported the prediction.

John Kingston, global director of oil for Platts, is more optimisticHe expects prices to ease this year with new producing wells inthe Gulf of Mexico, Russia and Nigeria boosting the market'scushion.

Still, he frets that continued Iraqi turmoil could pinch. Dailyexports there of 1.4 million barrels remain below prewar levels,according to Platts. Anti-U.S. insurgents last year mounted 96attacks on the c ountry's aging network of pipelines andproduction facilities, or one every four days. There is little reason to

expect quick improvement.

"The spot that concerns me the most is Iraq, and not so muchthe insurgents," he says. "The oil industry there has been heldtogether by spit and bailing wire. It's antiquated and needsmassive capital investment."

To those such as Roach, who are inclined to emphasize the risksthat things won't go exactly as expected, the links betweenpotential problems are the most worrisome element. The USA's fatcurrent account deficit could sink the dollar. As it plummets,emerging markets' exports dry up and oil prices, which aredenominated in dollars, rise. In no time, what starts as onecountry's difficulty becomes a global contagion.

"This is what we signed up for when we bought intoglobalization," Roach says. "The next global adjustment ordownturn most likely will reverberate very quickly around theworld with a speed we haven't seen before."


14/14

v Institute for International Economics

http://www.iie.com/

v Roubini Global Economics Monitor

www.rgemonitor.com

v USA TODAY Commodities Report

http://markets.usatoday.com

v Oil & Gas Journal

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

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

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.

CRITICAL INQUIRY

ADDITIONAL RESOURCES

1. Based on the article Tensions push Congress to get even with China, describe Chinas economic policy. Cite specific

information from the article in your explanation. Is China a threat to the USAs 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 generations 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

USA TODAY Collegiate Case Study: Global Economics

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