Two Roads to Times Square
In The Out of Towners, the protagonists George and Gwen Kellerman (played by Jack Lemmon and Sandy Dennis in the 1970 original; Steve Martin and Goldie Hawn in the 1999 remake) make a hellish trip to New York City .
When their flight intended for New York is diverted to Boston , the Kellermans improvise and push on to Manhattan by train. After a very long night including a mugging, a police chase, and sleeping outdoors, the Kellermans run into one of their fellow passengers from the original flight. Unlike the frazzled Kellermans, their calm compatriot rested overnight in Boston and took a morning flight. Both parties ended up in Manhattan for breakfast, but by very different routes.
Robert Kiyosaki - Rich Dad, Poor Dad Similarly, there are various paths the world can take as we adjust from the United States having the biggest current account deficit in history to a future with U.S. current account surpluses. Two relevant and recent examples exist in North America . In these sagas, Mexico took a painful Kellermanesque path of adjustment, while Canada eased through its transition with many fewer aches and pains.
In the 1960s and 1970s my family used to vacation in Canada 's Point Pelee National Park . As an industrious child, I scavenged for discarded bottles with my sister Miranda to make money on the deposits. On good days, we would gather more than 100 bottles, which, depending on the brand, each carried a 2 cent or a 3 cent deposit. We were able to get our hot little hands on 2 or 3 dollars for a few hours of work. But there was one small catch; we earned Canadian dollars (now also known as "loonies"), not U.S. dollars.
When we began our bottle collecting, the loonie was worth slightly less than its U.S. counterpart. 4 So we had a bit of disdain for the Canadian currency. Furthermore, because some of the coins were of similar size (particularly the quarters), people who lived in Detroit and the neighboring Canadian town of Windsor would often exchange the coins at an even rate. I was always happy if I could unload my Canadian quarters at full value, whereas I felt cheated when someone slipped me a Canadian quarter.
In the early 1970s something magical happened. The Canadian dollars that we earned from our bottle work became worth more than a U.S. dollar. 5 Although the adjustment was quite small, the movement to more than a buck was accompanied by tremendous pride. Instead of shyly sliding my Canadian dollar across the counter at Harry's hobby shop and hoping I wouldn't get yelled at, the crisp Canadian bills became something that I could proudly display.
Jim Cramers Real Money Sane Investing In An Insane World Were I to earn some Canadian dollars today they would be worth far less than a U.S. dollar. In late 2001, the loonie dropped to 63 U.S. cents. What happened to my beloved loonie?
For many years, particularly in the 1980s, Canada ran a large current account deficit. 6 In the post-1973 world, without governments controlling exchange rates under Bretton Woods , Canada 's current account deficits were among the largest for an industrialized country. In other words, Canada in the 1980s was consuming more than it produced to a degree almost as extreme as the United States in 2004.
In the 1980s, Canada was enjoying its Wimpy burgers with the promise of repayments on Tuesdays to come. The decline of the Canadian dollar indicated that it was Tuesday and time for repayment. The subsequent fall in the value of the Canadian dollar made Canadians less able to import products from abroad. The cheap currency also made Canadian products into excellent values. In short, Canada went through a textbook process. Years of consuming more than it produced were followed by repayment; this repayment, in the form of a current account surplus, was accompanied by a cheap currency.
Canada consistently runs a current account surplus, and the adjustment process was gradual. 7 Over a quarter of a century, the Canadian dollar fell from just over 1 U.S. dollar in 1976 to a low of 63 cents and has remained below 75 U.S. cents for almost 10 years.
Canada 's adjustment process was not painless, but it was relatively gradual and did not involve any panics. In contrast, Mexico took the Kellermans' route.
In the mid-1980s, my buddies and I used to make surf trips from San Diego down to Mexico 's Baja peninsula. Along the way we saw advertisements for Mexican investments "guaranteed" to return 40% per year. This seemed like an amazing deal, and some of my friends took up the offers.
For a time, my surf friends earned high interest rates on their Mexican investments. The process was very simple: Convert some U.S. dollars into Mexican pesos and invest the pesos for a year. Earn 40% on your pesos in a year, get them back, and convert your pesos into dollars. A $1,000 investment returned $1,400 just 12 months later. Not too shabby! Furthermore, the deposits were guaranteed to return 40% more pesos than invested.
There are few things more expensive than free lunches, especially in the investing world. The catch is that the Mexican deposits were guaranteed to return 40% more in pesos. The dollar value of those pesos was not guaranteed. Not to worry, though, how much can a peso devalue in a year?
As you might expect, this story involves the Mexican current account. In the early 1990s, Mexico was running a current account deficit that was 7% the size of its economy. As we have learned, such deficits are unsustainable and the road to repayment usually includes devaluing the currency.
In late 1994, a Mexican peso was worth about 30 U.S. cents. One year later it was worth about 12 cents. 8 Now consider the 40% guaranteed return on your peso investment. Your $1,000 still earns 40% in pesos, but when the proceeds are converted back into dollars the investment returns about a total of $500. Rather than earning a 40% positive return, this "guaranteed" investment lost half its value in one year.
While the Mexican peso devaluation was bad for foreign investors, it was a crisis for Mexicans and many others. In simplest terms, the adjustment from current account deficit to surplus requires a change in wealth.
Both Canadians and Mexicans became poorer because of their currency devaluations. The speed of the Mexican decline caused panic and severe readjustment costs.
The U.S. current account deficits will end. The adjustment path can be rocky or smooth. The U.S. situation is different, and in many ways better, than either the Canadian or the Mexican current account deficits. These differences lead many pundits to confidently predict a smooth path. Because the U.S. current account deficit is the largest in history, however, there is no precedent. Therefore predictions of the adjustment path are simply speculations, some well grounded, but speculations nonetheless.
The Country with the Golden Brain
Since the United States is in a dominant economic position, perhaps the best predictor of the coming current account adjustment lies neither north nor south of the border, but in our own history. In the early 1980s, the U.S. current account deficit reached then record highs (although Figure 6.1 shows that these deficits pale in comparison to more recent deficits).
What happened after record U.S. current account deficits in the early 1980s? Well, the most common effects of large current account deficits are clear in this case. First, the current account deficits shrank. Second, the move away from deficit was accompanied by a substantial weakening of the dollar. 9
This 1980s' bout of U.S. current account adjustment was very smooth; much more like the Canadian experience than the Mexican peso crisis. Should we then infer that the coming adjustment will also be relatively smooth? Perhaps, but the current situation differs for two reasons. First, the current U.S. deficits are much larger than those in the 1980s. Second, in the last few decades the United States has moved from being the world's biggest creditor to the biggest debtor.
The protagonist in Alphonse Daudet's "Man with the Golden Brain" is born with a skull full of precious metal—his brain is literally made of gold. Throughout his life, he spends his birthright to help his parents and then his beautiful wife. He is particularly lavish with his spouse and spoils her with gifts paid for by depleting his finite supply of metal. For each purchase, he must remove part of his brain and sell the precious supply for cash.
When the man with the golden brain's wife dies, he spares no expense on the funeral. On his way home from the cemetery, he stops to buy a pair of blue satin boots. The store clerk hears a scream and rushes to find the man clutching the boots in one hand, while the other hand is covered with blood and contains gold scrapings at the ends of the nails. His golden birthright was gone; his entire brain sold off bit by bit over the years.
In a far less dramatic manner, but to a far greater degree, over the last several decades the United States has spent its golden treasure. Figure 6.2 depicts how the United States has changed from an international creditor to a debtor. The figures are calculated by adding up all the U.S. investments abroad and then subtracting foreign investments in the United States .
In the early 1980s, and throughout most of its history, the United States was a creditor. The value of U.S. investments abroad exceeded the value of foreigners' investments in the United States . The positive figure in 1982 of $328 billion represented accumulated U.S. savings.
When a country runs a current account deficit, it is borrowing. In the case of the United States , it began borrowing from a position of strength. The early years of borrowing just reduced the savings that had built up over decades. In the late 1990s and beyond, the growth in accumulated debt became extreme. The U.S. debt to the world at the end of 2004 stood at $3.5 trillion.
As with the current account deficit, the debt that the United States owes to the world is the largest amount in history. As with other figures, there are nuances where the figures are adjusted for the size of the economy and the current value of the assets (the data in Figure 6.2 use the historical cost of the investment, not the current market value). When these nuances are taken into account, the trend is identical. The United States has had a dramatic change from global creditor (and saver) to debtor (and consumer).