The US President, Mr Bush, in his second term in office, faces considerable challenges in dealing with the US economy. Just a day after his re-election, the financial markets were already returning their focus to the enormous deficits on the federal budget and on the current account of the US balance of payments.
These threaten to slow US economic growth and to cause instability on the markets. To minimise these threats, Mr Bush needs to put forward a credible strategy to address the imbalances represented by the twin deficits. There is little evidence that he will do so, although he did allude yesterday to the need to reform the US social security system.
The twin deficits indicate that the US economy is living beyond its means. The budget deficit represents the excess of US government expenditure over revenue, now equivalent to more than 3.6 per cent of GDP. The deficit on the current account of the balance of payments is mainly a reflection of the fact that US imports are running well in excess of exports. To fund this deficit, international investors pour billions into financial assets each day. There is a risk that international investors will lose confidence in dollar assets, undermining the dollar and creating instability in international financial markets.
What can Mr Bush do to address these issues? A credible plan to address the budget deficit would be a welcome first step. Perhaps inevitably, neither candidate was prepared during the election campaign to outline detailed measures to cut the deficit, although Mr Kerry did put forward a proposal that any new tax or spending proposals be matched by savings elsewhere. Having been re-elected, however, Mr Bush needs to take a hard look at the gap in the federal finances. His strategy to cut taxes and hope that the resulting boost to growth will lower the deficit is hardly credible. If he is to deliver on his promise to halve the deficit during his second four years, then Mr Bush will need to take some tough decisions.
A period of retrenchment and somewhat slower growth in the US economy - combined with a weaker dollar - may be needed to address the deficits. Ideally this would happen gradually and the adjustments could be made without undue instability being caused in the financial markets. This benign outcome is far from guaranteed. Now that the election is over, attention returns to the fundamental difficulties facing the US economy and to the poor growth outlook for the euro zone, which makes it all the more difficult for the kind of US export growth needed to lower the current account deficit. Both issues require more resolute policy action than has been seen to date.