  urlLink Previously I discussed the U.S. current account deficit and how it related to the federal deficit. In that post I stated that the federal deficit is simply a reflection of the current account deficit shift from private into public hands. This rationally makes sense, due to the fact that much of the deficit was created by tax cuts. Those tax cuts allowed the public to increase or maintain their current purchases (there by maintaining the current account deficit) while the government footed the bill.
This spells bad news for the economy in my opinion. The existance of a large current account deficit means that we are buying more than we are selling, in regards to the rest of the world. This cannot continue indefinatly. It is an indication that the economy is not sufficiently producing products domestically to match the demand for such products. As such we are purchasing those products from abroad. Now, that does not mean we should not purchase those foreign products. Thanks to the market, we can simply make products that are more valuable to the rest of the world to reduce the deficit. How can we do that? Normally the market will do that on its own, provided it isn't fiddled with in the mean time. So who has been fiddling with it? Answer: Everyone. Japan and China, along with most other East Asian currencies manipulate the exchange rates to keep their currencies, and therefore their products, cheap. With those currencies cheaper than the market would set it is artificially making their products more desireable than the U.S.'s. Now, there are other factors, including maintaining stability in China, on why those countries are manipulating their exchange rates.
I am attempting here to simply analyze, not place blame. Additionally, the Bush Administration's tax cuts have fiddled with the economy. Around the beginning of the decade the economy was slowing as, I believe, it was attempting to correct the current account deficit. I like to call this a purification cycle, others call it a recession. At this time the tax cuts were being pushed through, and many people were remarking on the excellent timing of it to avert the recession.
And indeed, it worked. The recent recession is remarked as being one of the mildest in history. However, at what cost? Already it is visible that the recovery was slow in coming. That however may be attributable to other circumstances, such as the enhanced gains in productivity. What about the future though? We still have a large (5% of GDP or so) current account deficit that the market will keep trying to correct.
One way to correct is for the exchange rates to adjust, with the dollar falling. However the dollar needs something to fall against. East Asia won't let their's fall. Europe is simply unattractive, and with the potential of interest rate reductions, will become more so. The other, more likely option is for the previous solution to be attempted by the market again: purification cycle. 
