An unsustainable black hole
(The US current account deficit)
Martin Wolf
Financial Times, February 27 2002

Klas Eklund: USA har ryckt åt sig ett stort försprång och har världens mest framgångsrika ekonomi.

Alan Greenspan's Federal Reserve has done a good job of rescuing the US economy from recession. Yet there remains a worry.

By its monetary easing, the Federal Reserve has followed the core principle of Keynesian policymaking: look after the short run and the long run will look after itself. But the long run can bite back. The belief that it will do so underlies the gloomy prognostications of those who fear a "double dip" recession.

Behind this worry is the view that three imbalances emerged in the course of the second half of the 1990s:

- excess corporate investment;

- insufficient household savings;

- and an unsustainable current account deficit.

Of these, only the first is disappearing.

The other two have not been corrected. On the contrary, the Federal Reserve's strategy and the hopes of the rest of the world for a US-led recovery depend on their not being corrected.

I have looked at household savings before ("When shoppers become savers", January 23). But will the current account deficit continue on its merry way?

"Not for ever" is the answer.

At the end of 2000, the net international investment position of the US was minus $2,187bn, a little over a fifth of gross domestic product.

The current account deficit in the first three-quarters of 2001 was running at an annualised rate of $419bn. If one ignores changes in valuations, this means the net international position must have been roughly minus $2,600bn at the end of last year.

Thus, neither the current account deficit nor, inevitably, the stock of net liabilities to the rest of the world improved, even during a slowdown.

The US, it is hoped, is now on its way to a demand-led recovery. The current account deficit is therefore likely to widen further.

Goldman Sachs forecasts a rise in the US current account deficit from about $420bn last year (4.1 per cent of GDP) to $730bn (5.9 per cent of GDP) by 2006.

Five years from now the stock of net liabilities (if one ignores changes in valuations) would be $5,800bn. This would be 46 per cent of US GDP and about 15 per cent of the rest of the world's GDP (provided the dollar stays strong).

Even that is not the end of the story. In a study published in 1999, Catherine Mann, formerly on the staff of the Federal Reserve Board, argued that US net liabilities could reach 64 per cent of GDP by 2010. (Is the US Trade Deficit Sustainable? Washington DC: Institute for International Economics 1999)

This trend cannot last. The difficulty is knowing when and how it will end.

But the longer the process continues, the more painful that ending is likely to be.

In considering how it might finish, one must ask who is financing the deficit. The answer, strangely, is that we do not really know.

The International Monetary Fund says last year the US current account deficit was about $392bn. The largest offsetting surplus was Japan's $91bn. Newly industrialised Asian economies added $44bn, Asian developing countries $24bn and oil exporters $51bn. The European Union contributed nothing, with a surplus of only $1bn.

But the world as a whole ran a notional current account surplus with itself of $182bn. About this black hole little can be said, except that it must largely consist of unrecorded exports and so capital flight from developing countries.

RE: Jfr Grassman

Japan's surplus is structural. Since their financial crisis, other Asian economies have also found it difficult to absorb their high savings. Thus there are sizeable surplus savings looking for a safe home. But that surplus is considerably smaller than the US deficits.

How stable the black hole in the global balance of payments is must be unknowable.

If we do not know how exactly the US deficits are being financed, we do know this is happening with ease. As J P Morgan Chase notes, the real trade-weighted dollar has risen by 6.5 per cent over the past year.

It is almost as high today as it was in the mid-1980s.

Yet it is hard to believe this financing will continue with such ease indefinitely. Many analysts downplay such worries. They argue that

- the rest of the world has to put its surplus savings somewhere;

- that the US is protected by its ability to borrow in its own currency and to attract inward direct investment and equity purchases;

- and that in 2000, for example, net payments of investment income to foreigners were a mere $9.6bn, even though net liabilities exceeded $2,000bn.

Yet the costs of service will rise, along with the net liabilities.

Moreover, the sum of net equity inflow and net inward foreign direct investment fell from $221bn in 2000 to an annualised rate of only $2.1bn in the first three-quarters of 2001, while net bond inflows, excluding treasury flows, ran at an annualised rate of $409bn, up from $275bn in 2000.

This shift was not surprising, given changes in equity valuations and corporate profitability. But it was also a way of hedging against valuation risks.

What makes the claims relatively safe for the US also makes them risky for foreign investors. As US assets become a bigger component of their wealth, they must become nervous about the currency and valuation risks.

The dollar is vulnerable to such changes in sentiment.

At present, exports of goods and services are about three-quarters of imports.

The growth of imports, other things being equal, is about 1.7 times as fast as GDP. If GDP grows at 3.5 per cent a year, imports will grow at 6 per cent in real terms.

If the trade deficit is to remain constant, exports must grow at 8 per cent.

Suppose, instead, that the trade deficit is to halve, in real terms, over five years. Then exports must grow at 10 per cent a year in real terms.

But US exports normally grow only as quickly as the rest of the world's GDP. If the world economy continues to grow as fast as it did over the past two decades, US exports would grow at about 3.5 per cent.

The dollar would need to depreciate enough to turn 3.5 per cent export growth into 10 per cent. This would demand a big and continuing decline.

As soon as investors become concerned, they will think about the depreciation ahead. That could create a downward spiral, as they rush for the door and the value of assets they own in the US, in their own currencies, declines.

Even the Federal Reserve might find its ultra-easy monetary policy difficult to sustain and that, in turn, would affect domestic confidence.

The strong dollar has made life for the Federal Reserve very easy. Maybe this happy state of affairs will continue for years. But the elastic is not infinitely stretchable. It will snap back in the end.

Full text

What this means for Germany

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