Raging US deficit threatens painful adjustment ahead
FT.com / Home UK - Raging US deficit threatens painful adjustment ahead
By Andrew Balls
Published: October 6 2005 03:00 | Last updated: October 6 2005 03:00
The US remains the fastest-growing of the world'srich economies and its current account deficit continues to expand.
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The International Monetary Fund, in its World Economic Outlook released last month, forecast US growth of 3.5 per cent this year and 3.3 per cent next year and a current account deficit of more than 6 per cent of gross domestic product in both years.
President George W. Bush's administration has committed itself to halving the fiscal deficit over its second term - though economists and budget experts point to holes in the plan.
But with foreign investors willing to continue to finance the US current account deficit on easy terms - in spite of the foreign exchange losses they suffered during the dollar's decline from 2002-04 - there has been little market pressure to date.
Rather, long-term interest rates atahistorically low level have contributed to the housing market boom and low household savings, exacerbating global imbalances rather than prompting a correction.
The UK, Australia and New Zealand have also run current account deficits - though they are lower in the UK and Australia as a percentage of GDP.
In all three cases they are far lower than the US deficit in dollar terms and are therefore much less important to the overall global adjustment required.
Another English-speaking country, Canada, an exporter of commodities, has run a current account surplus.
In most countries, foreign investors would balk at financing a current account deficit of about 6 per cent of GDP and rising.
A sliding currency and rising interest rates would prompt an adjustment in the economy away from domestic-led growth and towards the export sector, in what might be a painful process.
The US, however, enjoys a unique advantage in the fact that the dollar is the world's reserve currency.
The easy financing of the US current account deficit reflects in part the actions of Asian central banks, buying US assets to prevent their currencies from rising against the dollar. But private investment flows to the US have also been robust.
Ben Bernanke, chairman of the White House Council of Economic Advisers, explains both the pattern of trade imbalances and low global interest rates by talking about a "global savings glut".
The IMF argues a better formulation is that while savings are not particularly low outside the US, investment is unusually low, re- flecting a range of structural and demographic factors.
There is a debate among economists over how long the US can continue to run such a large current account deficit.
But the longer the process goes on, the bigger the imbalances become, and the more difficult the eventual reckoning will be.
Foreign investors will not finance the US current account deficit on such favourable terms indefinitely.
But it may be that US legislators lose patience with the unbalanced pattern of global growth before investors do.
Trade tensions over the bilateral trade deficit with China have probably died down only temporarily following China's announcement of a new currency regime in August - with little subsequent action to allow the renminbi to appreciate against the dollar.
The policy actions required have been discussed repeatedly among the Group of Seven leading industrialised countries - and the conversation will continue at the G20 meeting in China later this month.
The overall plan boils down to the need to promote stronger domestic-led growth outside the US - including emerging Asian governments allowing their currencies to rise against the dollar - and for a slowdown in US domestic demand, fiscal consolidation and a rise in household savings.
But progress has been slow, in part reflecting political obstacles to the difficult actions needed in key countries.
In the US, what progress there has been in cutting the fiscal deficit looks more like one-off boosts to tax collection than any improvement in the underlying structural deficit.
Pledged government spending following Hurricane Katrina means fiscal policy is set to turn expansionary again.
"At the moment, post-hurricane, we have to view fiscal policy as being turned to be even more pro-active than before," said Kathleen Stephansen, head of Global Economics at CSFB in New York. "If the hurricane does not derail the expansion, then against the backdrop of continuing strong domestic demand growth and fiscal policy becoming expansionary, monetary policy will have to become much less accommodative."
While the Federal Reserve has raised interest rates in 11 quarter-point moves, the impact has been partially offset by the decline in long-term rates over the same period. Fed policymakers have signalled their strong resolve to keep raising interest rates, prompted by concerns about rising inflation pressures.
The disruption caused by Hurricane Katrina is seen as likely to have only a temporary impact on the economy.
"The Federal Reserve is playing a bit of catch-up," says Ted Truman, fellow at the Institute for International Economics and a former senior official at the Federal Reserve. "The problem is that if the housing market does not cool down and if they keep raising rates, they may crunch other parts of the economy. With less labour market slack, they are more concerned they will have to crunch the economy than a year ago." This article is the fourth in a series.
By Andrew Balls
Published: October 6 2005 03:00 | Last updated: October 6 2005 03:00
The US remains the fastest-growing of the world'srich economies and its current account deficit continues to expand.
ADVERTISEMENT
The International Monetary Fund, in its World Economic Outlook released last month, forecast US growth of 3.5 per cent this year and 3.3 per cent next year and a current account deficit of more than 6 per cent of gross domestic product in both years.
President George W. Bush's administration has committed itself to halving the fiscal deficit over its second term - though economists and budget experts point to holes in the plan.
But with foreign investors willing to continue to finance the US current account deficit on easy terms - in spite of the foreign exchange losses they suffered during the dollar's decline from 2002-04 - there has been little market pressure to date.
Rather, long-term interest rates atahistorically low level have contributed to the housing market boom and low household savings, exacerbating global imbalances rather than prompting a correction.
The UK, Australia and New Zealand have also run current account deficits - though they are lower in the UK and Australia as a percentage of GDP.
In all three cases they are far lower than the US deficit in dollar terms and are therefore much less important to the overall global adjustment required.
Another English-speaking country, Canada, an exporter of commodities, has run a current account surplus.
In most countries, foreign investors would balk at financing a current account deficit of about 6 per cent of GDP and rising.
A sliding currency and rising interest rates would prompt an adjustment in the economy away from domestic-led growth and towards the export sector, in what might be a painful process.
The US, however, enjoys a unique advantage in the fact that the dollar is the world's reserve currency.
The easy financing of the US current account deficit reflects in part the actions of Asian central banks, buying US assets to prevent their currencies from rising against the dollar. But private investment flows to the US have also been robust.
Ben Bernanke, chairman of the White House Council of Economic Advisers, explains both the pattern of trade imbalances and low global interest rates by talking about a "global savings glut".
The IMF argues a better formulation is that while savings are not particularly low outside the US, investment is unusually low, re- flecting a range of structural and demographic factors.
There is a debate among economists over how long the US can continue to run such a large current account deficit.
But the longer the process goes on, the bigger the imbalances become, and the more difficult the eventual reckoning will be.
Foreign investors will not finance the US current account deficit on such favourable terms indefinitely.
But it may be that US legislators lose patience with the unbalanced pattern of global growth before investors do.
Trade tensions over the bilateral trade deficit with China have probably died down only temporarily following China's announcement of a new currency regime in August - with little subsequent action to allow the renminbi to appreciate against the dollar.
The policy actions required have been discussed repeatedly among the Group of Seven leading industrialised countries - and the conversation will continue at the G20 meeting in China later this month.
The overall plan boils down to the need to promote stronger domestic-led growth outside the US - including emerging Asian governments allowing their currencies to rise against the dollar - and for a slowdown in US domestic demand, fiscal consolidation and a rise in household savings.
But progress has been slow, in part reflecting political obstacles to the difficult actions needed in key countries.
In the US, what progress there has been in cutting the fiscal deficit looks more like one-off boosts to tax collection than any improvement in the underlying structural deficit.
Pledged government spending following Hurricane Katrina means fiscal policy is set to turn expansionary again.
"At the moment, post-hurricane, we have to view fiscal policy as being turned to be even more pro-active than before," said Kathleen Stephansen, head of Global Economics at CSFB in New York. "If the hurricane does not derail the expansion, then against the backdrop of continuing strong domestic demand growth and fiscal policy becoming expansionary, monetary policy will have to become much less accommodative."
While the Federal Reserve has raised interest rates in 11 quarter-point moves, the impact has been partially offset by the decline in long-term rates over the same period. Fed policymakers have signalled their strong resolve to keep raising interest rates, prompted by concerns about rising inflation pressures.
The disruption caused by Hurricane Katrina is seen as likely to have only a temporary impact on the economy.
"The Federal Reserve is playing a bit of catch-up," says Ted Truman, fellow at the Institute for International Economics and a former senior official at the Federal Reserve. "The problem is that if the housing market does not cool down and if they keep raising rates, they may crunch other parts of the economy. With less labour market slack, they are more concerned they will have to crunch the economy than a year ago." This article is the fourth in a series.
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