David Altig recommends this paper from Michael Kouparitsas entitled “Is the U.S. Current Account Sustainable”. He poses the question initially in a manner similar to how Thomas Sargent and Neil Wallace posed the government deficit issue back in 1981. Updating the Sargent and Wallace Unpleasant Monetarist Arithmetic model to today’s General Fund deficit issue let the debt to GDP ratio be 70% and the current non-interest surplus (s) be negative 3%. The present value condition is simply that s must be increased so that s/(r – g) = debt/GDP, where r = the real interest rate and g = the steady state growth rate for real GDP, if the debt/GDP ratio is not to increase. If we assume that r = 3% and g = 2%, then s must rise from negative 3% to positive 0.7% – which of course pretends we have someone other than the current leaders running Washington, D.C.
OK, political sermon aside so we can discuss what Kouparitsas was addressing. He shows U.S. assets to be near 70% of GDP and our debt to the rest of the world near 95% of GDP so net foreign assets are near negative 25% of GDP. So does he suggest that net exports have to rise from their currently massive negative levels to be at least 0.25% of GDP. Not quite- he suggests that we can retain a non-interest deficit near 1% of GDP to avoid further deterioration of net foreign assets relative to GDP. How does he come up with this Pleasant Arithmetic? He notes that our assets have earned higher returns than the interest expense on how debt over the past 27 years and he assumes this differential will continue into the future. Is this a reasonable assumption for steady state modeling?