Current Account Deficit Sustainability
As I mentioned in a brief post last week, the BEA has released the most recent figures for the US current account (CA) deficit, which suggests that the CA deficit for the year will be in the neighborhood of 6.5% of GDP. Yesterday, Brad DeLong continued his excellent ruminations on the sustainability of this amount of borrowing by the US. The crux:
Is the current situation “unsustainable”? For how long could the U.S. continue to run a current-account deficit of, say, 7% of GDP?
Assume… a constant 7% of GDP current-account deficit, and find that in 2022 the U.S. net foreign asset position crosses -100% of GDP, with a current-account deficit of 7% of GDP, a trade deficit of 3% of GDP, and net income payments to foreign owners of capital of 4% of GDP. A net foreign asset position of -100% of U.S. GDP is conceivable: Britain, after all, had a net foreign asset position of +150% of then-British GDP in 1913. The trade deficit between now and 2022 has to shrink by an average of a little less than a quarter of a percentage point per year. That’s a very gradual rate of closure of the trade deficit.
…There is an alternative scenario, one in which foreigners’–including foreign central banks’–desired holdings of dollar-denominated assets shortly hit the wall, and the asset price shifts that result from desired holdings’ hitting the wall reduce, or do not increase, confidence in the dollar.
…I am very cautious about declaring that I know a fundamental external imbalance when I see it. But one thing makes me exceptionally nervous–makes all of us exceptionally nervous right now. The market’s current prices appear to give a zero weight to the hit-the-wall hard-landing scenario, and 100% weight to the U.S.-acquires-an-enormous-negative-net-foreign-asset position.
I have no better insight than Brad about whether the current situation represents a fundamental imbalance. However, while preparing something for one of my classes this week I put together the following chart.
To make this chart I’ve tried to identify all of the episodes in the past 30 years where an OECD country has run a CA deficit of greater than 5% of GDP for at least one year. As the picture makes clear, all of these episodes have one thing in common: deficits of that magnitude have never lasted for more than a couple of years.
This means that one of two things must be true: either the US CA deficit will shrink substantially in the next couple of years; or the US experience will be something with no historical precedent.
Three last points about this. First, I haven’t gone back further than 1975 to see if there are other historical examples of 5%+ deficits for more than a few years. There could be some such examples in earlier periods (though none immediately come to mind), and I would be curious to know about them.
Second, note that one of the important points that those in the “big deficits can easily continue as far as the eye can see” school of thought make is that the US is fundamentally different from other countries because it can borrow in its own currency. Well, most of the countries in the chart above were doing most of their borrowing in their own currency, too. Despite this fact, one thing or another caused the 5%+ CA deficit to be unsustainable for more than a couple of years in every single case.
Third, if the US experience is not completely anomalous, so that its CA deficit does drop to below 5% of GDP in the next couple of years, the process will probably (though not certainly) involve a significant amount of economic distress for the US. In particular, US imports will have to fall substantially, and the only plausible ways to acheive that are through a substantial dollar devaluation, a recession, or both. This is what worries me: I don’t claim to be able to predict the mechanics of how or why the US deficit will fall… but if the US does adhere to all historical experience, then the CA deficit will fall, and bad stuff will have happened to make it fall.
One thing seems clear to me from this. If you’re not worried about the US’s CA sustainability, then you are necessarily positing that the US experience will be dramatically different from that of other countries – even other rich countries that, like the US, could borrow in their own currency.
Kash