At least according to Tim Geithner, President of the Federal Reserve Bank of New York:It matters because of the size of the U.S. imbalance. Our current account deficit is now running at a rate of above 6 percent of GDP, a level without precedent for a major economy. It matters because of the composition of the imbalance. Our trade deficit is now roughly the size of the current account deficit, and very large relative to our export base. And our net investment income balances are now likely to move into deficit.
It matters because of the trajectory of the U.S. imbalance. On reasonable assumptions about its likely near term path, this deficit will produce a very large net deterioration in our net external liabilities relative to national income, with progressively larger net transfers of income to the rest of the world.
This pattern should concern us because it is not simply the result of the savings and investment decisions of the private sector. The fact that we are using a substantial part of the savings we are borrowing from the rest of the world to finance an unsustainable level of public borrowing leaves us more vulnerable than if those savings were being used for productive private investment. . ....
It should concern us because of how the imbalance has been financed. A substantial portion of the capital inflows that finance our current account deficit has come from foreign central banksâ€”which have been accumulating dollar reserves to preserve exchange rate arrangements that are unlikely to be sustainable and are already in the process of change. ....
And most importantly, perhaps, these imbalances matter because at some point they will have to reverse. Market forces will at some point induce an adjustment. And that inevitable process of adjustment will bring with it the risk of large movements in relative prices, greater volatility in asset prices and slower growth in the United States and in the rest of the world.
I would not say that Geithner comes out on the international side of Brad DeLong's international economist v. domestic economist debate about the likely nature of the US external adjustment process. But he does seem to think that risks are building:
The size of the imbalances and the persistence of the forces supporting them probably mean that we will be living for a prolonged period of time with the tensions that could come with the need for adjustment ...
A number of observers have suggested that we can live comfortably with these imbalances for a long time, with very little risk to the U.S. and world economy. The rise in the surplus savings of the rest of the world, the relative ease with which those savings now move across borders, and the increase in the relative attractiveness of claims on the United States together may suggest the world can sustain larger imbalances, more easily, for a longer period of time.
These factors, however, do not alter the fundamental judgment that our external position is unsustainable and the adjustment process ahead could materially affect future economic outcomes. The fact that these imbalances might be sustained for some time shouldn't make us more confident that they will be. Even if we could be confident that the world would be comfortable financing the United States on these terms going forward, that would not make it prudent for the U.S. to continue borrowing on this scale.
Time doesn't necessarily help. The longer these gaps continue to build, the greater the risks, and the more difficult their resolution.
Tyler Cowen is right. No one can say they were not warned.