Deep thoughts

I spent most of the first two quarters of 2008 marveling at the pace of Chinese reserve accumulation -- which was topping $200 billion a quarter for a while (counting funds shifted to the CIC and the increase in the PBoC’s other foreign assets, i.e. China’s hidden reserves). That kind of reserve growth far far exceeded any number I expected to see. China probably won’t post that large an increase for calendar 2008, as reserve growth slowed recently (though we don’t really know by how much; the December number -- which will undo the valuation losses from the euro’s fall in October -- will be telling). But the total increase in China’s foreign assets -- counting its hidden reserves -- from September 2007 to September 2008 likely came close to matching the US current account deficit over that time.

I expect to spend the first few quarters of 2009 marveling at the size of the US fiscal deficit. If the CBO is close to accurate, the deficit will easily top $1 trillion this fiscal year (and this calendar year). The CBO estimate includes $400 billion to cover the estimated losses on the TARP and the cost of the Fannie/ Freddie bailout; that is part of their $1.2 trillion estimate. Obama’s proposed stimulus though isn’t included in their $1.2 trillion estimate.

Any way you cut it, the deficit will be very big. So, incidentally, will be the recession. The CBO is forecasting that output will fall by 2.2% without a stimulus, with unemployment rising over 9%. That is a big fall. And it is part of the reason why the CBO expects such a large deficit. Automatic stabilizers and all.

As a share of GDP, though, China’s reserve growth still takes the cake. $200 billion a quarter, annualized, is $800b -- a bit over 20% of China’s GDP. $1.2 trillion isn’t even 10% of the United States’ GDP.

But it is unquestionably huge. Perhaps surprisingly, I would guess that it mostly will be financed by domestic US savings. The fall in the price of oil, absent a big rise in the non-oil deficit from a far larger fall in exports than imports, implies a current account deficit in the 3 to 4% of US GDP range ...

I don’t think many expected a year ago that the US would be running this kind of deficit -- or that the CBO could credibly forecast (p. 13 of its report) that the Treasury would be able to finance such a large deficit at a lower rate than it financed the far smaller ($455b) deficit in fiscal 2008. The CBO forecasts an average yield on the ten year Treasury of 3% in 2009, and a slight fall in the Treasury’s net interest payments (table 5, p. 16)