from Follow the Money

Not priced in

March 22, 2006

Blog Post

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United States

Budget, Debt, and Deficits

Trade

David Bassanese recently wrote in the Australian Financial review:

"Provided inflation remains benign, the goods news is that the US economy does not appear to be facing many downside risks, and its equity markets could be poised to rise."

And as Barry Ritholz likes to note, there are not that many bears left on Wall Street either.  Bearish bets have not paid off recently.

I realize that my concerns about the rising trade deficit have so far not been shared by the market - and if anything financial markets have moved in ways that will tend to make the deficit larger not smaller over time.   Still, isn't there at least some risk that the US won't be able to finance a $ trillion current account deficit? 

I realize the Australians -- including Australian central bankers -- worry a bit less about current account deficits than most.  They certainly are used to them.  


I would note that even Australia hasn't been able to sustain a constantly rising trade deficit.   Its current account deficit stems primarily from significant net interest payments.   It then moves up or down depending on the expansion or contraction of a trade deficit that is far smaller than the US trade deficit.   See Chart 1 of this Australian Treasury presentation

The US too will need to get used to ongoing current account deficits.   The US has set itself on a course that will make it into a much larger version of Australia, if all goes well.  If the trade and transfers deficit shrinks by about 0.5% a year from its current level of around 7% of US GDP over the next fifteen years (a huge change from the current pattern of rising deficits), the US net debt will stabilize at roughly Australian levels, and becuase of interest on that debt the US will run a current account deficit from now til eternity.  

But even getting from here to there requires some big adjustments, adjustments that may prove a bit more disruptive than Bassanese allows.  The US cannot have a stable current account deficit if its trade deficit doesn't stop rising and start falling.

The changes required to bring that about certainly seems to me to be a risk to the long-term outlook for the US.  And in the short-term, I would argue that there remains a risk that the markets (scratch that, markest and central banks) will not be willing to finance a roughly $1 trillion current account deficit on current terms.

Tyler Cowen of the New York Times(congrats, by the way) -- I think it is pretty clear that my dark scenarios for disorderly adjustment are not priced in to the current market.  The market briefly considered the possibility that trade deficits might matter in 2004.  It then concluded either that trade deficits don't matter or that China and the oil exporters will finance the deficit no matter what and lost interest ...

More on:

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