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$900 billion -- 7.2% of expected 2005 US GDP -- sounds extreme.
But it is not entirely implausible.
Assume oil stays at $55 a barrel or more for the remainder of the year. In that case, the higher oil import bill alone adds roughly $60 billion to the trade deficit.
Project out current non-oil import growth and export growth rates, and the results are scary. It does not matter to much whether you take the y/y growth rate for non-oil imports and exports for January, use the three month moving average, or take the q4 04/ q4 03 number, the results are scary. Non-oil imports are growing a 15% plus clip -- a rate that practically guarantees a significant expansion of the trade deficit.
Assume the 15% q4 y/y growth in non-oil imports and the 10.3% growth in exports continues in 2005 (y/y growth in non-oil imports was 17% in January, and growth in exports was about 13.5% -- the data comes here, and here). Assume oil stays high, and oil import volumes continue to grow slowly, in line with recent trends. That would generate a trade deficit of $790 billion.
A large expansion in the trade deficit certainly seems to be on the cards: it is robust call across a range of assumptions.
Assume non-oil imports grow by $15 billion a quarter in 2005 (that’s how much they increased between q3 and q4 of 2004); and assume exports grow by $6 billion a quarter (that’s how much they increased between q3 and q4). The trade deficit would reach $810 billion.Assume export growth catches up with non-oil import growth, and both grow at 15%. The trade deficit still reaches $750 billion. Assume non-oil import growth falls to 10%, the same growth rate as exports. The trade deficit would still increase to $720 billion.
What sort of current account deficit would a $790 billion trade deficit generate? The transfers deficit is likely to be in the $75-80 billion range. And income payments are likely to turn negative: the income deficit could well be $30 billion (v. a surplus of $25 billion in 2004). Remember, our debts are rising, and so are interest rates. By my calculations, the average rate of interest payments on Treasuries held abroad was 3.8% in 2004. It was around 6% back in 2000. Some of the 6% Treasury bonds sold back in the 1990s are still around, and with interest rates on new bond issuance rising, the overall interest rate is likely to creep up.
Add the trade, transfers and income (mostly investment income) deficits up, and the current account deficit would be in the $895-900 billion range.
That kind of deficit implies that the US shrugs off higher oil prices -- consumers don’t cut back on other spending just because they are spending more on oil. So household savings falls. Perhaps business savings falls, or investment rises. The end result: a wider gap between what the US saves and what it invests so long as the fiscal deficit stays constant.
In all honesty, I think it is a bit too early to estimate a $900 billion current account deficit. I suspect that both export and import growth with slow a bit during the course of the year. There is some evidence in recent US data (though not so much in January’s data) that export growth is slowing a bit. There are plenty of signs that growth in Europe and Japan is slowing, something that likely will weigh on US exports. Higher oil prices may not be slowing the US economy, but they seem to be starting to have an impact abroad. No current data suggests US non-oil import growth is slowing, but at some point, it has to ...
If export growth slows to around 7.5% and non-oil import growth slows to 11.5%, (taking oil into account, that brings overall import growth down to around 13.5%), the trade deficit would reach $770 billion. With a transfers deficit of $77 billion and an income deficit of $30 billion, that generates an overall deficit of $877 billion -- almost exactly 7% of estimated 2005 GDP.
These are big numbers. A $877 billion current account deficit would be about $200 billion larger than the already large 2004 current account deficit. Obviously, such a large increase may not materialize. Alan Greenspan’s crystal ball sees a slowdown in import growth on the back of a rise in US household savings and higher import prices, as European producers start passing on more of the impact of the dollar’s fall ...
But the continuation of current trends, including relatively strong, consumption-driven US growth, in the face of current oil prices certainly implies another large increase in the current account deficit.