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Richard Cooper has an oped in today’s FT (avaible here, subscription needed) arguing that the US current account deficit is "not only sustainable, it is perfectly logical".
Cooper argues that a $500 billion current account deficit is sustainable indefinately. The strange thing is that if you delved int the depths of Nouriel and my analysis, we too would argue that a current account deficit of $500 billion is sustainable (so long as the economy grows, it will be a declining share of GDP, and debt sustainability hinges on the trade deficit, not the current account deficit). However, Cooper seems to think current policies will put us on a trajectory that produces constant nominal current account deficits, and thus falling current account deficits in real terms. Nouriel and I disagree with that. We think current policies will put the US on a trajectory that generates a current deficit that is growing both in nominal terms and as a share of GDP.
Consequently, I disagree with the implied policy conclusion in Cooper’s analysis, namely that there is nothing to worry about. Richard Cooper bases his argument on two points:
1: a current account deficit is consistent with a stable external debt to GDP stock (true), and with cooper’s assumptions,a current account deficit of 2.8% of GDP is consistent with a stable debt to GDP ratio (that is something cooper suggests the US will hit in 2018, when the US debt to GDP ratio peaks at 46 % of US GDP)
2: it is reasonable to think the world will continue to lend the US $500 billion of its $6 trillion in annual savings -- 10% of world savings is not so much in globalized economy, particularly if the United States need to import external savings will fall over time in relation to a growing supply of savings from a growing global economy.
The first point is fine as it goes -- it actually is a reasonable approximation of the "fast adjustment" scenario in the external sustainability paper that Nouriel and I did (we will be updating our September paper very shortly). In our updated "fast adjustment scenario, the US current account deficit is expected to be about $500 billion in 2015, with the US external debt to GDP ratio estimated at a bit over 50% in 2015 -- within Cooper’s ballpark. But getting there, in Nouriel and my analysis, requires a sustained adjustment to reduce the trade deficit by about 0.5% of GDP every year between now and 2015, and thus a steady fall in the dollar if US growth continues.
Afterall in 2015, by our forecasts, even if the US adjusts, it will be paying about 2% of GDP in interest (nearly $400 billion in 2015), so moving from our 2004 current account deficit of well over 5.5% of GDP to a 2.4% of GDP current account deficit in 2015 requires entirely getting rid of a 5% of GDP trade deficit over the same time, more or less.
Cooper’s analysis seems a bit dated. The 2004 current account deficit is likely to be closer to $700 billion (I am estimating $670 billion) than $500 billion, and next’s years deficit -- barring a recession -- is likely to be above $750 billion. Not $500 billion.
With end an end of 2004 debt to GDP ratio of nearly 30% of GDP, and with current account deficits of 6% of GDP or more in 2005 that look more likely to keep on rising than to fall, the US external debt is set to reach 46% of GDP in 2008, not 2018 -- so long as the dollar does not fall substantially against a range of currencies and the US continues to grow.
Cooper avoids discussing whether current fiscal policies (in conjuction with low private savings) and current exchange rates are at all consistent with a current account deficit that falls as a % of GDP (And a trade deficit that falls even faster as a share of GDP). Nouriel and I think not, not at all! That is our core difference.
As for Cooper’s argument about US deficits only absorbing a small fraction of total global savings and the US offers "higher returns on real investment than Europe or Japan" and "more safety and security ... than do emerging markets," I would note three things.
One: right now the US has a large deficit in net equity investment. Europe and Japan are no longer investing in the US. US equity investors -- particularly US firms -- are investing abroad in search of higher real returns far more than foreign equity investors are investing in the US.
Two. It may be that investment opportunities in the US will prove attractive to wealthy Chinese and Indians private citizens, so that the end of exchange controls in those economies will generate large net inflows to the US. But remember, to generate net private inflows, the US has to be more attractive to Chinese and Indian investors than China and India are to US investors. I rather doubt that will be true over the long run (without some adjustment in US interest rates). Chinese/ Indian private investors would be lending to a country with a significant current account deficit whose currency would likely fall in real terms, while US investors would be investing in countries with large potential for real appreciation. Russia generates ongoing private capital outflows to finance the rest of the world, but if China and India avoid Russia’s fate (Russia’s capital outflows are largely the legacy of disputed privatization of the country’s natural resources, something China and India don’t have to worry about as much), they may well avoid continuous sustained capital outflows. In real terms, it is hard to see how the dollar offes a better store of value for Indian and Chinese private savings than the currency of an economic zone with a more balanced trade account (say the euro) or investment at home, particularly at anything like current US real interest rates.
Three. Cooper argues that the accumulation of dollar reserves will naturally make up for any shortages in private capital inflows in the US, and this is ok, if not carried to the extreme. Well, maybe -- i’ll take in the Bretton Woods two argument at another time. But in 2003 such reserve accumulation totalled $414 billion, and finaced about 80% of the US current account deficit. To me, that seems to be something which is already being carried to the extreme. Moreover, unless private inflows pick up, the US will become more dependent on reserve accumulation over time as US deficit grow. And it is hard to see how dollar denominated assets -- given that the dollar is likely to need to depreciate substantially to put the US on Cooper’s sustainable trajectory of $500 billion in current account deficits over time -- offer a stable and secure store of value to the central banks of major asian economies. Current real interest rates are unlikely to make up for likely future dollar depreciation.
All in all, I am not persuaded.
One final point: if anyone in the US has read this entire post rather than gone out and voted, you have badly misallocated your time. Vote.