from Follow the Money

You know, there are safe havens that do not have a current account deficit of $1 trillion …

May 25, 2006

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Incidentally, I am not the only one who thinks that the US current account deficit is heading toward a trillion.   The OECD now forecasts $965b current account deficit in 2006 (7.2% of GDP), and $1070b in 2007 (7.6% of GDP) -- rather than link to the full report, with the actual numbers, I’ll just link to the summary.   Justin Lahart of the Wall Street Journal reports that the April ports data suggests strong imports and not-so-strong exports, which supports this forecast. And, given the pending surge in net US interest payments as the interest rate on US external debt rises from 3.4% (2005) to something closer to 5.5%, it seems likely to me that the US current account deficit will be above $1 trillion for a long time.  Barring a very hard landing.

Still, David Altig notes that the US remains a safe haven in times of stress.  David Altig asks “where else would you go?”    Actually, he puts it in a slightly more colorful way.

To anyone waiting for the greenback slaughter, I have one question: If, heaven forbid, the global economy goes south, who ya gonna call?

He asks, I answer.

If the global economy goes south because of an oil supply shock, I would run into the Canadian dollar and the Norwegian krone.  I would even rather hold the Russian ruble than the US dollar.  Putin isn’t the nicest guy, but Russia is now a substantial net creditor – and with oil at $70 Russia is adding about $150b to its reserves a year.  I kid not -- Russia's reserves have been rising by $5b a week recently. Its external fundamentals are solid.  And I doubt the central bank will be able to resist nominal ruble appreciation forever.

I would also prefer the euro and even the yen to the dollar.  Both Japan and Europe have more energy efficient economies than the US (yep, energy intensity is a structural problem).   Oil exporters want to spend their windfall on European goods, not American goods.   And if oil gets higher, Americans will want to import more Japanese energy-saving technology (hybrids).   But I realize that the euro/ yen over dollar call is a bit more conversial – Peter Garber of Deutsche Bank thinks the dollar would rally in the event of a big oil supply interruption.   Lots of petrodollars would need a home.  My botton line though is simple: in the face of a shock that increases the current account deficits of all oil importers, I wouldn’t want to hold the currency of the oil importer with the biggest deficit.

If the global economy goes south because of a global demand shock and oil falls, Canada, Norway and Russia aren’t the obvious safe havens.   But Asia still looks pretty good to.   Read Bill Gross – he is kind of good at these things.  Asia exports savings – unlike the US.   It imports a ton of oil, so if oil prices fall, Asia’s current account surplus would rise.   Of course, Asia also exports a lot of things – and if US demand growth slows, that would also hurt.  But net/ net I suspect that the impact of slower growth in exports is offset by lower import prices.  And if oil falls because of a global demand slump, US interest rates would likely fall, reducing the interest rate differentials that now favor the US.   

Afterall, a slump in global demand would probably stem in the first instance from a slump in US demand.  The US has been the engine driving global demand – and thus is the biggest potential source of trouble.

And particularly if German consumers start to act a bit more like Spanish consumers (i.e. start spending), the euro also looks like a better safe haven than the US.   Europe doesn’t have a big external deficit that it would need to finance during a downturn, when it is offering international investors a low interest rate.   And unlike the US, Europe is building up its stock of dark matter, not drawing it down.   The eurozone probably took in at least $150b from the central banks of the emerging world, and rather than using the funds to finance big external deficits, it used the flows to finance European foreign direct investment abroad.

Altig and others would probably say I am underestimated the United States strengths.  

But I say that they may be underestimating the problems created by running a current account deficit that exceeds your goods exports.   OK, I should throw in service exports.  But the US is running a 7% of GDP trade and transfers deficit off an export base that is only a bit over 10% with a dollar that is weak against the euro and with global demand for capital goods – the kind of thing the US makes – quite high.  The United States core external fundamentals are not so hot.   The US needs a gradual fall in the dollar that reduces its trade deficit slowly (and increases the value of US assets abroad) to stabilize its external debt at 60% of US GDP, and stabilize US net interest payments at something like 3% of GDP. 

A run into the dollar that pushes the dollar up would imply a trade and transfers deficit of 8 or 9% -- and a currnet account deficit of 10 or 11% as interest payments rise.   That doesn’t sound like safe haven to me.  

It also implies a bigger future depreciation of the dollar and a US net external debt level that maybe stabilizes at 80% of US GDP.

Stephen – current account deficits really don’t matter – Kirchner, and lots of others, would say I am underestimating demand for US assets – and the United States skill at creating assets.

I concede that the US is good at selling debt to the People’s Bank of China.   But I would argue that Kirchner and others underestimate the long-term risks associated with depending on the central banks of nice places like China, Saudi Arabia and Russia – along with Japan’s version of day (carry) traders – for financing.  

The smart money betting on the US is betting – I think – that if private demand for US assets falters, central banks will step in.   The US is too big for China and Japan to let it fail (sort of like Russia was too nuclear too fail?).   That may be right.   Central banks so far have stepped up their purchases when the dollar is under pressure – and, as Ted Truman and Anna Wong nicely demonstrate, central banks also bought more dollars and fewer euros when  the dollar is under pressure in 2004, and then relatively speaking more euros in 2005 when the euro was under pressure.   That is the opposite of diversification.   They could act that way in the future too.  Or they could decide that there are limits to the number of dollars they want to hold …    

I recently read that US investors – mutual fund investors – put $20b into emerging markets in 2005, and $30b into emerging markets in the early part of 2006.   Those kind of flows – plus additional hedge fund flows – bid up thin markets big time.  The withdrawal of those funds, in turn, pushed lots of the same market down over the past two weeks.

But relative to the flows the US needs, $20b – or even $30b – is chump change.

China added $20b to its reserves a month in 2005.   And in the first quarter of 2006.  it probably will be more in the second quarter.  In a month, China provides about as much financing to the US as US investors put into all emerging economies in 2005.

The $30b that US investors dumped on emerging markets in 2006 less than what Russia and Saudi Arabia now add to their reserves in month.    Russian reserves are going up by about $20b a month.   Some of that is valuation changes, some may be capital inflows.   But most comes from selling oil and gas.  Saudi Arabia hasn’t released data for April or early May, but it doesn’t take a genius to guess how much it is now raking in.   Bill Gates has nothing on Saudi royal family.  Hell, with only $80b in 2005 profits, the big (western) oil companies have nothing on the Saudis.

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