Dick Nichols
The second article in this four-part series on the Australian economy (see GLW #672) discussed the causes of the US economy's unprecedentedly large current account deficit (CAD), which reached 6.4% of gross domestic product at the end of 2005. But is this CAD (and matching current account surpluses in other economies) really a serious problem?
Without doing too much damage to the subtleties of the debate, the spread of opinion about these "global imbalances" oscillates between two poles — the complacent and the alarmist.
Harvard economics professor Richard Cooper best represents the former position. "I believe that the US has comparative advantage at producing marketable assets", wrote Cooper in the Brookings Papers on Economic Activity journal (No. 1, 2005). "We sell these marketable assets to the rest of the world. As long as Americans use the proceeds of the sale of those marketable assets productively... I do not see why that process cannot go on indefinitely ... on the current scale, that is, roughly half a trillion dollars a year."
International Monetary Fund economic counsellor Raghuram Rajan exemplifies mainstream alarmism, asking in the IMF's April 2006 World Economic Outlook April 2006, "should we worry about the size of the global current account imbalances, given that they have been financed for so long? I think we should. For one, the benign global financing conditions appear to be turning so the past need not say much about the future. More important, the imbalances are unsustainable at their current level..."
A third possibility — that the global imbalances may produce a brutal rerun of the 1997-98 Asian crisis on a global scale — can't be ruled out. It's the spectre haunting the debate, but doesn't get much of a run in public, partly for fear of spooking those very markets capable of triggering a violent "adjustment".
The debate revolves around three broad themes. What is the real economic situation revealed by the US CAD (and how reliable are the balance of payments statistics anyway)? How likely is an abrupt CAD reversal? In the event of reversal, what would be the likely impact on the US and the other main economic blocs?
Assessing debt burden
A persistent argument made against general CAD alarmism is that it is misleading to talk about a country's debt being, for example, 58% of GDP (the Australian case), when the vast majority of this debt is not debt for which "the country" is liable. These foreign borrowings have been made by private capitalist businesses that have calculated that the debt can be serviced out of future profits. If that calculation proves mistaken, they will go bankrupt, be taken over or restructure their debt.
The only debt burden that really bears on the economic credibility of the country is official (i.e., government) foreign debt, which in the Australian federal case has been wiped out by the Howard-Costello government's penny-pinching. At the state government level, debt has been reduced to the point that all Australian states have regained their AAA credit rating. The IMF is holding up Australia as "top of the class" for this policy.
A second general point against alarmism is that it is misleading to measure a country's net foreign liabilities (an accumulated stock) against its GDP (which measures the flow of output produced). For example, when Australia's net foreign liabilities are measured as a percentage of its private wealth less housing, its foreign debt position has improved over the past decade (from 26% to 18%).
One motive for scepticism about the seriousness of the US CAD arises because, despite years of increasing net foreign liabilities, the US each year still registers a net profit. For some this can only be explained by unobserved "dark matter" in US assets abroad (e.g., the drug trade).
The counter argument stresses the vital fact that US investments abroad have always earned a higher rate of return than assets in the US owned by foreigners (a difference averaging 3.1 percentage points between 1983 and 2003).
When US foreign assets are valued in terms of the actual flow of profits they generate (rather than in conventional stock terms), the net US international investment position as a percentage of GDP is +7% rather than -22% (as of December 2004). However, if present trends continue, even this way of measuring the US's position will soon turn negative.
Other observers stress that net foreign debt doesn't just express the accumulation of CADs — it is the residual between gross stocks of foreign assets and liabilities. In the US case, with huge stocks of both foreign assets and liabilities, influences on their value (for example, share market performance) can have a big impact on net debt as the residual.
Also, US gross foreign liabilities are almost all in US dollars, while US gross foreign assets are only 40% in dollars. Therefore, a depreciation of the dollar, besides making US exports cheaper, also improves its net international investment position: US asset holders get more for their non-dollar investments in dollar terms while foreign investors in the US get less in their own currencies for their US assets.
According to some economists, up to a third of US foreign debt obligations has been covered by this revaluation effect and today's US CAD is actually smaller in real terms than in 1987 — the year of the last CAD scare — because the stock of US assets held abroad in foreign currencies is proportionately larger. Given the increasing percentage of US national economic assets owned by foreigners this effect can be expected to continue.
The alarmists acknowledge this "revaluation scam", but point out that it can last only so long as investors in dollar assets are prepared to put up with lower rates of return. Sooner or later, they argue, the victims of any scam wake up — who will buy dollar assets if convinced that the US intends to deliberately devalue them at some time in the future? At that point US interest rates would have to rise to prevent investors exiting into other currencies and the end of the dollar as the world's reserve currency and store of value would be one step closer.
East Asia-US 'co-dependency'
What real likelihood of a US CAD crisis is there when east Asian central banks have to buy up US debt in order to stop their currencies from appreciating? According to this argument, the east Asian surpluses and the rough peg of their currencies with the US dollar — the basis of their export-driven development model — determine that the US CAD will continue.
Any sell-off by these central banks, particularly by the Chinese and Japanese central banks, would depreciate the dollar, force the US to raise interest rates, slow world growth and reduce demand for these countries' exports. In short, east Asia's own economic health depends on feeding the US debt habit.
The alarmists take little comfort from this argument for "structural co-dependency". They argue that even from the point of view of east Asian economic self-interest, "co-dependency" isn't set in stone. Returns on their US assets are low and at some point the benefit of the deal must come into question, especially as there would be huge losses for east Asian economies if the dollar depreciated unexpectedly. Also, within the east Asian economies themselves, it may prove hard to prevent their huge foreign currency reserves from eventually feeding inflation.
Need a sharp "correction" of the US CAD have a disastrous impact on the "real economy"? A recent study for the US Federal Reserve Board argues that, as opposed to the 1997-98 Asian crisis, sustained CADs in developed capitalist countries have usually ended benignly and that wide shifts in currency values aren't necessarily disastrous for the "real economy".
The sceptics point out that the study deals with CADs in the order of 3% of GDP or less. Above that level, examples of sharp devaluations that have not stifled growth have been exceptional (like Australia in 1997-98 and 2001) — especially when combined with a sudden stop in capital inflow a current account "reversal" has usually resulted in a big growth slowdown.
That this scenario has not yet taken place in an economy the size of the US's should ring more alarm bells, not less. Never before has the dominant country in the international monetary system built up liabilities on such a scale — the impact of a CAD shock on the US and the world economy would surely be immense.
Behind the reasoning of the optimists lies the usual faith in the self-correcting ability of markets. They stress that global financial integration and deregulation have reduced the dependence of national economies on national savings. Wider current account deficits and surpluses have become the new norm — even calling them "imbalances" is a misnomer. According to Cooper, "The startlingly large US CAD is not only sustainable but a natural feature of today's highly globalized economy".
The alarmists recall moments of "market failure" like the 1987 stockmarket crash and the 1997-98 Asian crisis. They point out that there's no way that the present global imbalances can be unwound without a substantial depreciation of the US dollar (at least by 30%), especially considering that to eliminate its CAD through higher exports alone, US export revenue would have to increase by 60% over 2005 levels.
Former IMF deputy managing director Stanley Fischer argues that such a devaluation is possible without disaster if "instead of happening overnight, it happens over a period of years... In support of that I'd say that it's pretty remarkable that for two major currencies — the dollar and the euro — between 2002 and 2004, the exchange rate moved 30%."
Of course, the custodians of the system aren't just speculating about the future — they are putting forward measures to avoid the Armageddon scenario. The economic and political impact of these — including on Australia — will be taken up in the last article in this series.
[Dick Nichols is the managing editor of Seeing Red. For sources used in this article contact <dicknichols@greenleft.org.au>.]
From Green Left Weekly, July 5, 2006.
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