The massive U.S. budget deficit — expected to be $500-billion (U.S.) this year — gets a lot of attention, in part because it's a useful stick with which to bash U.S. President George W. Bush.
But the deficit that has many economists increasingly worried is the even bigger — and rapidly growing — U.S. current account deficit. It hit a record $145-billion in the first quarter and is expected to reach a record $600-billion or more this year. That's equivalent to more than 5 per cent of U.S. gross domestic product.
It's a growing problem that could not only sideswipe the U.S. economy, but the global economy — and Canada could be a prime victim.
A country's current account measures the inflow and outflow of both goods and services — that is, the balance of trade — as well as returns on investment (such as interest payments and dividends). Canada, for example, has a positive balance of trade and investment with the United States and the rest of the world and, therefore, has a current account surplus of about $38-billion on annualized basis. In other words, the value of all the goods, services and investment returns flowing out of Canada is larger than that flowing in.
The United States, by contrast, has had a current account deficit for more than a decade. This net imbalance of imports, exports, interest payments and dividends has also been growing at a rapid pace: As recently as 1997, it was only 1 per cent of GDP.
That has some economists and senior policy officials — including those at the International Monetary Fund and the Group of Seven — concerned.
A current account deficit is like a line of credit; it means a country is financing its growth by relying on others instead of using its own savings or income.
And U.S. citizens are saving less and less: Household savings were less than 1 per cent of GDP in 2000, down from 6.5 per cent in 1992.
In order to finance its consumption, the United States has relied on China, Japan and other countries to buy massive amounts of U.S. debt — an estimated $1.5-billion every day.
One way to reduce the deficit would be to allow the U.S. dollar to slide, as it has been for the past year. That reduces the relative cost of U.S. exports and makes them look more attractive next to goods from other countries, which stimulates exports. It also poses a number of problems for the rest of the world, however. For example, if the U.S. dollar were to drop by between 25 and 50 per cent — as some economists believe it must — other countries would pay the price.
Canada would be one of those countries, since a sharp decline in the U.S. dollar could push the loonie even higher, and put even more pressure on our export-driven economy. It could also create a spiral effect in the U.S. economy, if the United States was forced to boost interest rates in order to prevent a dramatic selloff in the dollar. Those hikes could put the brakes on growth, as a similar move did in the mid-1980s, and that would also hurt U.S.-dependent countries.
U.S. Federal Reserve Board chairman Alan Greenspan has said he isn't too concerned about the current account deficit. He says the high level of foreign investment in the United States is a tribute to the strength of the U.S. economy, and how much other countries want to invest in it. This is the "oasis of prosperity" theory — the idea that a large current account deficit is a sign of how strong the U.S. economy is compared with others, rather than a sign that the United States is living beyond its means.
Even if Japan and China scale back their purchase of U.S. assets, Mr. Greenspan says global financial markets are efficient enough to handle any disruption and the strength of the U.S. economy would attract other investors.
Fed governor William Poole says the United States may even be unique in its ability to carry a large deficit when other countries — such as Mexico and Argentina — became insolvent as a result of theirs.
But what if the United States isn't unique? What if the "oasis of prosperity" is a mirage? Then the market might impose the solution itself, forcing the dollar to tumble and interest rates to rise. That's one of the things keeping economists awake at night.
© The Globe and Mail
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.
