US current account deficit adds to wories about the economy
With the US economy again seeming to be in rude good health, it has been tempting to forget about America's bloated current account deficit.
The US has racked up a deficit of around $2,247bn (€1,821bn, £1,260bn) since 2001 without suffering the ill effects predicted by textbooks: chronic currency weakness and surging interest rates.
In fact, the dollar has staged a modest revival over the past six months. More mysteriously, America's debt to the rest of the world has actually declined as a share of national income since 2001.
However many economists believe the US has been living in a fools' paradise. Its debt to the rest of the world looks set to rise steeply over coming years. By the end of the year - and for the first time since records began in the 1960s - the US is likely to be paying more to service its debts than it gets in foreign income.
As this happens America will find itself borrowing not just to fund current spending but simply to service previous debts - a position more commonly associated with a developing economy.
So why have the figures looked so good for the US in recent months?
Between 2002 and 2004 the US has run a cumulative current account deficit of $1,188bn. Yet its net foreign liabilities rose by just $87bn and have actually fallen relative to gross domestic product since 2001.
This strange state of affairs is partly the result of currency movements. Since the lion's share of US assets abroad are held in foreign currencies, the decline of the dollar between 2002 and 2004 actually lifted the domestic value of overseas investments.
Meanwhile, because the dollar is a reserve currency, most of America's foreign liabilities are also in dollars - so the value of the liabilities did not increase as the dollar fell. The fall in the US currency has actually boosted wealth and income from overseas investments.
The second reason the US did not suffer from the swelling current account deficit is due to the mix of assets it holds overseas. Americans have tended to invest in riskier assets abroad, while foreigners have been more inclined to opt for safer Treasury bonds. About one-third of US money overseas is in direct investments, one-quarter is in equities, and just 10 per cent is in bonds.
As a reward for taking greater risks, Americans secured a rate of return of more than 7 per cent between 2002 and 2004, compared with 3.4 per cent for overseas investors in the US. So, although US assets overseas are worth about $2,500bn less than foreign assets in the US, Americans still earn more than they pay out.
But neither of these factors will provide long-term safety for the US economy. Americans' preference for direct investment and equities has been helpful during the good times but would become a curse if the world economy slowed.
Meanwhile, as US rates rise, so do US payments for overseas investors.
Finally, in order for the currency to offset rising debt as it did last year, the dollar would need to continue to fall. This would increase the chances of overseas investors eventually demanding a risk premium for US assets.
Either way, the US has a problem and it is hard to see a painless solution to this debt problem over the long term.
If the dollar keeps its gains from the past six months, the rise in indebtedness should become much more obvious in the next set of annual figures. With a deficit heading towards $800bn for the year and the currency strengthening, US net external liabilities are expected to rise by about $1,200bn to $3,700bn.
Economists believe that the US may start paying out more than it receives as early as the second or third quarter of this year. The investment income surplus of $36.2bn in 2004 had dwindled to $4bn in the first quarter of 2005.
Some believe that 2005 could see an overall deficit of $75bn. With few signs that the trade deficit is likely to narrow, many economists believe that the current account deficit will reach $950bn in 2006.
Productivity - output per hour of work - rose at an annual rate of 2.2 per cent in the second quarter, down from a 3.2 per cent gain in the first three months of the year.
The US has racked up a deficit of around $2,247bn (€1,821bn, £1,260bn) since 2001 without suffering the ill effects predicted by textbooks: chronic currency weakness and surging interest rates.
In fact, the dollar has staged a modest revival over the past six months. More mysteriously, America's debt to the rest of the world has actually declined as a share of national income since 2001.
However many economists believe the US has been living in a fools' paradise. Its debt to the rest of the world looks set to rise steeply over coming years. By the end of the year - and for the first time since records began in the 1960s - the US is likely to be paying more to service its debts than it gets in foreign income.
As this happens America will find itself borrowing not just to fund current spending but simply to service previous debts - a position more commonly associated with a developing economy.
So why have the figures looked so good for the US in recent months?
Between 2002 and 2004 the US has run a cumulative current account deficit of $1,188bn. Yet its net foreign liabilities rose by just $87bn and have actually fallen relative to gross domestic product since 2001.
This strange state of affairs is partly the result of currency movements. Since the lion's share of US assets abroad are held in foreign currencies, the decline of the dollar between 2002 and 2004 actually lifted the domestic value of overseas investments.
Meanwhile, because the dollar is a reserve currency, most of America's foreign liabilities are also in dollars - so the value of the liabilities did not increase as the dollar fell. The fall in the US currency has actually boosted wealth and income from overseas investments.
The second reason the US did not suffer from the swelling current account deficit is due to the mix of assets it holds overseas. Americans have tended to invest in riskier assets abroad, while foreigners have been more inclined to opt for safer Treasury bonds. About one-third of US money overseas is in direct investments, one-quarter is in equities, and just 10 per cent is in bonds.
As a reward for taking greater risks, Americans secured a rate of return of more than 7 per cent between 2002 and 2004, compared with 3.4 per cent for overseas investors in the US. So, although US assets overseas are worth about $2,500bn less than foreign assets in the US, Americans still earn more than they pay out.
But neither of these factors will provide long-term safety for the US economy. Americans' preference for direct investment and equities has been helpful during the good times but would become a curse if the world economy slowed.
Meanwhile, as US rates rise, so do US payments for overseas investors.
Finally, in order for the currency to offset rising debt as it did last year, the dollar would need to continue to fall. This would increase the chances of overseas investors eventually demanding a risk premium for US assets.
Either way, the US has a problem and it is hard to see a painless solution to this debt problem over the long term.
If the dollar keeps its gains from the past six months, the rise in indebtedness should become much more obvious in the next set of annual figures. With a deficit heading towards $800bn for the year and the currency strengthening, US net external liabilities are expected to rise by about $1,200bn to $3,700bn.
Economists believe that the US may start paying out more than it receives as early as the second or third quarter of this year. The investment income surplus of $36.2bn in 2004 had dwindled to $4bn in the first quarter of 2005.
Some believe that 2005 could see an overall deficit of $75bn. With few signs that the trade deficit is likely to narrow, many economists believe that the current account deficit will reach $950bn in 2006.
Productivity - output per hour of work - rose at an annual rate of 2.2 per cent in the second quarter, down from a 3.2 per cent gain in the first three months of the year.
posted by Drs Search @ 11:53 AM
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