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Never before has the world's largest and most advanced economy accumulated net liabilities to the rest of the world on so vast a scale. Globalisation of financial markets has allowed this process to go on for much longer and on a far larger scale than anybody imagined a decade ago. But it cannot go on forever.
The question is how and when it will stop. Precedents are quite encouraging. The US current account deficit reached what seemed the worryingly high level of 3.5 per cent of US gross domestic product (GDP) in the fourth quarter of 1986. But it had melted away by 1991.
This history is encouraging, but not as encouraging as one would like.
First, the current account deficits are almost twice as large in relation to US GDP this time and the US has become a large net debtor.
Second, in the 1980s, it proved relatively easy to generate a large real depreciation of the dollar, but the exchange-rate policies of Asian surplus countries now block the needed adjustment.
Finally, in the 1980s, the principal counterparts to the US deficit were German and Japanese surpluses. But these two countries' surpluses make up less than 40 per cent of the US deficit this time.
Thus, according to the International Monetary Fund (IMF), the US ran a current account deficit of some 1.6 per cent of world GDP last year. Meanwhile, the principal surplus regions were: emerging Asia, with a surplus of 0.5 per cent of world GDP; the oil exporters, with a surplus of 0.5 per cent of world GDP; Japan, with a surplus of 0.4 per cent of world GDP; and the eurozone, Denmark, Switzerland and Norway, also with a surplus of 0.4 per cent of world GDP.
Adjustment now demands changes among a very wide range of countries with very different structural characteristics and policies. The question is whether that adjustment could occur naturally and smoothly.
One reason it might is that four special factors go a long way to explain the soaring surpluses of much of the world: high corporate savings, exceptionally weak investment in many economies, astonishingly high savings rates in China, and recent jumps in the price of oil.
According to the IMF, corporate savings in the member countries of the Organisation for Economic Co-operation and Development (OECD) reached 9.0 per cent of world GDP in 2003. This was a significantly higher share of global GDP than in any year since 1970.
Hit successively by the bursting of the Japanese bubble in the early 1990s, the financial crisis in Asian emerging economies in 1997-98 and the bursting of a technology bubble in 2000, corporate investment has also been weak almost everywhere. It has been particularly weak in Japan, the eurozone and east Asian emerging economies.
Again, while investment has been strong in China, savings rates have risen even more.
Finally, soaring oil prices have shifted income from spenders to savers, with a substantial impact on global spending.
These special structural factors could well unwind naturally. Thus if corporations outside the US went on an investment spree, if China raised its investment in relation to its savings or if oil producers started spending more of their increased income, the current account surpluses would shrink, world investment rates would rise and consumer spending in the US would slow, in response to higher domestic interest rates.
The baseline scenario in the IMF's latest World Economic Outlook assumes just such automatic corrections. Under a benign version of this scenario, the US current account deficit shrinks smoothly, to about 2.0 per cent of GDP.
Yet there are risks of a much more abrupt reversal, triggered by a big increase in protectionism in the US, a sudden decline in the world's demand for US assets or, more probably, both together. This could generate a sharp slowdown in the US and the rest of the world, possibly even a world recession.
Given the risks of such an abrupt reversal, the IMF recommends deliberate policy change. A combination of fiscal tightening in the US, flexible exchange rates in Asia and structural reform in Japan and the eurozone would lower the US current account deficit by as much as 5.0 per cent of GDP over 10 years from the current level.
So what will happen? Nobody knows. But we do know that the explosive increase in US current account deficits cannot continue indefinitely. It is possible that a smooth adjustment will indeed occur. It is also quite likely that the ultimate adjustment will be both swift and brutal.
That unhappy outcome certainly seems more likely this time than in the 1980s. Given these risks, policy change all round is obviously the best alternative. But there remains little sign that the needed changes are coming in the near future.
Under syndication arrangement with FE
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