Arguments For
Many experts around the world think the U.S. current account deficit is the greatest threat to global prosperity. Why?
The reasons are summed up in a Congressional Budget Office (CBO) report. Between 1997 and 2005, the current account deficit rose from 1.7% to 6.1% of GDP. In 2006, the current account deficit reached a record $800.6 billion.
The U.S. had such a large deficit because consumers spent more in imports than U.S. businesses exported. To help pay for this trade deficit, the U.S. was borrowing 6.1% of its total output each year. Congress was concerned because no country ever had a budget deficit that large, and most experts agreed it was unsustainable. (Source: BEA, U.S. International Transactions in 2006, April 2007)
To pay for the budget deficit year after year, the U.S. government borrows from foreign governments' central banks. Between 2003 and 2006, foreign holdings of U.S. Treasury bonds rose 50%, from $1.45 trillion to $2.13 trillion. Foreigners owned more than 40% of Treasury debt held by the public. Of this, 31% was owned by Japan and 19% was owned by China. The EU owned 15% and oil-exporting countries owned 5% that we know of. Since a large percentage is owned by tiny countries in the Caribbean, the Treasury Department suspects that some of this is actually owned by fronts for these oil-exporting countries.
In addition to Treasury bonds, foreign investors owned U.S. assets such as stocks and real property. The total figure was $13.6 trillion, which was 109% of the total GDP for 2005. In other words, if foreign investors called in their loans and sold all their assets, it would take more than a year for the U.S. economy to generate enough revenue to buy it all back.
Of course, the U.S. owned foreign assets, which could be sold. However, that still wouldn't be enough. Even after selling all foreign assets, the U.S. would still owe 20% of a year's worth of production. The sheer size of the deficit raises concerns about whether the U.S. economy can pay a decent return to investors. If foreign investors panic and start selling U.S. assets at any price, this could cause the dollar's value to collapse. The greatest threat is that, due to the large size of the current account deficit, at some point investors will lose confidence that they will get their money back. No one knows what this tipping point could be, because no country with an economy this large has ever run a deficit this large. Once investors lose confidence, a panic could ensure, causing everyone to sell their Treasury Notes immediately, at any price, to avoid losing more money.
Arguments Against
Despite the above arguments, many experts state that the sheer size and importance of the U.S. economy will prevent any disastrous crash. All countries involved will work diligently to keep the U.S. economy afloat, because they know that if the U.S. ship goes down, all their ships will, too. Although they agree that, at some point, other countries will stop lending the U.S. money to buy their goods, the process will be stable and with little negative impact.Outcome
If the U.S. current account deficit raises concerns about the safety of investing in the U.S., other investments woul become more attractive:- The global stock market is becoming more transparent.
- Latin American and South East Asian countries have become more open to investment.
- Japan's economy is slowly growing. Some even say Japan's earthquake could eventually spur economic growth.
- Many central banks throughout the world did not dropped rates as low as the U.S. This makes their own countries' bonds look more attractive.
- U.S. Senators put pressure on China to raise its currency to allow the U.S. to become more competitive. The higher China allows its currency to rise, the less Treasury notes it needs.
The CBO warned that even a gradual decline in the dollar value would lead to a lower standard of living for U.S. residents, thanks to higher interest rates and inflation from higher-priced imports.
What the CBO Recommends
The CBO report is to the Budget Committee of the House of Representatives. Therefore, the CBO recommends two options for lawmakers:- Increase personal savings without tax incentives. An example would be automatic payroll deductions for 401 (k) plans.
- Thoroughly review options that constrain health care costs. This would reduce government spending, which is the same as increasing the national savings rate.
