CBO Report on the Current Account Deficit: The Congressional Budget Office (CBO) reported on the U.S. current account deficit to the U.S. Congress. Between 1997 and 2005, the current account deficit rose from 1.7% to 6.1% of GDP. The U.S. has such a large deficit because consumers are buying more in imports than the U.S. exports. To pay for the deficit, the U.S. borrows 6.1% of its total output each year. Congress is concerned because no country has ever had a deficit this large, and most experts agree it is unsustainable. In 2006, the current account deficit rose even higher, to $856 billion. (Source: BEA, U.S. International Transactions in 2006, April 2007)
To pay for this 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 own more than 40% of Treasury debt held by the public. Of this, 31% is owned by Japan and 19% is owned by China. The EU owns 15% and oil-exporting countries own 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 own U.S. assets such as stocks and real property. The total figure is $13.6 trillion, which is 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 over a year for the U.S. economy to generate enough revenue to buy it all back.
Of course, the U.S. owns 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.
How the Current Account Deficit Got So Large: The U.S. is a great place to invest, thanks to a strong economy and legal protection for investors. However, the U.S. government and its citizens don’t save enough to have anything left over to invest. Combined, the U.S. saved only 2% of its income last year.
However, an amount equivalent to 8% of total U.S. income was invested last year. That means that foreigners invested an amount equivalent to the difference. Another way to look at it is that foreigners invested 3x as much in the U.S. as domestic investors.
In a way, this is a compliment to the strength and security of the American economy. Between 1997 and 2000, a series of financial crises occurred that culminated in the LTCM hedge fund crisis in 1998. This caused Asian countries, especially, to look for a safe harbor, which they found in the U.S. economy.
However, the sheer size of the deficit is raising concerns about whether the U.S. can and will 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.
What the CBO Predicts: The CBO does not think there will be a sudden dollar collapse. Instead, it predicts a gradual softening of demand for U.S. assets, including Treasury bonds. As this happens, yields will rise and the dollar will gradually lose value relative to other currencies. As this happens, the value of the U.S. assets will fall relative to foreigners’ currencies, further depressing the demand for U.S. assets. Most “dollar collapse” doomsayers predict that this will lead to a tipping point, at which investors will dump U.S. assets at any price to avoid holding worthless assets.
The CBO, however, notes that U.S. holdings of foreign assets are denominated in foreign currency. As the dollar declines, the value of these assets rise, thus further reducing the current account deficit. In addition, a lower dollar will increase exports and decrease imports. These trends will stabilize the current account deficit before a run on the dollar could lead to a dollar collapse.
The CBO does warn, however, that even a gradual decline in the dollar value will 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.
The CBO does admit, however, that any of these options will necessarily reduct personal consumption, a key driver of GDP growth. Again, this would lead to a lower standard of living for Americans. However, the CBO says this is preferable to a long-drawn out dollar decline and the risk of a sudden dollar collapse caused by the monstrous U.S. current account deficit. (Source: Congressional Budget Office, Testimony on Foreign Holdings of U.S. Government Securities and the U.S. Current Account, June 26, 2007 pdf)
