Reply #61: Global: Twin Deficits at the Flashpoint?

[54anickel]

http://www.morganstanley.com/GEFdata/digests/20040816-mon.html#anchor0

June’s enormous US trade deficit should be a wake-up call to America and the rest of the world. It is a direct manifestation of a lopsided global economy that remains biased toward unprecedented external imbalances. As long as the US continues to live well beyond its means and as long as the rest of the world fails to live up to its means, this seemingly chronic condition will only get worse. The imperatives of global rebalancing are reaching a flashpoint.

America’s record $55.8 billion trade deficit in June was a shocker. Annualized, it is equivalent to a $670 billion shortfall, or 5.75% of nominal GDP. Nor can this deterioration be explained away by surging oil prices. Excluding petroleum products, the trade deficit for goods still widened by $2.7 billion in June -- an enormous swing by any standards. The plain fact of the matter is that America has never come close to running such an outsize external deficit before. By way of comparison, the last time the US had a “foreign trade problem” was in the latter half of the 1980s; back then, the trade deficit (as measured on a national income accounts basis) peaked out at 3.2% of GDP in the second quarter of 1987. Needless to say, that was not the most tranquil of times in financial markets. As America’s external imbalance widened in mid-1987, the dollar came under sharp downward pressure and US interest rates were pushed higher. Those were the classic manifestations of a current account adjustment that many (myself included) believe were at the heart of the stock market crash of October 1987. Today’s external imbalances dwarf those of 17 years ago.

It’s easy to point the finger at others in diagnosing the problem. In the political season, the blame game always intensifies. US Treasury Secretary John Snow blames it on new weakness in the global economy. The Democrats tie America’s trade and jobs problems to the pressures of outsourcing and unfair foreign competition. As usual, there are some elements of truth in both explanations. The global economy does, in fact, appear to be sputtering. Goods exports plunged by 5.9% in June (in real terms), the largest monthly decline on record. While month-to-month fluctuations can never be taken too seriously, I don’t think it’s a coincidence that such a sharp decline in overseas shipments of American made goods occurred as slowdowns became increasingly evident in China and Japan and sluggishness persisted in Europe. On the other side of the trade ledger, renewed sluggishness on the US job front and a 1.8% surge in non-petroleum imports in June (sequential monthly rate) certainly speak to the unrelenting pressures of foreign penetration into US markets.

Yet this finger pointing misses the basic problem -- that of a saving-short US economy that is locked into the destructive spiral of ever-widening twin deficits. Lost in all the shuffle was the latest monthly update on that “other deficit” -- a $69.2 billion shortfall in the July federal budget deficit reported last week by the US Treasury. Not only was that about $7 billion worse than expected, but it puts America easily on track to break the $400 billion threshold on the budget deficit for the first time ever. While America’s budget deficit has been larger as a share of GDP -- the estimated 3.6% gap in the current fiscal year falls well short of the 6% peak hit in 1983 -- the sheer volume of financing is obviously of critical importance for the capital markets. Nor has the US ever experienced such a massive turnaround in its budget position -- with the deficit for the current fiscal year representing a swing of 7% of GDP relative to the 2.4% budget surplus recorded in 2000.

Moreover, there’s another key aspect of this problem: Unlike the deficits of the 1980s, America is lacking in any backstop in private saving. Net of depreciation, the private saving rate of households and businesses, combined, stood at just 4.5% of national income in 2003; that’s only a little more than half the 8.3% average recorded in the latter half of the 1980s -- the last time the US had a deficit problem. In addition, the personal saving rate fell back to just 1.2% in June 2004 -- underscoring the asset-dependent US consumer’s seemingly chronic aversion to income-based saving. This deficiency of private saving means that outsize government budget deficits are now putting a greater strain on the US economy and financial markets than was the case during the latter half of the 1980s.

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