Steve Johnson’s market insight column in Thursday’s Financial Times keys off Morgan Stanley’s currency strategist Stephen Jen’s argument that “As long as Asia insists on staying inside this dollar area, then the current account deficit is not what people think it is.” Rather, the US current account deficit excluding the Asia dollar zone is only 2.2% …
What? Jen’s numbers are right, much of the US currrent account deficit is with Asia and it is offset by financing from Asia. But why does it make sense to net all this out and hide the real size of the US external deficit? Dollar claims on the US held in Asia are still external debts of the United States, and claims on future US exports. Stephen Roach, Morgan Stanley’s chief economist is more worried, both about the underlying 5.7% of GDP current account deficit in q2 and the assumption that the rest of the world will finance it in the face of rising disenchantment with US hegemony.In a sense, Stephen Jen’s core argument is right: to quote Johnson paraphrasing Jen: “the current account deficit run being run against Asian nations is not unduely worrying as long as Asia continue to park its capital surpluses in US assets.” Current account deficits are never a problem so long as they are financed! The real question is whether a growing deficit can continue to be financed by Asia, and when will the strains start to show.
Jen’s call may suit the relatively near-term time frame of currency strategists — though I would be reluctant to bet that the dollar will rise in the face of large expected q3/ q4 current account deficits (oil above $45 a barrel does not help the current acccount). But more importantly, the basic analytics are off. The fact that Asia is part of a de facto dollar zone does not mean that it makes sense to net out the US current account deficit with Asia, or that the US current account deficit with Asia won’t cause problems.
Argentina was a part of the dollar zone until the end of 2001, but that did not mean that its current account deficit and rising external debt did not matter … or that what really mattered was the current account deficit Argentina ran with the non-dollar zone. What mattered was the stock of external debt relative to its export capacity, and Argentina’s ability to borrow to pay interest on its existing extenral debt, and in the process to run up its debt stock. Once it could no longer borrow, it had to adjust, and since the currency board blocked rapid adjustment, it ended up defaulting.
The US is in a better position because it is borrowing its own currency, both from Asia and the rest of the world, and so its creditors are taking the risk the dollar’s real value will fall. But presumably Asia’s willingness to keep financing the US in dollars is a function of the size of the total set of external claims on the US economy relative to the United States ability to service those debts, not just the external claims on the US from outside the Asian dollar zone. If the United States’ current account deficit with Asia doubled, to 6% of GDP (pushing the overall deficit up to 8.5%), would Jen really argue that the relevant US external deficit is only 2.5% of GDP? All external debt, including debt owed to the Asian dollar zone, is claim on US exports.
Stephen Jen leaves out two points that I suspect will cause tensions within the US/ Asian dollar zone in the near future — though my definition of the near future (next two-three years) may be a bit different than his (next two-three months?).
1: The imbalances created inside the U.S. economy by a large and growing current account deficit with Asia, financed by Asian inflows into the US fixed income market. That favors interest sensitive sectors, and hurts manufactures and other producers of tradables. It encourages a housing bubble, and the shift of resources out of goods production. That risks protectionist pressure, but in this case, the pressure reflects not just the tensions created when one sector is falling and another rising, but rather the broader macroeconomic imbalances created when a country imports close to 16% of GDP and exports a bit less than 11% and makes up the difference by borrowing from abroad. The US is taking on external debt, but not building up it s future export capacity. China’s export growth to date has come in part by taking market share from other Asian exporters (total US imports from the Pacific Rim were roughly constant between 2000 and 2003), but China can only sustain its current pace of export growth by moving into markets now served by US producers. That is happening in 2004 — overall US Pacific Rim exports are rising, suggesting China is no longer just taking market share from other Asian producers, and that trend is only going to continue looking forward. If it is not offset enormous growth in US goods exports to china/ asia (enough to shrink the overall deficit), not just the export of US treasuries to China’s central bank, there is almost sure to be friction. Think about Republican congressmen running for election in ohio in 2006 …
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