The IMF just published its annual report on the US economy.
The report was in some ways remarkably frank. And it outlined the core policy choice the US government has made, namely, not to do anything to try to reduce the vulnerabilities associated with the large – and I suspect still growing – US current account deficit.
The money quote: "The authorities observed there was little more than US policy could do to address global imbalances"
The IMF does not agree: their work (see Chapter V) suggests more aggressive efforts to reduce the fiscal deficit would have an impact.
Ted Truman (and Paul Volcker) do not agree. Truman thinks monetary policy should try to maintain balance between aggregate supply and aggregate demand – which, in practice, means the Fed should do more to reign in demand growth.
The problem is not just that the US is borrowing large sums from abroad, but it is borrowing in ways that are unlikely to generate the future income needed to pay the debt back, as (to quote the summary of the IMF's Executive Board discussion) "foreign savings and corporate profits increasingly [are] financing government and household spending."
The last (2004) IMF Article IV report on the US forecast – almost magically – the US current account deficit would wither away. It predicted the deficit would peak at around 5% of US GDP in 2004 and start falling in 2005. That forecast was no doubt done at the end of 2003 and the IMF assumed (like many) that dollar depreciation would have a bigger impact than it did. Still, the IMF's old forecast for the 2005 current account — around 4.5% of US GDP — is not going to even be close to this year's number, and that was clear from the moment it was released. This year's Article IV report represents something of an improvement: it forecasts a 6.1% of GDP current account deficit from now until 2010.
The IMF does its forecast right. Since net debt and net interest payments are rising, a constant current account deficit implies a small reduction in the trade deficit.
p. 12 of the Article IV report includes a series of charts that show the evolution of the US net international investment position if large US current account deficits are sustained. They look a bit like some of the charts in Roubini and Setser (2004). Note in particular that exports as a share of GDP have been rather flat for some time, and have actually fallen since 2000. That is not a good sign if your external debt is rising.
Since the IMF forecasts only a modest slowing of US domestic demand growth (it falls from 4.8% in 04 to 4% in 05 and around 3.5% from then on) and solid but not spectacular growth in US trading partners (it is expected to be between 2.8 and 3.0% going forward, a bit lower than in 04) and still high oil prices, the IMF implicitly (maybe even explicitly) is forecasting further dollar depreciation to shift demand from foreign to US goods.
Economic wonks know that standard elasticities for the US would generate faster import growth than export growth if US domestic demand grows faster than foreign demand and the dollar is constant, and thus a rising trade deficit. Remember, keeping the trade deficit constant requires exports to grow much faster than imports.
The Fed staff certainly expects the dollar should fall further. To quote the IMF's staff report: "Fed officials agreed that a significant depreciation of the dollar would be needed to narrow the trade balance and stabilize the net investment position."
But make no mistake, even if the dollar depreciates and the trade deficit falls slightly over the next few years, as the IMF forecasts, the US is on track have a mountain of external debt. Net external debt is forecast to reach about 50% of its GDP by 2010 – a very high number for a country that only exports about 10% of its GDP.
To be honest, I think a realistic forecast should include further widening of the current account deficit in the near term. A bigger current account deficit implies a bigger gap between savings and investment. So a bigger deficit implies that savings – household savings at least – might go negative. Or business investment would need to rise without triggering higher interest rates and a fall in residential investment.
You can certainly argue that this is a bit unrealistic, and market forces will kick in to push the US back toward equilibrium before the current account deficit reaches 7% of US GDP. Greenspan was making a variant of this argument in the spring. Yet right now, is sure seems likely that the q3 and q4 2005 current account deficits will be above 6.5% of US GDP – it looks like an inventory correction kept imports unusually low in q2, so import growth looks set to resume its upward march later in the year. Barring a slowdown in the US or collapse of the dollar, I expect a 7% of GDP 2006 US current account deficit.
That is a quibble though. Far better for the IMF to forecast a constant current account deficit than to forecast the deficit will disappear without any action from the US government.
Note as well the IMF's forecast for the future evolution of the fiscal deficit if government spending grows at something like its historical norm. That would require President Bush to show a greater commitment to limiting spending in his second term than in his first. Under those assumptions, the US fiscal deficit more or less stays around 3% of GDP for the next few years, maybe a bit less if this year's revenue surprise is sustained. No matter: it is far too high a level for a country that does not save.