Anantha Nageswaran of Libran Asset Management in Singapore has submitted a set of (lengthy) comments that respond, in some sense, to many of the points I and others have raised on this blog. Check them out.
Dr Nageswaran argues that we here are a bit too pessimistic about the US. Oil may act as an automatic stabilizer for the US economy - rising to cool excess demand, but falling if US demand falters. A fall in housing-driven US consumption might lead to a fall in oil – and with housing bubbles in Europe too, it is not obvious that the dollar would lose out if there is a global housing correction. Or – to insert the views of Dooley, Garber and Folkerts-Landau – the US is simply too important an engine of demand for the United States' biggest creditors to ever pull the plus. A strong dollar is so important to China that China will continue to prop the dollar, and US demand, up. And if China wants to lend us the money needed to buy their goods and expand our housing stock, we should do it, even if it makes the US domestic economy look unbalanced to some.
I have not commented extensively on the US current account deficit recently, largely because there has not been much new to say. But this seems a good time to reiterate my base case for why we in the US – and everyone in the world too – should worry about the US trade and current account deficit. That afterall is the basis of most of my concerns about the trajectory of the US economy.
The US current account deficit is now, to state the obvious, quite large. It was around 6.5% of US GDP in the first half of 2005, and I expect it will head towards 7% by the end of the year and will come in at over $800 billion. Lewis Alexander of Citibank forecasts a deficit of more than 7% of US GDP in 2006.
That is very large in relation to the United States' small – 10% of GDP — export base. I think the United States' small export base and its leveraged economy, which makes the US vulnerable to a rise in interest rates, offsets the (very real) advantages of borrowing in your own currency, and having substantial foreign assets whose value rises if the dollar falls.
Unlike in the 1980s, the US is now a significant net debtor. US net external debt will likely hit 30% of US GDP by the end of the year. In 2006, interest payments on the United States' external debt will start to add significantly to the current account deficit. Looking ahead, rising interest payments on a rising external debt imply that the trade and transfers deficit of the US has to fall just to keep the current account deficit from rising.
Even if the trade and transfers deficit stabilizes at around 7% of US GDP, the US current account deficit will keep on rising as a result of rising (net) interest payments on the US debt. A current account deficit of over 7.5% of GDP in 2007 and close to 8% of GDP in 2008 is quite possible even if the trade deficit (as a share of GDP) stabilizes at roughly year-end levels.
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