In an article in yesterday's Financial Times, Jim O'Neill, who heads global economic research at Goldman Sachs, asks if the US trade deficit is about to disappear. According to him the latest monthly data show that the US trade deficit, at $59 billion, has declined from 7% of GDP to 5%. Exports have been growing nearly 15% year-on-year whereas imports have been growing at just over 5%. If a subprime-crisis-related economic slowdown keeps import growth at this level, and a weak dollar also keeps export growth at this level, the trade deficit would drop to 3% of GDP within one or two years.
I am not smart enough to say whether O'Neill's speculations are loony or sound, and I am not sure what is driving this shift, but O'Neill points out that retail sales are growing in all the BRIC countries at double-digit levels (China recorded over 17% growth in July). They only account for half the global share of GDP that the US does, but their spending growth is double the US rate.
This satisfies the savings-glut model by suggesting that a slowing down of the growth rate of developing-country savings is having the expected effect on the US balance of payments. The weaker dollar and the consumer fears arising from the sub-prime crisis, I guess, satisfy the excess-US-consumption model. Either way, if things continue at this rate and the US trade deficit declines sharply – a big if, I know, I know – we could see a major shift in the world economy, and it might not necessarily be a very pleasant one.
I say this not because I am one of those apparent crazies who are not terribly worried about the US trade deficit, and even believe it is a necessary pre-condition for the very difficult demographic adjustment needed by Europe, Japan, Russia and especially China in the coming decades. I am, but my concern is different.
As I said in an earlier post I believe that the recycling of the US trade deficit has been the main factor underpinning the recent globalization cycle. If so, and when the current cycle ends, if history is any indication the adjustment from the insanely happy days of too much liquidity (with its attendant surge in risk appetite) to a more “normal” level of liquidity will be a very difficult one and can result in significantly reduced global growth lasting many years – especially for those countries that begin the slowdown with the weakest and most rigid financial systems.
In previous cycles, financial systems, which during the good times had evolved into greater risk-taking activity and more-tightly-stretched asset-liability structures, were suddenly caught short by the secular change in risk appetite. In many cases their ability to intermediate the flow of capital slowed considerably, and what followed often involved considerable economic slowdown.
My evidence is largely anecdotal, but it seems to me that those countries with the highest levels of financial risk-taking and the least flexible financial systems were the ones that did most poorly – the United States in the 1930s, with its reliance on thousands of small banks with rigid deposit bases, a weak and inexperienced central bank, and an investment banking industry in shock, of course did among the worst, although there were plenty of other non-financial factors that exacerbated the problem (by the way, it is worth remembering that in 1929 the US had, after several years of very high trade and capital account surpluses, very high levels of reserves, which in the end didn't help).
I am curious to know what readers of this blog think are the major economies with the most susceptible financial systems. IF the US trade deficit really is declining sharply, and IF the recycling of the US trade deficit really was the industrial-strength punch that kept this party going for so long, who is most likely to be hurt when the punchbowl is taken away?