Brad Setser

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Will the US current account deficit fall faster than the IMF forecasts?

by Brad Setser
October 9, 2008

The authors of the IMF’s World Economic Outlook have a difficult job. They have to forecast the trajectory of the global economy — itself not an easy task. Their forecast will be judged and evaluated in real time. But the work according to a schedule set by the need to consult the IMF board and the demands of physical rather than virtual publication. In practice, that means that the forecast never fully reflects the most recent data. “IMF Board” time, “internet” time and “market” time are all very different things.

Sometimes that doesn’t matter. But right now is one of the times when it does. A lot happened this September. And I suspect that much of what has happened isn’t reflected in the IMF’s forecasts.

Specifically, I now expect a larger fall in US output and a larger fall in the US current account deficit — and for that matter, the combined current account deficit of the US and the EU — than the IMF currently forecasts (see the WEO’s data tables).

In the past I have argued that the IMF has had a tendency to forecast problems like the US current account deficit away, and in effect assume that the US current account deficit would tend to shrink even if neither China nor the US adjusted their policies. The IMF has also tended to downplay the role the official sector has played in financing the US.

Now I suspect that there will be more adjustment than the IMF expects.

Specifically, the IMF now forecasts that the 2009 US current account deficit will fall to $485b in 2009 (around 3% of US GDP)– well below its 2006 peak of $790b, and down from an estimated $665b in 2008. The deficit has been running at around $700b, so the IMF is forecasting a fall in the deficit in the second half of the year (see Table A10).

That fall seems reasonable. Indeed, the fall in the United States external deficit could be much bigger:

— the IMF forecast is based on a $100 a barrel average oil price. If oil stays around $90 a barrel, the US deficit would be about $50b smaller (and the surplus of the oil exporters would be reduced by around $150b).

— The credit crunch could cut into investment, reducing demand for imports

— Households seem to have, at least temporarily, stopped spending, pushing savings rates up and cutting into imports.

A rise in the fiscal deficit could help offset the slowdown in consumption and fall in investment — and the pace of US export growth will almost certainly slow as the world slows (the dollar’s recent rebound doesn’t help either).

But all in all, it would seem to me that the US deficit could fall by more than the IMF forecast — in a rather abrupt adjustment triggered by a sudden fall in US household consumption.

The IMF forecasts that the EU’s 2009 deficit to be about $220 billion, roughly the same as the $230b deficit forecast in 2008. That implies the IMF now expects the combined deficit of the US and Europe would fall, and the combined surplus of the emerging world would shrink.

That is important. The US deficit actually peaked in 2006 at just under $800b. It has been falling since. But the $125b improvement in the US current account deficit has been offset, in a global sense, by a $170b deterioration in the EU’s deficit (it went from $60b in 2006 to a forecast $230b in 2008). Yes, Virginia, exchange rates do matter: this deterioration in the EU’s overall balance followed the appreciation of most European currencies

The combined deficit of the US and EU consequently rose over the past two years even as the US deficit fell, allowing — in a broad global sense — Asia’s surplus to rise even as the oil exporters surplus rose. Indeed, in aggregate, Europe (not the US) has been the driver of global demand growth over the last four years. From 2004 to 2008, the US current account deficit rose from $625b to $665b while Europe swung from a $65b surplus to a $230b deficit. That is close to $300b swing in the current account balance of the EU (the swing in the eurozone’s balance is far smaller). From say 2002 to 2005 the US did drive global demand growth, but starting in 2005 the EU picked up and from 2006 through 2008 it carried the baton.

In 2008, the IMF forecasts a combined US and EU external deficit of around $900b — up from $450b in 2002 (see Table A10).


What about the other side of the ledger?

Well from 2002 to 2008, the Middle East’s surplus increased from $30b to $440b — and emerging Asia’s surplus increased from $65 billion to an estimated $380 billion. The simultaneous increase in the Gulf’s surplus and China’s surplus explains why the combined deficit of the US and Europe became so large — it was the only way the global economy could balance.


The IMF’s data also leaves no doubt that the surplus in both the Gulf and emerging Asia reflects an savings glut not an investment drought. In both regions investment is well above its levels in the 1990s. Savings just increased more (see Table A16).

Looking forward, the IMF doesn’t expect much adjustment in Asia. Its surplus is expected to remain roughly constant in nominal terms — in large part because China’s surplus is expected to remain constant. I agree. Export growth will slow, but so will import growth — and import prices. On balance emerging Asia’s surplus might end up falling by a bit more than the IMF forecasts as the US and Europe slow dramatically.

The Middle East’s surplus is expected to fall from $440b to $365b. That is a meaningful fall — but it still leaves the Middle East’s surplus well above its 2005 and 2006 level of around $250b. Personally, I would expect a bigger fall — in part because I do not current expect oil prices to average around $100 and in part because I expect domestic spending and investment and thus imports have increased by more than the IMF assumes. Forecasts for the Middle East are particularly challenging because the region generally doesn’t release timely balance of payments data!

The IMF’s data tables also are loaded with information about the composition of capital flows to and from the emerging world: Table A13) shows clearly that net capital outflow from the emerging world that corresponds with the emerging world’s estimated $870b current account surplus in 2008 is entirely an official flow. The IMF expects $1270b in outflows from the growth in the emerging world’s reserves and another $160b in “official” outflows (largely the Gulf’s sovereign wealth funds). That implies that the governments of the emerging world are on track to about $1.4 trillion in US, European and Australian assets — along with a few Japanese assets.*


The detailed data tables includes estimate of for the oil money that has been channeled through the Gulf sovereign funds (an estimated $150b in 2008) as Asia’s 2008 reserve growth ($750b). In 2009, the IMF expects the Gulf funds to get another $115b — and Asia to add about $550b to its reserves. Net official flows from the emerging world to the US and Europe would remain over a trillion dollars — though they would fall back from the 2007 and 2008 levels.

For once I even think there is a risk that the IMF may have over-estimated official asset growth. The IMF assumed large net private flows would combine with the emerging world’s current account surplus to drive the enormous growth in the emerging world’s reserves and official assets. Net private capital inflows to the emerging world were forecast to top $500b in 2008 — just off the record $630b in inflows in 2007. However, over the last several months — and particularly over the last few weeks — much of the private money that flowed into the emerging world in 2007 and the first part of 2008 started to flow out. That will cut into official asset growth.

As a result, the US almost certainly will rely less on central banks and sovereign funds for financing in 2009 than it did in 2007 or the first half of 2008. That will be true even as the US dramatically scales up Treasury issuance, and the size of the US budget deficit rises. For the first time in a long time, private American households seem to have decided that they need to save a bit of money rather than spend all they take in — and for the first time in a long time private US savers seem to want to hold low yielding US treasury bonds.

And I increasingly suspect that one consequence of United States and Europe’s recent financial crisis will be a smaller deficit in both regions, and a smaller surplus in the emerging world.

NOTE: I added the graphs to this post several hours after I initially put up the text; creating the graphs took a bit of time.


  • Posted by Pallj

    Yes, mbug, Paul de Grauwe puts it very neatly indeed.

    The Icelandic banks that failed all had enviable equity and were turning a profit as they failed. One is hoping that under state ownership again they’ll eventually get the wheels back in motion here, but as the profitable business they were these banks are history.

  • Posted by DJC

    China’s Leaders ignore US financial fiasco, focus on domestic rural problems

    BEIJING — China’s leaders began an annual policy-setting meeting Thursday, turning their attention from the global financial crisis to the economic issues facing the nation’s 730 million farmers.

    The decision to focus the high-level Communist Party conclave on rural matters shows how China’s relative insulation from the credit crunch is allowing it to continue working on a crucial long-term issue. It also shows the gravity of the situation in the countryside. China’s reforms began there 30 years ago, but rural incomes have been growing only slowly and grain production has reached a plateau.

    President Hu Jintao has signaled that this week’s meeting will take up the question of rural property rights.

  • Posted by glory

    re: state capitalism (run by ex-goldman alums and PIMCO 😉

    We need a new banking system… The Great Depression had bank failures, we have bank zombies.”

    From central bank to central planning? …despite all this, we still have not had enough central planning in finance. For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market. And it is the price of risk that is the source of our current distress… The Fed and the Treasury are walking down a road that ends with making the price of risk in financial markets, along with the price of liquidity, an administered price.”

  • Posted by gillies

    have any of the contributors who were recently so anxious for the chinese to get out of the doomed dollar, and into the euro, commodities, etc. – sent flowers, chocolates, or an apology of some kind ?

    – and when is mr paulson’s next lecture tour of beijing ?

    – and to all world leaders this weekend who think that there is no easy way out – look, the crash IS the easy way out.

    – and as the fastest way out of a crash is straight through it . . . . why persist in trying reducing interest rates to a level at which people are once again prepared to borrow ? why not raise interest rates to a level at which people are once again prepared to lend ?

    – buffet is right when he says that we have experienced – or are experiencing – an economic pearl harbour. but history never repeats itself, and i suspect that the difference is that this time around WE are the japanese.

  • Posted by glory

    from the WSJ: Japan’s finance minister said his country is prepared to help bail out nations running out of funds amid the worsening global financial crisis.

    [flush with nearly $1 trillion in foreign exchange reserves] “We are ready to provide our funds to the IMF,” Mr. Nakagawa said.

    Such a move would send a lifeline to countries like Iceland, where the government’s efforts to bail out the country’s three biggest banks has pushed the small nation to the edge of bankruptcy.

  • Posted by glory
    The country of Bubblia has a problem… Alan Bernson, a loyal government servant in charge of the Federal Car Reserve, has an idea. We’ll call it the “Bernson Plan”. Currently, because of all the lemons in the car market…

  • Posted by Akin

    The very process of financial innovation changes the probability of default.

  • Posted by Michael


    I think you’ve got the solutions you requested, in a two-step process, right here among the comments on your blog:

    1. ” – and as the fastest way out of a crash is straight through it . . . . why persist in trying reducing interest rates to a level at which people are once again prepared to borrow ? why not raise interest rates to a level at which people are once again prepared to lend?” – Gilllies

    (This is the solution to the “Death of a Thousand Cuts” deleveraging chaos we are now experiencing)

    2. “Then if we survive this, a very serious look needs to be taken at what kind of financial instruments are allowed, and also rationalize mortgage lending standards. Be nice if we re-criminalized white collar crime too. Perhaps we need something like the FDA for financial products. Do it like drug apps. Make Wall Street present their products for approval and make their case why we need them. If we can’t understand them, the answer is NO!” – Cedric Regula

    (This is the post-crisis way to not have to go through the same thing again in twenty years)

  • Posted by glory – “Since the 1990s, risk management on Wall Street has been dominated by a model called ‘value at risk’ (VaR)… Lurking behind the models, however, was a colossal conceptual error: the belief that risk is randomly distributed and that each event has no bearing on the next event in a sequence… But what if markets are not like coin tosses? What if risk is not shaped like a bell curve? What if new events are profoundly affected by what went before? Financial systems overall have emergent properties that are not conspicuous in their individual components and that traditional risk management does not account for. When it comes to the markets, the aggregate risk is far greater than the sum of the individual risks… As long as Wall Street and regulators keep using the wrong paradigm, there’s no hope they will appreciate just how bad things can become. And the new paradigm of risk must be understood if we are to avoid lurching from one bank failure to the next.”

  • Posted by Howard Richman


    This is what the start of a global depression looks like. With American households unable to borrow, savings currently exceeds investment in the world economy, even though investment is high. First stock markets crash, then investment crashes, then prices go down, then factories lie idle.

    Only the Asian trade-surplus countries, especially China, can pull the world out of this right now. The Asian governments could do so if they suddenly switched to all-out fiscal, monetary, and trade policies designed to stimulate consumption and imports and reduce their countries’ savings.

    That won’t happen. Instead, China will buy even more dollars and euros in hopes of lowering their currencies versus the dollar and euro stealing more U.S. and European market share. This will cause U.S. companies to go bankrupt, but won’t help keep their factories active because the markets for their goods will be shrinking too fast.

    Ironically, the current Chinese leadership is signing its own death warrants when they continue to pursue their export-oriented-growth policy even after that policy is no longer possible (due to debt-laden consumers in the importing countries). When factories go idle in China, a hardline-Communist ruler will take over and force the current leadership to undergo re-education sessions where they have to confess their capitalist tendencies.

    The United States still has a solution which avoids all of this. Warren Buffett’s Import certificates plan ( ). There is no surplus of savings in the United States. If we adopt the Buffett plan to balance trade, our businesses stay profitable no matter what happens in the rest of the world.

    Howard Richman