Friday, October 01, 2004

How low can it go?

In 2004:II the United States current account deficit hit -5.7% of GDP (although that figure may be revised slightly upwards). This bombshell forced the ever-optimistic Richard Berner at Morgan Stanely to lower his own deficit floor. Today he says that the CA deficit will reach -6.5% of GDP before making its eventual turnaround.
Only three months ago, I warned that the US current account deficit � the imbalance with the rest of the world in trade in goods and services, investment income, and transfers � might not peak until it reached 6% of GDP (see �When Will the Current Account Peak?� Global Economic Forum, June 25, 2004). I now think I was too optimistic. Despite a healthy July rebound in export growth, it now appears that the red ink could reach 6�% of GDP before stabilizing and subsequently shrinking.

Three factors have darkened the outlook: First, global growth is now falling short of the US pace, dimming the odds that US export growth can outpace that of imports. Second, payments overseas from foreign investments in the US are now outpacing income receipts from abroad, reducing our income surplus. And third, crude oil prices have jumped by more than $10/barrel since June, and unless that rise is reversed, the US annual oil bill will increase by $40 billion more than appeared likely three months ago.
All very good reasons to believe the current account deficit will swell to truly gargantuan proportions in the quarters to come. But why does Berner think that -6.5% of GDP will be the end point rather than simply a way-station on the path toward oblivion?

After spending eleven paragraphs describing all the reasons the deficit will only grow larger, this is all Berner has to say on this score:
Still, there is hope for future stability in the current account for three reasons. First, the exchange-rate pass through has been nearly completed in services, reducing US imports and boosting exports such as foreign travel and tourism to the US. Moreover, US companies have allowed the dollar�s decline to pass through to export prices, enabling them to increase market share especially in Europe. And I think that the lag between the time currencies move and volumes begin to adjust is 1-2 years. So the lagged effects of the dollar�s cumulative decline should begin to show up more significantly in trade volumes later this year and in 2005.
Ah, yes, the "lagged effects of the dollar's decline". Of course, this is the mantra that the Pollyanna set has been mouthing for at least five years. But let's give Berner the benefit of the doubt for a moment and see if he has any reason at all to be sanguine.

There has been no marked growth in the US services balance. In 2003 the services balance actually fell 17%, and so far in 2004 it has grown only 4% over last year. The big "reducing US imports and boosting exports" trend in services is based on a single month's data.

How are US exports doing in Europe? The goods trade balance with the EU-15 this year (Jan.-July) stands at -$59.3bn. Through the first seven months of 2003 the balance was -$52.8bn. That's a 12% increase in my book. The latest trends don't look any better. In all of 2003 there were two months in which the goods trade deficit was larger than $9bn. In the first seven months of 2004 there have been four.

From early 2002 to early 2004 the dollar fell 25% as measured by the major currencies index. In 2001 the CA deficit with the EU was -$53.0bn. In just the first half of 2004 it stands at -$53.5bn, set to double the level of 2001. In 2001 the balance with Canada was -$28.8bn. So far in 2004, -$19.8bn (-$39.7bn annualized). How about Japan? In 2001, -$78.5bn. So far in 2004, -$45.4bn (-$90.7bn annualized). What the hell is Berner talking about??

In their "modest adjustment" scenario, Roubini and Setser predict that in 2008 the US current account deficit will hit -6.5% of GDP (even that seems rather optimistic now). But it's not stopping there. By 2012 it will balloon to -8.05% of GDP. And that's with some adjustment! In their baseline scenario which tracks current trends into the future, the deficit hits -8.06% of GDP as early as 2008 and -12.13% by 2012 -- a virtually unimaginable figure.

There is no chance in hell that we are at the end of the dollar's decline, that its 25% slouch since 2002 will be enough to bring current trends to a pleasant and easy end. Assuming China revalues the renminbi upwards in the near future, the dollar will decline further, but there will still be a fixed exchange rate, Japan will still dirty float, and nothing will change dramatically without some pretty stunning US export growth combined with import decline. In the past, the only formula to deliver that combination is a US recession.

Up, up and away, in my beautiful balloon.

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