Thursday, June 02, 2005

Martin Wolf of the Financial Times has long worked with a simple but effective geography to analyze the contemporary global economy: the Anglosphere and the rest. The Anglosphere -- especially the US, UK and Australia -- is the global engine of consumption, running huge trade deficits, even huger current account deficits, big housing bubbles, low household savings, and a dominant finance capital sector.

Although the US is certainly the center of this Anglosphere, one should not forget its other members, not least of which is because what happens in the UK and Australia is likely a portent of things to come in the US. I've harped on this theme regarding the UK often (recent examples are here and here), but I haven't given Australia its due. Time to begin making amends today.

Australia made big news on Tuesday for tallying a 2005:I current account deficit in excess of 7.2% of GDP. It makes the US CA deficit of 6.3% of GDP (in 2004:IV) look downright tame. In addition, the Australian net international investment position is even uglier, at some -64% of GDP, while the US NIIP in 2004 was around -25%. One is even tempted to ask if the Australians can run such enormous deficits, why worry about the US?

While the Australian economy looks even more unbalanced than does the US, and thus more susceptible to a wrenching adjustment, this is only apparent. Much of Australia's enormous CA deficit is made up of negative investment income flows. For 2005:I net income was -4.0% of GDP. In the US net income flow is much much smaller, just +0.1% in 2004:IV.

In turn, the Australian trade deficit is a much smaller proportion of the current account deficit, and thus of GDP, than is the US trade deficit. In 2005:I the Aussie goods and services balance was -3.3% of GDP; the American balance was a much larger -5.7% of GDP. Thus while the Australian CA deficit is much larger in relative terms than is the US CA deficit, the Australian trade deficit is much smaller in relative terms.

One sees the same thing when looking simply at the export side. The relative size of the Australian export sector is nearly twice as large as that of the US. In 2005:I total Australian exports (goods and services) were around 18.5% of GDP, while in the US they were only 10.0%.

This is an important difference between the two economies. As Nouriel Roubini and Brad Setser have pointed out (see p. 26), the ongoing Australian CA deficits have, until recently, been due to payments on existing debt whereas the US CA deficits are the result of structural trade deficits. In addition, the larger Australian export base means the country can better sustain a high debt-to-GDP ratio than can the US with its small export base. Finally, the Australian dollar has begun responding to these large deficits per a 'soft landing' scenario, its trade-weighted index down some 5% since February 2004 and down 1.6% over the last month. The USD, on the other hand, has only been strengthening in the face of larger and larger deficits.

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