Friday, July 14, 2006

Do current account deficits still matter?

Recently I attended a debate in London hosted by Reuters with the above title as the point of contention.

Not that there was much contention.

No direct answer to the question was offered by either participant.

This reflected both an unwillingness to address, and distint lack of understanding of, the issues underlining this misguided question.

It is not the deficits themselves that 'matter'. It's the debts they have spawned, in this case within the US household sector, that will eventually force through an outcome.


One attempt at a solution was offered: a 40% real reduction in the dollar.

Apparently, in the past few years we have already seen half of this decline and "all we need is for the US current account data to reflect this."


So, all we need is for the dollar to weaken and this will make US households spend less and reduce the current account deficit?

If only.

It's not the dollar that has gotten us into this situation and it isn't the dollar that's going to get us out of it.

The answer lies in Asia.


On the flip side of US profligacy is Asian thrift.

This counterparty to US excessive consumer spending is what has kept the whole party going for the past decade or more.

The party is over.

No longer are Asian central banks providing a free lunch to the US in the form of low interest debt. The bill has arrived. And it's called inflation.

Inflation is what has led interest rates in the US to rise to the level they are now. And it's these interest rates that will push US consumers into a level of indebtedness they haven't seen in years.

Once US consumers stop spending it will slow US growth to such an extent that the US current account deficit falls.

It's not the deficit that matters, but how it corrects.

In fact it won't take long before the US current account could be in surplus. An explanation of how that happens will be for another day.

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