Twin Deficits are Back

October 5, 2004

The US is the indebted superpower. It has massive current account deficits whose domestic counterpart are huge public sector borrowings. Is this something the two presidential candidates wish to discuss? "No" is the answer. They are intent, instead, on competing to spend money they do not have.

The US slide into debt is impressive by almost any standards. Its net external liabilities could easily reach 50 per cent of gross domestic product before the end of the decade. Not only are current account deficits over 5 per cent of GDP, but exports are only 10 per cent. Because exports are so small in relation to GDP, the ratio of debt to exports is already close to 280 per cent. It could attain 500 per cent by 2008, well above that reached by Argentina before its recent financial meltdown.

This, alas, is not the only similarity between the US and some of the calamities to the south. Until the stock market bubble burst, in 2000, the domestic counterpart of the current account deficit was surging investment. It is now fiscal deficits. Net national savings are running at about 2 per cent of net national product, a historic low. A large part of the reason for these low national savings are public sector deficits that are forecast by the International Monetary Fund to reach 4.9 per cent of GDP this year.

These trends are more than undesirable. They are unsustainable. According to Dick Cheney, vice-president, Ronald Reagan proved that deficits do not matter. What the former president proved, instead, was that someone will be forced to fix the mess, sooner or later. But the mess is so big this time that waiting another four years could well prove a disastrous mistake.

So what should the presidential candidates be discussing? They should state that US external deficits are, at present, needed to sustain global economic activity. They could add that the fiscal deficits have also been required to sustain US demand, at a time when the corporate sector was forced to retrench. But now, as recovery takes hold, these trends must be reversed.

The more urgent and the more fundamental of the twin challenges is that on the external side. Active US leadership is needed to promote changes in exchange rates and macroeconomic policies around the globe. The dollar must fall further now if it is not to fall far more dramatically later on. As these adjustments begin, the US current account deficit will start to shrink, which will automatically stimulate the US economy. If interest rates are not to soar, thereby crowding out private sector investment, the government will then have to retrench.

The mixture of low national savings with huge fiscal deficits, financed from abroad, has ruined many smaller economies in the past. The US is indeed far bigger. But remember: the bigger they are, the harder they fall.

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