United States: Upside Risks for the US Current Account
Richard Berner (New York)
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 6½% 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.
Before examining each of those developments, it’s worth reviewing the four other hurdles to stability — much less narrowing — in the current account gap that were present even three months ago. The arithmetic is daunting, ‘J-curve’ effects are in play, rising US interest rates will increase payments abroad, and rebuilding Iraq will modestly boost overseas outlays and transfers. Most are now bigger obstacles to current account stability than they seemed three months ago.
First, daunting deficit arithmetic locks the current account gap into a vicious circle that is hard to escape. With imports of goods, services and income now 40% bigger than exports, exports must grow that much faster than imports just to hold the current account constant. The bad news is that this ratio has begun to rise again after being stable for a year.
The so-called “J”-curve means that currency depreciation will perversely widen the current account deficit before it narrows it. That’s because import prices rise relatively quickly in response to the declining currency, boosting nominal imports, but trade volumes aren’t highly sensitive to price changes and adjust slowly. Although the dollar on a trade-weighted basis has been roughly stable since the beginning of 2004, import prices are accelerating. Thus, I estimate that the 2.8% rise in nonfuel import prices over the year ended in June increased the nominal merchandise trade gap by roughly $28 billion over that period.
A renormalization of US interest rates is a third factor that will widen the current account gap as interest payments to foreign investors and central banks increase. Near term, the effect will be small for two reasons. Rates are rising globally, so US investors will also benefit from increased investment income receipts. And most of our debt holdings are in UK securities; rates are higher in the UK and have risen by much more than US rates will have risen by year-end. Nonetheless, in June my colleagues Rebecca McCaughrin and Shital Patel calculated that, other things equal, renormalizing US interest rates could add $60–80 billion (0.5–0.7% of GDP) to the current account gap over the next two years.
The fourth factor that will widen the current account deficit is payments for war, relief and reconstruction in Iraq. The Congressional Budget Office estimated in January that reconstruction costs will run $34–40 billion over the next three years. While most defense outlays, even if made overseas, don’t show up in the international accounts, a lengthy transition in Iraq would net higher outlays. CBO estimates that the per-year defense cost of a 10-year presence could run between $18 billion and $39 billion.
As if these hurdles weren’t enough, three new factors will increase the red ink over the next year. First, US-overseas growth differentials are starting to widen again. Courtesy of slower growth in Asia, real growth abroad, at 4.3%, has fallen short of the US rate by half a percentage point over the past year. As evidence of the impact, US exports to the Pacific Rim region rose by just 8.7% in the year ended in July, accounting for only 19% of the growth in overall US merchandise deliveries abroad, or far less than their 25% share in total exports.
Second, America’s surpluses in services and in income received from investments abroad are at risk. That combined surplus in 2003 netted to more than $84 billion, but it shrank to a $64 billion annual rate in the second quarter. It’s not just the result of rising interest rates; net receipts from direct investment and services are falling as growth abroad is coming up short.
Finally soaring oil prices have bloated the nominal US imported energy bill, adding $38 billion to the current account gap during the year ended in June. The $11/bbl additional rise in crude quotes since June, if sustained for a year, would add another $40 billion to the current account deficit.
For a while last year, it looked like the process of trade adjustment, courtesy of a long slide in the dollar, was underway in earnest. Unfortunately, the shift in import volumes and thus trade adjustment has so far been limited, partly because the “pass-through” from the dollar’s decline to import prices has amounted to only about one-third. Consequently import penetration — the ratio of imports to US domestic demand — has lately risen, not declined.
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. |
