In my previous post on US trade, I argued that if the current account deficit is to be stabilised at a sustainable level, the balance of trade on goods and services must return to surplus in the next decade or so. In this post, I’m going to ruIe out a soft option and argue that, while a smooth market-driven adjustment is not inconceivable, it’s unlikely.
The soft option is the idea that central banks will keep on buying US dollars indefinitely in order to keep the world trading system indefinitely, and that the US can therefore consume as much as it wants, subject only to the capacity of the Treasury to keep printing dollars. This option is not a goer for both economic and geopolitical reasons. On the economic front, there comes a point when the risk of being left with a pile of worthless paper exceeds any benefits from being able to export goods.
On the geopolitical front, there’s no point in spending hundreds of billions of dollars a year becoming a military hyperpower if you’re going in to hock to your rivals/potential adversaries for a similar amount. On current trends, the Chinese central bank will hold the better part of a trillion dollars in US government bonds in a few years time. Should there be any minor unpleasantness on the foreign policy front, nothing would be more natural than for the Chinese to stop buying a bit and diversify some of their existing holdings, say a hundred billion dollars or so, into yen and euros. At this point, Wall Street and the Treasury would demand immediate capitulation.
There are also various private sector versions of the soft option, based on the idea that foreigners desperately want to hold US assets, but none of these will stand up to the pressure of chronic trade deficits. As other countries have found out, relying on hot money to finance chronic deficits guarantees a crisis of confidence sooner or later.
If the soft option is ruled out, we’re left to consider paths by which the US can return to trade surplus. Currently the US exports about half as much as it imports. The imbalance could be reduced in a number of ways
* A (further) devaluation of the US dollar
* Reductions in US wages relative to those overseas
* Increases in US relative to foreign productivity (the relevant concept here is multifactor productivity, taking account of both capital and labour inputs)
* Reductions in US consumption relative to foreign consumption
To get back to balance or surplus in a decade, and without a crisis, no one of these would be sufficient. For example, to get to balance by devaluation alone would require a devaluation of the order of 50 per cent, which would certainly entail both an upsurge in inflation and an increase in interest rates. A lot of emphasis is (rightly) put on productivity but even on the most optimistic accounts, the gap between the US and other countries is no more than one percentage point per year, which is nowhere near enough. About 40 per cent of the marginal dollar goes on imports, so the restoration of balance through increased household saving alone would require an increase in saving equal to something like 12 per cent of GDP, and this seems most implausible.
If the adjustment were to begin almost immediately and everything went right, it could go smoothly. But the odds against this seem long. So it’s worth considering alternatives.