The record US trade deficit of $66 billion naturally raises the question “How long can this go on?”, and not in a rhetorical sense. To be more precise, the question is “How long before the US trade deficit starts declining” and my best estimate is “No more than two years”.
The reasoning is simple. Given two more years of growth in the deficit, the annual current account deficit will be around 1 trillion dollars (about 8 per cent of GDP) and accumulated net debt will be pushing 40 per cent of GDP. At this point, the effects of compound interest start to bite, as interest on the accumulated debt adds to the income deficit. If trade deficits continue to grow, or even remain stable, the current account deficit explodes. This can’t continue.
If a trend can’t continue, it won’t. Therefore the US trade deficit must begin to decline, and soon. Flow-on effects to Australia are likely.
To be continued …
The figures were affected by Hurricanes Katrina and Rita. As discussed by the BEA, the hurricanes disrupted oil trade, reducing crude oil production and also crude oil imports and increasing imports of refined products. The net effect was to increase the trade deficit, though, as Brad Setser notes, this doesn’t entirely explain the observed increase.
On the other hand, receipts of insurance payouts and foreign aid mean that the hurricanes will tend to reduce the income deficit.
fn1. I think the historical figures understate the net position of the US. Although the US is supposed to be a large net debtor, the income account is roughly in balance, which would suggest that, valued in terms of their capacity to generate income flows, US assets abroad are about equal to foreign liabilities. My guess is that equity assets accumulated in the past, when the US was a net foreign investor, are undervalued. However, after making this adjustment, the analysis above still goes through.