source: Bureau of Economic Analysis (www.bea.gov)
Finally, here is a snapshot of America’s willingness to finance consumption of material goods by selling of assets. That kind of economic behaviour shows up in the current account balance…the difference between what Americans produce and export and what they import and consume. The primary component of the current account defict is the balance of trade, which, lately for America, has been running a deficit (although Boeing had a good year in 2006.)
Outright financial disaster is averted because America’s trading partners take their dollars and use them to buy dollar-denominated U.S. stocks and bonds. This transaction takes place in the capital account, not the current acccount (the two, along with the financial account, are reckoned up in final balace of payments.)
The capital account, lately, reflects a demand for U.S. dollar-denominated assets, whose returns have been higher than assets elsewhere. Thus, despite the dollar’s relative decline on currency markets, the yield on dollar-based assets has kept foreign buyers lined up in U.S. markets. But even though this acts as a floor under U.S. stocks prices (and, perhaps, as a ceiling on U.S. interest rates, as foreign buying keeps Treasury prices high and yields relatively low) does it really, when you strip away all the analysis, make good economic sense for America?
Of course not. You don’t get rich consuming more than you produce. Instead, you sell off your assets to finance your appetites. Or as a Mr. Joseph Carson, director of resesarch at Alliance Bernstein in New York, put it in a recent letter to the Wall Street Journal:
At the basic level, by running a current account deficit the U.S. is selling its assets (real and financial) to support spending. Looked at from another angle, the current account deficit indicates that the ownership of America is changing and foreign ownership of U.S. assets will continue to increase as long as we run a deficit. The best way to promote economic growth and additional wealth is by creating new assets, not selling existing ones. The U.S. should not embrace the deficit, but instead it should eliminate it. The best way to do that is to encourage more direct investment by U.S. and foreign companies.
In 1985, when the member of the G5 deliberately devauled the dollar in an organized fashion, it was to boost U.S. exports overseas by weakening the dollar (see dollar chart above.) The strong dollar caused huge, headline-grabbing stories in the U.S. about the trade deficit, especially with Japan. At the time, the current account deficit was only 3.5% of GDP.
Today, at $225 billion, the current account deficit is nearly 7% of GDP. Despite a dollar at historic levels of weakness, it has not been enough to boost the competitiveness of American exports, at least not faster than the rate of increase in American imports. And if the dollar rallies from its low levels now, that should mean an even larger current account deficit as a percentage of GDP going into mid-2007.
Does anything have to change? We don’t know. But in the meantime, America will continue to sell off its assets in exchange for cash to spend at the store. Does that seem like a good long-term trade to you? To the Russians? To private equity? The Chinese?