The Looming U Deficit

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					                                                                     November 10, 2010

                         The Looming U.S. Trade Crisis
                         By William Krist and Jonathan Bennett

Once again the U.S. has run up a huge merchandise trade deficit, some $56.9 billion for
the month of September and $492.0 billion for the first nine months of 2010. Our deficit
is largely funded by foreign purchases of financial assets, but at some point in the not-
too-distant future, according to many economists1, we will likely reach a crisis point
where foreign lenders will be reluctant to continue funding our deficit.

Our imports of goods amounted to $164.4 billion in September, far exceeding our exports
of manufactured and agricultural goods, which equaled only $107.6 billion. The
resulting deficit in merchandise trade was only slightly offset by a surplus of $12.9
billion in our trade with other countries in services – that is, items like the sale of
insurance products, tourism and so forth.2

To assess the health of our trade relations with the rest of the world, economists consider
a number of other items along with our balance of trade in merchandise and services.
These items – called net factor income and net transfer payments – include such things as
net transfers of interest and dividend payments, foreign aid, and remittances sent home by
individuals working abroad. The merchandise trade balance, net transfer payments and
net factor income make up what economists call the current account. The current account
is a snapshot of our position today – and our position should be a cause of concern for all

Our current account deficit has skyrocketed in the past two decades. In 1992 it was $51.6
billion or 0.8 percent of our gross domestic product in that year. By 2000 it had soared to
a deficit of $416.4 billion, or just over 4 percent of our GDP. In 2006, the current
account deficit rose to just under six percent of our GDP, a level many economists
consider to be a huge red flag3. Then, because of the global financial collapse, our
current account deficit declined to just 2.7 percent of our GDP in 2009, as Americans
consumed fewer foreign products and the price of oil declined. Now as our economy is
slowly recovering, we are back in the danger zone. And it is the enormous deficit in
merchandise trade that is driving our current account deficit, as can be seen in the table

Table. Importance of Merchandise Trade and Current Account4:
       (In millions of dollars)

                  Merchandise      Current                        Current Account
                    Trade          Account                         Balance as a %
                    Deficit        Balance      Nominal GDP           of GDP
           1992          -96,897      -51,613         6,342,300              -0.81%

           2000         -446,233     -416,371         9,951,500               -4.18%
           2006         -839,456     -802,636        13,398,900               -5.99%
           2007         -823,192     -718,094        14,061,800               -5.11%
           2008         -834,652     -668,854        14,369,100               -4.66%
           2009         -506,944     -378,432        14,119,000               -2.68%

The U.S. has far and away the largest current account deficit of any nation in absolute
terms. Spain, the second largest deficit country, had a deficit of $81 billion in 2009,
compared to our deficit of $378 billion, although Spain‟s deficit as a percent of gross
domestic product was larger: 5.5 percent compared to 2.7 percent for the U.S. that year.
The other three European Union countries that have been targets of concern are Greece,
which had a current account deficit equal to 11.2 percent of its GDP in 2009; Portugal,
which had a current account deficit of 10.0 percent of GDP; and Ireland, whose deficit
was only 3.0 percent of GDP.

Many developing countries also have large trade deficits. In most of those cases,
however, the deficit is caused by investment in new infrastructure, factories and other
productive activities, and is expected to generate future income to pay back the debt. In
our case our trade deficit is in consumption items – TV sets, cars, and so forth – which
lose their value. So our deficit will have to be paid back in the future in real assets, and
our ability to keep up this hyper-consumption depends on the willingness of foreigners to
lend us money.

Countries with the largest current account surpluses in 2009 are China ($297 billion),
Germany ($163 billion), and Japan ($142 billion). These countries all have high savings
rates and strong manufacturing industries. Other countries with high savings rates,
particularly Taiwan, the Netherlands, Korea, Switzerland and Singapore, all had large
surpluses in the $32 to $43 billion range. Other countries with large current account
surpluses were the oil exporters: Norway ($50 billion), Russia ($50 billion), Saudi Arabia
($23 billion), Iran ($12 billion), and Kuwait ($29 billion).

What would happen if other countries decided not to continue funding our trade deficit?
Basically, interest rates in the U.S. would rise in order to continue attracting foreign
capital, and the value of the dollar would fall, making imports more expensive and our
exports more competitive on world markets. If this happened suddenly, interest rates
could soar, causing severe recession.

When might this happen? Fred Bergsten argues “research at both the Federal Reserve
Board and the Institute for International Economics reveals that industrial countries,
including the United States, enter a danger zone of current account unsustainability when
their deficits reach 4-5 percent of GDP5” A study by Richard Clarida6 and other
economists found “significant evidence for the existence of „current account thresholds,‟”
that is, points at which current account adjustment become necessary, whether by market
forces or by policy action.

Clarida also found that these thresholds differ from country-to-country. He and some
other economists speculate that the U.S. may have larger scope for large trade deficits
than other countries. For example, William Cline of the Petersen Institute believes that a
reason we may have more slack than other countries is that we owe our debt in dollars,
and thus we are “thus not subject to the ballooning of obligations if forced depreciation

Bergsten, Cline and others argue that the sooner this adjustment takes place, ideally under
joint international action, the greater the chance that adjustment can be smooth and will
not take a “catastrophic form.”

The Causes of Our Trade Deficit
Our huge trade deficit has three main causes: first our low national savings rate, second
our dependence on foreign oil, and third currency manipulation, particularly by China.

A number of economists believe the major cause of our trade deficit is our extremely low
rate of savings as a nation, particularly when compared to nations with high savings rates,
as can be seen in the table below.

Table. Net National Savings Rate as Percent of Gross National Income8:
            China     Japan     Germany       USA
  2005     41.80%     6.20%       8.40%      1.50%
  2006     44.40%     6.40%      10.10%      2.90%
  2007     44.00%     8.00%      11.80%      2.40%
  2008     43.80%     12.60%        na      -1.40%

Savings, of course, finances investment in new plant and equipment; because we do not
save as much as we consume, our infrastructure, plant, and equipment have not kept up
with developments in nations with high savings. Because our savings are less than our
consumption and investment, we have to import capital from other countries. The
resulting financial account surplus is the mirror image of our current account. (Most
economists believe our current account deficit drives our surplus in the financial account.
But economists never agree, and there are a few, such as William Poole, former President
of the St. Louis Fed, who argues that a savings glut in some countries - particularly in
China, Japan, and Germany - drives our current account deficit.9 This is very much a
minority view, and in any case the fact is U.S. savings are not sufficient to finance our
consumption and investment.)

Our low savings rate in turn has two primary causes: low savings by households and
large federal budget deficits. In 2007, net savings as a percentage of disposable income
by U.S. households was 1.7 percent, down from 7 percent in 1990. (In 2009 the net
savings percent of disposable income rose to 4.3 percent due to the recession, but is likely
to return to its lower rate as the economy recovers.) By contrast the Germans saved 11.3
percent of their disposable income in 2009 and the Swiss saved 15.3 percent10. The
Chinese household savings rate is estimated to be as high as 38 percent!11 In addition to
low household savings, our Federal budget deficit has grown enormously since 2000,
when we had a small surplus, to a deficit of over $1.29 trillion in 2010.12

Without addressing our savings problem, it is unlikely that we can bring our trade deficit
to a sustainable level. Increasing our savings requires both reducing the federal budget
deficit and increasing private savings. Perhaps our recent elections will spur real change
in federal budget policy, but even more important is the need to encourage private

Since World War II U.S. government tax policy has promoted consumption over savings
while most other countries supplement an income tax with consumption or value added
taxes. While we have some sales taxes, ours our much lower than value added taxes in
many other countries. Additionally, some of our tax deductions are for consumables,
most notably the mortgage tax deduction. By contrast we tax savings, for example
through taxes on capital gains and dividends, and the income tax applied to interest

A second factor contributing to our huge current account imbalance is our dependence on
imported oil. Our trade deficit in petroleum products accounted for some 40 percent of
our total merchandise trade deficit in 2009 ($204.5 billion of $506.9 billion). Our deficit
in petroleum products was just $44.5 billion in 1992, and then more than doubled to
$108.3 billion in 2000, and then almost doubled again by 200913. (Some of our deficit in
petroleum products is recycled in purchasing exports from the U.S., such as when Saudi
Arabia buys Boeing aircraft, so the actual impact is not quite as large as would be
indicated by these raw numbers.)

Unless the U.S. finally gets serious about developing an energy policy, our deficit in
petroleum products will only grow in the future. Of course, in addition to creating
problems for global financial stability, our dependence on foreign oil has enormous
implications for national security and climate change.

The politicians know what we need to do to reduce this dependence on foreign oil, such
as encouraging drilling for new oil in the U.S., promoting alternative energy sources such
as nuclear, wind and solar, and promoting energy efficiency. One way to encourage all
of these at once, if policymakers are unable to agree on a more comprehensive approach,
would be to impose a tariff on imported oil. This would raise the price of imported oil in
the U.S., which would encourage drilling and development of alternative energy, and
would also help to promote conservation.

Under such a policy, we would undoubtedly want to exclude countries with which we
have free trade agreements from this tariff. Thus imports from Canada, Mexico,
Colombia, Oman and Peru, which together account for almost one-third of our petroleum
imports, would be excluded. Under World Trade Organization rules, we would also have
to provide compensation to the other countries that are members of the WTO that would
be affected by our tariff. This compensation would be in the form of tariff reductions on
products of interest to those countries; if we were unable to agree on compensation, these
countries would be authorized to increase their duties on our exports to an equivalent
level. As can be seen in the table below, this would particularly involve Venezuela,

Saudi Arabia, and Nigeria, as well as a number of smaller suppliers. However, three
suppliers of our petroleum imports (Algeria, Russia and Libya) are not WTO members
and would not be entitled to compensation.

Table. Major Suppliers of Crude Oil Products to the U.S. (2009, in thousands of
                                Non-FTA Partners that are WTO
 From Our FTA Partners          Members                              Non WTO Members
 Canada      37,682,816         Venezuela           23,894,635       Algeria 6,451,527
 Mexico      22,345,311         Saudi Arabia        22,102,730       Russia  4,437,030
 Colombia     5,287,401         Nigeria             18,213,276       Libya   1,218,221
 Oman           817,930         Iraq                 9,583,305
 Peru           324,071         All Other           42,081,242
   Total     66,457,529                            115,875,188                 12,106,778

Of course, imposing a tariff on imported oil would particularly impact some groups in
America, particularly the poor, truckers, and others. Those groups could be compensated
through some of the revenue generated by the tariff, if policy makers so wished. To be
effective in reducing our trade deficit, such a policy needs to be coupled with policies to
raise our level of national savings, or our dependence on foreign capital might lead to
trade imbalances in other products.

The third cause of our merchandise trade deficit is deliberate manipulation of foreign
exchange rates, particularly by the Chinese. In theory, as we run a large trade deficit the
value of the dollar should depreciate, which would make our exports cheaper and our
imports more expensive, thereby reducing the deficit. However, China and some other
countries have pegged the value of their currency to the dollar, preventing this
mechanism from operating.

The way China and other countries do this is to require exporters to swap dollars (or other
export earnings) for domestic currency. Then the government buys U.S. Treasury
securities or other U.S. financial assets, which holds the dollar up and keeps their
currency at the same rate to the dollar.

This type of exchange rate manipulation has always been recognized as an unfair trade
practice, both by the World Trade Organization and by the International Monetary Fund.
WTO/GATT Article XV states that members should not take exchange rate actions that
“frustrate the intent of the provisions of this Agreement” 15. In the event that this
happens, however, the remedy is to refer the issue to the IMF. While the IMF also
recognizes currency manipulation as an unfair trade practice, it has never taken action to
address this issue.

In theory, the U.S. could prevent this currency manipulation by blocking foreign
purchase of our treasury bills, securities and real estate. Obviously this would be a
draconian action that would have many bad unintended consequences.

Another approach would be to emulate the policy actions of 1984/85, when the U.S.
responded to Japanese currency manipulation by threatening trade sanctions. This led to
the so-called Plaza Accord of 1985 that temporarily restored a better balance in exchange

However, the best approach, if China and other countries are willing, is to resolve this
through negotiations. China pursues its policy of currency manipulation to promote
domestic employment through exports to the U.S., an understandable objective.
However, the risks entailed by our trade deficit and the negative impact on our economy
caused by the trade deficit require the U.S. to take serious and prompt action. What is
needed is a better balance in international trade, and if necessary the U.S. should use the
threat of access to our market to achieve agreement.

At the meeting of the G-20 finance ministers16 in South Korea on October 23, 2010, the
member countries agreed that “We are all committed to play our part in achieving strong,
sustainable, and balanced growth in a collaborative and coordinated way. Specifically,
we will . . . move towards more market determined exchange rate systems that reflect
underlying economic fundamentals and refrain from competitive devaluation of
currencies.” (The U.S. had previously proposed that major industrialized nations limit
their current-account deficits or surpluses to no more than 4% of GDP, but this proved to
be controversial17.)

Immediately preceding the meeting of the finance ministers, China increased its
benchmark interest rate by 25 basis points, a move designed to allow its currency to
appreciate slightly18. However, China continues to peg the renminbi to the dollar.

Following the G-20 finance ministers meeting, the U.S. Federal Reserve Bank launched a
program of quantitative easing whereby it will inject an additional $600 billion into the
economy over the next eight months in an attempt to accelerate growth and cut
unemployment19. This quantitative easing will have the significant side effect of dollar

A number of our trade partners, particularly Brazil, South Korea, and Germany, have
objected strongly to this policy, because China – with the renminbi pegged to the dollar –
will also depreciate its currency. As a result, these countries have to either depreciate
their currencies, which is inflationary, or lose export share to China.

The G-20 heads of state will be meeting in South Korea on November 11-12, and it
remains to be seen if these 20 wealthy nations can agree to proceed forward in a
coordinated manner. Even if they do agree, the huge gap in international rules on foreign
exchange still needs to be addressed.

 For example, see Maurice Obstfeld. “America‟s Deficit: The World‟s Problem.”
Twelfth International Conference of the Institute for Monetary and Economic Studies,

Bank of Japan, Tokyo, May 30-31, 2005. University of California, Berkeley. Also see Catherine L. Mann, “International
Capital Flows and the Sustainability of the US Current Account Deficit,” in The Long-
Term International Economic Position of the United States, ed. C. Fred Bergsten.
Washington: Peter G. Peterson Institute for International Economics, 2009. For
employment impact see Erica Groshen, Bart Hobijn, and Margaret McConnell. “U.S.
Jobs Gained and Lost Through Trade: A Net Measure.” Federal Reserve Bank of New
York. For national
security impact see Adam S. Posen, “International Capital Flows and the Sustainability of
the US Current Account Deficit,” in The Long-Term International Economic Position of
the United States, ed. C. Fred Bergsten. Washington: Peter G. Peterson Institute for
International Economics, 2009.
  The most recent trade data is available from: U.S. Census Bureau, “U.S. International
Trade in Goods and Services (FT900),” September 2010 release, Exhibit 1: U.S.
International Trade in Goods and Services, balance-of-payments basis, last accessed 10
November 2010,
  For studies indicating such a threshold, see Richard H. Clarida, Manuela Goretti, and
Mark P. Taylor. “Are There Thresholds of Current Account Adjustment in the G7?” G7
Current Account Imbalances: Sustainability and Adjustment. Chicago: University of
Chicago Press, 2007: 169-203; also see Freund, C. “Current account adjustment in
industrialized countries.” International Finance Discussion Paper no. 692. Washington,
DC: Board of Governors of the Federal Reserve System, 2000; also see Freund, C.
“Current account adjustment in industrial countries.” Journal of International Money and
Finance 24, 2005. 1278–98.

While most economists believe our massive current account deficit should be a matter of
concern, as always in economics, there is an “on the other hand” school of thought. For
example, former Fed Chairman Alan Greenspan argued at one point before the recent
financial crisis that the growing U.S. deficit was not a major concern. See Alan
Greenspan, Remarks at the 21st Annual Monetary Conference, Washington, DC. Federal
Reserve Board.
  Merchandise trade data available from: U.S. Census Bureau, “U.S. International Trade
in Goods and Services (FT900),” annual releases, seasonally adjusted, Exhibit 5: U.S.
Trade in Goods, annual data on a balance-of-payments basis, last accessed 10 November

Current account balance data for the United States, annual basis, available from: Bureau
of Economic Analysis, “U.S. International Transactions Accounts Data,” using annual
data, Table 1: U.S. International Accounts, last accessed 8 November 2010, GDP data
available from: Bureau of Economic Analysis, “National Income and Product Accounts

Tables,” annual data. Table 1.1.5: Gross Domestic Product, last accessed 8 November

Annual current account data for other countries available from: International Monetary
Fund, World Economic Outlook database, October 2010, last accessed 8 November 2010,
  C. Fred Bergsten. “Can the United States Afford the Tax Cuts of 2001?” Presentation to
a Roundtable of the Annual Meeting of the American Economic Association, Atlanta, 5
January 2002.
 See Richard H. Clarida, Manuela Goretti, and Mark P. Taylor. “Are There Thresholds
of Current Account Adjustment in the G7?” G7 Current Account Imbalances:
Sustainability and Adjustment. Chicago: University of Chicago Press, 2007.
 William Cline, “Long Term Fiscal Imbalances, US External Liabilities, and Future
Living Standards,” in The Long-Term International Economic Position of the United
States, ed. C. Fred Bergsten. Washington: Peter G. Peterson Institute for International
Economics, 2009. 15.
 See World Bank Databank, World Development Indicators & Global Development
Finance, Adjusted savings: Net national savings (% of GNI),
 For more information, see William Poole, “Changing world demographics and trade
imbalances,” presented to the American European Community Association at the Round-
Table Conference Luncheon Brussels, Belgium, April 16, 2007.
  “HouseholdSavingRates.” Economic Outlook No. 87, Annex Table for Saving.
Organization for Economic Cooperation and Development. Last accessed 9 November
  Source: Christopher Power, “How Household Savings Stack Up in Asia, the West, and
Latin America,” 10 June 2010,
  Source: Monthly Budget Review, Congressional Budget Office, 7 October 2010,
   See U.S. Census Bureau, “U.S. International Trade in Goods and Services (FT900),”
2009 annual revision, Exhibit 9: Exports, Imports, and Balance of Goods, Petroleum and
Non-Petroleum End-Use Category Totals, last accessed 8 November 2010,

   Source: See U.S. Census Bureau, “U.S. International Trade in Goods and Services
(FT900),” December 2009 release, Supplemental Exhibit 3: General Imports of Crude Oil
by Country, Not Seasonally Adjusted. CIF value.
   The 1947 General Agreement on Tariffs and Trade is available at, courtesy of the World
Trade Organization.
   The G-20 is the main economic forum of the 20 wealthiest nations. The press release
on this meeting is available at
 See “Japan‟s Noda Downplays Chance of G20 Current Account Deal,” ABC News, 8
November 2010,
 For more information, see “China surprises with first rate rise since 2007,” Reuters, 19
October 2010,
   For the most recent Federal Reserve press release on the matter, see “Press Release,”
Board of Governors of the Federal Reserve System, 3 November 2010,