EYE ON
AMERICA US debt: Devil in the
details By Peter Morici
On Monday, the US Commerce Department
reported that the third-quarter 2006 current-account
deficit was US$225.6 billion, up from
$217.1 billion in the second quarter.
The current account is the
broadest measure of the US
trade balance. In addition to trade in goods
and services, it includes income received from US
investments abroad less payments to
foreigners on their
investments in the United States.
In the
second quarter, higher oil prices and surging
imports of consumer goods from China drove the
trade deficit. Also, the lack
of
exciting, reliable, fuel-efficient vehicles at
General Motors and Ford weighed heavily as well.
In the third quarter, the current-account
deficit was 6.8% of gross domestic product (GDP)
and was financed largely by borrowing from
foreigners, as opposed to foreigners investing in
productive assets in the United States.
Anatomy of the deficit The
United States had an $18.3 billion surplus on
trade in services. This was hardly enough to
offset the massive $218.6 billion deficit on trade
in goods and the $3.8 billion deficit on interest,
dividends and other transnational income payments.
The remainder of the current-account deficit came
from US transfer payments to foreign individuals
and governments, which was $21.5 billion.
The deficit on petroleum products was
$75.2 billion, up from $71.4 billion in the first
quarter. The price of imported petroleum rose 4.7%
and the volume increased 3.4%.
The deficit
on automotive products was $35.5 billion. This
deficit will rise in the future, because as US
production moves from the former "Big Three" to
Toyota and other Asian transplants, the US content
of vehicles declines - transplants use fewer
US-made parts in their vehicles. Moreover, Korean
auto makers will continue to make inroads,
challenging both Toyota and other Japanese
transplants, which are developing their own cost
problems.
The restructuring programs
announced at GM and Ford may provide a temporary
return to profitability but will increase the
automotive deficit further. Down the road, more
cutbacks should be expected as the concessions
offered by the United Auto Workers union and
corporate restructurings announced are inadequate
to redress the domestic industry's fundamental
competitiveness problems.
"The Wal-Mart
effect" was broadly apparent. The trade deficit
with China was $63.9 billion, up from $54.5
billion in the second quarter.
Together,
the deficit on petroleum and automotive products
with China totaled $170.8 billion - 78% of the
$218.6 billion deficit on goods and services. The
trade deficits on petroleum and automobile
products are not affected much by recent
exchange-rate movements; therefore, the deficit on
goods and services will not improve much, and in
fact will likely worsen, until substantial
progress is accomplished on China's currency and
other protectionist practices.
The US
dollar remains at least 40% overvalued against the
Chinese yuan and other Asian currencies. China
continues to peg against the dollar. Although
China revalued the yuan from 8.28 to 8.11 in July
2005, and announced that it would adjust it to a
basket of currencies, the yuan continues to track
the dollar very closely. Currently it is trading
at about 7.84 to the greenback.
Other
Asian governments must ensure that their currency
policies conform to China's, lest they lose
competitiveness in US and European markets. To
sustain undervalued currencies against the dollar,
foreign governments purchased $80.8 billion in US
securities. This created a 14% subsidy on exports
to the United States.
If China were to
revalue the yuan, the US bilateral deficit with
China could shift to other Asian exporters.
However, to maintain their resulting large trade
surpluses with the United States, these Asian
nations would have to replicate China's
intervention in currency markets and transfer of
buying power to Americans, which comes to 9% of
China's GDP. That would prove a Herculean task,
and ultimately the dollar would trade lower
against all Asian currencies, and the US trade
deficit would decline.
Financing the
deficit The current-account deficit must
be financed by a capital-account surplus, by
foreigners either investing in the US economy or
lending Americans money. Some analysts argue that
the deficit reflects US economic strength, because
foreigners find many promising investments in the
United States. The details of US financing belie
this argument.
In the third quarter, US
investments abroad were $223.8 billion, while
foreigners invested $400.2 billion in the United
States. Of that latter total, only $44.1 billion,
or 11%, was direct investment in US productive
assets. Most of the remaining capital inflows were
foreign purchases of US Treasury securities,
corporate bonds, bank accounts, currency, and
other paper assets. In essence, Americans borrowed
$356.1 billion to consume about 6.8% more than
they produced.
Foreign governments lent
Americans $80.8 billion, or 2.4% of GDP. That well
exceeded net household borrowing to finance homes,
cars, gasoline and other consumer goods. The
Chinese and other governments are in essence
bankrolling the US consumer.
The
cumulative effects of this borrowing are
frightening. The total external debt now exceeds
$5 trillion and will likely exceed $6 trillion by
the end of 2006. That will come to about $20,000
for each American, and at 5% interest, $1,000 per
person.
Peter Morici is a
professor at the University of Maryland School of
Business and former chief economist at the US
International Trade Commission.
