Are the US Current Account Deficit and Debt Accumulation Unsustainable? Concerns from the Fed

Author: Nouriel Roubini  ·  August 16th, 2004  ·  91153http%3A%2F%2Fwww.economonitor.com%2Fnouriel%2F2004%2F08%2F16%2Fare-the-us-current-account-deficit-and-debt-accumulation-unsustainable-concerns-from-the-fed%2FAre+the+US+Current+Account+Deficit+and+Debt+Accumulation+Unsustainable%3F++Concerns+from+the+Fed2004-08-16+21%3A02%3A55Nouriel+Roubinihttp%3A%2F%2Fwww.economonitor.com%2Fnouriel%2F2004%2F08%2F16%2Fare-the-us-current-account-deficit-and-debt-accumulation-unsustainable-concerns-from-the-fed%2F › Share This Print

Missed by most of the media in its reporting of last week’s FOMC Fed Funds increase decision was a most interesting nugget from the Minutes of the June 29-30 FOMC meeting. At that meeting, the FOMC discussed staff papers and presentations on the US current account deficit; the conclusion from the ensuing discussion was that:

“The staff noted that outsized external deficits could not be sustained indefinitely….the possibility that the adjustment could involve more wrenching changes could not be ruled out.”

The analysis, as usual for the Fed, was cautiously couched and included all the caveats that “the historical evidence indicated that such deficits could be quite persistent, and the adjustment of imbalances was not necessarily imminent. The adjustment, once under way, might well proceed in a relatively benign fashion”.

Still, for a Fed that until recenty had expressed little external concerns about the US current account deficits (see Greenspan’s speech on the subject last November), this new staff report suggested an increasing alarm at the Fed on the issue of the US current account deficit. With Treasury still being blissfully and recklessly blase’ about the US twin fiscal and current account deficits and the CEA (and even theCBO) still following the official deluded party line that US current account deficit represent only the great investment opportunities in the US and the capital inflow that finances it (that was true in the roaring 1990s but not after 2001 when investment collapsed and the growing current account deficit is now due to the swing from large fiscal surpluses to large fiscal deficit), it is refreshing that someone in the US official sector is now starting to worrying about this unsustainable accumulation of external liabilities. Recently, eminent figures such as Rubin and Summers have expressed alarm about such twin deficits. It was time that someone in the US government would too, as the US trade deficit ballooned to new historical highs in June.

Brad setser and I are finishing a new paper on such twin deficits and the unsustainability of the external debt dynamics of the US. Stay tuned next week for a first draft!

And see also the section of my Global Macro site on the US current account deficit sustainability for many more materials on the subject.

Here is the extended wording from the FOMC June 29-30 Minutes about the discussion within the FOMC of the issue of the US current account deficit:

“At this meeting, the Committee discussed staff papers and presentations on adjustment of the U.S. external accounts. At more than $500 billion, the deficits in trade and current account balances are quite large in comparison with aggregate income. Financing of the deficits had recently included both large foreign private purchases of U.S. securities and increased foreign official inflows. The sizable current account deficit could be viewed as reflecting very low levels of national saving, in both its government and private components, in relation to investment opportunities in the United States that were very attractive. The staff noted that outsized external deficits could not be sustained indefinitely. However, the historical evidence indicated that such deficits could be quite persistent, and the adjustment of imbalances was not necessarily imminent. The adjustment, once under way, might well proceed in a relatively benign fashion, particularly if fiscal, monetary, and trade policies were appropriate, but the possibility that the adjustment could involve more wrenching changes could not be ruled out. In any case, a movement toward balance in the trade and current accounts would likely have effects that differ appreciably across sectors of the U.S. economy. Members of the Committee noted that monetary policy was not well equipped to promote the adjustment of external imbalances but could best contribute by maintaining an environment of price stability that would foster maximum sustainable economic growth. Fiscal policy had a potentially larger role to play by promoting an increase in national saving, but the adjustment would involve shifts in demand and output both domestically and abroad, and changes to U.S. fiscal policy alone probably would not be sufficient to foster the adjustment.”