U.S. Finances as a Global House of Cards?

Why has the current U.S. account deficit not scared off international investors?

January 8, 2004

Why has the current U.S. account deficit not scared off international investors?

Analysts around the world are viewing the U.S. current account deficit as the country’s Achilles heel. They are certain it will take the United States down — but are not sure when exactly it will happen. In this Globalist Interview, David Folkerts-Landau — Head of Deutsche Bank’s Global Markets Research — presents a very different view of this key topic on the global economic agenda.

Will the United States be able to sustain its massive current account deficit?

“Yes, and perhaps for much longer than many of the current account deficit pessimists might suggest.”

How so?

“Simple. The United States is being underwritten by Asia for the foreseeable future.”

Why are Asian countries willing to do this?

“People are underestimating Asia’s desire and ability to amass significantly higher U.S. holdings. To them, it is an attractive alternative to letting their currencies appreciate significantly.

“If that happened, it would impair their ability to support domestic growth through continued exports to the United States.”

How long is this expected to last?

“In my view, the growth requirements of Asia can keep this system going for another 20 years.”

What might happen if European investors — nervous about the current account deficit — sell their U.S. holdings?

“The first thing that will happen is that the euro will appreciate against the U.S. dollar. This, in turn, would depress European growth, despite the lower European interest rate that would result from reduced capital outflows.

“And in all likelihood, Asia would step into the breach, happily increasing its exports to the United States in place of European exports — and amass even more U.S. holdings.”

How would this impact Europe’s market share in the United States?

“If European investors pull back from the United States, Asia can then drive European goods from U.S. markets. This also implies that worldwide recessionary forces would be refocused entirely onto Europe.”

So it is a Catch-22 for Europe?

“In a way, yes — and certainly as long as Asia remains willing to keep increasing its U.S. holdings. If anything, Europe might be in the greatest danger from an early unraveling of the current status quo — with a sharply rising euro focusing worldwide deflationary pressures on Europe.”

How would Asia react to all this?

“In Asia, the chance to capture the U.S. market will not likely be missed. At the same time, ever greater bilateral trade surpluses with the United States will require even greater financing through official accumulation of U.S. financial assets.

“Fortunately for the Asian region, though, this can be accomplished with little or no adjustment in real exchange rates — since they will merely be filling the vacuum created by Europe.”

Is there anything that might disrupt this global recycling system?

“As U.S. debts accumulate ever more, U.S. willingness to repay both Asia and Europe comes more naturally onto the radar screen of investors and analysts worldwide.”