In 2004, everyone started talking about global imbalances. With its current account deficit at an alarming 5.3 per cent of GDP, it was feared the US net foreign-debt-to-GDP ratio would climb to the point that foreign investors would demand a higher risk premium on US dollar-denominated assets. The spectre of a “sudden stop”, a dollar crash and an international payment crisis seemed to be stalking the global economy.
None of this has happened. Instead, the US current account deficit shrank, averaging 2.7 per cent from 2009 to 2021. More impressive, its investment income remained positive despite its massive net debt, meaning that debt servicing was never a problem for the US government.
Yet, the United States’ external sustainability is hardly a foregone conclusion. Its current account deficit has grown since 2020, reaching 3.6 per cent of GDP last year – its highest level since 2008. At the same time, its net foreign debt reached US$18 trillion, or 78 per cent of GDP.
Fast-rising inflation has prompted the US Federal Reserve to begin raising interest rates and reducing its holdings of Treasury securities – moves that are likely to impede growth and increase the government’s borrowing costs.
If the US net foreign-debt burden grows too large, rolling over its liabilities will be increasingly difficult. Foreign investors could become suspicious that the US will choose to inflate away its debts and start demanding a higher interest rate on US dollar-denominated financial assets, or even stop buying them altogether.
In other words, if the US fails to stabilise its foreign-debt position at a reasonable level, the external sustainability question will return.
How much danger are the US and the global economy facing? To answer that question, we must consider the four variables on which external sustainability depends: the gap between private saving and private investment; the size of the budget deficit; investment-income levels; and, the rate of GDP growth.
Beginning in the 1950s, private saving and investment were relatively balanced in the US. That changed after the 2008 subprime mortgage crisis, with private actors saving more than they invested – an average difference of around US$1 trillion per year – from 2009 until 2020.
This “ savings glut” is largely a result of fast-growing income and wealth inequality. When the Fed’s massive post-crisis quantitative easing programme drove up asset prices, the wealthy – people who own shares and properties – reaped the rewards. This group has a much higher propensity to save than lower-income households.
The savings glut might be set to decline. In the first quarter of 2022, US gross private saving and gross private domestic investment were up by 7.2 percentage points and 25 percentage points respectively, compared with the same quarter in 2020, meaning the gap between saving and investment has narrowed. In the relatively near term, savings might continue to decline, to the point where they exceed investment by less than 2 per cent of GDP.
The US budget deficit, by contrast, is set to keep growing. According to the Congressional Budget Office, the deficit-to-GDP ratio averaged 3.5 per cent annually during the past 50 years but 5.7 per cent from 2009 to 2019. While it should stand at 3.9 per cent this year, according to the CBO, it is on track to reach 6.1 per cent in 2032. It is thus safe to assume the US budget deficit will average 5 per cent of GDP annually in the next decade.
When it comes to investment income, too, the US might be on a less-favourable path. So far, investment income has always been positive, despite the US being the world’s largest debtor country. This reflects several factors, especially the high returns reaped on outward foreign direct investment on the asset side of the international investment position and large amounts of low-cost foreign investment in US Treasuries and bonds on the liability side.
Based on its past record, one can assume that US investment income accounts for about 1 per cent of GDP. But, in recent months, the US has damaged its own financial credibility. This could contribute to a decline in America’s investment income.
Finally, there is economic growth – yet another area where the US might struggle in the near future. It can be assumed that annual US growth will average about 2 per cent in the next decade. Together with the other assumptions listed above, that would mean the US foreign debt burden could reach 100 per cent of GDP in the coming years.
Geopolitics might compound the challenges ahead. The US has avoided a balance-of-payments and currency crisis in the past largely because Asian central banks and oil-exporting countries have tirelessly purchased US government bonds and Treasury bills. But, amid rising geopolitical tensions, these buyers might decide to rethink their purchases.
It is against this backdrop that the Fed is pursuing interest rate increases and quantitative tightening. But increased demand for foreign capital to finance the trade deficit, together with greater reluctance by foreign investors to purchase US government bonds and Treasuries, might put the US in a quandary. It can either contain inflation or maintain external sustainability but not both. That is unless, perhaps, US GDP growth slows significantly.
Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright:Project Syndicate