US current account deficit / debts

[Perrington]

Ive read about 50 articles in recent days, attempting to clarify what exactly is negative in the long-term with regards to the USA's current account deficit. I have a couple of questions that I would like answered regarding this subject as there are so many conflicting viewpoints in other articles that I could be forgiven for thinking this issue is open to personal interpretation. However I dont believe this is so, and feel there is a definitive answer....

If the US economy is importing more than they are exporting then they have a current account deficit and a capital account surplus, why is this bad in the long-term ?

Firstly, why are foreign nations so concerned about this deficit if the US themselves are not concerned, (with the exception of Greenspan's occasional reference to the issue whenever it suits him) if the US are concerned, then why do they pursue such reckless policies ? (see conspiracy section below). Also, I dont understand why foreign nations are so concerned about the US defecit as its their own corps that are profiting from exporting goods to the USA, albeit in return for a dollar that has lesser value, then the logical step is to raise the price of the exporting goods to compensate or take a cut in profits, which aint so bad aslong as your making a profit.

To help me understand, I assume that the bulk of the orders from foreign nations are purchased in dollars at the coroprate level, is this correct ? if it is, then why is the deficit considered debt ? Do the US corps not pay for the foreign exporter's / suppliers upon receipt of the goods and services out of profits they have historically accumulated ?

Or

Are the foreign corps extending "credit" on a corporate level, through borrowing from there own banks in order to access the lucrative global market, expecting a dollar repayment at some time in the future, from whichever US corp ordered the goods ? My interpretation with regards to the forex market, is that foreign corps are paid in US dollars for goods, and these dollars are held in "reserve", traded on the forex market or used to buy up assets within the states where the dollars can actually be spent.

Or

If the foreign corps are not extending credit, then the deficit must be funded internally within the USA as US corps borrow from the US banks to pay for these foreign goods? Is this correct ?
If this scenario is the "correct" one, can someone briefly explain the mechanisms needed to manage the debt internally, and explain why the foreigner's to the US are progessively becoming more jittery about this. Briefly is ok

Bush Jnr recently said the USA intended to maintain a strong dollar policy. I can understand how this protects the foreign investor's interests who are exporting goods, buying up assets and securites etc. However what does a strong dollar policy do to "solve" the deficit ? If the Fed raises the interest rate, then the dollar rises, and then exports are less competetive on the global level, so therefore imports increase and the defecit gets bigger.... do I understand this process correctly here ? How does the US keep everyone happy ? Higher interest = better return's for the foreign corp's, lower interest means a weaker dollar, less return's for the foreign corp's, lower value in assets and a reduction in the current account deficit due to an expanding US exporting economy..... At what level are foreigner's so keen to see this deficit reduced ?

And now onto the conspiracy section, I dont like to talk about conspiracies regarding subjects that I dont fully understand at the fundamental level, but here it go's anyway. I read an article suggesting the US are deliberately creating the defecit to force China into discarding the Yuan peg. My assesment based on how I think the Neo-cons are thinking is that if China wont play ball, then we wont pay you for your goods.... but this is where I also get lost off in terms of where the debt's origionate from, because what is there to pay back ? if the goods are paid for in dollars borrowed by US corps from US banks then any debt is owed internally... Also most of the corporation owner's are in the bilderberg group who in bed with the banker's.....

Apparently the dollar / yuan peg must be lifted by 2008, so there is no logic in creating a defecit to hurt China, as it only serve's to hurt the US themselves more in term's of "debt repayments".(ofcourse the neo-cons may have a long-term war agenda for China, however I would like to remain within economic boundarie's so lets assume they dont have a long-term war agenda for China).

So.... who is the debt actually owed to and at what level ? please someone who knows the score here respond and put me out of my misery

 

[LION63]

The US Government and Congress are very deeply concerned about the twin deficits (government and current account/trade) as they have the potential to push world financial markets over the brink. There are a number of ways to combat the problem but none of them are palatable and as such, it will probably be a combination that will work in the end - higher interest rates; subsidies; tariffs; higher taxes; reduction in government spending and a devaluation of the Dollar. For political reasons and to avoid panic, they will not be announcing any of these measures and some are already in place.Note that the Dollar has fallen by 48% against the Euro and has declined against all major currencies.

Imported goods and services are paid for in Dollars and therin lies the problem for exporters to the US, as the Dollar falls, margins are squeezed and trades become less profitable; a trade done at $1.25 is 4% less profitable at $1.30. In most cases, the US companies will pay for such goods/services with funds borrowed in the US from domestic banks in US Dollars. This is not a problem for the company in fact, they now make 4% more or pass this on to their customers in the form of lower prices. However, the US banks borrow these funds in the debt markets which unfortunately rely a lot on foreigners who nurse big losses every time the Dollar falls. Assuming you run a Japanese pension fund that bought US bonds at 120 Yen per Dollar and you see the Dollar shed 15 Yen, you are nursing a 12.5% loss and are in big trouble (assuming the bond price remained the same).

A knock on effect is that the falling Dollar makes imports more expensive in relation to domestic products which leads to fewer sales. Inflation will rise as a direct result which in turn will lead to higher interest rates that fail to sustain the value of the currency because it is viewed as high risk. This then causes contraction in the domestic economy leading to higher rates of unemployment; lower tax revenues; reduced government spending; lower bond prices etc.

The best way to view the situation is like this -

Mr X earns £1,000, receives a bonus of £500 and also earns £200 for overtime, giving him a total of £1,700. He spends £2,000 and makes up the balance by borrowing £300 from the bank. The following month he spends £2,200 leaving a deficit of £500, which he also borrows from the bank; remember he pays interest on the borrowings. He eventually ends up owing £5,100 which is 3 times his income (US position) just as interest rates are rising and his bonus and overtime are being slashed. What do you think will happen to him and his bankers? Big trouble and sleepless nights; he may well survive and they may get their money back after a lot of restructuring and pain.

The US creditors are mostly throwing good money after bad and most are just plain stupid as they are not able/willing to cut their losses. They cannot foresee the US defaulting on the masses of debts or the Dollar falling another 20% plus. Commodities have risen mainly due to the falling Dollar yet these lumps fail to accept that they have got it wrong, they are hoping for a miracle to bail them out.

The Chinese cannot afford a free floating Reminbi as it would wipe out their trade advantage and put them in a crises of their own, but they cannot buck the markets, it is a case of when and not if. Conspiracy theories can be discarded for harsh economic reality, when a few creditors say enough is enough, the debt bubble will burst and the folly of the World's bankers will be there for all to see.

The UK are facing similar problems and whilst there is no reason to panic, the alarm bells are starting to ring.

The debts are owed to all and sundry - Japan, China, S. Korea, India, Germany, France, Switzerland, Saudi Arabia etc. It is in the form of treasuries, bonds and corporate paper etc. and the foreign creditors have also picked up huge chunks of American real estate and US shares. What a silly bunch.

 

[JumpOff]

The concern has to do with sustainability. I believe The U.S. has carried nearly this amount of debt as percentage of GDP before (but I think that was just after WWII). At that time much of the european and asian manufacturing infrastructure and banking systems were on their knees, so the US was perfectly poised to grow and pay it down.

Nations often feel the same way that people do - they are willing to carry debt if it is backed by assets - currencies backed by precious metals, infrastructure improvements, trained and healthy citizens who can outperform other workers, etc... and if they feel their income prospects are good and they will have no trouble making the payments.

But the US population is aging (living on reduced income and needing assistance from the state), our monetary system is completely divorced from reality, and some economists are starting to realize that "more productivity" (this means the work is done by machines or cheap foreign labor) eventually means a loss of aggregate demand in the younger work force. (Someone has to have a well paying job in order to buy things and pay taxes)

Historically, nations that debase their currencies in the way the US has done go through very painful transitions. If you are really concerned, you can take steps now to increase your own flexibilitiy - should such a transition occur.

I find it is all "too big" for me to worry about. If I am piloting a tiny sailboat, I need to pay attention to what I *can* do by my own actions, and not spend too much of my energy on trying to analyze changes the gulf stream current. I have to keep an eye on things like weather, and know what the currents are doing - but I must know what is within my sphere of influence and what is not.

JO

 

[peterpr]

Perplexing isn't it?

1. Current account - US government expenditure (armed forces + public sector) running at around 5% more than is raised in taxes (Euroland rules allow 3% max - with a bit of rule-bending leeway for a while) - balance financed by borrowing (Bond market)

2. US Balance of payments - deficit currently running at @ 4% of GDP.

Together they amount to circa $1 trillion per annum


Foreign countries' dollar receipts for their exports are higher than their dollar payments for imports. Bulk of the surplus is invested in US government bonds which is largely what finances the current account deficit. They pay their workforce in local currency - hence their need to peg to the dollar to remain competitive and keep supplying the US consumer with all these indespensible consumer goods. Just how long they will deem it prudent/necessary to contine in this vein is anybody's guess.

80% of US government debt is in the hands of non-US nationals, many of them - esp China - not well disposed towards the US with their own agenda's which we should NOT assume coincide with those of the West. This makes the US the biggest debtor nation in history by several orders of magnitude.

Lots of aggravating and sustaining factors (ie Japanese 'carry-trade' where near-zero yielding Yen deposits are exchanged for dollars on margin and invested in long-dated US bonds and the yield difference pocketed - nice little earner for Jap Central Bankers but ..... ?

The question is just how long can all this continue on its current trajectory before the whole thing just collapses under its internal contradictions? Maybe beyond the timeframe I'm inclined to care about, who knows. But forecast it accurately and you'll clean up whilst the US and most of the rest of the world is paupered.

In the meantime I suggest that the average trader is better off just ignoring it (after all there's sod all he can do about it) and just watch the price action.

 

[culion]

The concern has to do with sustainability. I believe The U.S. has carried nearly this amount of debt as percentage of GDP before (but I think that was just after WWII). At that time much of the european and asian manufacturing infrastructure and banking systems were on their knees, so the US was perfectly poised to grow and pay it down.

Nations often feel the same way that people do - they are willing to carry debt if it is backed by assets - currencies backed by precious metals, infrastructure improvements, trained and healthy citizens who can outperform other workers, etc... and if they feel their income prospects are good and they will have no trouble making the payments.

But the US population is aging (living on reduced income and needing assistance from the state), our monetary system is completely divorced from reality, and some economists are starting to realize that "more productivity" (this means the work is done by machines or cheap foreign labor) eventually means a loss of aggregate demand in the younger work force. (Someone has to have a well paying job in order to buy things and pay taxes)

Historically, nations that debase their currencies in the way the US has done go through very painful transitions. If you are really concerned, you can take steps now to increase your own flexibilitiy - should such a transition occur.

I find it is all "too big" for me to worry about. If I am piloting a tiny sailboat, I need to pay attention to what I *can* do by my own actions, and not spend too much of my energy on trying to analyze changes the gulf stream current. I have to keep an eye on things like weather, and know what the currents are doing - but I must know what is within my sphere of influence and what is not.

JO

With respect to deficit as a percentage of GDP, the present percentage was exceeded 6 times in the past 25 years, reaching a maximum of 6% in 1983. How does this compare with other countries? As for what all of this means, a recent article in Foreign Affairs notes:

"Summary: The United States' current account deficit and foreign debt are not dire threats to its global position, as would-be Cassandras warn. U.S. power is firmly grounded on economic superiority and financial stability that will not end soon. (http://www.foreignaffairs.org/20050...evey-stuart-s-brown/the-overstretch-myth.html)."

So at least one reputable think tank does not believe that the end of the world is around the corner.

 

[peterpr]

With respect to deficit as a percentage of GDP, the present percentage was exceeded 6 times in the past 25 years, reaching a maximum of 6% in 1983.

There are three big difference between other deficit periods and now:

1. Today it is not just a historically high current account deficit OR trade deficit. Its both at the same time.

2. Hitherto there has never been a period in US history when the percentage of outstanding US government debt held by foreigners has exceeded about 50%. IT NOW STANDS AT 80%

3. During previous deficit periods the US were net savers. Today, they are net borrowers by a wide margin with a high proportion of their debt secured on an unprecedented bubble in asset values - most notably domestic property.

Sure there are sincere comentators who believe there's a non-painful way out of this mess. But there is an increasing air of 'whistling in the wind' about them. As for Wall St and the political establishment - well there's neither money to be made, nor votes to be had in pointing out things that people just do not want to hear.

My own view ? A pretty ugly few years ahead - but not before a bit more of Big Al's 'irrational exuberance' inflates the bubbles even further at the behest of the 'let the good-times roll' cheerleaders.

PS - I forgot a fourth item viz : Astronomical unfunded public sector pensions and Medicair liabilities. The numbers involved here are so large as to be incomprehensible (ie how does $44 Trillion sound?). These are largely on account of the post war baby boomers - beginning to fall due progressively from about now through the next 5 years. How to reduce an already large current account deficit with that lot hanging over it?

 

[ducati998]

Australia is also running a CAD,

The CAD of $55 to $60 billion p.a. has been financed by a combination of an increase in foreign debt and sale of assets to foreigners (eg OPTUS sold to Singapore telco; power plants sold to American interests, MIM sold to Xstrata, new apartments sold to foreigners. etc).

If Xstrata buys WMR eventually, the billions that Xstrata will pay to the shareholders will flow into the local economy (excluding the percentage of shareholders who are foreigners who might move their money to another country or repatriate funds). This will reduce the need to borrow a higher level of foreign debt going forward, other things being equal.

If Costello vetoed the sale, global financial markets might question the future funding of the CAD (which is a monthly proposition), because FIRB approval is somewhat arbitrary.

Some might say, so what? Well, if global financial markets decide to raise the risk premium of lending to Australia; interest rates will go up, irregardless of RBA action. Why? The bulk of the foreign debt is owed by the banks. When rollover dates arrive for maturing I.O.U.'s; foreign lenders can dictate a higher risk premium through an increase in basis points. They do not need the permission of RBA or anyone else.

A fortnight ago, a Federal Court judge handed down a ruling in the Media World court case that has led to some US investors in Australian corporate bonds considering whether to stop investing in Australian debt securities or to demand a greater risk premium. Pls see The Age 12/2/05 Business section page 1.

I did read Ross Gittin's article when it was published in The Age and I did not agree with him. A huge chunk of the foreign debt has been used by the household sector debt of $750 billion. A portion of the expenditure has been non income generating. It is one thing to borrow $10,000 and invest to try to make $12,000 p.a. and repay that $10,000. It is quite another to borrow $10,000 and spend it on a holiday in Paris (nothing wrong with Paris, mind you, except for the price of a cup of coffee perhaps) and not know when you are going to repay that $10,000 or even worse, delay it to the never never.

If the foreign lenders demand repayment when the loans mature, we have a major problem because the banks have lent long term (up to 30 years) to most households. The Australian banking industry has the highest proportion of foreign borrowings as a percentage of total assets in the whole world.

In The Age today, in the Money caption, on page 3, Access Economics is concerned that financial markets have not been paying enough attention to the CAD. "Markets, like people, tend to focus on one factor and ignore any signs that conflict with the prevailing view.....a year ago, the markets were concentrating on interest rates.....more recently, the focus has been on rising commodity prices, their positive impact on corporate profits.....I think the next trend will be to look at the CAD which is headed for 7% of GDP, larger than any OECD nation, including the US at 5.7%.........Soon people will realise the CAD is shocking and not likely to get better."

Time will tell whether the CAD and foreign debt are problems, or not.

If foreign lenders demand repayment of $420 billion (this is principal sum and excludes compounding interest) which represents around 50% of GDP; I do wonder how Australia is going to pay this. For a start, the CAD of $55 to $60 billion would have to be funded entirely through asset sales if foreign lenders lend no more. Any answers - anyone ???

Get the picture? We are now economically reliant on the willingness of foreign lenders to continue to lend us money. Even if they continue to lend us money, what happens if they demand 10% p.a; or even worse 15% p.a.?


In page 109 from the book "Warren Buffett Speaks", it is stated that Buffett says the US trade deficit is a dangerously accruing debt that is secured by US assets: "Our riches are our curse in our attempts to attain a trade balance. If we were less well-off, commercial realities would constrain our trade deficit. Because we are rich, however, we can continue to trade earning properties for consumable trinkets. We are much like a wealthy farm family that annually sells acreage so that it can sustain a lifestyle unwarranted by its current output. Until the plantation is gone, it's all pleasure and no pain. In the end, however, the family will have traded the life of an owner for the life of a tenant farmer."

Legend has it that Albert Einstein was asked what is the most powerful force on Earth?

His answer: Compound interest.

Australia has compound interest working against the country because of the size of the foreign debt. Even if we can get our trade balance to equalise (i.e. exports equal imports), we still have a CAD because of compounding interest on the debt and dividend payments to the foreign shareholders.

This problem is real and will not go away just by ignoring it or saying it is not a problem. If we continue on the existing trend, we will eventually reach a stage when foreign lenders say "No More debt - Pay up". In that scenario, we learn immediately just how big a problem it is.

 

[JumpOff]

This problem is real and will not go away just by ignoring it or saying it is not a problem.

The situation is real. Is it a problem? Depends. I had a very cagy old neighbor that was debt free young man with a little money in the bank during the great depression here in the states. He had arranged his life to live very simply and not be reliant on a big income. By the time I knew him, he owned much of the property in my county. He had bought it for 10 cents on the dollar, because that was the fair price at the time, and he was able to pay.

Someone is going to get some bargains in the coming years....
JO

 

[pony_x]

just buy gold. period