Untangling the US Deficit

Untangling the US Deficit

Evaluating Causes, Cures and Global Imbalances

Richard A. IIey and Mervyn K. Lewis

As the US current account deficit has expanded to a record level of $811 billion in 2006, debate about the deficit’s causes and consequences has also grown. Is the deficit a product of American profligacy or a ‘glut of savings’ in the rest of the world? Is it a serious problem or essentially benign? Untangling the US Deficit charts a course between the competing explanations in a systematic and rigorous approach, incorporating the latest academic research and market data. Particular attention is given to the China–United States trade imbalance and to the special role of the US dollar and US capital markets in global finance.

Chapter 6: The Sustainability of the Deficit

Richard A. IIey and Mervyn K. Lewis

Subjects: economics and finance, financial economics and regulation, money and banking

Extract

6. The sustainability of the deficit HOW MUCH OF A THREAT? In the previous chapter we said that the sustainability of a current account deficit for any country depends ultimately on what is done with the borrowings or realization of assets. No nation (or grouping of citizens) can borrow indefinitely or sell off assets without limit to consume more than it produces, although it can do so for some, perhaps considerable, time. In the words of Joan Robinson (1973): The deficit country is absorbing more, taking consumption and investment together, than its own production; in this sense, its economy is drawing on savings made for it abroad. In return, it has a permanent obligation to pay interest or profits to the lender. Whether this is a good bargain or not depends on the nature of the use to which the funds are put. If they merely permit an excess of consumption over production, the economy is on the road to ruin. The United States is not exempt from such admonitions, but the role of the US dollar as international money does mean that the constraints that it faces are very different from those of other countries. Nowhere is this more evident than in the investment income flows and the external balance sheet. Indeed, for all countries the major implication of growing financial integration and the international financial laissez-faire framework is that the examination of a current account deficit, and its ramifications and...

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