Forgive us if we’re mistaken, but weren’t large current account deficits supposed to be totally manageable for sizable industrious nations like the United States and the United Kingdom? No problemo. All fine and dandy. More debt? Yes, please ma’am. Et cetera, et cetera, et cetera.
That at least, as far as we can remember, is what official political and economic rhetoric has always maintained. So what an interesting turn of events has transpired in about the space of a week. June might as well become known as ‘the month the world discovered the deficit problem’.
Of course, we’re not saying there haven’t been those foretelling impending deficit-related doom all along — the likes of Jim Rogers, Peter Schiff and even Dr Doom himself, Nouriel Roubini, instantly come to mind for example. But this week, the deficit issue really seems to have gone mainstream.
To emphasise our point, here’s an extract of a Foreign Affairs article penned by Nouriel Roubini and Brad Setser back in 2005 entitled How scary is the deficit? in which they write:
The U.S. current account deficit — the gap between what the United States earns abroad and what it spends abroad in a year — is on track to reach seven percent of GDP in 2005. That figure is unprecedented for a major economy. Yet modern-day Panglosses tell us not to worry: the world’s greatest power, they say, can also be the world’s greatest debtor. According to David Levey and Stuart Brown (“The Overstretch Myth,” March/April 2005), “the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated.” Indeed, they write, “the world’s appetite for U.S. assets bolsters U.S. predominance rather than undermines it.”
But in fact, the economic and financial risks that arise from the U.S. current account deficit (and the resulting dependence on foreign financing) have not been exaggerated. If anything, they have received too little attention — and are set to grow in the coming years.
And now even his esteemed US Treasury owning higness Bill Gross appears to have cottoned on to the problem. From Bloomberg:
June 3 (Bloomberg) — Bill Gross, founder of Pacific Investment Management Co., advised holders of U.S. dollars to diversify before central banks and sovereign wealth funds ultimately do the same amid concern about surging deficits.
The U.S.’s “fortune-producing capabilities seem to be declining, which might suggest that its relative standard of living is doing so as well,” Gross wrote in his June investment outlook posted today on the Newport Beach, California-based firm’s Web site. “If so, the implications are serious.”
US Treasury Secretary Timothy Geithner, meanwhile, was also keen to emphasise his awareness of the problem while in China this week. As a note from BNY Mellon reminded this week he was quoted among other things as saying:
“I will, of course, make it clear that we are committed to a strong USD, that we are committed to bringing our fiscal deficits down over the medium term to a sustainable place, to a sustainable level.”
As well as:
En route to Beijing Secretary Geithner tells reporters: “No one is going to be more concerned about future deficits than we are.” He also notes that the Federal Reserve is “completely committed to keep inflation low and stable over time.” He says that the US “will do anything we need to do to make sure that we bring down our fiscal deficits and improve the strength of the US economic fundamentals.”
What’s even more fascinating, the issue appears to have finally hit the radar of the US Federal Reserve too –by that, of course, we mean in an official statement-making capacity (we’re pretty sure they were already aware of the problem before, or at least we hope they were).
Note the following comments from Ben Bernanke’s latest testimony to the House budget committee, as reported by Bloomberg:
“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” Bernanke said in testimony to lawmakers today. “Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.“
And then there’s this:
“In recent weeks, yields on longer-term Treasury securities and fixed-rate mortgages have risen,” Bernanke said. “These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows and technical factors related to the hedging of mortgage holdings.”
And it’s not just high-level officials. The volume of analysts banging on about this new clear and present danger has also reached fever pitch. Here’s a slither of comments just from our inbox this week:
From Barcap’s FX team on Wednesday:
The pervasive theme in currency markets of late has been that of USD weakness. The reasons are many: 1) Risk aversion and tail risk to the global economy has meant that investors are no longer looking to the USD as a safe haven; 2) the rebound in commodity prices as the global economy reflates has been a USD negative; 3) the market has become increasingly concerned about the size of the US fiscal deficit and sustainability of its debt position, especially whether it will continue to attract capital flows; 4) despite the USD sell-off, positioning still appears to be very long USD; and most recently, 5) concern from countries with large USD holdings about the stability of their investments.
From BNY Mellon on Monday:
Certainly, given the position both nations find themselves in, it seems reasonable to speculate that one of the outcomes of the meeting (albeit one not stated openly) could be an agreement by China to speed up the pace of currency reform (in order to reduce their need to buys USDs in the first place) in return for the US administration providing rather more robust verbal support for the greenback as well as promises that the fiscal deficit will be reigned in as quickly as possible .
From Marc Ostwald at Monument Securities on Wednesday:
Absorbing the end of the long and tortuous road to Chapter 11 for GM, attention can turn to Geithner’s China visit, which is likely to yield many a platitude from the U.S. on reining in its budget deficit, and from China that it will not dump the USD or US Treasuries (why would they want to cut their noses off to spite their faces?
From Dennis Gartman at the Gartman Letter on Wednesday:
Simply put, the US fiscal circumstance has become a laughingstock, and we do not say that lightly. It is, however, true.
You get the picture.
Although at least one investment house still appears to be shying away from the deficit problem. Here’s what Credit Suisse had to say on the matter on Wednesday:
We believe the Fed will stop bond yields rising much further.
Clearly with nearly US$2trn of US Treasury issuance and planned Fed purchases of just US$300bn (of which only 37% has been done), there are concerns over the funding of the debt.
However, we are not too alarmed by this as we believe that QE can be stepped up to cap the rise in bond yields and that the Fed would rather risk a dollar crisis than a US budget funding crisis. We believe the Fed can step up QE as: (i) US net foreign liabilities are just 18% of GDP. Historically a country only becomes at risk of default when net foreign liabilities rise beyond 60% of GDP (according to the Bank of England). Clearly the US is very far from this position. (ii) More importantly, nearly 90% of US foreign liabilities are dollar denominated. Therefore, a weaker dollar only has a very minimal impact on net foreign liabilities. (iii) Inflationary pressures look exaggerated. With an output gap of 8% and GDP growth of just 1 ½ –2% for 2010E, it seems that inflation is unlikely to be an issue until 2014.
Phew!
Related links:
China’s fake recovery redux, or who’s laughing now? - FT Alphaville
Quote du jour, Chinese snickers - FT Alphaville
China to US: We hate you – FT Alphaville