America's burgeoning deficit in trade, investment income and other transactions poses an increasing threat to the nation's otherwise healthy economy, according to many economists and government policymakers.
In the second quarter of this year, this shortfall was $80.7 billion, which meant that to finance it, close to $1 billion a day of new foreign money had to flow into the United States to keep the country's international books balanced. For the full year, the deficit could easily reach the $320 billion to $340 billion range.
The risk is that the foreigners providing that money could decide they can get a better deal elsewhere and slow or reverse their investments in the United States.
If that were to happen, in all probability, the value of the U.S. dollar would fall, interest rates would rise, corporate profits and stock prices would decline and overall economic growth would slow.
The key unknown is whether this deficit in what is known as the nation's "current account" can be brought down gradually, so the long-running U.S. economic expansion can continue, albeit with growth and personal incomes rising at a slower pace. If the adjustment were abrupt, the impact on the economy might be hard enough to cause a recession, some analysts say.
The largest component of the current account deficit is U.S. trade in goods and services, which was $65 billion in the red in the second quarter. But foreigners also earned $4.4 billion more on their stocks, bonds and other investments, such as direct ownership of companies, than Americans earned on similar investments abroad. In addition, there was an $11.3 billion deficit in "unilateral" transfers, which include U.S. government grants and pension payments and private remittances, such as those sent by immigrants to family members in their home countries.
The total current account deficit has more than doubled over the past two years, to a level equal to 3.6 percent of the U.S. gross domestic product. Only in 1986 and 1987 has the current account deficit ever been in that range.
The rapid increase has raised "the potential consequences if the world suddenly decides it does not want to finance $1 billion per day worth of overspending by Yanks," said Carl B. Weinberg, chief economist at High Frequency Economics Ltd. in Valhalla, N.Y.
"If the dollar takes a hard turn south, it could spark a run of money out of U.S. stocks and bonds with spectacular consequences. Of course, the resulting recession would depress demand for imports and narrow the U.S. external deficit very quickly. We are sure no one wants to see the gap closed in such a disorderly fashion," Weinberg said.
The record $25.3 billion monthly trade deficit in July and the recent sharp drop in the value of the dollar against the Japanese yen have highlighted such concerns.
But while the current account deficit clearly poses a risk to the economy, it also provides major benefits.
For instance, in the second quarter, the United States had an $84.6 billion deficit in trade in goods, partially offset by a $19.6 billion surplus in trade in services. At a time when the U.S. unemployment rate is only 4.2 percent and many employers are coping with worker shortages, the U.S. economy alone would have a hard time producing enough goods to satisfy the nation's rising demand. The availability of imported goods allows households to consume and businesses to invest more than they could otherwise.
"In the current robust economic environment, it would be difficult for the U.S. economy to produce the additional goods and services without the risk of inflation and a monetary policy response that would slow the economy," said economist Catherine L. Mann of the Institute for International Economics in her new book, "Is the U.S. Trade Deficit Sustainable?"
Federal Reserve Chairman Alan Greenspan also has expressed concern about this growing imbalance in the nation's international transactions. In congressional testimony in July, he described a different way of looking at the problem:
Consumption has risen so strongly in recent years, Greenspan said, that there isn't enough private saving to finance the nation's investments in new plants, equipment and housing. Government budget surpluses cover part of this gap between saving and the cost of investments, but most of it has been filled by foreign money flowing into the United States.
This is the same money that is financing the current account deficit, and it has been attracted in recent years by a "marked increase in rates of return on U.S. investments." Moreover, until recently, rates of return in many other countries have declined because their economies were in recession, such as in many Asian nations, or suffering from sluggish growth.
"As U.S. international indebtedness mounts, however, and foreign economies revive, capital inflows from abroad that enable [U.S.] investment to exceed domestic saving may be difficult to sustain," Greenspan said. And he warned that any decline in the foreign appetite for U.S. investments "could well be associated with higher market interest rates."
Another immediate likely outcome would be a drop in the value of the dollar. When foreigners want to increase the amount of money they are investing in the United States, they must first swap their own currency for dollars, which boosts the dollar's value. That's one reason the dollar has been so strong in recent years.
Of course, the opposite is also true: When foreigners aren't as willing to put money into the United States, the value of the dollar usually falls. That in turn raises the cost of most imports while making U.S. exports less expensive for foreign buyers--with both those changes tending to cause the trade deficit to shrink. Unfortunately, higher prices for imports can also add to inflationary pressures in this country.
The dollar's recent decline against the yen may be an example of this process, as investors have bought Japanese stocks in response to signs of economic recovery there. However, the dollar has largely held its value against most other currencies and strengthened against the euro, the joint currency of 11 European countries.
While a cheaper dollar would eventually lead to smaller trade and current account deficits, it would do so only with a lag of several months or more. And in the short run, a lower dollar would make the deficits worse by increasing the cost of imports. Meanwhile, the current account deficit would still have to be financed and the need to attract the necessary foreign money would be one more force pushing U.S. interest rates higher.