This article is from the Australian Property Journal archive
The US current account deficit has for years been inspiring predictions of imminent doom for America, the global economy and investment markets from long-term bears and causing worry for mainstream global institutions such as the OECD and IMF. But despite all the hand wringing, disaster has failed to materialise.
There are many reasons for this, but perhaps the most significant is that the US current account deficit (along with deficits in countries like Australia) is the flipside of current account surpluses in many other parts of the world, including Asia, which represent savings seeking to find a home. These excess savings have played a big role in driving investment markets until recently. The focus over the last year or so has been on inflation worries and rising interest rates with excess global savings taking a bit of a back seat. But the issue of excess global savings has never really gone away and in fact could be about to make a comeback as a major theme for investors.
The US current account and the doomsters
Global imbalances remain a big worry for many “perma bears” with the US current account deficit being at the centre of these worries. A current account deficit [1] means a country is spending more than it earns and must rely on capital inflows (ie, foreign savings) to finance it. If foreigners are unwilling to provide their capital, then the risk of an exchange rate collapse rises. As such, the bigger the current account deficit the greater the risk. With the US current account deficit having risen to ever-higher levels of GDP – now over 6% – there have been numerous prophecies of doom.
Source: Global Financial Data, AMP Capital Investors
The basic fear is that the rest of the world will soon tire of having to buy US assets (bonds, property, equities and companies) to fund the US current account deficit and that when they do the $US will collapse threatening higher US inflation (via higher import prices) and pushing up US interest rates causing global financial and economic chaos.
It’s not as MAD as it looks
But these worries are nothing new. In fact, concerns about US budget and trade deficits have been around since President Reagan’s time. It used to be thought that once a current account deficit rises to around 3% of GDP it will start to cause trouble. But the US current account deficit is well above that. While the risk of something going wrong is certainly worth keeping an eye on and the combined budget and trade deficits are good reason to be cautious about US assets on a long-term basis, the likelihood of an imminent crisis is low.[2] The doomsters miss several points:
· Firstly, US imports are small relative to the huge US economy. As such, a fall in the $US is rarely seen as much of a threat to US inflation. American authorities rarely get too concerned about a falling $US.
· Secondly, the fact that the US dollar is the world’s major reserve currency and most US borrowings are in US dollars gives America more flexibility compared to other countries with current account deficits. This helps ensure that there will always be significant demand for US dollar denominated assets. A shift to other reserve currencies (eg, the euro) is likely to be very gradual.
· Thirdly, the current situation is bit like the Cold War nuclear stand-off between Russia and the US. Yes, there are tremendous risks if something goes wrong but neither side wants to upset the apple cart because it will result in Mutually Assured Destruction (MAD). In the current situation the trade surplus countries – in particular Asia – are quite happy to provide capital to the US to finance its current account deficit because they can sell their goods to America in return. On the other hand, the US is happy to run a trade deficit because it maintains US living standards. Neither side has an interest in upsetting the status quo, so it is allowed to persist. Just like the Cold War, it need not end in catastrophe
· Finally, and most importantly, there is a “chicken and the egg” situation here. While the doomsters have focused on the US trade imbalance, it is reasonable to argue that the key driver has been excess saving in many other parts of the world. This includes high savings rates across Asia, many other emerging markets and the Middle East oil producers that show up as big current account surpluses. This excess saving has been looking for a home and the US economy has been the only country able to absorb the bulk of it. Focusing only on the US and its deficit is to focus on just one half of the equation.[3]
None of this is to say the US current account deficit is sustainable indefinitely. But it does indicate that the situation is far less risky than the doomsters would have us believe. The global economy would have been far worse off if the US had run more restrictive economic policies and not led the way out of the tech wreck a few years ago when Japan and Europe were stagnating. Just like the Cold War, the problem with global imbalances need not end in catastrophe. But it is likely to be corrected over time thanks to a combination of slower US economic growth relative to Europe and Asia and a somewhat lower dollar. (Note that the $US has already fallen 17% from its 2002 high on a trade weighted basis.)
Excess global saving has not gone away
Until about a year ago there was much talk of excess global savings coming from the current account surplus countries. This was a major factor in pushing global bond yields lower and pushing the gap between government bond yields and the yields on more risky assets (ie, risk premiums) ever lower as the excess savings sought a home. Some described this as the “carry trade” where money was borrowed at low interest rates and reinvested into higher yielding assets. Over the last year though talk of excess savings has disappeared as stronger global growth and raw material prices pushed up headline inflation rates, interest rates and bond yields. However, the excess savings issue never really went away. If anything it might be about to make a comeback over the next year:
· Asian savings are continuing to pile up, led by the ballooning Chinese trade surplus. This may get even bigger as Chinese producers seek to use their expanding capacity to export more, particularly as growth in China moderates. In turn, this will also help to bring inflation back under control;
· Excess savings are continuing to surge in oil producing regions such as the Middle East and Russia (which have current account surpluses equal to 20% and 12% of GDP respectively);
Source: IMF, AMP Capital Investors
· Corporate demand for funds is low, reflecting strong profits and evident in share buybacks; and
· US savings are set to rise as a slower housing sector leads to a slowdown in consumer spending (weaker house prices will lead to less borrowing against the family home to finance consumption).
As a result, the theme over the last year of rising interest rates could be replaced by a renewed global theme of excess saving over the next year. This will be given a push along if as we expect global growth moderates, inflationary pressures abate (which looks like getting some help from lower oil prices) and US interest rates start to fall next year.
Investment implications
The return of the excess global saving theme is likely to have a number of investment implications including downwards pressure on bond yields, a return of strong investor demand for high yielding assets (eg, for global non-residential property assets and infrastructure) and continued strong inflows into private equity funds. In the short term the ride is likely to remain rough for share markets as investors fret about slowing global growth, which is also giving rise to a cyclical correction in commodity prices. However, the global savings glut should be positive for shares on a six to 12 month view.
By Dr Shane Oliver, head of investment strategy and chief economist, AMP Capital Investors.*
[1] A current deficit arises when a country’s export income and investment earnings from overseas assets is less than what it pays for its imports and the earnings foreigners receive from investing in the country.
[2] The Australian current account deficit has regularly been above the 3% level in recent times without causing a major calamity. A difference between the Australian and US trade deficits though is that Australia’s savings shortfall reflects low private saving – the public sector is actually in surplus in contrast to the US which has big budget deficits. Furthermore, Australia’s call on global capital markets is a fraction of that of the US.
[3] Various other theories have been put forward regarding the US trade imbalance, eg, some saying it only exists because of measurement problems or that it is just accounting transactions between US companies. While there is some merit in these claims the evidence would suggest that the US trade imbalance can’t be dismissed quite so easily.
